Q3 2023 Ellington Financial Inc Earnings Call
Okay, well, thanks, Don Hey, we do appreciate your patience messenger. Please continue to standby.
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Yes.
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Good morning, ladies and gentlemen, thank you for standing by welcome.
Welcome to the Ellington Financial's third quarter 2023 earnings conference call.
Today's call is being recorded at this time, all participants have been placed in a listen only mode.
The floor will be opened 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.
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If you should require operator assistance again, please press star zero. It is now my pleasure to turn the call over to our D. In Chile. Please 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 Securities Litigation Reform Act of 1995 forward looking statements are not historical in nature.
As described under item one day of our annual report on Form 10-K, and part two item one day of our quarterly report on Form 10-Q for the quarter ended June 32023 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 day.
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.
I'm joined on the call today by Larry Penn Chief Executive Officer, Ellington financial Mark to coffee co Chief investment Officer of EMC and Jr. Herlihy, Chief financial Officer of BSC.
Described in our earnings press release, our third quarter earnings Conference call presentation is available on our website Ellington financial Dot 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 end notes at the back of the presentation with that I will now turn the call over to Larry.
Hello, Dan and good morning, everyone.
As always thank you for your time and interest in Ellington financial.
I'll begin on slide three of the presentation.
For the third quarter, we reported net income of <unk> 10 per share and adjusted distributable earnings of 33 per share.
Steady performance from our credit portfolio, along with along with significant net gains on our interest rate hedges exceeded net losses in agency MBS and we delivered a positive economic return in an extremely volatile market.
On this slide three you can see the strong contribution from the credit portfolio, which was led by positive performance from our residential transition non QM and commercial mortgage bridge loan businesses and our credit risk transfer securities.
Our agency strategy on the other hand contributed a loss of <unk> 16 per share for the third quarter.
What was arguably the most challenging environment for agency MBS investors, we've seen since March of 2020.
During the quarter long term interest rates rose sharply and volatility spikes as the market priced in a higher for longer interest rate environment and the uncertainty related to a possible government shutdown.
While we did have a significant loss in our agency strategy, our interest rate hedging strategy, which included aggressive duration rebalancing throughout the quarter and a positive contribution from our short TBA positions help prevent further losses.
We had entered the third quarter with high levels of liquidity and additional borrowing capacity and because of that we were well positioned to capitalize on the investment opportunities that the market volatility presented.
With agency yield spreads near their historical Wides, we took advantage by adding staff portfolio and we also captured attractive yield spreads by expanding our non QM residential transition loans and reverse proprietary mortgage loan portfolios during the quarter.
Moving forward I expect that our loan portfolios will continue to grow but for our agency portfolio. While we grew that opportunistically. This past quarter to take advantage of wider spreads I still expect that portfolio to shrink over time as we redirect capital to crack.
Also during the quarter, we continued to ratchet down our commercial mortgage bridge lending given the ongoing headwinds in the commercial real estate sector.
Loan Paydowns and payoffs continue to exceed new origination volume in our bridge lending business.
While the share of our portfolio represented by multifamily grew to an even larger majority of our overall commercial mortgage portfolio.
At September 30th a commercial mortgage loan portfolio was as small as its been in nearly two years.
But considering the distressed opportunities that we are starting to see at the market now this portfolio can expand again in future quarters.
We remain patient as the cycle progresses, and we'll pick our spots.
A long rich segment. Meanwhile, generated positive results for the quarter despite the volatility.
The segment had substantial interest rate hedging gains and those gains exceeded net losses in originations and on the proprietary reverse mortgage portfolio as well as net as well as the net mark to market loss of $8 $2 million on the reverse of MSR portfolios.
Maybe taking a step back for a second and actually be a little confusing. However, reverse msr's are shown on our balance sheet and I'm going to try to clarify that.
Now some of our MSR appear on our balance sheet justice individual MSR assets and those are straightforward enough.
However, our biggest MSR comes from the billions of dollars of each MBS securitization at long Beach has done over the years and since we consolidate those H MBS securitization those msr's don't actually appear on our balance sheet as msr's per set.
Instead, those msr's are basically represented by the difference between our on balance sheet, H MBS assets and our on balance sheet <unk> liabilities.
That's why in our public filings and financials, we refer to our H M. B S related MSR as our H MBS MSR equivalent.
Our GAAP financials, you compute the value of the MSR as the value of certain assets minus the value of certain liabilities and that result is equivalent to the value of the H MBS related MSR.
Okay getting back to that $8 $2 million mark to market loss on our reverse MSR portfolios, let's dig a little deeper.
That was actually a result of offsetting factors.
The loss primarily reflected the difference between on the one hand, a large markdown on our existing msr's, including the H MBS MSR equivalent and the other on the other hand, a less large mark up on the MSR portfolio that we acquired out of a bankruptcy proceeding on July 1st.
First I'll address the MSR Mark down.
To evaluate Msr's, we get input from two of the most widely respected reverse MSR valuation experts in the industry.
Despite that fact, we concluded that a couple of their assumptions and their fair value assessments were too aggressive.
First we decided that it was appropriate appropriate to use a higher yield to discount the future projected MSR cash flows as compared to the yield that they use <unk>.
Second based on our observations of where H MBS tails have been trading we decided that it was appropriate to assume a lower exit prices for future tail securitizations as compared to the prices that they are shipped.
In addition, we also assumed that we would incur higher future sub servicing expenses as compared to what we were told previously with a standard expense assumptions.
In order to reflect the sub servicing expenses that we think will actually be able to obtain and maintain.
So all of these factors explain the markdowns on our existing Msr's.
Second as the MSR market we have.
Applied these more conservative MSR pricing assumptions to that MSR portfolio, we acquired out of bankruptcy in early July.
While this resulted in an evaluation that was considerably lower than our third party experts valuation.
The valuation was still considerably higher and a distressed price at which we acquired that MSR MSR portfolio went the markup.
In summary, we believe that our more conservative assumptions more accurately reflect fair value and our belief is further validated by several offerings of reverse MSR portfolios that we've seen recently in the secondary market.
