Q2 2022 Ellington Financial Inc Earnings Call
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Ladies and gentlemen, thank you for standing by. Welcome to the Elington Financial Second Quarter 2022 earnings conference call. Today's call is being recorded at this time. All participants have been placed in unlisted only mode. The floor will be open for your questions following the presentation. If you would like to ask a question during that time, simply press star, then the number one on your telephone keypad. If at any time your question has been answered, you may remove yourself from the queue by pressing star two.
Lastly, if you should require operator assistance, please press star zero. It is now my pleasure to turn the call over to Jason Frank, Deputy General Counsel and Secretary Sir, you may begin.
Thank you. Before we start, I would like to remind everyone that certain statements made during this conference call may constitute forward-looking statements within the meaning of the safe harbor provisions of the Private Security's litigation Reform Act of 1995.
Forward-looking statements are not historical in nature. As described under item 1A of our annual report on Form 10-K , forward-looking statements are subject to a variety of risks and uncertainties that could cause the company's actual results to differ from its beliefs, expectations, estimates, and projections. Consequently, you should not rely on these forward-looking statements as predictions of future events. Statements made during this conference call are made as of the date of this call, and the company undertakes no obligation to update or revise any forward-looking statements.
whether it is a result of new information, future events, or otherwise. I am joined on the call today by Larry Penn, Chief Executive Officer of Ellington Financial, Mark Tukosky, Co-Chief Investment Officer of EFC, and J.R. Herlihy, Chief Financial Officer of EFC.
As described in our earnings press release, our second quarter earnings conference call presentation is available on our website, EllingtonFinancial.com. Management's prepared remarks will track the presentation. Please note that any references to figures in this presentation are qualified in their entirety by the endnotes at the back of the presentation. With that, I will now turn the call over to Larry.
Thanks Jay and good morning everyone. As always, thank you for your time and interest in Ellington Financial.
The challenges of the previous quarter intensified during the second quarter of 2022. The challenges of the previous quarter intensified during the second quarter of 2022. The challenges of the previous quarter of 2022. The challenges of the previous quarter of 2022.
The Federal Reserve sought to slow inflation by accelerating its interest rate hiking cycle and initiating the runoff of its balance sheet, while recessionary and geopolitical concerns also wait heavily on markets.
Interest rates continue to surge. And the interest rate volatility spiked to levels not seen since the COVID liquidity crisis in early 2020. And before that, not seen since the global financial crisis in 2009. The COVID-19 crisis in 2009. The COVID-19 crisis in 2009.
Prices fell and liquidity dried up in most markets, including the securitization markets.
Volatility really was the great equalizer across asset classes this past quarter, as most everything sold off in concert, even agency MBS and US Treasuries.
Ellington Financial had an economic loss of 6% for the quarter.
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 sustain significant market market losses on our investments in loan originators, where unrealized losses totaled $26.5 million or $44 per share during the quarter. $44 per share during the quarter.
Lenscher was again profitable in the second quarter, but it further revised downward its earnings projections for 2022, which led to a mark to mark a drop in the value of our equity stake in the company.
However, we believe that LendSure is well positioned to emerge from the current market volatility with increased market share and stronger earnings prospects.
The partnership between Ellington Financial and LenSure continues to be highly synergistic.
We believe that Lentcher's underwriting standards are absolutely top notch. As demonstrated by the stellar credit performance of the $3 plus billion of loans, we've bought over the years from them.
Meanwhile, EFC provides a reliable takeout for the non-2M loans that Lenscher originates. That's no small benefit for Lenscher and Rocky Markets. That's no small benefit for Lenscher and Rocky Markets.
And in return, EFC can buy at wholesale prices from Lenscher, not retail and have confidence in the underribe. You can buy at wholesale prices from Lenscher, not retail and have confidence in the underribe.
In the second quarter.
during our typical commitment and warehousing period while we were accumulating non-QM loans from Lensure and others.
The non-QM securitization market widened substantially.
In other words, our securitization takeout economics deteriorated between the time that EFC committed to by loans from Lenscher and the time that we actually completed the securitization of those loans.
So our timing was perhaps a bit unfortunate, but the good news is that the origination market has now fully reprised to the wider secularization market and then some.
As a result, we now find ourselves in a market where we're again seeing very healthy night interest margins on the non-quium loans we're currently buying, both during the warehouse period and projected post-securitization.
In the reverse mortgage market, we have seen hecum yield spreads growing wider throughout the year. And that has weighed heavily on profitability at Longbridge. Longbridge had a significant at loss for the second quarter, driven by a further reduction in the value of its MSR portfolio and losses on its pipeline committed loans. The
However, on the bright side, securitization spreads are showing signs of stabilizing, and long-range continues to add market share.
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 interest payments.
The challenging market conditions also adversely affected performance of some of our other loan originator affiliates, most notably an agency mortgage originator.
The Freddie Mac 30-year mortgage survey rate increased by more than 2.5 percentage points over the first half of the year, skyrocketing to its highest level since 2008.
As a result, most of the existing mortgage universe now has no refinancing incentive, and so we've seen prepayment rates plummet.
Furthermore, supply shortages have kept housing prices strong. So with mortgage rates much higher, housing affordability has been absolutely pummeled.
Home sale volumes have been dropping fast to levels not seen since the deaths of the COVID crisis.
Putting it all together, given the extreme weakness in both refinancing volume and home purchase volume, this environment is about as challenging as possible for conventional mortgage originators.
For Alanton Financial, however, only a tiny fraction of our originator investments relate to conventional mortgage or registered originators.
The vast majority of our original stakes are in more specialized sectors. Reverse mortgages, non-QM mortgages, specialty consumer finance, residential transition loans, commercial mortgage bridge loans.
In these particular markets, we project stronger growth and more durable profit margins over the long term.
Meanwhile, we continue to see strong performance in the second quarter from our short duration loan portfolios and our retained non-QM interest only securities.
And we also benefited from significant net gains on our interest rate hedges and credit hedges.
So while a overall decline for the quarter was certainly significant, our diversified portfolio and discipline hedging help prevent further losses.
The silver lining of the market selloff is that we...
and payoffs, particularly on our short duration loan portfolios.
