Ellington Financial Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 7, 2024

There are 10 speakers on the call.

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Ellington Financial Second Quarter 2024 Earnings Conference Call. Today's call is being recorded. At this time, all participants have been placed in a listen only mode.

Operator

The floor will be open for your questions following the presentation. I'd now like to turn the call over to Aladdin Shele. Please go ahead.

Speaker 1

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 1A of our annual report on Form 10 ks and Part 2, Item 1A of our quarterly report on Form 10 Q, forward looking statements are subject to a variety of risks and uncertainties that could cause the company's actual results to differ from its beliefs, expectations, estimates and projections. Consequently, you should not rely on these forward looking statements as predictions of future events. Statements made during this conference call are made as of the date of this call and the company undertakes no obligation to update or revise any forward looking statements, whether as a result of new information, future events or otherwise.

Speaker 1

I am joined on the call today by Larry Penn, Chief Executive Officer of Ellington Financial Mark Tecotzky, Co Chief Investment Officer, EFC and JR Herlihy, Chief Financial Officer of EFC. As described in our earnings press release, our Q2 earnings conference call presentation is available on our website, ellingtonfinancial.com. Management's prepared remarks will track the presentation. Please note that any references to figures in this presentation are qualified in their entirety by the endnotes at the back of the presentation. With that, I will now turn the call over to Larry.

Speaker 1

Thanks, Elodine, and

Speaker 2

good morning, everyone. As always, thank you for your time and interest in Ellington Financial. I'll begin on Slide 3 of the presentation. In the Q2, broad based contributions from our diversified credit and agency portfolios as well as from our reverse mortgage platform Longbridge drove strong results for Ellington Financial. For the quarter, we generated an economic return of 4.5 percent non annualized.

Speaker 2

We grew our book value per share after paying dividends. And we increased adjusted distributable earnings per share by a full $0.05 to $0.33 per share. And we see momentum for our ADE to keep increasing from here. I am very pleased with these results. I'll first highlight the strong performance of our Non QM loan business in the quarter.

Speaker 2

In April, we completed our 1st NonQM securitization in 14 months, taking advantage of the tightest AAA yield spreads we've seen in 2 years and booking a significant gain as a result. In the months leading up to that April deal, we've been taking advantage of strong whole loan bids in the marketplace by selling many of our NonQM loans rather than securitizing them. While the whole loan bid for NonQM loans remain very strong, we saw AAA securitization spreads tighten back to early 2022 levels. And so in April, we decided to securitize some of our non QM loans rather than sell them. That securitization transaction not only provided attractive economics, but it also provided us with high yielding residual retained tranches to boot.

Speaker 2

Following that April securitization, we proceeded to sell other non QM loans into that strong whole loan bid. As you can imagine, given the recent risk off move in the financial markets, all this activity turned out to be extremely well timed. In addition, the continued strong demand for NonQM loans drove improved origination volumes and gain on sale margins industry wide, which generated excellent results at our affiliate NonQM loan originators, LendSure and American Heritage Lending and led to mark to market gains on our equity investments in those affiliates. Meanwhile, Longbridge also contributed robust earnings for the quarter, led by both strong origination volumes and strong performance of proprietary reverse mortgage loans. Similar to the boost in industry non QM volumes, HECM origination volumes were also up significantly for the quarter, including for Longbridge.

Speaker 2

But unlike NonQM, we saw wider yield spreads in the HMBS securitization markets. As a result, gain on sale margins for Longbridge's HECM business actually compressed in the quarter, which mostly offset the benefit of their higher origination volumes. Finally, following quarter end, but prior to the recent market volatility, we successfully completed our second securitization of proprietary reverse mortgage loans originated by Longbridge, achieving incrementally stronger execution than our inaugural deal that we executed in the Q1. This securitization converted another slug of short term repo financing into long term locked in non mark to market financing. Again, given the risk off move we've seen in August, this was another well timed transaction.

Speaker 2

That transaction also provided us with high yielding residual retained tranches. On last quarter's earnings call, we predicted a second quarter turnaround at Long Ridge. And Longbridge did a great job and delivered both on a GAAP basis and ADE basis. Longbridge is an important part of that ADE momentum I mentioned earlier. Also in the Q2, Ellington Financials results benefited significantly from the very solid performance of our residential transition and commercial mortgage loan strategies as well as non agency RMBS.

Speaker 2

Both for the Q2 and continuing into the third, we have added attractive high yielding investments over a wide array of our credit strategies, especially HELOCs and closed end seconds, Crop Reverse, commercial mortgage loans, residential RPL NPL, CMBS and CLOs. The growth of the commercial mortgage portfolio has included both new originations as well as the purchase of 2 additional non performing commercial mortgage loans. At the same time, we have continued to call securities in lower yielding sectors, including agency and non agency RMBS. Since we generally utilize higher amounts of leverage in our MBS portfolios, especially our agency MBS portfolio, these MBS sales coupled with the non QM securitization drove down our leverage ratios overall in the Q2, despite the increased capital deployment in our credit strategies. Moving forward, we have plenty of cash and borrowing capacity to drive portfolio and earnings growth with significant unencumbered assets plus other lightly leveraged assets.

Speaker 2

That dry powder is particularly valuable given recent spread widening. And with that, I'll turn the call over to JR to discuss the Q2 financial results in more detail. JR?

