Q3 2022 Ellington Residential Mortgage REIT Earnings Call

To all sites on hold we do appreciate your patience and ask that you. Please continue to standby. Thank you.

[music].

Good morning, ladies and gentlemen.

Thank you for standing by welcome to the Ellington residential mortgage REIT 2022 third quarter financial results Conference calls.

<unk> call is being recorded.

At this time, all participants have been placed on a listen only mode and the floor will be opened for your questions. Following the presentation.

If you would like to ask a question at that time. Please press star one on your telephone keypad.

At any time if 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 floor over to Jason Frank Deputy General Counsel and Secretary, Sir you may begin.

Thank you and welcome to Ellington residential third quarter 2022 earnings conference call before we begin 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 Securities Litigation Reform Act of 1095 forward looking statements are not.

Historical in nature as described under item <unk> of our annual report on Form 10-K forward looking statements are subject to a variety of risks and uncertainties that could cause the companys actual results to differ.

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 as a result of new information future events or otherwise joining.

Joining me on the call today are Larry Penn Chief Executive Officer of Ellington residential Mark <unk>, Our co Chief investment Officer, and Chris Martin off our Chief Financial Officer.

As described in our earnings press release, our third quarter earnings Conference call presentation is available on our website <unk> dot com or.

Our comments this morning will track the presentation. Please note that any references to figures in this presentation are qualified in their entirety by the end notes at the back of the presentation with that I will now turn the call over to Larry.

Thanks, Jay and good morning, everyone. We appreciate your time and interest in Ellington residential.

After a challenging first half of the year the third quarter started off on a constructive note with interest rates declining and interest rate volatility subsiding in July .

As has been the typical pattern this year yield spreads followed the direction of interest rates with both declining in July and virtually all fixed income products benefited <unk>.

Agency RMB as investment grade corporates and high yield corporates reverse most or all of their losses from the prior months and posted significant outperformance during July versus treasuries and interest rate swaps.

<unk> residential itself generated a positive economic return of nearly 6% in July .

The good news proved short lived however continued elevated inflation led the fed not only to raise the fed funds target range by 75 basis points in both July and September , but also to accelerate its balance sheet runoff.

Central banks around the Globe also continued tightening their monetary policies.

Over the course of August and September interest rates rose sharply.

Large segments of the yield curve inverted further and volatility surged.

The move index, which measures the yield volatility implied by short term options on long term treasury notes and bonds reached its highest level since the COVID-19 related market volatility of March 2020.

Market sentiment steadily weakened and we saw widespread selling across asset classes, including forced selling by some asset managers to meet margin calls and redemptions, particularly towards the end of the quarter.

Liquidity deteriorated and yield spreads widened in virtually every fixed income sector, including agency MBS with many sectors hitting their widest levels of the year.

Technical headwinds in the agency MBS market included not only the <unk> acceleration of the reduction of its MBS portfolio, but also extremely weak bank demand.

Turning to slide three.

On the top half of the page you can see just how large these yield curve moves were during the quarter.

Then on the bottom half of the page you can see the impact of these huge moves had on agency MBS yield spreads and prices.

Both nominal yield spreads and option adjusted yield spreads widened significantly across the coupon stack and the combination of wider spreads and higher rates led to sharp price declines.

You can see on this slide <unk>, five and a half which was still the current coupon at September 30th dropped by more than four points quarter over quarter.

As you can also see on this slide that represented an absolutely massive 57 basis points of OAS widening on that coupon. According to J P. Morgan's models.

And Meanwhile, for the longer duration, Fannie three fives, which wasn't is fairly a fairly representative coupons within the 30 year portion of Ellington residential agency portfolio.

That coupon drop in more than six points in price.

Also representing substantial OAS widening.

Since the primary mortgage market takes its lead from the secondary mortgage market the mortgage rates at homeowner C surged in sympathy with agency MBS yields.

Freddie Mac 30 year survey rate ended the quarter at six 7%, which was its highest level in the past 15 years and even touch 7.08% two weeks ago that was its highest level in over 20 years.

As expected. Following these recent mortgage rate increases prepayments continued to grind to a halt housing is much less affordable home sale volumes are declining and we're seeing the first clear evidence of declining home prices nationally.

In summary, the market environment in August and September could hardly have been more difficult for agency MBS.