Between our residential transition loan, commercial mortgage loan, and consumer loan portfolios, we received principal paydowns of $177 million during the second quarter, which represented nearly 15% of the combined fair value of those portfolios coming into the quarter.
During the second quarter, we deployed some of this dry powder.
Our loan origination businesses provided much of our asset acquisition volume during the quarter, but we also took advantage of the market sell-off through secondary market purchases of discounted non-QM loans and credit securities, most notably credit risk transfer bonds, or CRTs.
To illustrate just how much spreads have widened in CRTs since earlier this year.
Ellington Financial itself bought a piece of Stacker 2021-HQA1B2, a CRT bond, and under $0.78 on the dollar in May.
This bond had traded above 102 cents on the dollar in January . So that was a 350 base splints wideen since January .
So, while our net interest margin has recently compressed, our NIMS should continue to recharge as we continue to deploy our dry powder and our recyclable capital into the much higher yields that are available today.
At June 30th, our credit portfolio stood at $2.66 billion, which was an increase of 29% from year end 2021. But we still had significant available capital and borrowing capacity to expand our credit portfolio further.
As I mentioned earlier, the non-QM securitization market has not been immune from all of the credit spread widening we've seen.
On the non-cument securitization that we completed last week, our execution on the triple-atrosh was about 150 base points and wider as compared to our first deal of the year back in January .
Nevertheless, I was still pleased to get last week's securitization priced and closed. As it moved those non-QM loans off repo, it turned out their liabilities and it freed up incremental capital to invest in a market environment that's presenting great opportunities.
Not every securitization will be a home run, but they represent a stable source of financing that enhances our balance sheet, cushions us against the potential impact of market shocks and puts us in a position to react quickly to market opportunities.
As such, securitizations continue to be an important component of a risk and liquidity management.
I'll move next to adjusted distributable earnings or ADE for short.
We previously referred to this non-gab metric as core earnings.
We're reporting 41 cents per share of ADE for the quarter, which is up a penny from the previous quarter.
Well, there are a few reasons why it's not yet covering our dividend, which JR will get into. We do project that ADE will cover the dividend as we get fully invested and turn over the portfolio at today's hiring investment yields, but there will be a lack.
In any event, ADE, which is a backward-looking measure, has its limitations as a measure of the full earnings power of our portfolio, especially in a market with large swings in interest rates and spreads like we're seeing today, and where liabilities are re-pricing faster than assets, like they did this past quarter.
But this is where the relatively short duration of so much of our credit portfolio comes into play in a big way.
Also, keep in mind that there's a portion of our portfolio that by design doesn't generate much ADE. This includes our short-term trading portfolio, including TBAs, and our equity stakes and loan originators.
ADE is an important metric for us, but over the long term, our gap earnings per share and total economic return per share are probably the best measures of our success.
One final note, the market volatility has also enabled us to be opportunistic with our capital management strategy so far this year.
Earlier this year, we issued shares out of our ATM, mostly in March, at an average price of $17.66 per share, which is right around book value at the time.
In late March, we took advantage of a narrow window that had opened in the credit markets by launching a $210 million, 5-7-8 coupon, 5-year unsecured debt deal.
And finally, during all the second quarter turmoil, we took advantage of the market selloff by repurchasing shares at an average price of $13.20 per share, which was about 78% of the prior month's book value per share.
I'll now pass it over to JR to discuss our second quarter financial results in more detail.
Thanks, Larry, and good morning, everyone.
I will start on slide 3 of the presentation.
For the quarter ended June 30th, Ellington Financial reported a net loss of $1.08 per share on a fully market-to-market basis and adjusted distributable earnings of $0.41 per share.
These results compared to a net loss of 17 cents per share and ADE of 40 cents per share for the prior quarter.
Beginning this quarter, you'll notice that we renamed core earnings as adjusted distributable earnings consistent with evolving industry practice.
Please note that if the name change only and the calculation itself is not changed, so it's valid to compare a current period of ADE to prior periods' core earnings.
There are a few reasons why adjusted distributable earnings did not increase proportionately with the growth of the portfolio in the second quarter and did not cover our dividends. First, undeployed capital. We now have interest expense on the new $210 million of senior notes, which amounts to five cents per share per quarter. And with the ATM issuance in March and early April , our share count increased by 2.6 million shares.
Until all of that capital is deployed, it will be a drag on ADE per share.
Second, our cost of funds increased sharply this quarter, primarily due to higher rates.
And even though we have a lot of floating rate loans and other short duration assets in the credit portfolio, the asset yields on our invested assets lag the increase in financing costs this past quarter, especially for fixed rate RTL amount to M loans. And thus our name compressed.
Moving forward, however, I expect that asset yields will catch up with the higher financing costs as we continue to turn over the portfolio and that should expand our name again and be a tailwind for ADE.
Moving back to the deck, on slide four, you can see that we further increased our capital allocation to credit investments during the quarter.
with 87% of our capital allocated to credit as of June 30th, which is up from 82% in year-end. And it's about the highest split it's been for EFC historically.
I expect credit to continue growing relative to agency based on the continued growth of our loan and our origination businesses. I expect credit to continue growing relative to agency based on the continued growth of our loan and businesses. I expect credit to continue growing relative to agency based on the continued growth of our loan
Average market yields are up on both our credit and agency portfolio sequentially. Buy about 60 basis points for both categories.
And as I mentioned,
We expect our own portfolio to reflect these higher reinvestment yields as we continue to turn over the portfolio.
Moving to slide five, you can see the attribution of earnings between our credit and agency strategies.
During the second quarter, the credit strategy generated a gross loss of 80 cents per share while the agency strategy generated a gross loss of 20 cents per share.
These results compare to gross income of 28 cents per share in the credit strategy and a gross loss of 34 cents per share in the agency strategy in the prior quarter.
As Larry summarized,
The main drivers of these losses were unsecuritized non-QM loans.
Agent CRMBS and Originator 6.
A portion of these losses were offset by strong performance on our short-eration loan portfolios, specifically residential transition loans and small-balance commercial mortgage loans, driven by net interest income, as well as by net gains on our non-performing loan portfolios.
