Ellington Financial Q4 2024 Earnings Call Transcript

Quartr
Provided by Quartr
February 28, 2025

There are 10 speakers on the call.

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial Fourth Quarter twenty twenty four 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 It is now my pleasure to turn the call over to Aladin Shalei. You may begin.

Speaker 1

Thank you. Before we begin, I'd like to remind everyone that this conference call may include forward looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not historical in nature and involve risks and uncertainties detailed in our annual and quarterly reports filed with the SEC. Actual results may differ materially from these statements, so they should not be considered to be predictions of future events. The company undertakes no obligation to update these forward looking statements.

Speaker 1

Joining me today are Larry Penn, Chief Executive Officer of Ellington Financial Mark Tekotsky, Co Chief Investment Officer and J. R. Herlady, Chief Financial Officer. Our fourth quarter earnings conference call presentation is available on our website, ellingtonfinancial.com. Today's call will track that presentation, and all statements and references to figures are qualified in their entirety by the important notice and endnotes in the presentation.

Speaker 1

With that, I'll hand the call over to Larry.

Speaker 2

Thanks, Aledine. Good morning, everyone, and thank you for joining us today. Q4 was a very strong quarter for Ellington Financial, capping off a very successful 2024. In the fourth quarter, as throughout the year, we expanded our loan portfolios and sourcing channels, we strengthened our financing and balance sheet and we steadily grew adjusted distributable earnings. I'll begin on Slide three of the presentation.

Speaker 2

In the fourth quarter, we generated net income of $0.25 per share, while our adjusted distributable earnings increased by another $0.05 per share sequentially to $0.45 per share, comfortably covering our quarterly dividends of $0.39 per share. Key drivers of our results included, first, another excellent quarter from our Longbridge Reverse Mortgage segment, again led by the proprietary Reverse Mortgage business. Second, continued strong performance from our NonQM and other loan originator affiliates. And third, sizable gains from several securitizations that we completed during the quarter. We continue to scale up our credit portfolio in the fourth quarter.

Speaker 2

Our closed end second lien, HELOC, Prop Reverse and commercial mortgage bridge loan portfolios grew by a combined 39%. This substantial growth reflected further expansion of our proprietary loan origination businesses, where we closed on yet another mortgage originator joint venture investment in the quarter. As is typical of how we structure these JVs, we tied our equity investment to a forward flow agreement with that originator. These forward flow agreements have been key to our portfolio growth and earnings growth as they enable us to lock in sources of high quality loans at attractive pricing and at a predictable pace. Meanwhile, we strengthened the liability side of our balance sheet in the fourth quarter in three key ways: executing on securitizations, adding and improving warehouse lines and redeeming our high cost debt and preferred stock.

Speaker 2

In securitizations, we capitalized on the tightest securitization spreads we had seen all year by completing four securitization transactions across three different product lines. First, we completed two nine QM deals, one in October and one in November, each at great execution levels. This marks the first time that we had completed two securitizations in the same calendar quarter, reflecting the increased velocity of our acquisitions in the NonQM sector. The faster the turnaround time on our NonQM loans from acquisition to securitization, the sooner that we can start earning the kind of outsized returns that we've been earning on our NonQM retained tranches and the sooner we can redeploy the freed up capital. Ellington's increasing market share in NonQM is due in no small part to the numerous originator investments and relationships that we fostered over many years now.

Speaker 2

Next, we completed our third proprietary reverse mortgage securitization of the year in a deal that was oversubscribed several times over and which priced considerably tighter than our two prior deals in 2024. Our wholly owned subsidiary Longbridge has become one of the largest originators of proprietary reverse mortgages, So we have good pricing power in that market as well as great visibility on the flow we'll continue to see of that product. Finally, we closed on our inaugural securitization of closed end second lien loans, which locked in non recourse match financing to drive further growth of that strategy. Home equity extraction remains a key theme in the mortgage market. This theme is an important driver of the proprietary reverse mortgage space, but that's a relatively small market.

Speaker 2

On a larger level, home equity extraction is fueling continued strong demand for second lien loans. Given the increased recent supply of second lien loans and the excellent long term financing terms we can get on second lien loans through securitization, this sector became an important component of our portfolio growth in 2024. With the securitizations we completed in the fourth quarter, we generated net gains, we secured non mark to market long term financing on the underlying assets, we freed up capital to redeploy and we retained the highest yielding tranches for our investment portfolio. We believe that our strategic use of securitizations remains a core competitive advantage for Ellington Financial. And we expect that our ability to source high quality loans, structure securitizations and retain high yielding tranches will continue to drive strong earnings, both GAAP earnings and adjusted distributable earnings and will help cover our dividend and help build additional franchise value in 2025.