Ellington residential experienced a significant net loss for the quarter as net losses on our specified pools exceeded net gains on our interest rate hedges and net interest income from the portfolio and as we incurred significant delta hedging costs as a result of all the volatility.

Our net loss was significant on a mark to market basis, but our disciplined and dynamic hedging strategy, which included aggressive to react duration rebalancing throughout the quarter and positive contribution from our meaningful short TBA position helped prevent even greater book value declines.

Next on slide four Youll.

Youll see that reporting 23 per share of adjusted distributable earnings for the quarter.

As we mentioned on last quarter's call, our ADC faces near term headwinds as the sharp rise in short term rates as repricing, our repo liabilities higher and the repricing higher very quickly at that.

And while our asset yields are also increasing that only gets captured in our NIM as we rotate our portfolio.

We're being patient about turning over our deep discount pools, given what we perceive as excellent relative value in that sector.

As a result, our NIM is compressing in the short term, but we think it's important to prioritize maximizing total economic return of or just trying to maximize short term adv.

It bears repeating that this all underscores the limitations of focusing too much on AE, which is a backward looking measure, particularly in market environments with large swings in interest rates and spreads such as we're seeing today.

The disciplined approach that we're taking with the portfolio turnover combined with our sequentially lower book value.

Also meant that our leverage ticked up this quarter.

As always we remain focused on liquidity and risk management and we continue to follow the same guidelines that have helped us manage past financial shocks effectively.

Of note, we continue to hold a strong liquidity position at quarter end with cash and unencumbered assets, representing 27% of our total equity at September 30th.

Okay.

Finally, I'd like to point out that a significant portion of Ellington residential losses for the third quarter and indeed for the year resulted from yield spread widening and I believe that the prospects of recouping. Many of these losses are strong.

I'll now pass it over to Chris to review, our financial results for the third quarter in more detail Chris. Thank.

Thank you Larry and good morning, everyone. Please turn to slide five where you can see a summary of Ernst third quarter financial results.

For the quarter ended September 30, we reported a net loss of $1 <unk> per share and adjusted distributable earnings of 23 per share.

These results compared to a net loss of <unk> 82 per share and <unk>.

28 per share in the second quarter.

ETE excludes the catch up premium amortization adjustment, which was.

Positive $1 $4 million in the third quarter as compared to a positive $1 $6 million in the prior quarter.

During the third quarter as Larry noted agency MBS significantly underperformed U S Treasury securities and interest rate swaps and that drove our net loss for the quarter.

Our net interest margin decreased quarter over quarter to $1, two 8% from 166% as higher interest rates drove a significant increase in our cost of funds, which exceeded the increase in our asset yields.

Our lower NIM combined with lower average holdings quarter over quarter caused the decline in Adv.

Meanwhile, average pay ups on our specified pools decreased modestly to 1.0% to 2% as of September 30 from 1.09% as of June 30.

Please turn now to our balance sheet on slide six.

Book value was $7 78 per share at September 30.

Compared to $9 seven per share at June 30.

Including the 24 cents of dividends in the quarter, our economic return was negative 11, 6%.

We ended the quarter with cash and cash equivalents of $25 4 million.

Next please turn to slide seven which shows a summary of our portfolio holdings.

In the third quarter, our agency RBS interest only securities and non agency MBS holdings all decreased modestly.

Agency <unk> portfolio turnover in the third quarter was 19%.

Additionally, our debt to equity ratio adjusted for unsettled purchases and sales increased to nine one times as of September 30, as compared to seven nine times as of June 30.

The increase was primarily due to lower shareholders' equity quarter over quarter as the portfolio size was relatively constant.

Similarly, our net mortgage assets to equity ratio increased to seven five times from six eight times over the same period.

I'll note here too that repo financing has remained stable and available despite the market volatility.

On slide eight you can see the details of our interest rate hedging portfolio.

During the quarter, we continued to hedge interest rate risk through the use of interest rate swaps and short positions in TBA U S Treasury Securities and futures.

Finally, we were optimistic with our capital management strategy during the quarter as we issued approximately 148300 shares through our ATM at a price of an average price of $8 43 per share and repurchased approximately 9500 shares at an average price us $6 53.

<unk> per share.

I will now turn the presentation over to Mark.

Thank you Chris.

Q3 was a unique quarter, whose defining characteristic was an enormous level of sustained volatility in almost every important fixed income metric beginning.