In addition, our portfolio of retained non-QM tranches appreciated during the quarter, driven by appreciation of our non-QM interest only securities.
as rising mortgage rates again led to lower actual and projected prepayment speeds.
We also had significant net gains on our interest rate hedges and credit hedges during the quarter.
Agency RMBS continued to face headwinds in the second quarter as duration extended in response to the higher interest rates and elevated volatility contributed to yield spread widening.
Net losses on our agency RMBs concentrated in lower coupons exceeded net interest income and net gains on our interest rate hedges, while we also incurred delta hedging costs stemming from the volatility.
As a result, we had a significant net loss for the corridor in our agency strategy.
Turning this slide six, during the second quarter, our total long credit portfolio grew by 16% sequentially to $2.66 billion at June 30.
The majority of the growth occurred in our non-QM, residential transition, and small-balance commercial mortgage loan strategies, where we continue to focus on multifamily.
On slide 7...
you can see that our long agency R&BS portfolio decreased by 11% to $1.3 billion due to net sales, paydowns, and net losses.
Please turn next to Slide 8 for a summary of our borrowings.
Our weighted average borrowing rate increased by 83 basis points sequentially to 2.61% at quarter ends driven by higher short term rates and a full quarter of interest expense on the 5 and 7 and 8 senior notes issued on the final day of the previous quarter.
In addition, we had disproportionately more borrowing secured by our loan portfolios, which carry higher borrowing rates than agency assets.
Financing has held up relatively well amid the market volatility, though recently we have seen haircuts increase or financing spreads widen on some of our loan facilities.
In conjunction with a larger portfolio, our recourse debt to equity ratio increased to 2.6 to 1 from 2.3 to 1 in the prior quarter.
During the second quarter, we marked down our 5 and 7 eighth senior notes by 2 points to $96.50. As a liability, this marked down generated positive income. However, we had a corresponding loss on the sofa swaps that we used to hedge that liability, which offset most of this income.
At June 30th, our combined cash and unencumbered assets totaled approximately $816 million, which was down from last quarter but was still well above pre-COVID averages.
Slide 10 details our proprietary stakes and loan origination businesses.
At June 30th, the combined value of our originator stakes was $112 million, or about 9% of our total equity.
By sector, that 112 million was distributed as follows.
53% and reverse mortgage loan origination, 30% and non-QM loan origination, 10% and consumer loan origination, 3% and residential transition loan origination, and 2% each and small bounce commercial and conventional mortgage loan origination. And conventional mortgage loan origination.
For the second quarter, total GNA expenses decreased sequentially by $3 per share to 14 cents, while other investment-related expenses decreased by $0.7 per share to $0.9, driven primarily by the costs associated with the senior node offering that we fully expense in the previous quarter. For the first time in the previous quarter. the previous quarter.
Also during the second quarter, we recorded an income tax benefit of $7.8 million due to a decrease in current and deferred tax liabilities related to quarterly losses at our domestic TRS, which related to our non-QM securitization activity, as well as our investment in Long Bridge.
As of June 30th, we had a net deferred tax asset of approximately $9.6 million against which we took a full allowance. As of June 30th, we had a net deferred tax asset of $9.6 million you
Our book value for Common Share was $16.22 at June 30th, down 8.6% from $17.74 per share at March 31st. The book value for Common Share was $17.74 per share at March 31st.
Including the 45 cents per share of common dividends that we declared during the quarter, our economic return for the second quarter was negative 6%.
Now over to Mark.
Thanks, JR.
The second quarter had an incredible volatility in every dimension. rates.
in credit emergency spreads and the expectations of Fed policy.
There was substantial widening in most sectors across fixed income and it was a very challenging environment.
Our economic return was negative six percent. Not a result you're used to seeing from us, not a result we want, but not a disaster either.
And a lot of it, I think we can earn back, because much of the loss was due to spread widening and non-crumb loans and ADNCMBS.
As is often the case after a quarter like that, the going forward opportunity set looks really good.
Today we see very wide spreads, very high yields.
and stable financing all with less competition for assets.
Credit performance is measured by the linkities, defaults, and credit losses.
continues to be very strong across our diversified portfolio.
But with a sharply increased risk of an economic slowdown, we have been very focused on tightening our underwriting guidelines with a particular focus on keeping LTVs low.
HPA has been strong, but there are clear signs of housing weakness. We have to be prepared for price declines in some regions of the country, given poor housing affordability.
During the second quarter, any sector with a lot of interest rate risk, a lot of volatility exposure, or where pricing is dependent on a securitization execution, got hurt.
Not surprisingly then, our non-chrome strategy is our biggest drag this past quarter. This is our biggest drag this past quarter.
To put the spread widening on non-QM this year in perspective, consider these two data points.
On January 14th, we priced the first non-QM deal over the year. The triple-A's priced at the spread of 97 to swaps. We added 2.2% fixed rate coupon and we're priced at par.
On July 22nd, we priced our most recent securitization. In that deal, the AAAs had a fixed coupon of 5% and they were priced below 99.
That's the spread of 250 detresories are more than 150 base points wider and spread than the triple A's compared to the January execution. The
Lower rated non-cure bands of white and even more.
when you consider that investment grade corporate bonds widened only about thirty five base points over the same period you can appreciate how significant the widening has been in non-QM
We've always been big believers in the benefits of securitization, but given how stable the repo financing market has become, repo is a viable alternative with non-trim securitization spreads currently so wide.
where those surprising things about this year has been the relative stability of repo spreads and repo availability in a market where everything else has been so unstable. Where everything else has been so unstable.
For that reason, we have continued to expand and deepen our repo lines.
I'm glad to report that we are currently close to adding yet another valuable loan financing facilities.
Meanwhile, Nankim spread the story to recover.
Another drag on Ellington Financial's performance in the second quarter was our investments in mortgage originators.
Everybody knows that mortgage origination businesses are cyclical. We know it. We've been through many disciples.
comparing the second half of last year on
Oh.
Sorry.
Yeah, comparing the second half of last year to the first half of this year, she was just how cyclical it can be. In the second half of 2021, you had record high loan prices. So big gain on sale margins and record high volumes for mortgage originators.
The product of those two things essentially tracks originator profits.
This year at the exact opposite.
