Q4 2022 Ellington Residential Mortgage REIT Earnings Call

March 7, 2023

We were able to be positioned this way because we have been patient about portfolio turnover and we have been opportunistic about adding new investments.

Throughout 2020 to reinvestment yields were surging, but yield spreads were widening as well, especially on the lower coupon pools, where we saw the best relative value.

Larger portfolio sales of our discount pools might have boosted a day in the near term, but at the potential longer term cost to book value per share.

Instead, we were selective in turning over those portions of our portfolio that we viewed as offering superior relative value, particularly those lower coupon pools, and we continue to prioritize total return over short term ADR growth.

Meanwhile, our strong liquidity position enabled us to add pools opportunistically in September when spreads gapped out.

Over the course of the fourth quarter, we continue to be opportunistic in this case by Opportunistically selling when we felt that the mid quarter rally had run its course.

As a result by yearend our net mortgage exposure has declined by a full turn to $6 six to one which brought it closer to our historical norms.

I'll now pass it over to Chris to review, our financial results for the fourth quarter in more detail, Chris. Thank you, Larry and good morning, everyone.

Please turn to slide five where you can see a summary of earned fourth quarter financial results.

For the quarter ended December 31, we reported net income of 88 per share and adjusted distributable earnings of 25 per share.

These results compared to a net loss of $1 <unk> per share and <unk> of <unk> 23 per share in the third quarter.

ETE excludes the catch up premium amortization adjustment, which was positive 658000 in the fourth quarter as compared to a positive $1 4 million in the prior quarter.

During the fourth quarter tighter agency MBS yield spreads and increased pay ups drove significant net realized and unrealized gains on our specified pools, which combined with net interest income exceeded net realized and unrealized losses on our interest rate hedges.

Our net interest margin increased slightly quarter over quarter to 137% from $1 two 8% as higher asset yields exceeded the increase in our cost of funds and that included the positive carry that Larry mentioned on our interest rate swap positions.

Our higher NIM drove the sequential increase in Adv, even as our average holdings declined quarter over quarter.

Meanwhile, pay ups on our specified pools increased to 126% as of December 31 from 1.0% to 2%.

September 30th.

As prepayment rates continued to decline market wide.

Specified pool investors are increasingly focused on extension protection rather than prepayment protection.

This has been a tailwind for the pay ups on our specified pools, because the market is recognizing the significant extension protection they offer relative to their TBA counterpart.

In addition, the pools that we did sell during the quarter had lower pay ups relative to our overall portfolio.

The combination of these factors led to the sequential increase in pay ups.

Please turn now to our balance sheet on slide six.

Value was $8 40 per share at December 31, as compared to $7 78 per share at September 30.

Including the 24 cents of dividends in the quarter, our economic return was 11, 1%.

We ended the quarter with cash and cash equivalents of $34 8 million up from $25 4 million at September 30.

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

In the fourth quarter, our agency MBS holdings decreased by 5% to $863 $3 million.

The decrease was driven by net sales and principal payments of $57 9 million.

Which exceeded net realized and unrealized gains of $11 8 million.

Agency MBS portfolio turnover in the fourth quarter was 18%.

Over the same period, our non agency MBS portfolio increased by $4 8 million to $12 6 million, while our holdings of interest only securities were roughly unchanged.

Additionally, our debt to equity ratio adjusted for unsettled purchases and sales decreased to seven six times as of December 31.

Compared to nine one times at September 30.

The decrease was primarily due to a decline in borrowings on our smaller agency MBS portfolio and higher shareholders' equity quarter over quarter.

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

On slide eight you can see 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.

The size of our net short TBA position based on 10 year equivalents increased quarter over quarter.

I will now turn our presentation over to Mark.

Thanks, Chris.

After a challenging nine months for agency MBS, it's nice to be able to report a strong quarter and to make back some of the prior quarter's losses.

Most parts of securitized products, where investors take on credit risk and the possibility of principal loss in exchange for excess yield.