Speaker 2

Okay. We're still on the liability side of the balance sheet, but let's move from securitization financing to warehouse financing. We've finally seen spreads in the warehousing financing market tighten in sympathy with asset credit spreads. More and more banks are providing financing and they're increasing the amount of capital allocated to providing warehousing financing. We capitalized on this increased competition both by negotiating improved terms on several existing loan financing facilities and by preparing lines with two new counterparties.

Speaker 2

We have plenty of borrowing capacity to accommodate hundreds of millions of dollars of increased loan growth. Our financing counterparties appreciate our creditworthiness, which is supported by the fact that EFC's unsecured notes remain NAIC1 rated. A definite goal for us in 2025 is to issue another round of unsecured notes, assuming we can get the cost of funds that we think we deserve. Finally, we repaid and refinanced some of our outstanding higher cost debt and we redeemed our highest cost preferred stock that we inherited from the Arlington merger, replacing that capital with lower cost debt. These are steps that are immediately accretive to earnings.

Speaker 2

With that, I'll turn the call over to J. R. To walk through our financial results in more detail. JR? Thanks, Larry.

Speaker 2

Good morning, everyone. For the

Speaker 3

fourth quarter, we reported GAAP net income of $0.25 per share on a fully mark to market basis, an ADE of $0.45 per share. On Slide five, you can see the net income breakdown by strategy, $0.32 per share from credit, $0.3 from Longbridge and negative $0.04 from Agency. And on Slide six, you can see the ADE breakdown by segment, $0.28 per share from the investment portfolio segment net of corporate expenses and $0.17 from the Long Beach segment. Positive performance in the credit portfolio was driven by sequentially higher net interest income, which reflected a wider net interest margin and larger portfolio quarter over quarter, net gains from non agency RMBS, HELOCs, Ford MSR investments and ABS, and net gains on our loan originator equity investments. Offsetting a portion of these gains were modest net losses on non QM loans and retained tranches, commercial mortgage loans and consumer loans, in each case driven by a slight decline in credit performance.

Speaker 3

In addition, we had negative operating income on REO workouts. Turning to Longbridge, the robust results from that segment were attributable to an excellent quarter for originations driven by higher volumes, which increased 18% sequentially across all products, improved origination margins in HECM and net gains related to the Prop Reverse securitization. Long Ridge also had a net gain on its MSRs driven by tighter HMBS yield spreads, as well as net gains on interest rate hedges with rates higher during the quarter. Meanwhile, the agency strategy generated a modest loss for the quarter as rising interest rates and intra quarter volatility around the presidential election drove underperformance of Agency RMBS relative to hedging instruments market wide. Our results for the quarter also reflected a net loss on our senior notes.

Speaker 3

We fair value those fixed rate liabilities on our balance sheet and despite higher interest rates, their fair value increased during the quarter due to tighter credit spreads and shortening durations as they pull to par with their maturities approaching. In particular, one of the tranches of unsecured notes that we brought over from Arlington matures next month and we intend to pay those off at par, which is around where they were marked at year end. With interest rates higher in the quarter, we also had net losses on the rate hedges associated with the fixed payments on these senior notes, as well as on our preferred stock, which we don't fair value under GAAP. Turning now to portfolio changes during the quarter. Slide seven shows a 5% increase of our adjusted long credit portfolio to $3,420,000,000 driven by net purchases of closed end seconds, HELOCs, commercial mortgage bridge loans and non agency RMBS.

Speaker 3

A portion of the growth was offset by smaller RTL and non QM loan portfolios driven by pay downs as well as securitization activity. On Slide eight, you can see that our total long Agency RMBS portfolio declined by another 25% to $297,000,000 by design as we continue to sell down that portfolio and rotate the capital into higher yielding opportunities. Slide nine illustrates that our Longbridge portfolio decreased by 15% sequentially to $420,000,000 as the impact of the proprietary reverse mortgage securitization completed during the quarter exceeded the impact of new originations in that business. Please next turn to Slide 10 for a summary of our borrowings. At year end, the total weighted average borrowing rate on recourse borrowings decreased by 56 basis points to 6.21, driven by lower short term interest rates and tighter financing spreads, as Larry mentioned.