Beginning with interest rates, the five year Treasury traded in a range of $2, 64% to $494 one 9% during the quarter that is 155 basis points swing within just one quarter.

The change in the shape of the yield curve was also dramatic the two year to 30 year Treasury yield spread had a range of 87 basis points just for the quarter, which is a bigger range than you would expect to see for an entire year.

Meanwhile, the market CTX I G index, which reflects the market's perception of credit risk for investment grade corporates had a range of 37 basis points for the quarter, whereas for all of 2021. It only had a range of 13 basis points for the benchmark index moved about three times as much Justice pass.

One quarter it did all of last year.

And most important for earn mortgage prices and mortgage yields were not spared at all from this volatility during the quarter Fannie fours trading and a nine point price range and Fannie <unk> traded in an incredible 59 basis point yield spread range.

This is not a normal market by any means the fed has now implemented 475 basis point hikes in succession, they've now more in the last four meetings did they had heightened cumulatively in the preceding 10 years.

<unk> had an economic loss of 11, 6% for the quarter and the rest of our peer group fared even worse on agency mortgage REIT is simply not designed to deliver good returns in the face of that magnitude of interest rate increases and mortgage spread widening I do believe that much of our loss is reversible if spreads normalize.

October was another month of a lot of volatility but through today. It looks like our book value is around breakeven for the fourth quarter. So far given the October volatility I think thats, a good outcome, but a negative.

Economic return of more than 11% for the third quarter certainly is not on.

On the other hand, the spread widening has ushered in an opportunity set for agency Reits that the best we have seen in years by virtually any metric mortgage spreads are extremely wide now.

Today, we have a 20 plus point price range and the coupons that trade and while some of the coupons with worst convexity characteristics are wider than the others. They are all wide and unlike what we used to get.

Unlike what we got used to trading in the for the past decade. Most agency MBS don't currently have a lot of negative convexity. So you don't require a lot of delta hedging.

Raise prices discount coupons to providing high quality Nims, you can put appropriate hedges in place and not give away much of your NIM by having to rejigger those hedges when the market moves.

And the MBS are also wide based on a close to worst case assumptions on prepayments speeds from a research from a research perspective, given that most everything recently has been trading at a discount rather than a premium our prepayment models and our research team have been doing the opposite of what they were doing last year.

Think about how the pricing distribution has changed last summer TBA, Fannie twos were $102 price TBA Fannie fours were 107 and the cost of loan balance protection.

<unk> was multiple points in pay up last year. It was all about finding the slowest prepayments for the pay up now it's the exact opposite for anything below 95 dollar price, which is most of the MBS universe. Excluding current coupon production. We are looking for the lowest pay up to get the fastest prepayments.

In fact, another source of additional value in the mortgage market. Today is that most models are currently under predicting prepayment speeds versus what we're actually observing.

Don't get me wrong, we think prepayments are going to be very slow I'm, just saying that there is upside from some of the worst case assumptions and Furthermore, if you know where to look you can find pools that have even more upside because they will pay much faster than model projections.

On the technical side supply is significantly lower in the agency market now cash out Refis are way down it's very few borrowers want to refi a low low rate mortgage and go into one that is at over 6% just to take out a little bit of money.

And on top of that Fannie Mae and Freddie are raising their fees on cash outs is it existing home sales are way down to that also lowers net supply because given the significant HPA we've seen over the past few years, most existing home sales.

I have involved the buyer taking out a bigger mortgage than the one the salaries paying off of course with housing affordability down. So much recently this dynamic is also changing.

Another huge difference between the agency MBS market this year than previous years is how much less banks are buying today.

A lot has been written about the huge losses and available for sale bank portfolios and weak deposit growth and the consequences for the agency MBS market have been dramatic.

Banks have been big buyers of MBS in past years, but have basically been absent. This year. So going forward. It would frankly be hard for them to buy any less than they currently are at.

As rates stabilize and they begin to replenish their capital some banks may return to the market and if we enter into a recession when banks start worrying about loan losses that is typically a time of increased bank buying incremental bank bank could be a big tailwind for the sector.

Further at the September Fed meeting, we got the clearest statement, yet from Paul on the subject of potential fed asset sales.

The fed's thinking can always change, but power basically said they plan to keep their current run off in place and they are not currently discussing MBS sales. This clarification by Powell is yet another supportive technical for the market.