The agency MBS market is unique in its ability to offer high yields without credit risk.

Most agency mortgage REIT had a good deal of their interest rate risk. So the primary driver of quarter by quarter economic returns for our hedged agency mortgage REIT is relative total return of agency MBS compared to hedging instruments, which are usually treasuries and interest rate swaps.

The total return of agency MBS starts with the carry on MBS assets compared to the carry on hedging instruments.

As interest rates and yield spreads move around you also have to factor in delta hedging costs and the relative price performance of MBS assets, both pools and TBA compared to hedges.

In quarters, where yield spreads are very volatile as we've seen for the past four quarters economic return tends to be driven primarily by the relative MBS price performance, where the outperformance.

Under performance.

For the first three quarters of 2022, the relative price performance of agency MBS was negative agency MBS dropped in price a whole lot more than a basket of similar duration treasuries in the face of heavy invested liquidations and soaring rates and volatility, but in Q4 that reversed dramatically.

So what happened in Q4 when you finally saw some evidence that inflation is responding the federal reserve tightening cycle and higher interest rate environment. These green shoots for the potential end of this hiking cycle insight and that changed the direction of fixed income capital flows from outflows to inflows.

And when considered against the backdrop of greatly diminished new MBS production those inflows led to significant MBS outperformance.

You can see that in the price changes on slide three across the board agency MBS prices significantly outperformed their hedges.

Markets generally normalized with Evercore pricing levels are what I mean by that is that the bond market participants and researchers, especially spread sectors like MBS typically start the assumption that current yield that current yield levels and spread relationships are fair I think it's worth reminding everyone of the magnitude of the repricing.

<unk> 2022, and what was considered fair versus where we are versus today.

We started 2022 with Fannie twos, the dollar price of 99, eight and we ended the year with them at 81, 6% down over 18 points.

With the start of the year, Fannie twos and there are more than one five trillion of them. We're the bellwether coupon and they yielded about 2% now we're buying Fannie five years after the discount and the nominal spread on the par coupon mortgage is significantly wider than the 20 year historical average.

Almost a 400 basis point move in a little more than a year and doing the 15 year bull market and bringing MBS yield back to their 2007 levels.

Now mortgage rates are higher than before the fed began its mortgage bond buying program and the fed is just sitting on a large portion of the market, which has reduced what's available to private investors.

So where are we now.

The market is currently pricing in a terminal funds rate of almost five 5% and that means more hikes from here, but the biggest moves are clearly behind us from the market's perspective.

And what's this inverted yield curve is saying about the future. It's lower rates are coming the two year note now youll almost 5% and the two year note two years in the future as this is expected to be over 100 basis points lower.

You put all this together and you can see why fixed income flows turned positive in Q4, there are some signs that inflation, while high is starting to slow.

Some fed watchers expect the heightened cycled to pause as soon as next quarter and the risk of recession has set market expectations of significantly lower rates sometime next year, whether all of that actually happens nobody knows but that set of expectations put fixed income in a pretty good place to attract capital.

Capital flowing into fixed income as opposed to out of it very significant for MBS fixed income investors have not seen yields as high since 2007, and they are voting with their wallet.

You can see funds flowing into Etfs and mutual funds.

But there are two headwinds first banks, which are normally huge agency MBS investors have been quiet, they're struggling with diminished capital from.

From held for sale losses and from weak deposit growth.

Competition from money market funds commercial banks, so year over year deposits shrink for the first time in 70 years.

And second of course is the absence of fed buying.

Get a lot of questions about what an inverted yield curve means means for AE and return expectations going forward.

<unk> in the fed funds rate is typically not only.

It's typically only a short term headwind.

Spreads have widened on longer term repo and in response, we've shortened the average tenor of over 10 of our repo as you can see on slide 17.

As a result, our repo expense now goes up almost in lockstep with the fed funds rate, but it takes at least a quarter longer four or <unk> to normalize for a few reasons.