Distressed loan prices and lower volumes have squeezed profitability and as a result we have marked down our originator investments.
All that said, I think it's noteworthy, but Lynch or was profitable this quarter. Lynch or was profitable this quarter.
A few things to consider on these investments for EFC.
Our originator stakes are only a small part of our capital base in large part because we know how cyclical those businesses are.
We only want these stakes to be a complement to the rest of the portfolio as opposed to a disproportionate user of capital. And if you consider our cost basis in these investments, they're an even smaller part of our portfolio. We are in favor of our portfolio. of our portfolio.
We believe that LendSure is growing market share and we think it's likely that loan prices will drift up as coupons have now been reset to reflect higher interest rates and wider spreads. Also, our stakes in both residential and commercial originators are critical because they enable us to control underwriting quality. That's becoming more important given the recent economic slowdown.
The 9Q mark is not going away because it's an important segment of today's overall mortgage market.
Of course, Fannie and Freddie are the lowest rate option for most borrowers whose W2 gives a fairly complete picture of their income and whose loan size fits within GSE limits. The W2 gives a fairly complete picture of their income of their income and whose loan size fits within GSE limits. it.
But not everybody fits in that box.
Post financial crisis beyond originating agency mortgages, banks are primarily focused on full-dot jumbo mortgages.
It's the non-QM originators who primarily serve self-employed borrowers and borrowers with some stenciling common addition to their W2.
We don't see this changing. We don't see if any may go into back statement loans.
Apart from non-QM and originator stakes, many of our other credit strategies performed really well in this past quarter. RTL continued with excellent performance. Those loans are not dependent on the securitization takeout, they just pay off. And they are so short, they don't have a lot of interest rate sensitivity. We have also been able to push up note rates on our recent originations and it feels as though we have a lot of pricing power.
to them in originator stakes. Many of our other credit strategies performed really well in this past quarter. RTL continued with excellent performance. Those loans are not dependent on the securitization takeout. They just pay off. And they are so short, they don't have a lot of interest rate sensitivity. We have also been able to push up note rates on our recent originations. And it feels as though we have a lot of pricing power. We have had a performance remained excellent.
Commercial bridge loans also continued with excellent performance. Our commercial bridge loans are all floaters, so interstate movements and interstate volatility doesn't affect them much.
Despite the excellent performance, we are certainly becoming more conservative on LTVs at current property valuations.
So far in the third quarter, the market environment has been much more favorable relative to the second quarter. Interest rates have come well off their highs, stocks are off their lows, and credit spreads are off their wides.
liquidity was poor in June and early July , but is substantially better now.
New issues securitization are priced quickly with many tranches multiple times over subscribed. This is all a huge turnaround from the second quarter.
Our agency MBS portfolio was also a drag on EFC performance in the second quarter with a loss of about 20 cents per share, but that too performed very well in July .
In the agency MBS market today, prepayments are manageable, yield spreads are wide, and roles are attractive in higher coupons.
Recession fears tend to help that sector because the sector has no credit risk and in a recession the Fed may stop for slow down balance reduction.
So the market feels like it's in a much better place today as compared to the second quarter. Interest rates have retraced a lot of the second quarter sell-off. Five-year Treasury yields are now over 60 basis points below their mid-June highs, for example. While still elevated, implied volatility has also come down. In addition, spreads have tightened and the market tone is much better.
We're seeing this pretty much across the board in fixed income, not just in structured products.
IG spreads are in 20 basis points from their wides and high yield spreads are over 100 basis points tighter.
CRT is much tighter and there was a deal last week with Tronche's 15 times over subscribed that tightened 60 basis points in the initial talk.
Nankuem is tightened as well and some current deals have been over five times, have been over five times over subscribed.
Ever since the July Fed meeting, the market has had a different tone and has attracted a lot more capital for money managers and insurance companies.
EFC is in a strong position.
at quarter-end.
We had ample borrowing capacity and access capital to invest. We have an array of proprietary flow arrangements.
that gives a big say in loan underwriting, which has been critical to our success in the past, and which will take an increased importance should the economy enter a deeper recession.
We are currently buying a lot of high yielding loans with many sectors where a note rate is 7% or higher.
We estimate that July was a positive month for EFC and the opportunity said it's great. We benefit from diversified and deep financing and sourcing relationships. This year and every year, we have maintained our focus on protecting book value. We're protecting book value.
Maintaining strong liquidity and managing our credit risk that has allowed us to get by with only moderate drawdown so far this year. The year is down 7% for the year through June . The year is down 7% for the year through June .
which is not the result we want but not a disaster either. Now we plan to take advantage of historically widespread and high asset yield to driver turns going forward.
We have grown the credit portfolio to $2.66 billion, which I believe is the right thing to do when spreads are so wide. EFC also has experienced management and portfolio managers, which are invaluable in volatile markets.
We have to maintain our focus on credit quality.
We have to be prepared for the possibility of an economic contraction and with that higher default rates.
How do we do that?
Spreads are so wide right now that there is no reason to stretch into high-rel TVs or lower-ficos.
We believe we can meet our return targets while focusing on loans with lower LTVs and higher FICOs and on securities with more seizing and greater credit enhancement.
We're seeing some of the best opportunities and the highest quality yield spreads that we've seen in the past 10 years and are focused on capturing those opportunities to drive our dividend and grow book value. Now back to Larry.
Thanks Mark. Hey everyone, I hear that there have been some audio issues at the conference call hosting service. They're having some technical difficulties. So we're going to look into whether we can, you know, post, you know, perhaps post the script somewhere or provide perhaps on the audio replay that will, you know, that'll have all the content. So we're going to look into that. OK, just to conclude though.
So far in the third quarter, volatility has subsided a bit, interest rates have dropped somewhat, and yield spread in most sectors have retraced a portion of their second quarter widening.
Per our normal process, later this month, we'll be putting out a book value per share estimate for July 31st. So keep an eye out for that update.
Meanwhile, time will tell how long the contraction in the origination markets will last, and how much more of a shakeout will occur.
In non-QM, lower-ho-long price premiums and falling volumes have taken their toll, especially on those originators who did not properly hedge their life, their lock-long pipelines, or were under capitalized or both.