With the notable exception of that distressed acquisition of hours in July. These recent MSR offerings ultimately did not trade because reserve prices were not met.
Back to long bridges results for the quarter, while our Longbridge segment was profitable on a mark to market basis, including hedges the segment's contribution to our adjusted distributable earnings for the quarter turned negative.
In a nutshell challenging market conditions compressed gain on sale margins and loan valuations, particularly in the back half of the quarter.
As a reminder, longbridge is origination P&L is a component of our adjusted distributable earnings creates volatility in our <unk>.
This past quarter. It was the negative contribution from Longbridge that caused Ellington financial sequential decline in overall.
Looking ahead with our updated MSR valuations and a growing proprietary reverse mortgage portfolio and with Longbridge is increasing market share in the industry I believe that longbridge is well positioned to make meaningful positive <unk> contributions prospectively.
Looking to the remainder of the year, we finished the third quarter with our recourse debt to equity ratio of just two three to one which is still towards the lower end of our historical levels.
As you can see on slide three our cash and unencumbered asset levels show that we still have substantial dry powder to invest.
Meanwhile, we are full speed ahead on our merger with Arlington and expect to close next month.
We've outlined several strategic benefits of the transaction and I'll briefly highlight a few of those again now.
First we will be adding a sizable portion of the portfolio of low coupon agency mortgage servicing rights, which gets us into the agency MSR business already at scale. These.
These msr's should perform well in a high interest rate environment.
And function as a natural complement to many of Ellington financials existing investments.
Second we will be able to tap into significant additional dry powder to deploy a market rich with investment opportunities. Both by financing Arlington's currently Unlevered agency MSR portfolio and also by monetizing arlington's liquid assets and rotating that capital into higher yielding investments.
We project the merger to be accretive to earnings per share and a day by the second quarter of this coming year.
Third we will significantly increase Ellington financial's capital base, and a highly efficient manner, not only with common equity, but also with low cost preferred equity and unsecured debt.
And finally by significantly increasing our scale and bringing us a new group of shareholders. This transaction should enhance the liquidity of our common stock while lowering our operating expense ratios.
With that I'll turn the call over to Jay to discuss our third quarter financial results in more detail.
Thanks, Larry and good morning, everyone for the third quarter, we reported net income of <unk> 10 per share on a fully mark to Mark basis, and adjusted distributable earnings of 33 cents per share.
These results compare to net income of four cents per share and <unk> of 38 cents per share for the prior quarter.
On slide five you can see the attribution of net income among credit agency and Longbridge.
The credit strategy generated 37 cents per share in net income driven by an increase in net interest income sequentially and significant net gains on interest rate hedges.
A portion of this income was offset by net realized and unrealized losses on consumer loans non QM loans commercial mortgage bridge loans at CBS. We also had small net losses on investments in unconsolidated entities and credit hedges and other activities.
Notably our loan originator affiliates Landshark Bar American Heritage and Sheridan all posted strong quarterly profit.
Although the fair value marks for those investments on <unk> balance sheet, which are based on third party valuations of these operating companies did not increase given the challenging market environment.
During the quarter delinquencies again ticked up on our residential and commercial loan portfolios, but those portfolios continue to continue to experience low levels of realized credit losses and strong overall credit performance.
And non QM.
We still realized zero cumulative losses like to date on the population that now encompasses nearly 10000 loans and $4 4 billion of total UVB dating back to 2015.
Meanwhile, for RTL in commercial mortgage bridge realized realized losses remain low compared to the amount of capital. We've invested in profit we generated which is largely thanks to our focus on first lien and low ltvs with built in equity cushion.
That said recently more loans have progressed to 90, plus day delinquency status and to Oreo and the story is still playing out on us.
We remain very focused on credit performance and managing through resolutions on these top performers.
Back to non QM raw delinquencies have been among the lowest in the entire sector recently, the third party servicer of our non QM or non QM loans was acquired by a much larger servicer and as a result, the servicing of those loans that transfer.
Unfortunately, the new Servicers handling of that transfer has not been smooth.
Given the situation, we do expect that delinquencies on non QM loans will temporarily increase in Q4, but we also expect that they will revert to more normalized levels in the coming months once all of the transfer related issues have been resolved.
Meanwhile, the Longbridge segment generated <unk> <unk> per share of net income drill.
Driven primarily by gains on interest rate hedges.
As Larry mentioned, we had a mark to market loss on the Heck am MSR equivalent partially offset by a mark to market gain on the bankruptcy related MSR portfolio purchase.
The Longbridge segment also had mark to market losses on proprietary loans and a net loss in origination.
The origination the combination of higher interest rates and wider yield spreads reduced gain on sale margins on both <unk> and Craig proprietary loans, which more than offset a modest uptick in overall origination volumes.
Our agency portfolio generated a net loss of <unk> 16 per share for the third quarter.
As agency RBS facing significant headwinds of elevated market volatility and rising long term interest rates.
<unk> spreads widened and agency MBS significantly Underperforms U S Treasury securities and interest rate swaps for the quarter with lower coupon MBS exhibiting the most pronounced underperformance.
Net losses on our agency MBS and negative net interest income exceeded net gains on our interest rate hedges, while our delta hedging costs, which are tied to interest rate volatility remains high.
On slide six you can see a breakout of adjusted distributable earnings among the investment portfolio Longbridge and corporate overhead.
Here you can see the negative Adv from Longbridge that Larry mentioned, driven by compressed margins and mark to market losses on prop.
Apart from Longbridge AE from the investment portfolio segment net of corporate overhead actually increased incrementally.
I'll note here that part of the increase was related to periodic payments on the interest rate swaps associated with great Ajax and have since been neutralized.
And also to the payment of past due interest related to a commercial mortgage bridge loan that converted from a nonperformer back to a re performer during the quarter.
Our accounting policy is to stop accruing interest income once loans become 90 days delinquent and only to recognize interest income again, if the loan becomes contractually current and we expect the loan to be fully repaid.