There was a lot of selling in Q3 that caused agency MBS underperformed as much as they did but so far November supply seems to be more balanced relative to demand and we are seeing more healthy two way flows.

Now what about earns a day going forward, we continue the process of rotating our portfolio into today's higher coupons. We are doing this methodically and as we do at our NIM.

Adjusted distributable earnings should get a boost because our book asset yields usually reflect our original purchase yields as opposed to current market yields with reinvestment yield so much higher portfolio rotation should be a tailwind for our adv and enable.

Our book asset yields to keep up with the rapidly increasing yields on our liabilities.

What did we do with the portfolio in Q3, given the extreme volatility we were more concerned with preserving book value value than maintaining or increasing AE.

Not as though we're taking a victory lap with down 11, plus percent economic return, but relative to other agency peers, it's a better outcome.

Raising ADR can come later and maybe starts now but in a volatile market. We believe that preserving book value is more important we did go up in coupon a bit during the quarter and given our drop in equity. We also shrunk the portfolio a little bit but spreads are really wide now they can always get wider but we think it's the right move to have relatively high mortgage exposure now.

What is your outlook going forward, while things have improved over the past couple of weeks. It is still too early to let our guard down I think we will need to see a slowdown in the magnitude of fed hikes and some progress on inflation to get some reasonable stability back in the market that said there are signs that demand for spread product is finally coming back into the market.

Which should be very supportive of our book value now back to Larry.

Thanks, Mark 2022 has proven to be a challenging year so far.

And while the market conditions are obviously hit our book value significantly. They are also recharged the opportunity set.

The so called mortgage basis, the spread between yields on agency, MBS and treasuries or swaps looks extremely wide on a historical basis today and with net mortgage supply likely to be much lower going forward as well as so much bad news already priced into the market. We think that agency RBS offer exact excellent investment value today.

In addition recession could actually be a boost for the sector because agency MBS have no credit risk and because in a recession, the fed might pause or even reverse the steps. It has taken to tighten its monetary policy, which would be a support of technical.

That said, we're near the upper end of the range, where we typically set our leverage and referring back to slide nine. We're also near the upper end of the range, where we've typically set our net mortgage assets to equity ratio.

The upshot is that I wouldn't expect us to be significantly adding to our net RBS exposure from here.

Finally.

Ellington residential has a broad mandate and we think that there are currently many opportunities in the non agency mortgage markets that offer even more compelling value than agencies. Therefore, we are planning to significantly increase our capital allocation to the non agency market, perhaps to 25% or more.

The last time, we did that was right. After the Covid market shocks in early 2020, and we ended up benefiting handsomely from that reallocation, which helped drive earns outperformance in 2020.

As we've pointed out before earn smaller size should enable us to be nimble as market conditions evolve.

And with that we'll now open the call up to questions.

Please go ahead.

Thank you.

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 from the queue at any time by pressing star two.

Once again that is star one to ask a question we.

We will pause for a moment to allow questions to queue.

We will take our first question from Crispin Love of Piper Sandler. Please go ahead.

Good morning, everyone.

First Larry on the comments that you just made on increasing non agency exposure, maybe up to 25% or so.

Can you talk about just give a little bit more detail on that and what kind of timeframe. You could do that is that something that would happen relatively quickly or thinking more over the next couple of quarters. Just because your I think you are in the very low single digits right. Now. So I was just a little bit surprised by that.

Yeah, No I think it could happen relatively quickly I mean, where we're a small company.

We're nimble.

We're talking about almost we have securities that are fairly easy to access so yes, I would say maybe even by year end.

Thank you Randy.

And is often a good time to be buying as you know.

Right right absolutely it makes sense and then.

Just looking at the relative.

Yield spreads that you have on slide 10.

Apprised, but pretty eye popping there just with everything here.

The agency market near 24 month slides give any outlook on on widening versus tightening kind of.

Near to intermediate term because you could have some some pretty big tailwind to book value. If we do see some tightening there.

And I'm going to let Mark answer that question, but I would say that it's interesting so.

Everybody's got a different prepayment model right and we've talked about how research and prepayments are so important so.

Slide I think it was three we show some OIS is based upon J P. Morgan's models.

On this slide I believe using Morgan Stanley 's.

OAS models.