We have seen several mortgage originators of yearly scaleback operations and even a couple close shop. And even a couple close shop.
While market dislocations have created a drag on the EFC's book value in the near term, our strong balance sheet is enabling us to lean into the wider credit spreads, and together this presents the opportunity for us to grow market share at our origination platforms.
Long-term, we believe that a thinning of the herd will be a net benefit for the stronger origination platforms remaining in their respective spaces. The herd will be a net benefit for the stronger
A final note I'll make on our originator investments is that it's important to keep the size of our originator investments in perspective relative to the rest of our investment portfolio.
These originator investments, which are currently spread across nine companies, in total comprise only about 9% of the EFC's overall equity, as JR mentioned.
In fact, they've typically started out as small DC type investments.
These stakes often have the added benefit of locking in loan production underwritten to our credit specifications.
So, properly sized, these investments further diversify our earnings stream and should be a powerful differentiator for the Ellington Financial franchise.
We've spoken many times before about the benefits of being both a lone buyer and a lone originator as the profit pendulum swings between the two.
Non-QM is a great example. As a result of all the market turmoil, we've been able to acquire lots of non-QM loans this year, including not only from Lenscher, but also from certain originators who are burned.
Buy the big market swings and unloaded inventory at discounts.
As I mentioned before, securitization spreads widened after we purchased some of these loans, and this hurt us in the second quarter. Nevertheless, we continue to lean in.
We have recently been able to purchase new non-QM loans with mid to high seven percent coupons, and with interest rates lower over the past few weeks, the economics on these new loans look very attractive, especially relative to the stabilization we're seeing in the non-QM securitization market.
Going back to the Arning's presentation for a minute, please turn to slide 12. Please turn to slide 12. Please turn to slide 12. Please turn to slide 12.
I pointed to this out on previous calls, but in this environment of rising rates and market turbulence, it's worth highlighting again our low level of interest rate sensitivity.
In the Table on Slide 12, the fifth line down, non-agency RMBS, CNBS, other ABS and mortgage loans. Non-agency RMBS, CNBS, other ABS and mortgage loans.
captures the vast majority of our long-credits portfolio.
As you can see, if rates shift up or down by 50 basis points, we estimate that the impact from the credit portfolio on overall book value would only be about plus or minus 1%.
That translates to an effective interest rate duration of a little more than two years on this portfolio. And that's even before taking into account our interest rate hedges. Our interest rate hedges.
We've accomplished this by focusing a significant segment of this portfolio on products like one to two year commercial real estate bridge lines.
Sub one year average life residential transition loans and short term consumer installment loans.
Particularly as market volatility spikes and spreads widen, we're very happy to see our short duration assets continue to run off naturally and quickly, enabling us to reinvest that capital at higher yields. TRANSPONTS
As we move into the back half of the year, we still have dry powder to deploy. In particular, I expect our recently raised 5-7% senior notes to be highly accretive to earnings once we fully invest the proceeds.
We're trying to be patient and pick our spots, looking for the right levels on the security side while continuing to support our origination businesses.
Our credit performance statistics remain strong, but we're keeping vigilant on underwriting standards, especially with housing affordability down dramatically and with economic growth turning negative. And with economic growth turning negative.
Given the abundance of investment opportunities available today, we believe that our patients will ultimately be rewarded.
With that, we'll now open the call up to your questions. Operator, please go ahead.
At this time, if you would like to ask a question, please press the star and one on your touchtone phone. You may remove yourself at any time by pressing star two. Once again, let us start and one if you would like to ask a question and we will take our first question from Trevor Canson with JMP Securities. Your line is open.
Thanks.
A couple of questions on the non-QM market.
First, I guess, after the substantial increase in rates on non-QM products,
And the disruption to some of the originators in that space, can you talk about how much origination volume you're expecting to see in that product over the second half of the year compared to the first half of the year? Thank you.
And as a second part of the question, you guys clearly kind of laid out the opportunity on the loan side there. With the spread widening, are you guys also interested in buying some of the...
up in the stack securities from other non-QM deals where you're really more focused on the long side at this point.
Hey Trevor, it's Mark.
I would say that...
The first question about change in volume.
So in terms of securitized volume for the second half of the year versus the first half of the year I think that's going to be down a lot, but part of the reason is
a lot of the securitized volume for the first half of the year with loans that were really originated back in
2021.
So there were a lot of platforms sitting on a lot of 4.5, 4.25, no-rate loans. They didn't secure ties in 21.
that they put into marking 2022.
So...
If you take away that I think
My projection is that just at these higher note rates and also at higher HCA, you're probably just gonna see organic non-QM volume dropped by, I would guess at least 30%. Has reaching from near the higher volt.
if fewer borrowers qualify, if fewer borrowers are looking to...
buy homes right now, given what the payments are, with this kind of double whammy of higher HPA and higher mortgage rates. And if you look at, um,
A lot of housing metrics, you know, if you look at like this was happening to views on Tell Not Owen.
I think you're gonna start to see it a little bit in listing times.
that I just think there's sort of an overall slow down that you're going to see in housing.
The other thing about
So buying pieces of other deals, so the way we think about the...
When we do securitizations, where we think about that is, the bonds we sell are really sort of replacing we boast, we consider them sort of term financing. So we do our own deals, depending on what trance is we retain. And some of it we're retaining because there's risk retention obligation, but sometimes we'll retain in excess of the risk retention obligation.
we look at those sort of as investments that the company is making. So to the extent that we can replicate those investments.
and other people's deals.
That's something that's of interest to us. One thing I would say is that the pieces you retain on securitization are pretty low down in the capital structure, so it's much more
you know, what's going to drive the returns on those things is going to really have a lot to do with loan performance as it's not like buying, you know, a...
a more senior security where it's more like prepayments and spread, you know, what happens to spreads. You're down to the capital structures, you're exposed to credit risk. And, you know, Larry mentioned on the call, but one of the benefits of having these original stakes is
we have an active dialogue in terms of underwriting standards and how we should be reacting to changes in the market and changes in the housing market. So I think we just have a level of comfort on the retained pieces as investments.
for the securitization we do.
Yeah, like I would just say like always known to be an angel.