In the third quarter, we saw loans move in both directions, <unk> 90 day, DQ status and out of it across our residential and commercial mortgage bridge loan portfolios of course, all P&L catches up upon ultimate resolution of the given loan but prior to that this dynamic can cause our interest income and that's H E.
To be lumpy over time.
Next please turn to slide seven.
In the third quarter, our total long credit portfolio increased slightly to $248 billion as of September 30.
Our non QM and RTL portfolios grew sequentially as net purchases exceeded principal Paydowns and we also net purchase non agency MBS during the quarter. Conversely, our commercial mortgage bridge loan portfolio continued to shrink as loan paydowns in that portfolio again significantly exceeded new originations during the quarter.
<unk>.
For the RTL commercial mortgage bridge and consumer loan portfolios in total we received principal pay downs of $393 million during the third quarter, which represented a remarkable 25% of the combined fair value portfolio is coming into the quarter.
This steady stream of principal Paydowns bolsters our liquidity.
Capital to redeploy where we see the best opportunities.
On the next slide slide eight you can see that our total long agency portfolio increased by 5% quarter over quarter to $964 million as opportunistic purchases exceeded sales principal repayments and net losses.
Slide nine illustrates that our longbridge portfolio increased by 14% sequentially to $488 million as of September 30th.
Driven primarily by proprietary reverse mortgage originations and the acquisition of the bankruptcy related MSR portfolio.
These increases were partially offset by a smaller H MBS MSR equivalent driven primarily by the markdown that Larry mentioned.
In the third quarter Longbridge originated $307 million of cross Turkoman prop, which is a 3% increase from the prior prior quarter.
The share of origination through Longbridge is wholesale and correspondent channels increased to 82% from 79%, while retail declined 18% from 21%.
Please turn next to slide 10 for a summary of our borrowings.
On a recourse borrowings the weighted average borrowing rate increased by 21 basis points to 686, 88% as of September 30, driven by the increase in short term interest rates.
Meanwhile, book asset yields on our credit strategy also increased over the same period and we continued to benefit from positive carry on our interest rate swap hedges, where we now receive a higher floating rates and pay a lower fixed rate.
As a result, the net interest margin on our credit portfolio expanded sequentially.
Sequentially.
However, an increase in the cost of funds on our agency strategy exceeded an increase in our book asset yields which caused net interest margin on agency to decrease quarter over quarter.
Our recourse debt to equity ratio adjusted for unsettled purchases and sales increased to $2 three to one as of September 30, as compared to $2 one to one as of June 30.
Our overall debt to equity ratio adjusted for unsettled purchases and sales also increased during the quarter to $9 four to one as of December 30, <unk> as compared to $9 two to one as of June 30.
Yes.
At September 30, our combined cash and unencumbered assets totaled approximately $569 million roughly unchanged from the prior quarter.
And our book value per common share.
<unk> was $14 33.
Down from $14 70 in the prior quarter.
Including the <unk> 45 per share a common dividend that we declared during the quarter. Our total economic return was a positive 54 basis points for the third quarter.
I'll shift now to our terminated transaction with great Ajax, which we announced on October 20th.
After careful consideration both companies' boards approved the merger a mutual termination of the merger.
As part of that termination, we paid great Ajax a termination fee of $5 million in cash and also invested $11 million in the company by acquiring $1 $6 7 million newly issued common shares for $6 60 per share.
As discussed on last quarter's earnings call, we had established hedges upon signing the merger agreement with Great Hs.
With the deal terminated we've now neutralize those hedges, but I'll note that gains related to the hedges covered all of our costs associated with that transaction, including mark to market losses on our termination related investment in the common shares of great Ajax.
The results reported for the third quarter included the gains associated with the hedges that we had established related to the potential great Ajax merger as well as net losses associated with the <unk> receiver interest rate swaps that we used to hedge the fixed payments on our unsecured long term debt and preferred equity.
The quarterly results also reflected expenses related to the Arlington and great Ajax transaction.
Now over to Mark.
Thanks J R. This was a very volatile quarter to quarter and the UFC wound up with a slightly positive economic return.
This was a quarter, where it seemed like there were two completely disconnected fixed income markets one for rate products and one for credit.
Our credit portfolio had steady returns and maintained strong overall credit performance.
Macro economic data released Sterling deal during the quarter supported the narrative of a surprisingly strong consumer and a resilient jobs market, which kept credit spreads well anchored Ellington financial short duration portfolio with a lot of floating rate loans and bonds was largely immune from the really violent price movements in the rates.
<unk> <unk>.
Investment grade bond indices traded in a relatively narrow spread range I just did spreads on leveraged loans that stable backdrop for credit spreads and continued strong credit performance of our portfolios drove solid results for our short duration credit strategies, specifically RTL commercial bridge, non QM and credit risk transfer.
One exception for US I would say was an unsecured consumer loans, we see potential headwinds for that sector with student loan repayments restarted persistent inflation for necessities like food and rent and potentially slowing wage growth our consumer loan portfolio underperformed during the quarter, but we've been shrinking that portfolio.
And don't have a lot of capital deployed in that sector.
At September 30th our consumer loan portfolio that was about one third the size it was pre COVID-19.
For rate strategies. It was a different story the 10 year yield the 10 year Treasury yield was incredibly volatile trading at a massive 85 basis point range with lots of twists and turns along the way and then ended the quarter around its 15 year high it was a terrible quarter for agency MBS performance with most coupons underperforming.
Measuring and swap hedges by well over a full point.
Rate volatility a high interest rate volatility money manager redemptions and re deleveraging. We're all on the minds of the market and push spreads to some of the widest levels seen in years. Despite the tailwind of only modest supply from new home sales and cash out refinancings.
We had a loss in our agency strategy that's shaped a full percentage point from <unk> book value per share for the quarter following quarter and the underperformance of agency MBS actually accelerated in October before posting a strong recovery in the past couple of weeks. The agency portfolio only uses a small slice of Dft's capital about <unk>.
10% at quarter end, but given the volatility we've seen all year I'm happy to report that as of yesterday, Our agency strategy P&L was almost flat for the year.