The floating rate leg, we receive on our swap will also reset higher but those only reset every three months and the extent that our fixed payer swap portfolio is smaller than our asset portfolio, we need to raise asset yield to turn it over to make up the difference.

But once the hike stop in our portfolio turnover continues our asset yield should catch up and fully reflect the wider spreads currently in the market.

Those wider yield spreads relative to financing costs and hedging instruments hedging costs.

Should drive <unk> moving forward.

But what will it mean for agency MBS. If the forward curve is correct and we get a mild recession and lower interest rates.

That's probably the best case for agency MBS Nomura has put out some great research explaining this dynamic.

A 75 basis point drop in the mortgage rate does very little forgetting coupons in the money. So it is not material for refi supply, but in a recession banks typically favorite securities over loans, it's been a mild recession, we would expect an incremental increase in bank demand also within fixed income agency MBS tend to outperform.

<unk> corporate center recession two.

Finally, slightly or rates are also probably supportive further fixed income flows.

Right now housing is relatively unaffordable looking at monthly mortgage expense at current rate levels relative to median income. So you are seeing existing home sales really dropped like a stone. The other powerful force did a slowing existing home sales is about mortgage researchers referred to as the lock in effect the locked in.

<unk> has been a homeowner has a mortgage rate that is several 100 basis points below the current rate they are locked in low payments significantly.

Them from moving lots of moves a local a growing family once an extra bedroom or empty nesters want to downsize. These moves are discretionary and a 300 basis point jump in a new mortgage versus an existing one will dramatically change their monthly mortgage payment.

<unk> also helped to keep new MBS supply in check.

All in all a mild recession, probably ushers in a decent pickup in agency MBS demand with only a very modest uptick in new supply.

So what did we do for the quarter and how are we currently positioned and what is their future outlook. You can see on slide 14 that we shrunk our agency MBS portfolio during the fourth quarter given the strong performance in the quarter. It made sense to reduce MBS holdings on a relative.

The relative value is not as compelling, but it was our disciplined hedging process in cash management that allowed us to hold our portfolio intact through some very volatile times in 2022 and that allowed us to capture returns in Q4 to offset some prior losses.

You can see on this slide that we reduced our holdings of 15 year mortgages, given the inverted yield curve that sector is seeing almost no new origination. So it's shrinking from pay downs. The net negative supply has driven prices to much tighter spreads relative to relative to treasuries and 30 year MBS that maybe they will continue but.

We are just finding better relative value in the 30 year market right now.

January was another month of strong performance February reverse some of those gains, but we're still solidly up for the year.

Spreads are currently attractive and the consensus path of a few more hikes, followed by some better inflation news and weaker economic numbers should be a very good backdrop for MBS performance, but experience has taught us that the forward curve is often wrong. So we remain disciplined about hedges and are prepared for a range of scenarios, we see lots of relative value.

<unk> in the market. So that we look to exploit to drive incremental returns now back to Larry.

Thanks Mark.

2022 was by many measures the worst year for MBS and at least 40 years and perhaps ever.

Ellington residential is long standing sector, a focus the agency MBS sector. It was truly nowhere to hide as.

So Bloomberg MBS index had its worst yearly performance on record on an absolute basis, and its second worst year ever relative to treasuries.

Throughout 2022, we had to navigate periods of extreme volatility and market dysfunction with interest rates rising rapidly and yield spreads widening along the way.

Despite these challenges our risk and liquidity management enabled us to avoid realizing even larger losses.

As a result, we were able to buy into extreme weakness late in the third quarter and then sell into strength in the fourth quarter.

By doing so we enter 2023 with reduced leverage and strong liquidity, which is now allowing us to play offense once again.

On last quarter's earnings call. We discussed that we are planning to selectively rotated a portion of our capital from agency MBS to other residential mortgage sectors and thats still very much on our radar screen.

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

And as usual.

Absent a big yield spread widening event, where we want to pounds, we plan to be patient and opportunistic picking our spots.

So far this year January started the year off on a positive note with agency RBS enjoying an excellent month as agency yield spreads tightened further.