In other pools of capital we manage, we are trying to attract a plane to non-cure space definitely. Thank you. Thank you.
Got it. Okay. That's all.
You guys talked about the challenges that a lot of originators are facing and the impact on your investments in some of those companies.
As you look at the originator landscape, are you guys?
looking at or pursuing any opportunities to maybe, you know, provide a capital injection to like a good quality company who's a little bit beaten up right now? Or are you guys just kind of comfortable with the investments you guys have at this point?
Yeah, we're definitely seeing opportunities like that. And I think...
Similar to what we've done in the past, I think a modest amount of capital absolutely could be a great use of capital to do that.
some sort of line of credit or capital infusion in exchange for and then getting forward flow, potentially warrants, you know, there's a lot of things that you know, these companies that are struggling could be, you know, help them basically get through this and provide a great opportunity for us. You know, again, we're not the type that usually writes big checks.
So, as we've said, but I think this could be a great opportunity to do that, and we are seeing a couple of opportunities presented. And we are seeing a couple of opportunities presented.
Okay, got it. And then last question on the agency portfolio, can you talk about how you're thinking about the overall net long exposure kind of given where? The overall net long exposure kind of given where?
spreads are in the agency market and where Volchold is at currently.
Yes, so you know we typically keep…
the net long in that portfolio.
significantly lower than what you'd see from sort of...
you know, an agency read and...
Part of that is just a philosophical belief that shareholders in Ellington Financial are primarily looking to generate returns to credit investments. So historically, we haven't wanted to introduce some of the risks inherent in the levered agency portfolio about volatility and basis widening. We haven't wanted that to really dominate.
you know returns for eft given that's really credit focus so i think jr can correct me i think the agency portfolio was down roughly six percent on its capital this quarter right so i think that's sort of like at the better end of what you're seeing from the agency peer group in part because you know it's fully hedged and also doesn't have as much more good exposure um... yet more bridges are certainly wide right now but they're wide for you know a week never but he knows right you have the
the Fed stepping back their purchases. You know, it's possible even though, you know, a lot of market participants think less likely, but it's certainly possible that they could engage in sales. And also, you know, the other thing is Fannie and Freddie greatly increased their loan limits. So the new crop of agency mortgages that are originated in the higher coupons, you know, four and a halfs and fives.
They're really big loan balances, so there's going to be a lot of sort of
Potentially an unfavorable prepayment curve for some of those things. So all that kind of feeds into spread. It's like right now. It's like right now.
You know, if you look at non-QM, non-QM or a lot of sectors of credit have sort of had spreads correlated with agency spreads a little bit. So I feel like, um,
You know, EFC has a lot of, it's taking advantage of wider spreads right now in some of these other sectors. So...
I wouldn't say right now, probably that's where we'd add a lot of risk. You know, agencies had a very good quarter in July , so they recouped some of that widening. But, you know, if we saw credit spreads tighten to the point where...
they weren't as attractive as they are now and agency spreads not then i think at that point it'd be a time to really consider increase in the uh... mortgage basis exposure in that in the agency portfolio and i think that it's what right now
We're in credit spreads, it's so wide. I think we're going to sort of take more of the risk in the portfolio, you're focused on the credit side. You're focused on the credit side.
Hey Mark, I just, you know, J.R. and R are looking at the numbers here. Yeah, the return on equity on the equity that was allocated to the agency strategy was, you know, was in the single digits, it was obviously a lot better than you've seen from, you know, the agency reads in terms of their return on equity. So, um,
And that's due to the fact that, you know, in no small part, as you mentioned, we hedge, you know, more of the basis risk via TBAs in that strategy.
than typical agency reward.
Okay, thank you guys. Thanks, Trevor. Thanks.
I will take our next question from Doug Harder with Credit Suisse. Your line is open.
Thanks. Can you talk a little bit more about your comment to hold non-term loans on warehouse clients longer? How you kind of think about the risk of that and kind of do you plan to kind of just be more opportunistic around the securitiesization market? Just to kind of flesh that out a little bit. Thank you. Yeah, you know, hey Doug, it's Mark. So. Thank you.
you know maybe i didn't phrase it properly but i wouldn't say it's our intention to hold on qm loans and repo because
we see a lot of benefits of being securitizers, right?
We certainly sawought it when you went through COVID-19 how having securitized a lot of our production.
leaves less mark-to-market risk in the portfolio and volatile times. I also think you build a brand.
Excuse me, you get tighter spreads over time, just sort of a virtuous cycle there. I was just making the comment that...
You know, you got near a point in July where secured inspiration spreads had widened.
so much relative to repo that for the first time in
Years and years.
We at least said, hmm, you know, let's look at leverage returns just from keeping things on balance. Since then, um,
Securitycer french. It's coming in so
I would say now, you know, our expectation is that we're going to continue to secure ties, but...
But you know, I would just say the stability in repo has sort of, for the first time in a long time, at least to us, and we're kind of guiding the both securitizers. This guy horsepower forces us.
been you know at least you know an alternative to consider.
And Mark, I just want to make one other point, which is that one thing that...
So yeah, so it's not first of all, it's not like we have a gun to our head, right? And need to get these things off Reaper right away. One thing that we look at very closely is we look at the relationship between the scuritization spreads and where we can buy loads.
non-QM loans, right? And so,
when we did the securitization which we completed last week you know one of the things that uh... i think contributed to our you know wanting to do that securitization even though you know spread or obviously a lot wider than they were in the year is that we can
Replace that risk if you will, right? So we're de-resking by doing the scaradization. So we're de-resking by doing the scaradization.
But we can replace that risk pretty much right away now.
with non-crum loans.
right that are priced very attractively relative to where securitization spreads are that was in true
you know a couple months ago the scuritization spreads widened uh... and it took a while before the primary market where you could buy you know what you could originate where you could originate and purchase via forward flow agreements or whatever it is you know there was a lag there so once that sort of re-normalize what should be which is that you know it should be profitable to originate loans and secure ties and so once that got back and it was like okay let's do the scuritization because we can now replenish that risk in a profitable way
terms of the loans that we are seeing available for you know for purchase today.
And I guess on that commentary about the ability to source loans, you know, I guess, how do you view kind of the timeline to aggregate enough to enough size to securitize how does that compare kind of in the back half to kind of what new experience in the first half?