Speaker 3

Thanks, Larry, and good morning, everyone. For the Q2, we are reporting GAAP net income of $0.62 per share on a fully mark to market basis and adjusted distributable earnings of $0.33 per share. On Slide 5, you can see the attribution of between credit, agency and Longbridge. The credit strategy generated a robust $0.80 per share of GAAP net income in the quarter, driven by strong net interest income and net gains from non QM loans, retained non QM RMBS, non agency RMBS and commercial mortgage loans. We also benefited from mark to market gains on our equity investments in LendSure and American Heritage Lending, which reflected strong performance from increased origination volumes and strong gain on sale margins for those originators.

Speaker 3

Similar to the prior quarter, we received another sizable cash dividend from LendSure in the 2nd quarter. In addition with interest rates slightly higher quarter over quarter, we had net gains on our interest rate hedges. Offsetting a portion of all these gains was a modest net loss in residential RPL NPL. Meanwhile, the Longbridge segment generated GAAP net income of $0.05 per share for the Q2 driven by net interest income and net gains on proprietary reverse mortgage loans along with positive results from servicing. In Hekim originations, higher volumes were mostly offset by a decline in gain on sale margins driven by wider yield spreads on newly originated HMBS.

Speaker 3

In servicing, tighter yield spreads on more seasoned HMBS led to improved execution on tail securitizations, which contributed to the positive results from servicing. Notably, Longbridge also contributed $0.06 per share to our AEE in contrast to its negative $0.01 per share contribution last quarter. Finally, and what was a down quarter for the agency mortgage basis overall, our agency strategy nevertheless generated positive net income of a $0.01 per share for the 2nd quarter as net gains on our interest rate hedges along with net interest income slightly exceeded net losses on Agency MBS. Our results for the quarter also reflected net gain driven by the increase in interest rates on our senior notes. This gain was partially offset by a net loss also driven by the increase in interest rates on the fixed receiver interest rate swaps that we used to hedge the fixed payments on both our unsecured long term debt and our preferred equity.

Speaker 3

Turning to Slide 6, you can see the breakout of ADE by segment. Here's where you can see that solid $0.06 per share contribution from Longbridge, which drove the overall increase in EFC's ADE which rose $0.05 per share sequentially to $0.33 Turning next to loan performance. In our residential mortgage loan portfolio, after excluding the impacts of our purchase of 1 non performing loan portfolio and our consolidation of another non performing loan portfolio, the percentage of delinquent loans increased only slightly quarter over quarter. Meanwhile, in our commercial mortgage loan portfolio, including loans accounted for as equity method investments, the delinquency percentage also ticked down sequentially. We also had a significant mark to market gain on one of our non performing commercial mortgage loans based on progress on the resolution process.

Speaker 3

That said, we continue to work through those 2 non performing multifamily bridge loans that we referenced last quarter. While not meaningfully higher quarter over quarter, loans in non accrual status and REO expenses continued to weigh on ADE in the 2nd quarter. Next, please turn to Slide 7. In the 2nd quarter, our total long credit portfolio decreased by 2.5% to $2,730,000,000 as of June 30. The decline was driven by the cumulative impact of the non QM securitization completed during the 2nd quarter and net sales of non agency RMBS, retained non QM RMBS and non QM loans, which more than offset net purchases of commercial mortgage bridge loans, HELOCs, closed end second lien loans, residential RPL NPL, CMBS

Speaker 2

and CLOs.

Speaker 3

For our RTL, commercial mortgage and consumer loan portfolios, we received total principal pay downs of $381,000,000 during the Q2, which represented 21% of the combined fair value of those portfolios coming into the quarter as those short duration portfolios continue to return capital steadily. That steady return that steady stream of principal payments should provide lots of dry powder to take advantage of opportunities, especially if we are entering a risk off environment. On Slide 8, you can see that our total long agency RMBS portfolio declined by another 31% in the quarter to $458,000,000 We continue to shrink the size of that portfolio and rotate the capital into higher yielding opportunities. Slide 9 illustrates that our Longbridge portfolio increased by 18% sequentially to $521,000,000 driven primarily by proprietary reverse mortgage loan originations. In the Q2, Longbridge originated $305,000,000 across Hekerman and Prop, which was a nearly 50% increase from the previous quarter.

Speaker 3

As Larry mentioned, shortly after quarter end in July, we completed our second securitization of prop reverse loans from Longbridge, which locked in term non mark to market financing at an attractive cost of funds. Please turn next to Slide 10 for a summary of our borrowings. On our recourse borrowings, the total weighted average borrowing rate increased by 11 basis points to 6.98% at June 30. We continue to benefit from positive carry on our interest rate swap hedges where we overall receive a higher floating rate and pay a lower fixed rate. The net interest margin on our credit portfolio declined modestly quarter over quarter while the NIM on agency assets increased.

Speaker 3

Our recourse debt to equity ratio decreased to 1.6:one at June 30th down from 1.8:one as of March 31, driven by the non QM securitization in April and a decline in borrowings on our smaller but more highly levered Agency RMBS portfolio. Our overall debt to equity ratio ticked down as well to 8.2:one from 8.3:one. At June 30, our combined cash and unencumbered assets totaled approximately $764,000,000 up from $732,000,000 at March 31. Our book value per common share was $13.92 at quarter end, up nicely from $13.69 in March 31. And our total Econ number of good churn was 4.5% non annualized for the 2nd quarter.

Speaker 3

Now over to Mark.