The tightest turned a bit since then with interest rates and volatility up both in February and so far in March, especially with palace comments. This morning.

Year to date through the end of February we estimate that earns book value per share was up close to 4%.

With that we'll now open the call to questions. Operator. Please go ahead.

Thank you Sir 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 by pressing star two.

Once again, please press star one to ask a question.

Our first question comes from Eric Hagen with <unk>.

Hey, Thanks, good morning, guys.

Got a couple here.

How are you thinking about volatility in the market, especially connected to a recession.

And the impact that it has on the flexibility from banks to support repo financing.

Like are there good ways, you think to hedge against the kind of credit risk at banks because of the transition to sofa.

From LIBOR over the last couple of years, and then as a smaller cap mortgage rate are you concerned about the access that you have to repo and banks is continuing.

Continues to rise.

And then.

How do you think mortgages would respond to any further backup in rates at the long end of the curve as well as the short end I mean, we all know that most of the sensitivity is concentrated at the long end, but how sensitive do we think the bases.

If fed funds are meaningfully higher than.

The forward curve currently projects. Thank you guys.

Hey, Mark why don't why don't I take the repo portion of that and then you'll address the how.

The mortgages should react to what's going on the yield curve.

Sure Yes.

Yes so.

No. We're not we're not really concerned about repo repo and especially in agency pools has just been <unk>.

Credibly resilient.

Including most notably through the financial global financial crisis.

We have a lot of very large diverse set of repo counterparties.

Explicitly limit our exposure to smaller counterparties.

And we.

Most of our repo is through the very large banks that are again since the global financial crisis extremely well capitalized.

It's.

It's something that we watch I mean, they have to spend a couple of banks that have been in the news and you have seen there. They are the credit spreads and their own debt there'll be a little bit volatile, but again.

We limit our exposure there at Ellington residential to those counterparties and its just not something that we're worried about.

Whether it be from a counterparty credit risk of our repo counterparties or from a repo availability perspective.

Perspective, I mean, we've just seen absolutely no blips.

In terms of that availability.

Mark do you want to handle the.

The second part.

Sure. So I think the first question Eric was about volatility.

Volatility has been pretty high this year, but the act, but realized volatility is certainly down from last year and like to me I think about sort of two types of volatility one is.

What's the volatility in treasury yields right. So how many basis points today or are they realizing versus what.

Kind of built into market expectations, and you've been sort of.

Realizing about whats built on more.

Market what market expectations.

Patients are priced in which sort of means that if you think about things in OAS terms that youre delta hedging costs are about what what.

The OAS you thought you were buying.

Is predicated upon so that has been definitely manageable, it's been a more manageable than last year now the other the other part of volatility that I think a lot about is what is the volatility of mortgage spreads relative to treasuries and thats, where you've really seen things come down debt.

The amount by which mortgages outperform or underperform treasuries on sort of a given day this year versus last year. It's a lot less so you've had kind of mortgages they've had modest outperformance this year.

But the isolation has been between sort of.

Their best performing days in their worst performing days or a lot.

Closer than what they were last year and I attribute that to the flows in mortgages are a lot more balance so sort of like anyone who needed to shed a lot of duration in response to.

The fed hikes last year outflows they had let's say, it's a mutual fund or.

Pension fund raising cash I think you've seen those those big outflows occur and if you look at.

<unk> data and mutual fund data, you've seen kind of modest inflows into fixed income.

And some inflows into.

Mortgages, specifically, especially through some of the Etfs. So the flows have been more balanced now. The second question you had about how to mortgages performed if.

<unk>.

Rates go higher then.

It is currently built into the forward curve, so I mentioned that sort of like mild recession, which probably the best case for mortgages and so I would say that the case, where I think right now sort of terminal fed funds rate is expected to be right around five 5%.

I think cases, where its materially higher than that.

There are scenarios, where you have say 10 year yields.