So you can see that Morgan Stanley 's model I mean.

On Fannie Threes, and I think on the other slide there was two 5% $3 asked but you get the idea.

As obviously, a much slower prepayment model.

And then many of the others so.

So it really is very model dependent the mortgage market, but we do we do think that.

That all assets are very wide, we think that perhaps more than staffing model is a little bit too much on the pessimistic side. So just wanted to point that outperform mark.

Addresses the question about where I guess, you are asking really way where would you see spreads heading.

Yep, Yep, Hey, Kristen.

So.

You can see that.

Given our historical.

Track record.

Our mortgage basis exposure is relatively high now which.

That is an indication that we do think it.

Yeah.

More likely that spreads tightened from where they are then widen and it also is even if they stay where they are theyre very wide you generate.

Very wide net interest margin.

In the prepared comments I did mention some of the things that I thought could be.

Supported by the mortgage basis.

Supply is way down.

I think some of the deleveraging selling that weighed on the market in Q3, some of that feels as though it's behind us.

I mentioned that.

Banks did a normally huge buyers throughout the course of the year have.

But noticeably absent from the securities market this year so.

It's sort of hard for them to buy less.

<unk> seen some overseas buying as well so I think it's.

You know this number today has moved the market a lot but it is.

It does feel to me that given the backdrop of greatly reduced supply.

Any kind of incremental buying from new pools of capital be it banks.

<unk>.

Managers, if the redemption stop.

Can really move the basis, a lot because youre not youre not dealing with a lot of supply coming into this market given how high mortgage rates are.

Obviously.

Political forces or other economic numbers Ken.

Can can be exogenous shocks that can change that but I would say.

We sort of think it's more likely than not that.

Spreads will recover from where they were at the end of the quarter.

And so that was sort of the thought process beyond our position behind our positioning.

Yes, that's great to add so I would just add one thing to that.

Often what you see right when you have got.

Good news like we saw today look why no one swallow does not a summer make but.

We could this could be the sign that we're moving in the right direction, often you see the liquid markets like the agency markets move first in terms of spread tightening, let's just say and that could really from a timing perspective work out very well right now.

Our recapture some of those losses from the spread widening earlier on our agency portfolio. The portion and then we will rotate out some of that granted theres still maybe more upside left in that but.

The non agency in the less liquid markets lag in terms of spread tightening it could work out really well to our to our advantage.

Great. Thanks, Larry and Mark for those comments just a final clarification question from me. So Mark you made some comments about book value. So far in the quarter I think you said breakeven.

Value at around 778, or so is that as of the end of October or even more recent than that.

Yes, Todd this is Larry.

Yes, we're talking really through today I guess.

And.

Yeah.

Don't want to sort of get into.

Putting an estimate as.

As of November <unk>, that's not our style, but but yes, I think we matched book value just to be clear.

Taking into account.

Any interim dividends.

And so we think book value is.

Around breakeven.

Perfect. Thanks for taking my questions.

Thanks, Kristen thank you.

Thank you. Our next question comes from Doug Harter of Credit Suisse.

Thanks.

Just talk about how you are.

<unk> to think about leverage.

No volatility.

So that kind of volatility to the <unk>.

But now it's kind of.

Continuing to kind of be.

Very large and kind of how you think about positioning into that type of market.

Yeah, Larry Hey, Hey, Doug.

So I think we.

So let's talk about the two types of leverage.

One of them.

Actual technical leverage in terms of our financial leverage our repo borrowings et cetera their quarter end at above 9% to one that's really I don't know if we've ever gotten above 10 to one.

At quarter end I don't think so we've been here before so this is really the upper end of the leverage range.

And so I wouldn't expect us as I said don't don't expect to see that go up much.

In fact, if we do start this rotation from some agencies to some non agencies and youll see that come down right. Because we obviously will leverage the non agencies a lot less than from a mortgage exposure Mark do you want to want to address that we ended the quarter at seven five to one also.

Near the upper end of our range in spreads is.

Obviously have tightened a little.

What do you think so.

I guess, what I would say is that.

Today, it's kind of an interesting day, something Larry and I were discussing really right before the call that.

While you are having this enormous move in interest rates took a 30 basis point move and a big move in credit spreads you know we've talked about that.

IGT index set things about six tighter today.

Since we talked about in the prepared comments, so while you're getting 30 basis point move in interest rates, which is I mean you.