Speaker 3

Driven by lower financing costs, the net interest margins on our credit and agency portfolios both increased sequentially. Our recourse debt to equity ratio was unchanged at 1.8:one quarter over quarter and including consolidated securitizations, our overall debt to equity ratio increased to 8.8:one from 8.3:one. In December, we redeemed our Series E preferreds, which we brought over with the Arlington acquisition and which recently reset from a fixed rate to a floating rate. At year end, combined cash and unencumbered assets increased to approximately $810,000,000 or more than 50% of our total equity. Book value per common share stood at $13.52 and total economic return for the fourth quarter was 1.8% non annualized.

Speaker 3

With that, I'll pass it over to Mark.

Speaker 4

Thanks, JR. I was really happy to see the strong portfolio growth this past quarter. Much of it was organic growth resulting from our vertical integration, which allows us to effectively manufacture our own loan investments in partnership with our originator affiliates. Early in 2024, we were also able to take advantage of attractive opportunities in the secondary market, but those secondary opportunities are more cyclical in contrast to the loan origination market where we are more in control of our own destiny. Generally speaking, the high the current high interest rate environment has led to relatively depressed levels of both home purchases and mortgage refinancings industry wide.

Speaker 4

Despite that, if you look at the roster of mortgage originators that we partner with in the origination sectors that we focus on, those originators have actually been growing volume and by all indications gaining market share. With their strong origination teams, reliable financing sources and with EFC as a partner, these platforms have the potential to really grow volumes should interface decline and housing activity pick up later in 2025. While asset spreads are now tighter across the board compared to say a year ago, we've been able to consistently lower our average financing spreads almost in lockstep with the assets. In March, I expect to add a new financing counterparty, providing us with the lowest financing rates we will have in both non QM and second liens. As Larry mentioned, we were very active securitizers in Q4, taking advantage of consistently strong execution on the new issue investment grade bonds.

Speaker 4

Importantly, thanks to the excellent historical performance of our EMT shelf EFMT shelf, the debt spreads that we were able to lock in were some of the best levels in the market. Our consistently strong deal execution is a real competitive advantage, which not only helps drive our earnings, but also enables us to pass along better pricing to our origination partners. And that in turn allows our origination partners to pass along more competitive mortgage rates to their customers, which helps them capture additional market share and produce a higher quality loan for us. We also had terrific performance in our Longbridge segment. Over the course of 2024, we completed our first three securitizations of proprietary private label reverse mortgages, which were all originated by our Longbridge subsidiary.

Speaker 4

With each succeeding deal, we've brought in a larger and larger roster of debt investors and we've executed at tighter and tighter levels. Continuing on the theme I just mentioned, that tighter deal execution translate directly into more competitive loan pricing for Longbridge, which is helping them build loan volumes and market share. Another growth area for us has been second lien and HELOCs. Much of the credit for that success goes to our phenomenal research team, which has built a robust framework for evaluating both credit and prepayment risk for these products. In addition, our sourcing effort has been built upon a foundation of our close relationship with mortgage originators, which in some case span decades to secure what we believe are among the best quality loans in the sector.

Speaker 4

Again, EFC wins with organic portfolio growth in this sector, retain the highest yielding portions of our securitization of loans from programs that we have selected with underwriting guidelines we endorse and in some case have helped construct. Another often overlooked benefit of active securitization is that EFC is building up a war chest of deal call rights. Non QM and second lien securitizations come with an option to call the deal in the future and potentially re securitize the underlying loans at a lower cost of funds. Before rates spiked in 2022, EFC made a lot of money exercising its NonQM call options and should interest rates decline again, they could be very profitable in the future. We did experience some headwinds in the fourth quarter.

Speaker 4

On the commercial mortgage side, we are making steady progress resolving our three most significant loans in the workout. One of these three loans should resolve in the next sixty days with the sale of the underlying property in contract. In the case of the second loan, the underlying properties have already been sold and we're basically just waiting for the bankruptcy court to finalize the expenses and divvy up the proceeds. These resolution processes are more protracted and more expensive than we initially anticipated, but I'm excited to know that we'll shortly be able to redeploy the resolution proceeds, which haven't been generating any AD for us during the workout period. Finally, the third loan is currently in a construction and lease up phase that is progressing, but more work needs to be done and that will take more time.