Go go materially through the highs of last year, I think last year, we got to $4, 35% or $4 40, we sit a little bit below 4% now so I think scenarios, where yields go up through last year's highs on the long end.

<unk>.

Fed funds rate is a lot higher than what is currently built into expectations. I think those are hardest scenarios for mortgages because I think.

In scenarios like that you're more likely to see fixed income outflows.

It's sort of a little bit of the opposite of.

What made sort of what may cause I think kind of a mild recession scenario, which is what is currently built into the forward curve.

<unk>.

That mild recession scenario those technicals are sort of the best for mortgages and I think materially higher rates.

Mark It seems like Inflations aren't coming down as much.

That I think is more challenging scenario.

Yeah I appreciate the color from you guys as always thank you.

Thanks, Eric.

Thank you. Our next question comes from Crispin Love with Piper Sandler.

Thanks, I appreciate you guys, taking my questions just.

First on looking at potential buyers of agency MBS over the near term Mark you talked about this a bit but with banks stepping back from the second sector. In 2022 do you still view that there's an opportunity there for banks to be a meaningful buyer in agency in 2023, if bank loan growth pulls back.

Would that be delayed into 2024, and then just any other.

Central tailwind for agency, you think are worth calling out.

Sure So I think.

What what really turned the dial on agency MBS performance in Q4 as opposed to.

Quarters, one two and three was really money manager buying in response to inflows right like investors like long term pools of capital pension funds insurance companies are.

We're seeing yields they haven't seen since 2007 right. So there has been enough to get people when they see some modicum of stability in rates.

Capital of fixed income so I think that was it was really money managers are the.

The type of buyers that really have driven.

Performance in Q4, and so far this year banks, so far has still been on the sidelines <unk>.

<unk> seen them basically sell some of the Fannie Freddie is the buying they are doing is mostly in <unk>, because it's a different capital waiting and they've also been.

Preferring loans over securities for.

Yes.

Lower mark to market impact.

Impact on their balance sheet so I.

You did see some bank buying banks typically buy.

After they've seen a little bit of a rally so they generally like they're not the kind of catch a falling knife type of buyer, they're sort of like they'd rather buy the bounce type buyer. So you did see a little bit of bank buying in.

Earlier this year when we had rallied some but I think thats dissipated a lot. So I don't think youre going to see material bank buying.

Unless.

Our rates sort of stabilize start going back down.

And.

If concerns about credit performance are significant credit performance and loan portfolios is significant enough to cause them to favor securities over loans for credit reasons, and you typically see that happen in a recession right now the economic numbers have been strong the other thing.

Which can also drive some of the bank behaviors now everyone's under this seasonal regime right. So if you do have.

Weaker credit performance in the consumer or credit performance in <unk>.

Loans, then that can drive a revision to.

The capital you need to hold against loan portfolios for seasonal and if that starts happening thats, certainly something that would cause them to favor.

Securities over loans.

Thanks Mark.

And then just one other for me, it's more of a numbers question for from the quarter, but.

Looking at core other income after making all the adjustments for AE was pretty sizable in the quarter versus the previous quarter. After backing out the adjustments I can still got check core other income about $2 7 million I'm. Just curious if you can comment on the key driver in the change there and kind of what's in there that drove the significant increase.

<unk>.

Versus the previous quarter.

Sorry can you repeat the question. This is Chris Yeah. So looking at core other income after making all the adjustments for AE.

It was about $2 7 million, which was a kind of a significant increase over the previous quarter after making the adjustments for different kind of realized and unrealized gains just curious if you can comment on kind of the key driver in what drove the higher core other income in the quarter.

We can definitely take this offline.

If you don't have it handy.

Yes, Chris.

The swap payments the swap benefit that we were talking about before.

Alright, perfect perfect. Thank you very much.

Yes.

Thanks, Chris.

Alright, thank you.

Thank you. Our next question comes from Mechelle government with JMP Securities.

Hey, good morning, gentlemen, congrats on a solid quarter and appreciate the book value update.

Just a quick question from me.