Do you see moves that big maybe once a year once every other year normally.

So implied volatility is actually down today. So while this is an enormous move for today.

At least what implied volatility is telling you that having seen a little bit of.

Inflation seem to respond to the.

Aggressive heightened cycle of the fed.

Sort of.

Implied vol is saying that thats going to usher in maybe less volatility going forward that you don't <unk>.

Dart to see economic numbers that are reflective of what the fed is done and I think the big.

Comment in Powells last statement that the market picked up on was this notion of long and variable lag. So theres a lag between when the fed hikes rates and when it flows through the economy.

And.

There's sort of like different sectors occur at different times. So the most responsive one to interest rates generally housing and you've seen housing really made 180 degree move right. It had been.

Up 20 plus percent in 2021, and then up 10%. The first six months of this year and now you've seen the last few months some of the biggest one month declines <unk> seen in a very long time, right, so housing where interest rates impact people's ability to qualify.

Hi.

You know what.

Where they are where they're at in terms of their debt to income ratios.

So housing has really slowed down dramatically in existing home sales back.

20 year lows.

New home sales slowing down builders talking about order cancellations. So housing it's been the first thing to respond which isn't surprising because it's the most interest rate sensitive.

Starting to see some movements in used car prices. So well there was a lot of volatility today I do think it's.

It has potential to.

Get us into.

A range of interest rates that we've seen that.

You may have some market participants more comfortable that okay. Now is the time to.

Commit capital to some of these markets so.

Again, what Larry said.

Mortgage exposure is towards the upper end of where we normally run it.

<unk>.

If you just look at repo borrowings that's towards the upper end, but you know a lot of what we own a lot of the pools, we own a relatively low pay ups. So while they have financing against them, there's not a lot of risk to them. They're not you know three four point pay ups.

That you saw a lot of other companies deal with during co.

Covid so.

There is a lot of pools that are positive carry versus rolls. So just even a low pay up pool versus being long that versus shorted TBA.

Can generate economic return to the company, which very very limited downside. So there's some of that in the portfolio.

I do expect especially.

If we.

If the timing is right and the valuations makes sense for us to retain the credit I think you'll see some of that agency mortgages.

Exposure come down and then that comes down you'll also see the repo borrowings come down.

We've also you know and that's those numbers are already almost six week in arrears.

Got it thank you.

Sure you're welcome.

Thank you we'll take our next question from Eric Hagen of BT IAG.

Hey, everyone you have eastern saggy on for Eric today. Thanks for taking my questions first one just how do you see dollar roll financing evolving and what conditions would it be most sensitive to.

So this is mark thanks for the question Ethan dollar Rolls right now so people think about the dollar roll market a few different ways. So one way a lot of people think about it and when we think about it is we kind of know what the repo rates are so one month repo rates right now.

Three 9% rate.

So you can look where dollar roll is and you can say, okay. What is the implied prepayment speed.

On that dollar role for me to be indifferent between doing the dollar roll or having a pool on repo.

And when dollar rolls are cheap, they're not special theres not a lot of demand for them.

You see the.

CPR is now now we're talking about discounts at very very low numbers right. So there are a bunch of roles now with the implied CPR is 1% to 3% and you can find pools that.

Pay above that so that's sort of a little bit what I was alluding to when I was answering doug's question. So.

Dollar rolls for all the discount coupons are trading relatively poorly so it's the opposite of what you saw in 2021, when the fed was buying so many Fannie six is in so many so many fannie twos. So many if any two and a half so many dwarf one and a half so many dwarf Tuesday those roles were consistently spec.

Those rules were higher each month than what you would've earned from having a pool and taking it on balance sheet. This year, it's kind of been the opposite the rules have not been.

I have nothing special in the discounts and I don't think Thats surprising given that you don't have you don't have the fed involved buying these things and you don't have.

Other players like banks involved in buying these lower coupons now when you get to some of the production coupons like Fannie six is that there has been some role volatility so.

I would say.

Financing has been orderly this year, but obviously the magnitude of the swings we've had.

Has made people I'm cautious about.

Having excessively large balance sheets and thats one of the reason why youre not seeing.

A lot of the.

The primary dealers and investment banks taken delivery on.

Big portions of roles to sort of earn a spread over.