Throughout 2023, we've remained disciplined in our approach to managing the agency portfolio trying to manage negative convexity at a time of extreme rate volatility taking advantage of relative value opportunities and keeping our net mortgage exposure roughly constant and leverage relatively low spreads remain extremely wide, but are materially tighter than the <unk>.
Spreads in October fundamentals look great and technicals are now starting to improve.
But a lot has changed since quarter end in October the rate selloff accelerated but moving into November rates rallied significantly from their October highs.
Fred the fed funds market the fed fund futures market now predicts that the fed will be complacently sitting on its hands for the next few meetings and the prospect for capital to flow back into fixed income funds and Etfs feels much better with the recent decline in volatility.
The fed is trying to get inflation under control by slowing the economy and recent data suggests that that slowdown is finally upon us after years of strong macroeconomic performance bolstered by stimulus money and low mortgage rates that fuel price appreciation and residential and multifamily real estate are much Bumpier ride lies ahead.
We actually have been preparing for that bump you're right since the spring of 2022, we've been more conservative in our RTL underwriting guidelines, we have pulled back from certain markets, where we have seen signs of actual or potential pullback in home prices from some of the Covid euphoria.
Okay.
Our commercial mortgage commercial mortgage bridge loan portfolio have shrunk as paydowns have greatly greatly exceeded new originations given a more stringent underwriting guidelines.
Many of the new origination opportunities we've seen in commercial mortgage bridge, just don't pencil out given the much higher debt cost costly tenant improvements higher insurance costs and slower rent growth that said, we do think this market will ultimately come to us as cap rates slowly adjust to the new market conditions.
Looking forward I am confident and really excited about the potential for EMC to thrive in this weaker economic backdrop.
Our current loans and securities are overwhelmingly low LTV and collateralized by real estate that has lots of built up equity.
We've done a fantastic job of avoiding the landmines and see MBS, we have a lot of experience in using credit hedges to mitigate downside risk.
Now, we see the potential to play offense in the distress cycle for commercial real estate banks and their advisors are beginning to sell loan portfolios and we expect the day of reckoning would come from any properties, including many good properties that won't be able to pay off their existing mortgage loans when they come due without a capital infusion or restructuring.
G R and Larry spoke about the Arlington transaction I'm looking forward to working with our pms to integrate and manage that portfolio and I am very happy that EMC will now have a stake in the ground in the agency servicing business.
We have one non QM and reverse mortgage servicing for years, but this is a much larger stake and a much bigger market now.
Now back to Larry.
Thanks Mark.
I am pleased with Ellington financials positive third quarter results in a very challenging market.
As usual our interest rate hedging was key in achieving this.
Going back to the launch of <unk> in 2007, we've never tried to predict the direction of interest rates and have instead in Denver to hedge them.
And this past quarter with interest rates spiking, our interest rate hedges were again very profitable.
That helped to offset mark to market losses on other parts of the portfolio.
The extreme pace of rate hikes since last year, clearly caught a lot of the market off guard, but our hedging has kept the FC relatively unscathed.
Our hedging program is one of our core strengths along with our strong track record underwriting credit risk our expertise in modeling consumer borrower behavior, and our willingness to continually improve our portfolio through active trading and portfolio rotation.
Looking ahead, whether we are in are higher for longer interest rate environment or not.
I believe that Ellington financial is well positioned thanks.
Thanks to our hedging expertise and liquidity management, our short duration high yielding loan portfolios and a highly diversified array of strategies, which will soon include agency MSR as well thanks.
Thanks to arlington's highly attractive MSR portfolio.
Historically, we've concentrated our investment activities in sectors, where banks are less active and where there is less competition and we have built up deep and experienced teams and strong rack track records across market cycles in these businesses, especially in the residential mortgage and commercial mortgage sectors.
Add to that.
<unk> now has access to servicing and workout platforms across a variety of alone businesses by virtue of our strategic equity investments you can see these business lines on slide 12.
These platforms have significantly broadened the scope of potential investments that Ellington financial can consider as.
As they allow us to deal more directly with any credit issues, we encountered in our own portfolio and they provide us with the expertise to take over and stabilize distressed assets that we see in the secondary market.
A recent example is the banks bankruptcy related MSR portfolio that we acquired through Longbridge in July which was only possible because of Longbridge is servicing platform and stellar reputation.
That investment is already returning strong results and we think it will be accretive to <unk> earnings in the quarters ahead.
The ongoing the ongoing dislocation in the banking sector should continue to generate compelling opportunities for Ellington financial both to buy distressed assets and to add market share at our originator affiliates. Thanks.
Banks are under pressure from regulators and from losses on their loans and securities and with deposits, leaving for higher yielding alternatives, we see an inefficient market getting even less efficient.
Stepping back means less capital available to make or buy loans, which should put upward pressure on the spreads weakened.
The opportunities in distressed commercial mortgage loans and see MBS could be particularly compelling.
Before I conclude I'd like to reiterate that we here at Ellington financial are all very excited to close on the Arlington merger next month.
Clinton shareholder vote is scheduled for December 12, and we would anticipate closing the transaction shortly thereafter so.
Arlington shareholders. We hope you agree that this pending transaction will be highly attractive and accretive for you as well.
We look forward to introducing ourselves and our company to more of you and we sincerely hope that your ownership continues.
With that we'll now open the call up to questions. Operator. Please go ahead.
Thank you at this time, if you would like to ask a question. Please press star and one on your telephone keypad.
You may remove yourself from the queue at any time by pressing star two and once again that is star one to ask a question we.
We will pause for just a moment to allow questions to queue.
Okay.
And we have our first question from Crispin Love with Piper Sandler.
Good morning, everyone.
First off just with the majority of your small balanced commercial portfolio multifamily, which I believe is primarily bridge and grew meaningfully.
Meaningfully in 2020 in 2000 22021 would you expect a good portion of those loans to be extended given the current environment. We're in or do you expect more tech to roll off as you alluded to during the call.
Marc once like that.