Speaker 4

Keep in mind that we fair value all of our workout loans through our income statement and on our balance sheet, and we believe that our valuations are conservative and reflect realistic estimates of the ongoing expenses and CapEx and timing to stabilization and sale. We've also seen an uptick in residential loan delinquencies, most notably in our Non QM portfolio. So far these Non QM delinquencies haven't translated into material losses nor do we expect them to going forward as we believe the vast majority of these loans are well secured by the underlying real estate. We think consumer credit is pretty pervasive. We attribute the higher delinquency rates in our non QM portfolio to the combination of bigger loan sizes and higher mortgage rates creating a much higher monthly payment obligation and therefore a greater likelihood of delinquency.

Speaker 4

On top of that, some parts of the country are experiencing a big jump in homeownership premium in the home insurance premiums. We have seen this cycle before. We have a big research effort to tear into the data and we have a very experienced team of underwriters and asset managers to address the issues. Relative to the market, we have been tight on underwriting, selective on what programs we buy and choose you about whom we partner with. That said, rising debt costs have taken their toll on some borrowers.

Speaker 4

We are very focused on this issue. So far in 2025, we've continued with our playbook and we've already closed two non QM securitizations and another second lien deal. This environment has really allowed us to leverage our vertical integration, which runs soup to nuts from equity stakes in the originators to underwriting guidelines and pricing informed by our models to a very efficient securitization process culminating in the creation of securities we want to retain at the prices we want. Now back to Larry.

Speaker 2

Thank you, Mark. With our accomplishments in the fourth quarter, I am pleased to have closed a successful year on a high note with great momentum heading into 2025. I'm proud of what we accomplished in 2024. Early in the year, we laid out the drivers to growing adjusted distributable earnings, which included growing the credit portfolio and returning to origination profitability at Longbridge Financial. And we delivered with 25% year over year growth of the credit portfolio and with the strong second half performance from Longbridge.

Speaker 2

Altogether, we increased our ADE from $0.28 per share in the first quarter of twenty twenty four all the way up to $0.45 per share in the fourth quarter. We are excited about the momentum at Longbridge and in particular, the growing demand for our proprietary reverse mortgage products. While I'm not counting on Longbridge's ADE contribution being quite so high each and every quarter, we do anticipate that EFC's overall ADE will continue to cover the dividend moving forward, which of course is always our goal. As we discussed earlier, our ADE will also be supported as we redeploy the capital from some remaining delinquencies in our commercial mortgage loan book. Mark talked about the upticks in delinquencies that we're seeing market wide.

Speaker 2

By being careful and diversifying across sectors, we have avoided the kinds of serious problems that you've seen at other companies. I can't stress enough how diversification has been key to our success. I believe that we're as diversified as any other mortgage REIT out there and I'd like to close by highlighting the many ways that we benefit from this diversification. First of all, we benefit from asset diversification in multiple dimensions. We diversify by actively investing in both securities and loans and we've built up a formidable loan generation machine, which has been crucial for us as spreads on securities investments have tightened.

Speaker 2

We diversify by investing in both residential and commercial mortgage loans. So the problems in the commercial mortgage sector have been relatively minor ones for us and we're back to playing offense in that sector. We diversify by investing in both forward and reverse mortgages. And in fact, we own one of the largest reverse mortgage loan originators in the country. Meanwhile, in the forward mortgage space, we own stakes in mortgage originators originating everything from non QM mortgages to residential transition loans to commercial mortgage bridge loans.

Speaker 2

We also own mortgage servicing rights, both forward MSRs and reverse MSRs. We also diversify by duration. We own short duration mortgages like RTLs, commercial bridge loans and second lien mortgage loans. And we own longer duration loans like non QM loans and proprietary reverse mortgage loans. Having so many short duration mortgages, even though it creates more work for us to be constantly reinvesting the pay downs, it can be extremely beneficial in times of stress.

Speaker 2

For example, in 2020 during COVID, we used the sizable cash flow coming off of our short duration mortgages to purchase distressed non agency RMBS, which had widened out dramatically during COVID due to forced portfolio liquidations. Okay. We further diversified by having both agency guaranteed, lower yielding assets on which we employ higher leverage as well as non guaranteed credit assets on which we employ lower leverage. The fourth quarter was a tough one for agency mortgages with rates soaring, but at under 5% of our overall capital allocation, it didn't spoil our quarter. Meanwhile, some other mortgage REITs saw large drops in book value per share due directly to interest rate volatility and their effect on agencies.

Speaker 2

When we see better relative value in the agency sector relative to the credit sectors, we can always refocus more on agencies. Finally, please turn to Slide 19. We add yet another dimension of diversification to our portfolio through our use of credit hedges, which I think really distinguishes EFC from the other mortgage REITs. Here, we try to be countercyclical. We want to have more credit hedges on when spreads are tighter and less when spreads are wider.