Speaker 4

Thanks, JR. This is a very solid quarter for EFC. Not only did we have a strong economic return, which drove book value higher per share, but we also had a sequential improvement in our ADE, which I expect to continue. Our earnings this quarter showed the value of EFC's vertically integrated platform. It's been a challenging couple of years for the mortgage origination business with mortgage rates so high, housing affordability so bad, existing home sales so low, but LendSure and American Heritage Lending have persevered and have both posted solid earnings in Q2 driven by a higher gain on sale margins and increased origination volumes, which led to an increased valuation for our equity stakes in them.

Speaker 4

Longbridge also contributed strongly to the ADE this quarter, driven by profits in their proprietary reverse business. But at EFC, we don't just own the originators, we also buy their loans, collaborate with them on credit decisions, maximize proceeds via securitizations when the ARB is attractive and retain what we expect to be high yielding assets from those securitizations for our portfolio. All that helped this quarter. The power vertical integration was on full display for us. We did another securitization of Longbridge's Prop Reverse Mortgages in July and we expect Longbridge's loan origination volumes as well as their securitization volume to continue to grow in that sector.

Speaker 4

In the second quarter, we also completed a non QM securitization and opportunistically sold more of those loans as well. Credit spreads were relatively tight in Q2, so we took some gains in a few different parts of the portfolio. Now we are well positioned for some wider spread opportunities that we are seeing this week with the recent volatility. We had another strong quarter from our commercial mortgage platform as well. Our affiliate originator servicer, Sheridan Capital has a like minded approach to commercial mortgage credit risk.

Speaker 4

They've been fantastic at not only sourcing opportunities, but also working with our EFC commercial team to help manage our few delinquent loans. Sheridan Capital has deep property management expertise to closely monitor construction progress, CapEx expenditures and renovation quality control. This expands EFC's capabilities to manage non performing loans in REO when necessary to maximize proceeds. While Q2 was a quarter of tight spreads and strong demand for structured products, this past week should serve as a reminder that market consensus can change on a dime, often leading to violent repricings in a matter of days. Look at Slide 19.

Speaker 4

We've kept many of our credit hedges in place. In Q2, they provided insurance we didn't end up needing, but they are once again showing their value in August. Hedges provide multiple benefits to us. We use them to minimize the risk of spread widening for upcoming securitizations. We use them to stabilize our NAV in times of volatility and we use them to potentially help offset some of the impact of increasing corporate and consumer stress if the economy weakens.

Speaker 4

We've been adding to our portfolio of high quality closed end seconds in HELOCs and even picked up an attractive pool late last week amid the sell off. As opposed to our non QM loan portfolio where we lend to borrowers who aren't served by the GSEs, these second liens in HELOCs generally are offered to borrowers with low note rate Fannie Freddie Ginnie Mae loans and provide a way for high quality low LTV borrowers to extract equity from their homes when having a low note rate first lien, which makes a cash out refi inefficient. We think this is a large and exciting opportunity for us and we have invested the time and resources to build out our prepayment and credit models and they've developed our sourcing capabilities. With their higher note rates, this sector adds a lot of ADE for Ellington Financial. As to the rate and spread volatility of the past week, while I wouldn't be surprised if it led to mark to market losses in some parts of the portfolio, we also see this volatility is recharging the opportunity set with wider spreads and some price dislocations to capitalize on.

Speaker 4

Furthermore, if lower interest rates were the lower interest rates we're seeing, if they stick, should lead to increased loan origination volumes in both NonQM and at Longbridge. Given that all these platforms have excess lending capacity, greater volumes should be supportive of bottom line economics. EFC is in a good position to add assets here and we're really excited about the current opportunity. Now back to Larry.

Speaker 2

Thanks, Mark. I was very pleased with our performance in the second quarter, where we saw strong results across our credit portfolios and took advantage of tight spreads to monetize gains. In particular, it was great to see the strength in our non QM and reverse mortgage loan platforms, which drove the sequential growth in our book value per share and ADE. At Longbridge, we have more work to do to grow origination volumes further, but the positive developments in the proper verse securitization markets and a strong July in originations should bode well for Longbridge going forward. Lower long term interest rates could also provide a big to Longbridge's origination business, since the size of the loans that borrowers are able to take out generally increases as long term interest rates decline.

Speaker 2

It is loan size more than loan interest rate that is the key driver of origination volumes in the reverse mortgage market, both for purchases and for refinancings. Meanwhile, both during calmer times and more volatile times, we continue to rebalance our portfolio and direct capital to where we see the best opportunities. So far in the Q3, we've added scale in Non QM, RTL, Prop Reverse, Commercial Mortgage Bridge and Closed End Seconds and HELOCs, growing each of those portfolios meaningfully. At this point, we are still trimming in some lower yielding sectors, but I expect the pace of that trimming to slow going forward. We are also working on adding to our financing lines specifically for our forward MSR portfolio and I see that getting done around the end of Q3.

Speaker 2

As we've been detailing today, our investment pipeline across our diversified proprietary loan origination channels is strong. And the loan originators in which we have invested are not only providing healthy flow into that pipeline, but generating operating income themselves. Because we have equity investments in those same originators, this in turn also helps drive our results. We continue to actively pursue making small but strategic investments in other NonQM and RTL originators. And in fact, we closed on another one following quarter end, helping lock in another strategic sourcing channel.