Okay.
Sure Hey, Chris.
So.
With this portfolio.
The borrowers have been.
Having to pay higher borrowing costs.
All of this past year as the fed has been heightened so as opposed to what you see say in conduit, where they're typically 10 year Io loans and then all of a sudden they're getting a big shock at.
At maturity.
This portfolio these borrowers have been.
Having to adjust to the higher rates all along.
All along the life of the loan so so far.
We've seen resolutions you know these were.
What we do in bridge all the properties are almost by definition.
In some form of transition so theres. Some number of units that are offline that need. Some you know maybe there was some molding them or they need some renovation and it's a plan where you get these things online you get tenants in sometimes there's some capex on the property that's going to bring rents fair market rents.
What we do in bridge.
Much every loan on the multifamily there's a business plan. There is an expectation that they're going to be growing net operating income right. So they've been growing net operating income and their debt costs have been increasing so so far our resolutions have been fine and if you look at what happened to the portfolio.
It's been shrinking because of resolution so I expect that to continue.
And art.
Yes go ahead.
Hey, I just want to add one thing.
Which is that.
Thank.
Not.
We're not sort of the extended 10 type when we when we do extend alone.
We usually will demand something in return right like we're very LTV focused.
And.
So we will expect that the loan is at maturity.
We will expect.
We will expect some additional principal pay down or something.
To compensate us for for extending that loan when we made these loans were very LTV focused.
And.
Okay.
That's something that we're not just going to just extended for because we're afraid to.
Take.
Any sort of more.
Aggressive action, whether it's foreclosure or anything else now some of these loans do have extension options built in those.
Part of the borrower and in those.
<unk>.
Those those will be extended part of there in terms of their contracts.
And then ones that arent.
Yes.
Oh I was just going to add that part of the reason why that portfolio has shrunk.
Is.
When we see new origination.
They're kind of shining the bright light on it of.
Increasing insurance costs in some cases.
Creasing property taxes.
Slowing expectation of rent growth.
And I mentioned that we're seeing fewer deals come across our desk.
That you know that pencil out that sort of work given that you know sofas $5 30, and you know.
These are you know sofa was $5 five or 6% so.
Hum.
And that skepticism, but that level of caution or that level of conservatism in the underwriting is part of the reason the portfolio has shrunk. Its just we don't want to get into situations where.
You have properties, where the owner is having a challenging time covering the debt service cost.
That makes sense remember also.
I just know I think we mark we mark our portfolio to market right. So our loans.
We we will mark those down and recognize a loss that will flow through our income statement and youll see it.
Financials, if we think there is an issue.
Alright.
Significant potential issue in terms of that loan.
Defaulting and maturity for example, and if we think that we're ultimately going to take a loss that will be reflected in the marks thats already reflected in the mark and for our real estate with the lower cost cost of market.
Okay that all makes sense, but on the loans that are maturing are they receiving permanent financing through the agencies or elsewhere.
Yeah some of them are through the agencies.
Some of them.
I'll just get you know a longer term loan from another credit source.
There has been no.
There is an opportunity coming we believe in commercial real estate as loans come to maturity.
And certain types of loans, we mentioned you're going to have a harder time refinancing, but theres also been capital raised to take advantage of that opportunity. So.
Youre seeing the agencies are certainly active but theres other pools of capital to that are out there extending credit to sort of filling filling in the gap left by the retreat of the regional banks.
And a lot of the loans that we make in multifamily right why did they come to us in the first place often because.
They're.
Making improvements to units.
It could be some sort of renovation some sort of transition right. We are a transitional loan for them. So a lot of times, even with rates higher they've done what they needed to do and so they can get more permanent financing.
Yes.
Okay and then just one last question for me the FDIC has announced that its selling some signature banks commercial real estate loans are these the types of assets that you'd be interested in acquiring and I guess.
I can't necessarily speak to those specifically.
Just more broadly have you begun to see opportunities for <unk> loan acquisition.
The security and loan side.
FDIC in particular, we're absolutely seeing that and were considering putting a bid and four.
For one or more of those portfolios yes.
Mark do you want to elaborate on that at all or talked about other opportunity. Yes. So I think the Fdic's signature bank.
Portfolio sales is interesting to us and the teams here have been doing a lot of work on that.
And we also think away from sort of that big public portfolio that sort of everyone knows about.
You're going to just see a steady drumbeat of properties I mentioned like a lot of times good properties that are coming up to their maturity date.
In the size of the new loan.
That's gonna be appropriate given current income growth and current debt levels is going to be smaller than the old loan and the limitation generally isn't going to be loan to value, but the limitation is going to be debt service coverage. So I think there is the big.
The signature portfolio, that's been well publicized but there is going to be just.
Constant.
Flow of prop of properties, where.
The debt is hitting the maturity date.
And.
They might require.
Some sort of capital infusion or some sort of restructuring and that's you know I think we spoke about on the previous call that was really the bread and butter of our commercial of our commercial loan strategy for years after the financial crisis and so.
That team that drove really exceptional results.
That strategy that workout strategy for us.
I'd say, that's what we were doing primarily prior to 2017 that that team is still in place they've pivoted to bridge and they've.
Added additional resources in terms of sourcing and workout capabilities, but that that team has so much experience in doing these workout. So we are really really.
Well positioned and excited about that being a future driver of returns for <unk> 2024 and beyond.
Yes.
Great. Thank you I appreciate you taking my questions.
Of course, thank you.
And we have our next question from Trevor Cranston with JMP Securities.
Okay. Thanks.
Question about the agency MSR asset class.
As you look beyond sort of the initial acquisition of the Arlington portfolio.
Can you talk about how you sort of envision being involved there whether it's through.
<unk> opportunistic bulk purchases or if you'd potentially look to have some sort of flow agreements on new production MSR. Thanks.
Yeah.
Yeah, Trevor it's good to hear your voice on these calls it's great.
I think it could be.
Both of those right so.
The agency servicing portfolio.
That we're acquiring given where rates are.
Zinc is going to be steady.
Steady.
Steady high return asset for us.