It kind of opportunities are you guys seeing in the non agency space I guess, you're mentioning here.

<unk> two on your list of the annual objectives is to continue to rotate to a portion of capital into that space. So I'm just curious about that.

Okay.

Yes, so the two sectors in non agencies that looked to us most attractive right now are some of the more seasoned credit risk transfer bonds and the other one is sort of the legacy non agency market. So that's sort of the pre crisis bonds.

2007, and earlier people have been in their homes 15 16 years.

It's kind of a fragmented market its a lot of smaller pieces. There is a lot of.

Securities, where youre backed by maybe 15 20 loans. So cash flows are lumpy, but our analytics are very strong in that area.

And.

Because you really need to take a granular approach to looking at the individual loans its deterrent to people that sort of just wanted by beta. So we see that sector is attractive now it's now.

You have to counter punch, a little bit there you have to wait for sellers, because it's not like the non QM market or another new issue market, where there is new issue deals and you can just put in your order on new issue and get invested that way. This you need to respond primarily to bid list, but those are the two sectors that.

We see the best relative value and we're not looking too.

<unk>.

That portfolio is not.

M D.

<unk> two it's not sort of contemplated taking a lot of credit risk. So we're going to put to work. There are securities that we think you can shark home prices.

Financial crisis shock and Youre going to get your capital back so it's not going to be way down the capital stack and things that are.

Subject.

Small changes in loss expectations really change your expected returns things higher up in the capital structure. It's not it's very similar to what we did in 2020 at a COVID-19 right 2020 out of Covid.

We raised cash once the fed started buying.

And.

Agency MBS tightened in agency MBS, they are tightening cycle preceded the tightening cycle in.

Credit sensitive assets so.

After the agency MBS, it really start to form well.

March of 2020, we rotated into some non agencies and it worked out really well.

Great. Thanks, Mark and just kind of curious obviously, it's not an issue at the moment, but.

Kind of looking forward at what point could.

Prepay speeds start to spike what kind of environment would we have to get to.

As rates keep on rising.

Like I said, obviously not an issue at the moment, but.

Okay.

What could happen down the rates are great question. It's a great question, we actually just got the new.

When you get these monthly prepayment reports fifth business day of the month. So we got the prepayment report last night.

And.

It showed a very modest uptick maybe 10% from extremely low levels. So I think about it two ways. There's some very small portion of the mortgage market.

Where people have note rates 757, a quarter percent bigger loans.

We think those borrowers.

I was going to be very responsive to refinance opportunities. If the forward curve is borne out and you see mortgage rates dropped and you have still been layoffs.

Industrywide among mortgage originators, but you still have excess capacity. So if you saw 2030 40 basis point drop in mortgage rates youre going to see that very small portion of the market that has high note rates. So people that took note rates you know.

Q4 of last year, those are going to be responsive and this actual this recent prepayment report yesterday, you saw a little bit of that behavior.

Behavior, because this prepayment report.

<unk>.

Mortgage rates are little bit lower than where we are now but now if you think of at the market in aggregate to.

To get a real prepayment wave you need to get big portions of the market refinance the ball and I don't think you see that until you get well.

Well below 5%, even move things 75 to 100 basis points here the percentage of loans that have a refinancing incentives.

It's very low the first thing I think you'd see is that if you drop in mortgage rates, let's say to five in a quarter.

Now all of a sudden people with.

Four in a quarter 454, and three quarter note rates, they're going to be more willing to do cash out refinance so.

So that can happen that'd be sort of incremental but to get.

We'll.

A big portion of the market refinanced a bowl with straight right revise youre going to have to be well under 5%, but I think youll see.

You got a little pockets of faster speeds, along the way and if you hold those pools you can get hurt on those pools, but it doesn't change the supply demand.

Demand dynamic for mortgages until you get significantly lower rates.

Got it. Thank you for that thank you very much guys best of luck going forward.

<unk>.

Thank you. Our next question comes from Jason Stewart with Jones trading.

Hi, Thanks, guys.