So it's compressed a lot for us. You know, it, uh...
but back we we have first we were a year between that i think six months for months three months now i think we have uh... enough flow and inventory frankly that you know we could be doing deals you know we could be doing deals
much more frequently and you know typical size deal for us is in the...
three to four hundred million dollar range. Yeah, our last year was about 350 and we acquired 550, originated 550.
in the second quarter.
That would imply, you know, factor that in. Exactly, right, exactly. So I think you could definitely see now every two or three months as opposed to every three or four months.
Great, thank you.
So we'll take our next question from Boy's George.
With KBW, your minus now active.
Hey guys, this is actually Mike Smith on for Bose. Maybe just one on leverage. If we look at total leverage currently at 3.8 times, just wondering if we get some macro clarity in the back half of the year, just wondering how high you could look to take leverage. But we'll deal with that sprint again in a moment.
Sure, so thanks for the questions, JR, I'll start out and then Mark and Larry obviously supplement as you see fit. So the 3.8 includes all the non-QM securitizations that we consolidate for a gap. So that's a total leverage statistic, but recourse test equity, which we talk about, that's the ratio we focus on because it excludes non-recourse financing, which is largely the non-QM securitizations.
That measure did increase from 2.3 to 1 to 2.6 to 1, 1.4 of a quarter. And 2.6 is higher than it's been kind of post-COVID, but not as high as it was pre-COVID. And we gave the statistic that fund-and-combred assets, about 600 million and plus cash of another 2.4. So we still had, that's one of the ways that we measure, you know, dry powder, Larry mentioned that we closed on the senior notes on March 31st, so that was 210 million of those.
out of the dry powder as we think about it. So, you know, I think the answer to this question is usually it depends on the opportunities, having that many unencumbered assets and cash that is above the balance that we typically carry implies that we have more borrowing capacity. On the other hand, we did do a securitization that closed last week, and so that takes
recourse financing off our balance sheet, but we've also continued to take advantage of investment opportunities. So there are different moving pieces. But I think, in short, we still have room to take leverage up further. You know, those unencumbered assets of about 600, if you say, let's just say 400 is readily financeable at attractive rates, and we leverage that one to one, or thereabouts, that would raise another 400 million.
Plus another say 50 of our cash. Cash is higher relative to nav than it typically is. That math would get us to the high twos before accounting for securitization. So we don't typically give leveraged targets, but those numbers might give you a sense of how much borrowing capacity we have remaining if we choose to use it. This is the way to use it. If we choose to use it.
And just to re-emphasize what JR said, when you think about where our leverage could go, I wouldn't focus on that recourse number because the non-QM securitizations do blow up the balance sheet.
and re-emphasize what JR said, when you think about where our leverage could go, I wouldn't focus on that recourse number because the non-QM securitizations do blow up the balance sheet.
but the amount of them.
You know, they don't blow up the balance sheet with incremental risk as far as that financing being pulled right that's locked in long-term financing. So when we do a $350 million securitization and well in the old days we would retain...
don't blow up the balance sheet with incremental risk as far as that financing being pulled right that's locked in long-term financing. So when we do a $350 million securitization, and well in the old days we would retain $20 million worth. $20 million worth. $20 million worth. $20 million worth.
of assets usually mostly IO, non QM IO and some subordinated tranches as well, right? So that's, blows up your recourse leverage by 350 million, which is not a small number given we have a billion dollars of equity, but in terms of how many really sort of assets you've added to the balance sheet, that's a relatively small number. We're retaining more now so that percentage has increased, but still relative to the size.
of the balance sheet the amount of retained tranches you know that we add when we do a securitization uh... is still pretty low so uh... um... so again i think focusing on the recourse number which is what we think of especially in terms of our liquidity management and making sure that we can withstand market shocks and things like that um... is you know better focus on
Great, that's a really detailed and helpful color. And then maybe just one on strategy and the potential for M&A. I'm just wondering how strategic of an asset is earned to Elinth in the manager? Just wondering if EFC could ever look to acquire earn and maybe to increase scale. Or could you ever look at any other strategic transactions? We saw a peer put themselves up for sale last night. So I'm just wondering, do you provide any color on the backdrop for M&A? That would be...
Thanks. Yeah, all I can say there is nothing's changed. People have asked us that and it's...
Of course, if it were right for both companies, it's something that we would absolutely have to consider, right?
You know, it's...
It's not on the radar screen right now and I wouldn't want to count more than that.
Thanks for taking the questions.
We'll take our next question from Eric Kagan with BTIG. Thank you. Thank you.
Hey, thanks. Good morning, guys. Hope you're well. I have a few here. Did you address the unsecured debt that's rolling over in September and how you'll handle that? It sounds like you haven't enough.
I just want to hear you kind of talk about it and say it. And then can you speak to some of the credit attributes, the quality of the non-QM portfolio? I think a lot of loans, or some of them anyway, just for the market generally have been bank statement loans and how you think about that.
including just how you think about it relative to the value of being able to lever something like a CRT. So JR, why don't you handle the question about the that field coming due, right? And then Mark will handle the. Yeah, I think it's, you know, we see it as we've planned. Yeah, I think it's, you know, we see it as we've planned.
We could have been wise to pay it off here in a few weeks.
there's nothing really more nuanced about that it's gonna be you know ordinary course that we plan to pay off the maturity and we've we've planned you know the look would decide to do so and if and if rates hadn't spiked and spread scapped out right after we did that other you know secured not to you we probably would have uh... use those proceeds to you know pay off
the five and a half coupon even sooner, but five and a half coupon, which was looking like a expensive short term funding just in March, it was now looking pretty attractive shortly thereafter. So we decided to keep it on. And we could have paid it off at any time, but it certainly looks like we're just gonna pay it off in maturity.
uh... with cash on hand mark uh... american repeat maybe the second half of the question right i think i got it with the uh... yes with the bank statement loans that sort of
I think that's sort of one differentiator.
among different non-crum originators is how they think about bank statement loans.
And I think...
The night camera originator we own, LenSure, has a very good process there. It's a really deep dive into...
The BLM people are self-employed. I'm going to really deep dive into the...