Where the financing even though it looks economic it's tied up a lot of balance sheet and the costs that balance sheet relative to what theyre going to make that calculus is just you've seen a little bit of it but you haven't seen a lot of it so roles I'd say for the lower coupons have been pretty uninteresting and if you look at our positioning we have pools there.

And we're short TBA is for that reason up in the higher coupons.

There has been some real volatility and we expect that to continue because.

You have a whole bunch of banks pilot to this market and you haven't seen this yet and I don't think you're going to see it like immediately but if you saw a whole bunch of banks come in and want to buy Fannie sixes.

Not a lot of float in that coupon that is sort of considered TBA.

And you could see some real volatility and you've seen some of that earlier than you have seen it.

<unk>.

You know in the last three or four months.

Got it that all makes sense and then.

Just another question kind of piggybacking off the last question on leverage just how much net mortgage leverage do you feel comfortable with and kind of if you can just talk about the relationship between the net mortgage leverage and debt to equity that'd be helpful.

Yeah. So.

We're comfortable with where we're at now.

I don't think we'd bring that up unless spreads were to take another leg wider.

And so basically if you take.

Our mortgage exposure right you can think about the company as having okay. If we just owned a bunch of pools and we're paying fixed out a bunch of so for swaps.

That's our mortgage exposure and then on top of that if we own some pools that are hedge with TBA that won't change our mortgage exposure because the mortgage exposure from the pool, we own is netted against the mortgage exposure were short and shorting ppas, so so having pools versus TBA.

Doesn't it.

Our net mortgage exposure, but it does increase our repo borrowings. So you can look at what we report for net mortgage exposure.

Report for the.

Total total repo borrowings and you can kind of partition of the portfolio is.

Some large portion of the pools hedged so for swaps and another portion of the pools hedged with being short TBA.

Yes, so if you if you.

You refer to slide nine.

You can see that as.

Well, our leverage ticked up but it's not on the slide.

Secondary end of second quarter, the end of third quarter, but are.

Our net mortgage assets to equity ratio also ticked up.

And that mid Sevens as Mark says.

That's towards the high end of the range for us.

So I wouldn't expect that.

Just pick up much from there.

Got it alright, thanks for answering my questions.

Thank you. Our next question comes from Mikhail Government of JMP Securities.

Hi, good morning, gentlemen, and I hope everybody's doing well.

Most of my questions. Thanks, most of my questions have already been touched upon but I was just kind of wondering.

Sort of hypothetical scenario.

Given the CPI print today in the market reaction, if we continue to it yet.

A more favorable CPI prints in the months ahead and the fed say decides to do 50 in December and then cuts.

<unk> down to 25 early next year and then stops.

At some point maybe.

And the later spring I guess the biggest wildcard is do we get a recession.

Around the same time, but I guess my question is.

My question to you is something that we know.

Like I said hypothetical scenario, yeah, I'm, just I'm, just kind of talk it all out.

Whats what would the ideal sort of portfolio construction.

Environment, where the fed has stopped hiking.

Forget forget about the potential recession, just the fed is that there is no longer a hiking they've achieved there.

Neutral rate or so.

Okay. Thank.

And you guys have gone with your portfolio rotation from from now till that point, what would the ideal portfolio looks like.

When that process kind of.

Look like.

So I guess I would say, we don't we have a great research effort here, but it's not about.

Predicting what the fed is going to do so we really tried to position these portfolios.

Agnostic to the direction of interest rates.

And.

Respectful.

Exotic things or surprise numbers that can move the market a lot. So so.

Just with that said.

Think that.

If.

You get.

More good news on inflation and it looks like the fed is near the end of their hiking cycle I think what youll see is like we have.

Comments with a lot of our clients.

At Ellington.

Having to do with the public companies.

Our perception is that there is a lot of capital that is getting interested in fixed income and getting into credit.

And has been waiting because the market has been too volatile and they want to see how far the fed goes in they wanted to see you know because this year, it's basically been a year of the market.

Inflation numbers being running generally higher than predictions and the fed responding and the fed dots going higher and higher. So so I know there's been a lot of people that have been patient and their patients who've been rewarded.

I do think there is a lot of cash.

<unk> is available for the.

The agency MBS market.

And the credit market.

So I think if you get some stability on.

If you get some.

Better news on inflation and.