Wanted to know a little bit further on your thoughts on investing across the agency coupon stack.

Vis vis the.

The dividend.

I guess.

Kind of where we see the most value now.

Is.

Like sweet spot like it's coupons that are high enough, where youre getting enough coupon that you're sort of like.

It's going to be close or getting close to your.

Financing costs, but arent, so high that a little bit of drop in mortgage rates you can see a big pickup in speeds. So I would say fours 4555, and a half that to us looks.

I think that's where you want to be I think you want to.

Be positioned such that if you have.

A drop in rates if the forward curve turns out to be right you have at least.

A few points of room before you get to par them before you really have to start worrying about prepayments.

I'd say that those coupons kind of fit that bill, but they also.

Do you also have the nice property that youre not seeing new production today in <unk> and $4 five so each month, if you own pools or even if you're on TBA is it sort of your own pools everything seasonal month by month, but even if you have TBA exposure there the assumptions, what's deliverable is getting older each months youre getting kind of the.

Benefit of seasoning, there and I think that.

It's sort of the very higher coupons, we have really big loan balance that a small drop in rates youre going to have an army of people trying to refi those loans that that to me is I think an area that we will have challenging performance. If the forward curve. It's borne out when you do have lower rates second half of this year and next year.

<unk>.

And if I could just add.

If you look at our net interest margin.

And you leverage that.

Given you can look at our debt to equity you can look at our net mortgage exposure, which we dial up and down you can see that.

Hi.

The dividend.

Be well covered from that perspective.

Especially given where short term rates are.

Because that's a tailwind as well.

<unk>.

It's really a.

Spreads have been so volatile lately I mean, we talked about how that GAAP debt at September tightened in November now.

Obviously this year.

Sort of a similar thing January .

Tightening in February and March widening so.

It's definitely a market, where we feel that by dialing down up and down that net mortgage exposure we can.

Generate incremental earnings and so I think.

With that as well, which obviously.

Came into play in a big way in the fourth quarter.

We can.

Absolutely cover the dividend.

Got you great. Thanks, guys.

Thank you that was our final question for today.

Thank you for participating.

Yes.

And the Ellington residential mortgage REIT fourth quarter 2022 earnings conference call.

You may disconnect. Your line at this time.

Have a wonderful day.

[music].

Good morning, ladies and gentlemen, thank.

Thank you for standing by.

Welcome to the Ellington residential mortgage REIT 2022 fourth quarter financial results Conference call.

Today's call is being recorded.

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It is now my pleasure to turn the floor over to Alan Dean Chalet with Associate General Counsel, Sir you may begin.

Thank you 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 and 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. We strongly encourage you to review the information that we have filed with the SEC, including the earnings.

Released in the Form 10-K for more information regarding these forward looking statements and any related risks and uncertainties.

Unless otherwise noted 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 me on the call today are Larry Penn Chief Executive Officer, Ellington residential Mark <unk>, our co Chief investment Officer.

And Christopher <unk>, our Chief Financial Officer as described in our earnings press release, our fourth quarter earnings Conference call presentation is available on our website <unk> Dot com. 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 notes at the back of the presentation and with that I will turn the call over to Larry.

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

During the fourth quarter inflation continued to moderate and the federal reserve ratcheted back the pace of interest rate hikes.

The market welcome these developments and agency MBS rebounded sharply following three consecutive quarters of dismal performance volatility.

Volatility declined incrementally and investor demand for RMB as increase together this drove nominal and option adjusted yield spreads tighter, especially in November and so the year ended on a more positive note.

Turning to the Investor presentation, and the bottom section of slide three you can see the significant yield spread tightening that occurred across the agency MBS coupons in the fourth quarter, which caused the MBS prices to rise, even though long term interest rates were actually moderately higher.

Meanwhile, short term interest rates spiked for yet another quarter you can see on this slide just how much short term interest rates moved not just during the fourth quarter, but also over the course of 2022 in absolute terms as well as relative to long term rates.