Speaker 4

In light of

Speaker 2

the recent market volatility, I am particularly happy to have executed on our recent asset sales and securitizations in different parts of the portfolio ahead of that sell off. These moves locked in gains when spreads were tighter and they also freed up additional borrowing capacity and capital to redeploy. We have ample dry powder and just in the past few days, we've been putting that dry powder to good use. I believe Ellington Financial is well positioned for continued portfolio and earnings growth over the remainder of the year. With that, we'll now open the call up to questions.

Speaker 2

Operator, please go ahead.

Operator

Thank We'll go first to Bose George with KBW.

Speaker 5

Hey, guys. Good afternoon. So the first question was just about capital deployment. How would you characterize your the level of capital deployment? Is there still you mentioned some dry powder, but just how much upside to ADE just from fully optimizing the balance sheet?

Speaker 3

Yes. Hey, Bose. Good morning. So I think that the first answer the first way to approach the question would be to look at the unencumbered and cash on balance sheet. So, we had $565,000,000 of unencumbered and I think close to $200,000,000 of cash.

Speaker 3

And typically, we'll keep, call it 10% of equity in cash. So that's maybe 150. If we add so the recourse leverage on credit was 1.5 times. If we took that to 2 times, that takes our overall recourse debt to equity back to 2 times and adds a few $100,000,000 more of borrowings or $600,000,000 more I guess in that example. So I would say in this quarter, we is that there are a few moving pieces in the portfolio, but we continue to trim and call lower yielding assets.

Speaker 3

So that's been offsetting. We went through the laundry list of credit portfolios that we grew in Q2 and into Q3, but then we also sold agency and non agency RMBS. So those are kind of working in opposite directions. But suffice to say, 1.6 overall leverage, we have lots of room both from excess cash on the balance sheet, those unencumbered assets to add leverage and then other assets like our forward MSRs that are levered but lightly levered. So you can draw several 100,000,000 of additional buying capacity just from those different numbers that would still take us just to 2 times recourse debt to equity.

Speaker 2

Yes. And as we this is Larry. As we trim that agency portfolio and more is focused just in the credit sectors, you could sort of think of that 2:one leverage ratio, I think, is kind of a fully invested as being fully invested. So probably, again, as we trim agency, probably not going to get all the way to 2:1 in terms of being fully invested. But at 1.6, we have 100 of 1,000,000, as J.

Speaker 2

R. Said of room to add even before we get close to that.

Speaker 3

Yes. And then that's and we're really focused on secured financing. Longer term, we have several tranches of unsecured debt at Ellington Financial and pricing for recent deals is a bit wider than it had been in prior years. But I think it's fair to say over the longer term, we see adding more in secured debt to the liability structure is another step that we would consider. So that would also take up the recourse debt to equity ratio, but again over a, I'd say, longer term period.

Speaker 5

Okay, great. That's helpful. Thanks. And then while you hedge your portfolio very closely, can you just talk about how the portfolio potentially benefits from a steeper yield curve if the forward curve is right and the Fed is cutting quite a bit over the next year?

Speaker 4

Hey, Bose.

Speaker 6

Good morning.

Speaker 4

So yes, in terms of interest rate hedging, we've tried to hedge out across the curve. So we don't really express an opinion on what the future shape of the yield curve is going to be to our interest rate hedges. So just kind of mathematically or on paper, just the first order effect of a steeper yield curve or a flatter yield curve, we kind of neutralize that with hedges. Now I think there's a couple other things going on. Whenever you have when the notional balance of your repo, exceeds the notional size of your swaps, then a drop in financing costs is going to be beneficial, right?

Speaker 4

Like if you have the if the swaps exactly equal the size of the repo and the market's predicting now, I think the base case is a 50 basis point cut in September, the Fed cuts 50 basis points okay, our repo costs go down 50 basis points, but the floating leg we receive on swaps goes down 50 basis points too. So if your repo exactly equal your swaps then it's kind of washes out. When you have repo in excess of your swap notional amounts then sort of that's a beneficial thing to you. I think the things we're thinking more about is

Speaker 2

when you

Speaker 4

see cutting cycle start, I do think you see investors with express a preference for fixed rate assets as opposed to floating rate assets. So we've been adjusting some of our hedges internally to be more focused on loan indices as opposed to say a high yield bond index. So that's kind of one second order effect I think makes sense. And it's kind of interesting if you look at some of the recent fund flows, there's this $11,000,000,000 AAA CLO ETF, JAAA that just came out of the blue this year. I think it had its first outflow ever yesterday, right?

Speaker 4

So the expectation of the market that you're going to see lower short term rates, that is starting to be reflected in fund flows. So we certainly think about in how we position the portfolio. And I also do think when you see steeper yield curves that does tend to be supportive of agency mortgages and non QM mortgages. So I think there's some second order effects for us and we're positioning around it. But in terms of like a big move in ADE for the portfolio, I think you're only going to see that really significantly to the extent that the notional amount of our repo borrowings exceeds the notional amount of the swap hedges.

Speaker 2

Okay, great. And I'll just add one thing, right. So I agree with yes, I echo everything Mark said. The if you look at though what's now a very large segment of the portfolio, which is residential transition loans. So we don't they're short.

Speaker 2

We don't really meaningfully hedge those from an interest rate perspective. And I do think that as you see the rates tend to be a little stickier in that sector. I do think that if you see a drop in short term rates, right, as everybody is predicting, I do think that you will actually have wider net ish margin on that portfolio because I think the our repo rates, they float, they'll absolutely ratchet down almost basis point per basis point with Fed cutting. But I think that the rates, the coupons that we'll be able to get on RTLs will be a little stickier. So and Brian, that's the opposite that we saw when rates were rising.