People's perception of the fed is that the larger hikes are behind US then I do think that money will get deployed I don't think it will wait any longer. So then in that case I think it's good for spread product right. It's good for agency MBS. It's good for the non agency MBS. We spoke in the prepared comments is one thing that.

We think can make sense for earn is to rotate some of the capital into non agency securities is something that we.

We did in 2020 made a lot of sense and part of that thinking is that different sectors.

Recover on different Timeframes, right and so you're already seeing.

Since you know our book value is roughly flat since.

At the end of the quarter to the end of September .

That does say something about what mortgage spreads have done if.

If you look at some.

The credit the non agency parts.

Of the securitized products, so credit risk transfer or legacy non agency bonds non QM bonds that even though you've seen.

A pretty good recovery in these liquid credit indices, we talked about the <unk> index does liquid.

High yield index, those indices did well in October and cash credit bonds generally didn't so crash cash credit bonds.

We're.

Where are the prices were weighed down by a lot of selling you know with mutual funds, it's all different corners.

Some of it was.

A lot's been written and lots been said about these UK pension funds that had doing a liability.

Driven these LD ice strategies, when they were getting margin called on there.

Swaps had to sell so.

You had a very big disconnect between.

Our structured product cash bonds.

From the agency MBS.

And I G and high yield indices.

October right you saw it in the CLO market. So on the CRT market. So that's kind of what.

Got caught our eye that you have a pretty a pretty big basis between cash and synthetic indices.

And so.

I think everything does well in the scenario, where you talk about the fed kind of pauses now in the scenario, where you talk about mild recession I do think that will be supportive of agency MBS because you know.

It's a spread product that doesn't have credit risk to it and so if people really start worrying about you know higher unemployment numbers.

And you've already seen some pretty weak performance in.

Some consumer loan deals in some sub prime auto deals, but if you really get people worried about credit.

Thank you.

It's a favorable thing for agency MBS and the other thing is if banks get worried about recession.

Get worried about.

The obligations under C sold to reserve more capital.

That can make.

Security is more attractive than loan you certainly saw that in <unk>.

Covid right when they've been you know a lot of banks were very concerned about.

Recession, and very concerned about loans, but wanted to put money to work and they were owed.

Well, maybe going into securities. So a lot of hypotheticals, there, but those are sort of some of the things we've been thinking about.

And yes, sorry, just.

I can't I can't resist on the type of debate on that question too.

So I think if you look at where a lot of the credit markets.

Price right now.

Frankly, even.

Some of the non credit markets like the agencies when you look at how.

Widespread Saar in implied volatility and all that.

I think the market is still pricing in a decent chance of rates going a lot higher from here right you could have wage wage price spiraling inflation, all sorts of things that are not off the table. Yet today, obviously is very helpful. So in your scenario.

Let's say that's off the table.

And we're not going to get to a 6% 10 year or something like that.

So that takes a lot of.

A lot of very specific risks off the table right. So.

I think one thing that the market is very concerned about is what's going to happen to real estate prices not just residential but also commercial if rates were to go much higher and if you're a debt holder a lender like we are.

You don't really worry about that so much about that first five or 10% drop in real estate prices, but you worry a lot about a drop.

If you got an LTV of 75, LTV as sort of being a typical lending levels you worry a lot about a dropped 15.

<unk>, 2025% right, because it's never going to be uniform anyway. So.

So I think if you take that kind of risk off the table.

Really spiraling inflation, then I think you will see strong moves in the credit markets.

Youll see real estate prices kind of stabilize.

Think there's a big difference right between if I think in your scenario if you've got more if you've got mortgage rates settling in.

And that 555% area, let's just say as opposed to six and a half maybe where they are now and possibly even lower now.

It just makes a big difference so.

I think that.

I think that just it just take we would take a lot of risks off the table.

And tightened spreads quite a bit and all sectors because it would take even in the agencies that would take a lot of extension risk off the table on current coupons.

Thank you very much gentlemen, that's great detail. Thank you.

Thank you that was our final question for today, we thank you for participating in the Ellington residential mortgage REIT third quarter 2022 earnings conference call.

You may disconnect your lines at this time and have a wonderful day.

Okay.

Okay.

Okay.

Okay.

[music].

Okay.

Okay.

[music] attack.

Okay.

[music].

Okay.

[music].

Okay.

Yes.

[music].

Okay.

[music] message.