And it gives us the capabilities. So we've always had sort of the capabilities on the modeling side because modeling prepayments so much a part of.
Our DNA, but now we're going to have more capabilities on all of the necessary infrastructure.
So it could be bulk purchases it could be flow if I had to guess I would guess in the beginning probably more of a focus will be on bulk purchases.
But that can be either way you know we mentioned in the prepared remarks.
We've been buying non QM servicing for years, and it's flown flowed into the portfolio and it's been a nice offset for some of the interest rate risk on non QM loans and so.
I think.
This acquisition gives us.
A lot of flexibility and a lot of capability on the agency servicing.
And with banks.
Banks.
Potentially being less interested in having significant capital outlay there.
I think it's a natural time for us to be able to acquire more portfolios.
Got it okay. That's helpful.
And then on Longbridge.
The portfolio there has been growing this year.
I was curious if you could talk about specifics.
Specifically I guess with the proprietary loan bucket.
How do you think about sort of capital allocation, there over time and if the different cash flow characteristics.
Reverse loans.
Sort of limit how much capital overall you'd be willing to allocate.
Sorry, what would limit can you say that again, what would limit the amount of capital.
Just the different cash flow characteristics of reverse loans not getting like the regular monthly payments like do you want to move.
Forward mortgage.
Okay, Yeah, so that I don't think thats really so much of an issue for us.
Given.
One of the things we talked about on the call is how much principal payments, we got on the rest of the portfolio.
So again, it's a good complement to have.
Something.
That something thats accretive, but with a very high yield rate.
Versus something that is very short and amortizing principal all the time, so that's actually a good combination of both our high yielding.
It doesn't really create any cash flow issues for us.
But.
But yes.
It is a long term.
Product and.
We're not if you look at the way that we've run other loan businesses.
Like non QM for example, it's not really our strategy to hold long term loans and.
And finance them with short term financing sort of indefinitely.
So.
I think that.
Sort of looking to wear.
That strategy is going I think it's probably better to think of.
Accumulating critical math similar non QM right because those are long term loans too.
Accumulating critical mass for Securitizations, or and then doing those securitizations and retaining junior pieces.
Sure.
Just hold on sales right. So.
And.
Different.
Different buyers potentially for non QM versus.
On the whole loan market versus <unk>.
Reverse proprietary reverse mortgages, but maybe not that different I mean insurance companies.
Have I think we've spoken about this before.
Has that really increase their appetite substantially in the last year for non QM, and we sort of see that given the.
Long duration, which is something of insurance guys tend to like add to high yielding aspect of this proprietary reverse mortgages, we think thats a natural home there as well so I think I would think of it more in terms of those.
Accumulating critical mass in any theyre doing whole loan sales and securitization.
Okay that makes sense appreciate the color. Thank you guys.
And we have a next question from Eric Hagen with BTG.
Hi, Thanks, Good morning, I wanted to check in on conditions for non agency repo.
Term financing for retained securities that you guys retain off of securitization how stable that the availability of that capital is and maybe even how rate sensitive do you think that financing is going forward.
I mean, we have here Sir.
Sure go ahead, Yeah go ahead Mark.
No I was going to say.
In a word it's been stable right even.
With there was a lot of price volatility and spread volatility and some of the credit products in 2022.
That hasn't been there hasnt been a lot of price volatility and spread products in 2023, but even in 2022 and now continuing this year.
Spreads have been stable so.
That financing to us is that financing for us is.
Is basically spread sofa. So the actual rate we are paying is going up and down with sofa goes up and down but what's been stable is that spread between sofa and our ultimate borrowing costs and the pools of capital interested in doing that financing is actually.
<unk> grown in the last couple of years, we've expanded our.
Range of Counterparties, so on the really short duration or the floating rate loans.
Then what youre really locking in a sort of.
You know a D. Your net interest margin is if we've got alone that silver plus six we're financing it sofa plus one and three quarters. Then every turn of leverage youre locking in that different so 425 beats just for kind of like <unk>.
Ballpark numbers and then when you have.
The fixed rate.
Moms, there say non QM than Youre doing generally a we've had to kind of hedges for non QM. This year.
Been paying fixed on so for swaps or it's been short TBA now it's more paying fixed on so for swaps, so you're paying a fixed rate.
Youre getting a fixed rate from the loan so you're getting that spread and then the sofa we receive on.
The floating leg of a swap that we're getting paid that essentially.
Pes to repo Counterparties.
The floating leg, we owe them on the financing. So there. We're also still kind of locking in the spread there. It's just the difference between.
The fixed rate on the loan and the rate we're paying on the sofa swap, but the pool of capital and the spreads to sofa has been stable and if anything it's actually been.
Coming down a little bit and I think the reason for that is is just repo now, giving you the shape of the curve is a really high yielding assets. If you can.
The repo book at Silver plus 175, you're sort of earning 7% so that low LTV loan its daily Mark to market Theres, a lot of protections repo lenders get that make that a very desirable asset for a lot of pools of capital I think that's why the.
Financings have been stable. If you go back to sort of days when sofa was close to zero with them was LIBOR than the all in yield on the financing just wasn't that attractive and then I felt like the financing markets were not as deep as they are right now.
Right Okay.
Thanks for that answer I wanted to go back to your comments around the consumer conditions. I think you gave some cautious commentary around the consumer loan portfolio like how does that outlook tie into other areas of the portfolio, where there's maybe some more asset level risk like obviously, the resi portfolio or some aspects of that portfolio.
Yeah.
So it's interesting we were looking at just some charts today that we're tracking delinquencies in different loan categories as a function of whether borrowers had student loans or not and you definitely see the impact of student loans turn on so I guess, what I would say is.
Where we've seen weakness has been lower credit score.
Borrowers so the difference in performance between lower FICO and high FICO, that's always been there, but the magnitude of the difference has gone up and I think the reason why we think that's the case is just a pretty high got gas prices and in some parts of the country very high.
Gas prices, if you look in California, so higher gas prices higher rent.