Speaker 2

Exactly, right. Yes, we've had some NIM compression in that sector versus where we were a few years ago when rates were short term rates were a lot lower. So yes, so I think that's one good thing to look forward. And then Bose, I think some of the things that I've seen you've written would echo this as well, which is that, let's say, we fast forward to a year and change from now and we've got long term rates and short term rates with a free handle, right? That's going to be good for you're going to see mortgage rates go down across the board just on an absolute basis and that should be really good for originators, right?

Speaker 2

Just you'll see a lot more refi activity, etcetera.

Speaker 5

Okay. Great. Very helpful. Thank you.

Speaker 3

Thanks.

Operator

We'll go next to Chris Benoit with Piper Sandler.

Speaker 7

Thanks. Good morning, everyone. Appreciate taking my questions. First, just on HELOCs and close end seconds. Is this an area that you expect to see a lot of runway just given home affordability, higher HPA, higher rates with many mortgages in the 3% to 5% range?

Speaker 7

Or if we do get a sizable rate rally, could this opportunity diminish in coming quarters, but then you get the benefit from higher originations as you've indicated. Just curious on your thoughts there.

Speaker 4

Yes. Hey, Crispin, it's Mark. If you just look at how many Fannie 2s and Fannie 2.5s and Fannie 3s that are out there in existence, all the stuff that was created in 2020, 2021, first half of twenty twenty two, That is an enormous pile of Fannie, Freddie, Ginnie loans. And for the 2nd liens in the HELOCs we've been buying, the originators are targeting borrowers with those really low note rate, 1st liens. So that if rates were just to stay where they are, that opportunity looks like it's pretty big.

Speaker 4

You're exactly right. If you saw a big rate rally and mortgage rates came down a lot, then all of a sudden doing a cash out refi is going to start to look to be comparable economics to people that are saying I'm going to stay put with my fixed rate first lien mortgage and if I want to borrow $70,000 to some home renovation or something, I'm going to take this closed end second lien. So yes, there is a trade off between we're firstly mortgage rates and how big that opportunity set is. But you're exactly right. We've positioned ourselves to have a seat at the origination table, not in Fannie Freddie space, but in Non QM space with our originators.

Speaker 4

And so lower mortgage rates across the board, I think, would be definitely supportive to the origination volume. So this we don't kind of think about it explicitly as sort of hedge on origination volumes, but it certainly functions that way. We're attracted to it now because you get a real high note rate. It's very supportive of ADE. We think we understand the prepayment function and the credit quality is really strong.

Speaker 4

So that's what sort of been driving us. It just looks like an attractive asset to add to the portfolio to complement already what we're doing in RTL and non QN and the private label reverse.

Speaker 2

Yes. And if I could just add to that Mark. I just want to add that I really based on what Mark said right about but rates would have to drop a lot for those all those low coupons that were originated pre 2022 especially, right, to become refinanceable. If mortgage rates are maybe they're getting close to 6% now, but you're that's still 200 basis points away, right? So you're going to need quite a big drop I think before HELOCs and close in seconds are going to no longer make as much sense for people.

Speaker 2

The thing that I'm a little more sort of on the radar screen about is what's going on with the agencies, right? So I'm not I don't think volume is necessarily going to be an issue for a very long time in terms of that market. But the question is with this agency pilot program coming out and all that, that could obviously lead to some serious competition. I mean, it's not a big pilot program, but if it becomes more than a pilot program, there could be some serious competition there. And we don't want to be competing with the agencies, but we're going to keep going.

Speaker 2

The assets that we're seeing now are looking great as Mark said and we'll see what happens.

Speaker 7

Great. Thank you. That all makes sense. And then just one last question for me. Are you seeing single asset, single borrower security opportunities in the current landscape?

Speaker 7

Is this an area where you're adding and would that fit well within ESP's credit portfolio on the commercial side? And just kind of curious what kind of returns you think you might be able to get right there if you are interested?

Speaker 4

Yes. We Yes. It's a great question. Do you want me to take it, JR? Or do you want to take it?

Speaker 3

Yes. So, I think the first SaaSV question, yes, that's part of the market we've been focused on. In small size, you see that the portfolio grew from $22,000,000 to $42,000,000 quarter over quarter in CMBS. So it's still a small percentage of the overall credit portfolio. But yes, certainly SaaS B is an area that we focused on.

Speaker 3

I mean in past years B pieces have been a much larger percentage of our CMBS portfolio and now much, much smaller. So yes, on the margin SaaS view of the deals we're looking at. In terms of how those yields pencil, I don't know if Mark you want to address that. We give the I'm just thinking about in our disclosures where we would give more detail. There will be more detail in the queue on that question, but I know anecdotally Mark if you want to talk about some of the SaaS B CMBS incremental yields you're seeing?

Speaker 4

Yes. It's been a wild sector, right? So for years, we had almost no SASB exposure. It was a market where sort of BBBs and above all kind of traded in a tight spread range and everything came at par and just didn't look that interesting to us. And now as you have this tremendous divergence of outcomes in commercial space is a function of property type, We've seen some really interesting opportunities.