Economics of that business.
It's looking at multiple years of bank statements.
And so the performance there has been excellent in a lot of ways.
learning more about those borrowers' financials than you do just on the regular full doc.
borrowers, financials, then you do just on the regular full dock. So we're totally comfortable with...
Bank statement underwriting it, Lenshure. When we start buying loans from other originators, then our team has to do a bunch of work to understand how they do the bank statement underwrite, and sometimes we can get comfortable with it, and there's time we can't. And there's time we can't.
You know, when I think about sort of the opportunities that I think you talked about in non-cure and retained pieces.
versus CRT, you know CRT is like more liquid and it's got pretty good financing terms you know. I think they're both attractive like for a long time I'd say you know like last year the year before we didn't find CRT particularly attractive because it wasn't that wide, things were at par and it always sort of has a little bit of this cat bond, the catastrophe bond quality to it that
You know, the enhancement levels are so thin that flooding in Houston was an issue for CRT.
You can see wildfires being an issue for CRT.
You could see a localized economic stress in one or two big MSAs related to a specific industry being an issue for CRT, whereas it's not when you have kind of just regularly diversified loan portfolios. So.
What's changed for us about the CRT market now and when we're finding more attractive investments is that it's season some so a lot of these deals that were done a couple years ago have had the benefits of very high HPA and also very high fast prepayments so you know there are instances where all of a sudden bonds have four times the credit enhancement now that they did at issuance because the deals have delivered so much or there are times where you know the LTVs are now marked to market 20 points lower than where it was in the deal got done and so there's
significant enough enhancement levels in parts of the CRT market that sort of mitigates or sort of neuters
some of the uh... that cat-bond characteristics that was always an issue for us because we knew it was kind of like a blind partner modeling like we don't have models to predict you know whether in fires and floods and so when we know the models uh... are taking into something into account but we know what they're not taking into account can be you know significant for that investment and a lot of times it's just like okay we don't feel like we have the
analytic tools to properly understand the distribution of outcomes of the security. So it's better not to participate. So. So. So. So. So.
Those changes though, the build up and credit enhancement.
and credit enhancement.
you know much lower l. t. v. because of h. p. a. now we're finding attractive opportunities there. e a lary reference to one of them in his prepared remarks. so.
I like both them for EFC. I like EFC having loans as well as having securities.
You know loans are proprietary. They're a little bit more work So a lot of times sort of the pot of gold at the end of the tunnel when you do everything is a little bit higher yield But you know a lot of times securitization is marked you know securities can Overshoot they can get cheaper than loans there's for selling or whatnot or turbulence like you've seen this year and When those are the times where we think the securities offer is good or better relative value than loans Will buy a lot of securities you know they have liquidity to them
It's easier to monetize gains. So I think there's a big role for both those things in EFC.
That was some really good stuff to think about. Thank you very much. Sure. We'll take our next question from Chris Bimov with Piper Samlar. Let your line is open.
Thanks, and thank you for taking my question. One question on the name for the credit portfolio. I saw about 2.75 second quarter down. Often we do have a short duration portfolio, especially in loans, where some loans are floating rate. And so those are adjusting real time. But others are technically fixed rate, but might have a six month average life, for example, many of our RTLs. And so if you have a six month loan that has a fixed rate, it's going to take...
you know, that time to turn over, whereas its financing might be floating to SOFR or LIBOR. So hopefully it's a short-term phenomenon and asset yields catch up and we mentioned that we've been able to, you know, kind of push spreads and we're seeing higher yields and spreads in the market and certainly the mom kind of catch up going forward.
Okay, great. Thanks for the color JR and just one last one for me.
I appreciate all of your comments that you've made on the securitization markets. I just have one clear pick.
on what you said on the non-yield in July versus January . Did you say 150 basis points wider? Yeah, yes, and spread. So obviously, much higher, yield much, much higher. Exactly, yep. Right, on the triple A. On the triple A. Although everything is lower.
Alright, yeah, and the coupon in the coupon was a 2.2 coupon.
in January .
and it was a five coupon in July and the five coupon in July traded about a point lower than the 2.2 coupon.
Okay, okay sound good model that's a big move
That's like wow.
Right, absolutely. Thank you for the color and the clarification. That's all for me. And Chris, I'm going to just add one more thing. And Chris, I'm going to just add one more thing.
You know, while we definitely look at ADE when thinking about our dividend, we're also looking at, looking forward, right, and seeing where we see these.
metrics going, including ADE and others and earnings, and where
So, I wouldn't necessarily focus too much on that.
necessarily over the near term. We're looking at market yields are very high. We're gonna turn over the portfolio. We still have an agency portfolio that from a relative value perspective we really like, but a lot of that was put on at lower yield. So I think you're gonna see over the next quarter or two, a lot of turnover and movement. Some of it is just taking advantage of the right time to sell some of the agency pools that we have and replace them just naturally with whatever's in the market at the time, but that's gonna recharge.
the uh... the them in the a d on the other thing i want to mention is that it hasn't been that long where uh... and they're still going up where short-term you know money market rates are higher and that's also
the name of the a.e. on the other thing i want to mention is that it hasn't been that long where uh... and they're still going up where short-term you know money market rates are higher and that's also uh... a boost
because all that cash that we have and sort of, if you will, the benchmark off of which our floating rate assets are yielding us, those are all going up and going up quite a bit, several hundred basis points from where they were literally last year. So that's.
also a good talent for that has not absolutely been fully factored in yet.
All right, thank you for the call, Larry. That was our final question for the day. I would like to turn the call back over to Larry Penn for any additional or closing remarks.
Yeah, thanks everyone. I just want to add, we're going to take a listen to the audio. And if there was something that we considered significant in terms of a gap based upon this issue that the hosting company had, we will definitely look into posting the script, the per-paramarks on our website. And for the Q&A, I think it seems like the audio was didn't gap there. So I think we're going to be OK in terms of just the normal services that post those transcripts. But we will look at posting the per-paramarks appropriate. Thank you. Always thank you for part.
We thank you for participating in the Ellington Financial 2nd Quarter 2022 Earnings Conference Call. You may now disconnect your line at this time and have a wonderful day.