And now what sort of squeezing people a little bit is a little bit slower wage gains so consumer we've.
We've seen it.
You haven't seen it and Fannie Freddie portfolios. If you look at sort of credit risk transfer performance Youre seeing it a little bit and this is just sort of.
Not because it impacts the portfolio just useful data points, you've seen it a little bit on Ginnie Mae.
Portfolios, it's lower it's a higher LTV lower FICO borrower than what you see on Fannie Freddie.
Subprime auto you've certainly see it so it's.
It's happening I think that you know the borrowers that you want to lend to.
You know primarily are the borrowers that have locks locked in la.
Low.
That cost with a 30 year, you know lowest shaped Morgan. So if you look at.
Credit risk transfer performance this year CASM stacker, it's been phenomenal because they think people pick up on the fact, okay.
Floating rate product with the investors like because it floats off a sofa and Sofia has been high relative to other points in the yield curve, but it is a floating rate product, where the ultimate borrower has termed out their debt and the even better than sort of corporate debt or high yield debt. It never roles just amortize so those borrowers have sort of.
Had the best and most stable credit performance and then as you get to sort of like non QM is second but non QM you have seen delinquencies pick up a little bit and that has nothing to do with servicer servicing transfer mentioned in her.
Prepared remarks, but you've seen a little bit of an uptick in.
Non QM.
And then when you get to borrowers that are renters that are.
Basically.
Having to deal with you know rising rest of the past year that you've been through a little bit weaker performance.
And I can just add to that.
If you look at for example, slide four right and you can see the consumer loan row $90 million.
That.
That includes some may be asset includes.
Some equity investments back.
Yes, you've got basically less than $90 million I, just want to make the point that the remarks that we made were.
Somewhat a little backward looking as opposed to a forward looking in a sense that.
We we've already.
<unk>.
If you look at we're projecting 11, 5% yield.
That portfolio to where we've marked it right. So we've marked it down.
And.
So we think thats a good deal going forward and I just.
After after the mark to market.
Price drops that we've.
Put in place.
Yes.
I also want to point out that most of that portfolio is actually secured consumer nine unsecured secured consumer so.
It's a small portfolio, it's under $90 million. We think it's marked right. We think it is going to yield of 11, 5% and thats.
On a unlevered basis, so we feel good about that portfolio going forward and.
It's possible that we add to that portfolio, if we get some good situations.
Yes.
Appreciate it guys. Thank you.
And we have our next question from Matthew Howlett with B Riley.
Hey, everybody thanks for taking my questions.
Hey, Matt.
It's just at a high level, we look at that.
Brazil supply the buy segment.
Credit was terrific with stable then you had obviously a negative contribution from one region and then it looks like the agency was negative it had negative contribution.
Backing those out of the normalized I mean, those are probably going to be Longbridge. I think was could keep contributing 10 cents in the first quarter and then of course, the agent said youre shrinking that but that will likely be a positive contributor.
I mean, when I look at dividend.
The dividend coverage I mean.
I mean, what sort of you're probably there.
Sort of one time ish events I mean, how do I look at it.
For it on a run rate basis, yes.
Hey, Matt.
I think that's I think we're close right. So.
I mean, one way to approach. It is long ridge was 14% of our allocated equity at quarter end.
And they they certainly had quarters, where they've contributed 510.
Our share of AE is theyre contributing 6% to 7%.
14% times 45.
If you add to that.
We picked up about 38 from.
The investment portfolio net of corporate overhead. So some of those is pretty close to the.
The dividend.
We did include in their prepared remarks.
I guess, you could say some caveat on how to model or think about 80 in the near term because you have.
Yes <unk>.
Synchronic behavior on our interest income when loans move into delinquency and we stop accruing interest income or when they re perform and we expected to be paid at par and then interest income kicks in again so.
And there will be some noise there we expect that to continue but.
Net net I think where we're on track run rate wise.
Given October was yes.
It's kind of a continuation of some of the challenges we saw in Q3, namely raise selling off and volatility to continue to be high.
Yes.
We're not out with October numbers, yet, but wouldnt be surprised to see some of the same challenges in October that we saw in Q3.
Origination channels and agency that might weigh on <unk>.
In Q4.
But yes.
All that said.
On a normalized basis, I think where we should be tracking if not in Q4, then as we get into next year and then you add in the contribution from from Arlington, including deployment.
Additional dry powder, which would be accretive.
There's a lot of pieces there that I that I grew up.
But hopefully that we're thinking about it.
No I'm glad you clarified it I'm thinking about it the same way you are looking at.
Stability to me, what really mattered in the quarter.
We think it will.
Longbridge I mean, when we think about modeling that it's the highest clearly one of the highest gain on sale margin channels. When we think about.
What can impact margins and volumes is it very much like when we think about it is it like the conforming conventional side, what we thought when you think about spreads and they track.
The agency spreads spreads.
Just walk me through.
Is it all about HPA or is it about lower rates sort of what could influence.
Positive or negatively longbridge, when we get into next year and some of this volatility comes down.
Sure.
I'll address that before I do I, just wanted to point out that and it's a great question because it actually impacts went about to say, which is that as long as we continue.
Continue to see.
Longbridge continuing to add market share right and to do the things that we think.
They need to do.
So that they will.
I mean, this was a tough quarter right from a.
From an <unk> perspective, but not from a mark to market perspective, but so we think that that <unk> once it normalizes with longbridge.
It is.
That that.
As Jeff said, we are going to be right. There in terms of our dividend. So we have no plans.
To sort of have our dividend.
Fluctuate because of the fluctuations in origination profits at long ridge, absolutely not so I think so so from an analyst point of view I think yes, youre going to see I mean, I hate to say.
Even think about another non-GAAP metric, but you could think about our E X longbridge.
As another thing to look at.
<unk>.
But.
Witness with this acquisition with their increasing market share and yes, it's been a really tough market. Okay. So to get back to sort of what is driving things along bridge.
We have now.
The MSR, we feel very good that it's now conservatively marked and it's going to generate.
A great yield.
We have.