Speaker 4

There have been bonds that are still investment grade SaaS B that have been down dollar price in the 30s 40s. And then so there's that. That's been an interesting opportunity for us. And the other interesting thing is you're getting a lot of new issue SaaS B and it's been a pretty big volume and it's pushed spreads a little wider. So from a levered spread basis, it certainly looks as attractive to us or maybe even slightly more attractive to us than some of the other sort of bread and butter sectors like CRT, your legacy non agency on the CUSIP side.

Speaker 4

So yes, what's been going on in SaaSBI has really been a lot of the focus of our CMBS team. As JR mentioned, for years we were very active in the B Piece market and just that market with not a lot of conduit issuance, it's just not it doesn't have the same opportunity set as it used to. But the SaaS B opportunity on either lower dollar priced distressed SaaS B where you're really doing very, very detailed analysis of the properties and then up the capital stack to some of the bigger SaaS B deals that we think are coming at very attractive spreads. I definitely think you can see more capital get allocated there.

Speaker 7

Great. Thank you for answering my questions. All super helpful.

Speaker 6

Thanks, Tristan.

Operator

We'll go now to Doug Harter with UBS.

Speaker 8

Thanks. Given the market volatility, can you talk about your appetite for potentially looking at more liquid assets versus your recent strategy of more proprietarily created loans?

Speaker 4

Sure. I mean, I think it's both, right? Like I think we've been opportunistic about that. And you followed us for years, right? You look at what we did in 2020, we added a lot of legacy non agency when a few months before that we were adding a lot of non QM loans.

Speaker 4

So we're constantly looking at the trade off between securities and loans and we take into account the difference in financing levels, the difference in liquidity. So I would say for this market volatility, what that means to me is that maybe you're looking for incrementally a bigger pickup in loans relative to CUSIPs than you might normally look for. And that's typically what happens when you see this volatility that sort of liquidity bases tend to accordion out. So you see it everywhere, less liquid shelves versus more liquid shelves, unrated seniors versus rated seniors, all those things had been kind of going one way this year up until last week or so liquidity spreads have been coming in. We did some loan selling and loan monetizing to take advantage of that.

Speaker 4

And now you seem to start to go the other way. So that relative value trade off is something we always look at. And I think when I sit down and we discuss things with the PMs, that means to us that the threshold for adding loans relative to securities is incrementally a little bit wider now than what it was a couple of weeks ago.

Speaker 2

And thanks, Mark. And the other thing I would add, this is Larry, is that it was we happened to be looking last week at a second lien portfolio and we pulled the trigger on that in the face of this sell off, which was great, got a better price. But in general, when you have these big market moves, and for example, we saw some mutual fund selling, right, or ETF selling. CUSIPs tend to trade more obviously and to be a little more volatile right in terms of just what you're actually able to buy. So I think when stuff like that happens, the first opportunities that are going to arise are going to be in CUSIPs.

Speaker 2

And absolutely if it looks like there's some for selling, we'll gobble those up. It's a little harder to kind of dial up your proprietary pipelines immediately, right? That's just something that is going to kick in longer. So as you have these big risk off moves and now in the last couple of days risk on moves, you're going to see more activity just in CUSIPs and be able to pounce on those. But longer term, as Mark said, I think our expectation is that it's going to be on the private side of the portfolio, the non CUSIPs where we're going to continue to see driving our our ADE.

Speaker 8

Great. Thank you.

Operator

We'll go now to Eric Hagen with BTIG. Please go ahead.

Speaker 6

Hey, thanks. How are you guys doing? I actually wanted to follow-up right there and ask about non agency securities repo and your outlook there for spreads over SOFR to stay stable, including just the general kind of supply of capital that's coming from some of the big banks that have typically supplied back capital and maybe the appetite to continue supplying funding there for the market in your perspective? Thank you.

Speaker 4

Yes. We have seen the same thing you've seen. The big banks now are very interested in repo as a balance sheet asset, right? It doesn't have price volatility. It has a healthy spread.

Speaker 4

So it contributes to NIM. So it's not only traditional banks, but you also have some very large sort of investment banks that converted to banking charters during the financial crisis. So we have seen we've gotten a lot more inbound calls from people wanting to add repo, not on the agency side where that's kind of been stuck at like SOFR Plus anywhere between 5 and 10, but it's been on the loan side, right, not the QSiP side. So anything sort of I'd say SOFR plus 125% to SOFR plus 2.25%, those kind of asset classes, there's been a lot of interest in lenders trying to get more borrowings on their balance sheet. And so we've seen but it's like what rate a lender is at is important, but it's not the only thing that matters on the repo side.

Speaker 4

It's how easy are they to work with, what's their eligibility like. There's a million other things, but we have been able to negotiate better financing terms on loans this year than what we had in place last year. And I think that will keep going because I think what would stop that would be if you saw sulfur really come down a lot, but it's 5.3eight now. SOFR comes down 50 or 100 basis points, I think that's still going to be attractive for the bank. So that's another way I think at the margin we're going to grow some ADE is just by continuing to negotiate and take advantage and be opportunistic about the best financing levels we can get.

Speaker 4

One thing that is sort of helping that is the securitization spread. Larry mentioned tighter non QM spreads this year. That is sort of give the lenders a little bit more confidence to come down on their SOFR spreads. So that has been across the board better whether it's CUSIPs or whether it's loans. But for the CUSIPs I'm talking about, it's sort of like SASB that Chris was asking about or CRT or legacy non agency.