This trend has continued into 2023 and the yield curve is now the most inverted it's been since the early 19 days with a two year tenure yield spread now more than 90 basis points negative.

The inverted yield curve has pressured net interest margins entry industry wide and coupled with the extreme interest rate volatility that we've experienced since the beginning of 2022, it's really put the effectiveness of interest rate hedging programs under a microscope.

For earn we've hedged along the entire yield curve and rebalanced our hedges frequently.

Both of which can be more expensive at times, but also more effective across a wide variety of market environments.

As interest rates surge last year, we were continuously rebalancing our hedges.

The delta hedging costs associated with this rebalancing were high but they were essential in preventing deeper book value declines.

With a yogurt currently converted we're at least getting the benefit of positive carry on our interest rate swap hedges, where we are receiving the higher sofa rate, while paying lower fixed rates.

In the fourth quarter. These swaps serves a dual function of offsetting some of the impact of the higher long term interest rates, while also boosting our net interest margin and adjusted distributable earnings.

Let's turn next to slide four for an overview of our strong results for the fourth quarter.

MBS had weakened significantly in September of last year, and we have responded by buying MBS aggressively into that weakness.

As a result, we entered the fourth quarter with our net mortgage exposure of seven 5% to one which did towards the upper end of our historical range that.

And that positioned us incredibly well for the spread tightening that occurred during the fourth quarter and so we were able to recoup a good chunk of unrealized losses from the prior quarter.

For the fourth quarter, we generated a non annualized economic return of 11, 1% and net income of 88 per share, which easily covered our dividends for the quarter.

We were able to be positioned this way because we have been patient about portfolio turnover and we have been opportunistic about adding new investments.

Throughout 2020 to reinvestment yields were surging, but yield spreads were widening as well, especially on the lower coupon pools, where we saw the best relative value.

Larger portfolio sales of our discount pools might have boosted.

In the near term, but at the potential longer term cost to book value per share.

Meanwhile, our strong liquidity position enabled us to add pools opportunistically in September when spreads gapped out.

Over the course of the fourth quarter, we continue to be opportunistic in this case by Opportunistically selling when we felt that the mid quarter rally had run its course.

As a result by yearend our net mortgage exposure has declined by a full turn to $6 six to one which brought it closer to our historical norms.

I'll now pass it over to Chris to review, our financial results for the fourth quarter in more detail, Chris. Thank you, Larry and good morning, everyone.

Please turn to slide five where you can see a summary of earned fourth quarter financial results.

For the quarter ended December 31, we reported net income of <unk> 88 per share and adjusted distributable earnings of 25 per share.

These results compared to a net loss of $1 <unk> per share and <unk> 23 per share in the third quarter.

<unk> excludes the catch up premium amortization adjustment, which was positive 658000.

In the fourth quarter as compared to a positive $1 $4 million in the prior quarter.

During the fourth quarter tighter agency MBS yield spreads and increased payoffs drove significant net realized and unrealized gains on our specified pools, which combined with net interest income exceeded net realized and unrealized losses on our interest rate hedges.

Our net interest margin increased slightly quarter over quarter to 137% from one 2% to 8% as higher asset yields exceeded the increase in our cost of funds.

And that included the positive carry that Larry mentioned on our interest rate swap positions.

Our higher NIM drove the sequential increase in Adv, even as our average holdings declined quarter over quarter.

Meanwhile, pay ups on our specified pools increased to $1 two 6% as of December 31 from 1.0% to 2% at September 30.

As prepayment rates continued to decline market wide.

<unk> investors are increasingly focused on extension protection rather than prepayment protection.

This has been a tailwind for the pay ups on our specified pools, because the market is recognizing the significant extension protection they offer relative to their TBA counterpart.

In addition, the pools that we did sell during the quarter had lower pay ups relative to our overall portfolio.

The combination of these factors led to the sequential increase in pay ups.

Please turn now to our balance sheet on slide six.

Book value was $8 40 per share at December 31, as compared to $7 78 per share at September 30.