Unfortunately, we're still in a high interest rate environment and what that means is that.
The amount of long term interest rates, especially around the 10 year part of the curve are what drive how much borrowers can borrow in a reverse mortgage that's just the way that.
The program the <unk> program works and it sort of makes sense right because youre looking at.
Long term gauges of inflation.
And it just makes sense right. So.
So.
Accretion right. These borrowers are not going to be making payments right. So you want to make sure that you're earning a market interest rate and then some on the loan and so the long term part of the curve is going to drive is going to drive that and thats going to discount.
And it's going to create a lower.
Principal amount that the borrower can draw as rates go up so that's been hurting all the entire reverse mortgage business and so it's a different reason.
That versus why it hurts.
The regular forward market.
But but nevertheless, so you've seen the market shrink, but then again you've also seen.
One very notable player and other smaller players sort of go by the wayside. So we see long ridge is having a larger market share in a market that is smaller but then the prop the prop business has a lot of room for growth.
Alright, because that because now you're you're tapping into borrowers that a.
How much.
Higher value homes.
So thats.
Just more profitable on a loan by loan basis, and Youre talking about borrowers that may not be as sensitive.
About.
Taking out less proceeds so.
So.
Looking forward like the long term prospects. We think are really good for longbridge and they continue to gain market share, but it's been a tough market and with the Youre right with agency spreads wide, that's affected and volatile that's affected the execution.
On the <unk> that Longbridge and on all the other participants issue on a monthly basis.
And so the gain on sale margins.
What they could be and so spreads normalize there ultimately that should also normalize as well so you'll see short term volatility I think NRA coming from volatility from Longbridge origination profits.
And so that's something that I think.
The market will have to adjust it for us.
I appreciate that the economy, you clarify it makes a lot of sense, though and not to get too complex on this call about the MSR related to reverse it has no prepayment so.
Just the higher rates negatively impacted that would be what I mean.
Going forward I mean is that going to perform the same way it conventional MSR performed we get lower rates.
Yes.
It is complex. So first of all a lot of the value is in a regular old servicing strip right and.
And it is it's not quite as prepayment sensitive as a forward.
Mortgage strip will be but when rates go down people do sometimes refinance there.
The reverse mortgages to take advantage of lower rates as home prices appreciate that sometimes refinance the two cash out refi. So.
A lot of the similar factors affect that so there is a prepayment aspect to it which is mildly negatively correlated to interest rates.
That's actually good for that portion of the MSR high interest rates.
But then there is a.
Couple other portions, but most notably there these.
Future draws.
The borrower can take out more money on the reverse mortgage and a significant portion of the value of these MSR as the profit you're going to have from turning those into Ginnie Mae. These are so called tails.
And that is also not.
It's really sensitive to spreads and rates but.
But more spreads so.
So yes. It is also maybe a correlation going the other way there.
<unk>.
Yes, so there are sort of offsetting factors.
That makes total sense, one branch is going to be a home run for you guys and I look forward to next year real quickly on <unk> did I hear you correctly on.
The MSR youre going to be.
Closes just go over those two.
Two points.
Yeah, No I think the proof.
Arlington already has preferred stock and unsecured debt outstanding on those travel.
Well the mergers so we inherit that so that will become our preferred and our unsecured debt and those are.
<unk> done it in a different interest rate environment, So that's very attractive financing.
Financing arm Peter financing for Us So and then in terms of financing the MSR, yes, theres forward Msr's.
Our.
There's a lot of financing availability for those I think you can get financing north of a 50% advance rate, but I think we would probably.
In practice stick to around 50%.
So when.
You could call that one turn of leverage.
Yes.
Perfect look forward, but the timing was terrific I look forward to closing the transaction.
Look forward to our continued success. Thank you.
Thank you thanks, Matt.
And we have our next question from George Bose with VW.
Hi, this is actually a frankie filling in for Bose.
Just one question on Slide 14, you provide interest rate sensitivity you talked about how sensitive your agency MBS position as to the changes in spreads and then.
Just a follow up how much do you hedge the agency spreads.
Sorry, it's sensitive to spreads are to race to spreads.
Okay, Yeah, right you can't see that.
On this slide but if you look to the slide that shows the TVA, yes, exactly yes. So I think 'twenty two is the place to go.
Slide 22.
Okay. Thank you charged it yes, if you turn to that yes I'll elaborate.
'twenty, one and 'twenty, yes, so you can see that.
Yes.
We.
When you net out our TBA shorts, which really had spreads.
Dollar for dollar.
On the equivalent amount of logs right you can see that our.
Net agency.
Call, our net agency pool assets to equity ratio was five four to one.
So then you can go.
And basically say okay.
What does that mean well actually if you look on the slide you can see that our net long exposure to agency pools of $698 million right.
And so if you think about.
10 basis points and spreads on the portfolio Mark would you say, that's 10 basis points as wide as it half a point ish. What do you think that's exactly I was going to say like five years, but yes.
Yes, so you're talking about.
<unk> moved by 10 basis points than 5% of $690 million about $3 five.
<unk>.
So.
10 basis points.
It's a significant move in spreads.
We could see we'd see 'twenty as possible.
But we're already near all time wide. So so it's not a I think in the context of our entire.
Portfolio, it's not a it's not a huge exposure, but it's one that we like right now given that you said I mean spreads.
Pretty close certainly on a on a notional basis, but even.
By other metrics, but certainly on a notional size are back close to where they were.
Right.
Right after Covid hit so.
So that's why yes.
Another rule.
Rule of thumb or sort of how you could take as the prior slide 21, you can see that 35% of our interest rate hedging portfolios in TBA.
Up a little bit from 32% at 630, but you can roughly say that that 35% is also addressing the spread widening risk, whereas the swaps stone so.
That fluctuate you can see how much of the mortgage basis, we're hedging.
TBA versus not through swaps.
Yes.
Okay.
<unk>.
And that was our final question for today, we thank you for participating in the Ellington financial third quarter 2023 earnings Conference call. You may disconnect. Your lines at this time and have a wonderful day.
Okay.
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