Speaker 4

And the agency stuff, that's been fine for years. It didn't really widen in 2022. It hasn't come into issue that sort of stuck where it is. But anything else, we've gotten better financing terms. And I do think that that's going to continue.

Speaker 2

And I think especially in repo on fixed income CUSIPs, I think it has further to come down given how much spreads have tightened. And just given how I mean, when was the last time you heard about a lender having a loss on fixed income CUSIP repo. I mean it's been a really long time. They're much better at managing that risk. The haircuts are high, a lot higher even than in a lot of like warehouse loan repo on the loan side as opposed to the CUSIP side.

Speaker 2

So I think that actually has room to come down more.

Speaker 6

Always appreciate your detailed response. Hey, one more. Can you share how much capital you have allocated to the credit hedges and how you think about maybe scaling that opportunity as you rotate more capital into the credit

Speaker 3

portfolio? Yes. So on Slide 19, we give an overview of the credit hedges and you can see on a it's not exactly the capital allocation, but a highly equivalent one 120,000,000 notional, is our CDX, which is where most of our corporate hedges are. We have a small amount in CMVX and then European related to currency risk for the most part. So it's meaningful and Mark went through the different uses and benefits that provides, but relative to the size of our several $1,000,000,000 credit and agency portfolios, it's small.

Speaker 3

But it does help on the margin in the ways that he mentioned. We have taken the size of these credit hedges down over time as we move more toward loans and away from CUSIPs that don't always have, hedging instruments available or the need to hedge with low short spread durations, for example?

Speaker 2

Yes. They really take minimal capital to put on and maintain. And they're in fact risk reducing. So in terms of when we think about they don't take any capital away certainly from our ability to add assets.

Speaker 6

Thanks Eric.

Operator

We'll go now to Matthew Ordner with Jones Trading.

Speaker 8

Hey guys, thanks for taking the question. Could you talk about current and expectations for credit performance? And then if recent economic data has kind of made you shift asset allocation, but I do know you're going more so into credit and away from the agency.

Speaker 3

Sure. Mark, why don't I take the first half of that and you can go second if that works. So on the performance of our loan portfolios, we mentioned in our prepared remarks and earnings releases that in commercial, the delinquency percentage declined quarter to quarter. We do still have the 2 multis delinquent loans that we're working through. But overall, the percentage of delinquencies relative to fair value declines between the two quarters.

Speaker 3

And then in resi, it ticked up slightly by 10 basis points call it, when you exclude NPLs that we bought during the quarter. So,

Speaker 2

yes, it's and credit realized losses continue to be small, but we do highlight those 2 non performing multifamily properties that we're working through. Remember and also remember that we mark to market through our income statement, right? So we've marked those 2 non performers down. And so when those resolve, we do not expect to that affect our net income in any negative way. And in fact, what it will do is free up capital to redeploy, so that we can continue to boost our ADE.

Speaker 8

Got you. Yes, that's helpful. Thank you guys.

Speaker 1

Sure. And the second half of

Speaker 3

your question about I think an economic slowdown and how that might change our perception of adding credit assets. Would you mind repeating that? And maybe Mark, if you wouldn't mind tackling that, please?

Speaker 8

Yes. Just kind of if we were to go into a recession, how you guys would think about asset allocation and if it would change from your current stance?

Speaker 4

Yes. I guess the way I think about it is, in the early days of NonQM, we had loss expectations on it and our originators would take loan loss reserves. And what we saw is that performance was so good, shockingly good that they built up a war chest to loan loss reserves and because there weren't any losses, right? And so to me, the aberration has been the really tailwind of home price is really strong default performance from say, I mean, we started LendSure 2014, 2014 up to middle of 2022, I think performance was aberrationally good. And I think now we're going into we're in a period of time where you're going to you see some delinquencies, you're going to see some losses.

Speaker 4

But I think it's absolutely consistent with sort of how we underwrite things and same thing is true for residential transition lending. You've seen the unemployment rate tick up. Jay Powell was talking about it a lot at the press conference. We make no predictions about the economy, but we watch things like a hawk, right? And so we slice and dice the data a 1000000 different ways.

Speaker 4

We've certainly seen a lot's been written about it that there's been kind of FICO inflation that a 700 FICO today is probably more like a 680 FICO 4 years ago, right? So that observation or that belief has informed our credit eligibility criteria. So we've matriculated up in FICO. And I think as an originator and this gets the point I want to make in the prepared remarks about how it's not just we own originator and we're hands off. We are collaborative, right?

Speaker 4

And so we give them access to our data scientists and our data and our research team to kind of come up with best underwriting practices where you can be relevant to the brokers or the correspondents you're working with, but you're getting great quality loans. And so if we see performance deterioration in certain parts of the portfolio, then that serves as a feedback loop when you change your eligibility. So that process, that iterative process of analyzing the data and then updating and adjusting guidelines as a reaction to it, that's I see that as a big part of our job. And it was a big part of our job 10 years ago, but just 10 years ago, you didn't see a lot of delinquencies. You'd look at it, say delinquencies are fine.

Speaker 4

Okay, let's go ahead. Now you're into sort of a much more normal regime. Home pricing more expensive, note rates are higher, people are signing up for bigger payments. And so there's going to be some delinquencies. And so we monitor it.

Speaker 4

We're pricing for it. And I think we're very well equipped to respond to it.

Speaker 8

That's very helpful. Thanks for all the color.

Speaker 2

And I want to add one thing. Just, if you turn to Page 12 of the presentation, right, you can see kind of the various segments of our loan origination business and those pipelines that we've been talking about. And you can see consumer loans, it's a very small segment, right, compared to the others, I mean tiny. And if you look at our portfolio generally, right, we are a residential focused company in terms of the credit risk that we're taking. And let's include also multifamily in that, right, because that's most of our commercial mortgages are on multifamily properties.

Speaker 2

And you can see that on another slide in the presentation. But as to your question, if we go into recession, right, you'll see rates come down. And even though there's definitely issues, right, on affordability of housing. There's also a lot of issues on supply, right? And you have those two things, very little supply versus the demand, but you've got an affordability problem, right?

Speaker 2

And so those two things are kind of counteracting each other. But if we go into recession, again to your question and rates go down and mortgage rates go down, which they would in that scenario, you're now all of a sudden, you're really helping the affordability issue, because you're going to have mortgage rates lower. And on the multifamily side, you're going to really help the cap rate issue. And remember, we're these are bridge loans that in terms of the vast majority of our commercial mortgage loan portfolio. So you're really talking about valuations at the end of that 12 or 18 month term.

Speaker 2

So with cap rates, they come down. So I really feel good about how our portfolio, again, being very residential based and giving the technicals of that market and in addition what would happen if long term rates came down. I feel very good about how we would withstand that kind of a scenario.

Speaker 8

Got it. Great. Thank you very much.

Operator

We'll hear next from Lee Kuperman with Omega Family Office.

Speaker 9

Thank you. I'm on a cell phone. Can you hear me?

Speaker 2

I can. Thanks, Lee. Good to hear from you.

Speaker 9

It's tuned in a little bit late because I had a doctor's appointment. So I have three questions. Most people own the stock for income. Given everything you had to say, you think you restore your dividend before the end of the year to the $0.15 per month level?

Speaker 2

I feel great about maintaining the dividend where it is. I at this point, no, that's not something that I would expect to raise it. And but we've tended to keep our dividend stable for a long time. And so I wouldn't have that expectation of raising it.

Speaker 9

So you would think the dividend will be sustained at the $0.13 a month level?

Speaker 2

Yes, absolutely.

Speaker 9

All right. The second question, you guys have been active in capital management. What is your attitude towards that presently?

Speaker 2

Yes. I think JR kind of alluded to it earlier. I think our next kind of big move on the capital management side is going to be unsecured debt. Rates have come down in those whether you look at baby bonds or other types of offerings, they tend to be a little sticky. So we're being patient and watching that market.

Speaker 2

So I think adding unsecured debt to the portfolio, I think is important. And it's also a little bit of a healthy cycle as you do that because ultimately, look, we're not rated by any of, let's say, S and P and Moody's, for example, right now. We have a great Egan Jones rating. But at some point that's something we might want to look into is to get a rating from let's say S and P and Moody's and the like and that will enable us to issue even more unsecured debt. Of course, as we add things like baby bonds, which aren't rated, that also helps the capital structure It can help us get those other ratings.

Speaker 2

So but anyway, the next move I think significant move again, this is just a prediction. I can't predict where the capital markets go and they're not there yet for us. I think would be some sort of an unsecured deal.

Speaker 9

I need you to help me out since you guys are smarter in the credit markets than me. Everyone seems to think interest rates are too high. I actually think they're low. And the evidence I would use is the stock market is near high. There's a lot of speculation in the market.

Speaker 9

Prior to the great financial crisis of 2,008, the 10 year bond yield in line with nominal GDP. If you have inflation of 2% to 3% and real growth of 2% to 3%, the 10 year would not be undervalued at a 4% or 6% yield. So I think interest rates are going to go up. And I read the Democratic platform, which is 80 pages long. I read the Republican platform, which is 22 pages long.

Speaker 9

Nobody seems to be cared about the debt they were creating in the system. So I think we're heading towards some kind of financial crisis. I don't know if it hits us in 5 years, 10 years or doesn't hit us at all. What's your view of what's going on in the country fiscally?

Speaker 2

Yes. So, again, as Mark said, I just want to reiterate, we try not to color and this is just us. I understand that other companies and of course you with your own portfolio, Lee, are going to take a different approach. But we try not to color our interest rate hedging. We try to focus more on, okay, here's where long term interest rates are.

Speaker 2

Here's where short term interest rates are, what can we buy just given those realities as opposed to and hedging appropriately. But I absolutely agree with you not on short term rates necessarily, but on I do agree with you on the longer term rates that given the increasing size of the debt, budget deficits, nobody's talking about really cutting in any meaningful way. And not to mention that it's not so clear that notwithstanding what we've seen a report or 2 that wage inflation is really behind us, which is the thing that I look at most closely, I think in terms of thinking about where all of could go. I agree with you. I think long term rates, I think it's going to be challenging for the Fed to get even not 2% or even 2.5% whatever.

Speaker 2

And so I think it's going to be challenging for long term rates ultimately to get where at least maybe the forward curve the markets are predicting.

Speaker 7

I

Speaker 2

agree with you.

Speaker 9

I'm on a conference call. Okay. Thank you very much for coming and good luck.

Speaker 2

Good luck to you too. Thanks, Lee. Always a pleasure.

Operator

Thank you, everyone. That was our final question for today. We would like to thank everyone for participating in Ellington Financial's 2nd quarter 2020

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Ellington Financial Q2 2024
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