Speaker 2

Even though our portfolio is mortgage focused, we mostly use corporate instruments to hedge credit because of their liquidity and their robust protection in big market tail events like we saw during COVID. On the right most column of this slide, you can see that to a lesser extent, we also use CMBX to hedge, which are credit default swaps on commercial mortgage backed securities. As you can see on both Slide 19 as well as on the prior Slide 18, we had a large overall credit hedging portfolio on the books at year end. In fact, the most we have had on in a long while. That makes sense for us since credit spreads tightened throughout 2024 and reached their tights in December.

Speaker 2

In fact, by many metrics, corporate credit spreads in December were the tightest they had been since late twenty twenty one, right before they started to widen out massively when it first became clear that inflation was a real threat to the economy. I'd like to point out that in these first two months of 2025, corporate credit spreads have widened out a bunch and so we've taken off some of our credit hedges recently. I fervently believe that diversification and discipline have been key to our performance in difficult years and key to our steady returns over market cycles. 2024 was another solid year as we delivered a 9% economic return and maintained our dividends. Our steadiness is illustrated both on Slide 13, which shows a standard deviation of our returns in comparison to our peer group and on Slide 25, which shows our resilience over market cycles and in particular through financial crises and market shocks.

Speaker 2

Moving forward in 2025, we are committed to building on our 2024 achievements, including maintaining the securitization momentum we have built across multiple business lines. As Mark mentioned, we've already closed three securitization deals so far in 2025 in just two months. We also have a few more originator investments in the pipeline, which we expect will further expand our asset sourcing channels. With a strong capital base, ample liquidity, a diversified portfolio strategy, prudent leverage and dynamic hedging, I believe that we are very well positioned for the year ahead. With that, let's open up the floor to Q and A.

Speaker 2

Operator, please go ahead.

Operator

We'll take our first question from Doug Harter with UBS. Please go ahead. Your line is open.

Speaker 5

Thanks. Can you talk a little bit more about some of the originator investments that you're making and kind of the appetite for non QM given the commentary you made around delinquencies?

Speaker 2

Mark, you want to take that?

Speaker 4

Yes. Hi, Doug. So the playbook we've had for originator stakes goes back to 2014 where we tend to make relatively small investments in platforms where we know the principles and we think there's a meeting of the minds on credit quality and underwriting. And what we look for is situations that are synergistic. And by that I mean, can we help them lower their warehousing costs with EFC's financial half maybe putting a guarantee in place?

Speaker 4

Can we help them by being a more consistent pricing for their loans? Can we help them by informing some of their underwriting processes with the data we have? And that has worked well. We've done a handful of them since 2014. Now what I said about delinquencies, this has been sort of going on for the past couple of years and the response from us, but also say from the market generally has to move up in FICO, move down in LTV and you've basically seen that.

Speaker 4

Even with those adjustments though, delinquencies are higher than what they were in the years right after COVID. I think for a long time, so we did our first NonQM loan, I think 2015. And so for many, many years, the credit losses on the loans were much, much smaller than our underwriting assumptions, right. And I just think you're going into a period of time where you might see credit losses more consistent with how we underwrite. It's nothing shocking and it's nothing that you haven't seen incrementally in other market cycles.

Speaker 4

And it's also it's not anything that we don't think we have the requisite tools to control and to monitor and to minimize the damage on. So it does inform though our loss expectations on NonQM, which then informs our pricing. But with where we are now and the assumptions we have, we still find a lot of value in that market.

Speaker 5

Great. Appreciate that. And then on Longbridge, can you just help kind of I understand that that's always going to be a slightly more volatile earnings stream, but can you help contextualize kind of the ranges of earnings that you would expect kind of and where kind of 4Q would sit and where 3Q sits kind of in that as we kind of think about the go forward earnings power of the business?

Speaker 3

Sure. Hey, Doug, it's JR. Last quarter, we talked about $0.09 per share per quarter coming from Longbridge, which we see as kind of a longer term run rate target and what we think is achievable. So we almost doubled that in Q4. And Larry mentioned we shouldn't expect such a high level, but I think that $0.09 run rate plus or minus is a good number to think about.

Speaker 3

If you multiply their capital allocation by our dividend run rate, it's actually above their kind of contribution if you will, but we have been able to exceed the dividend here in the last couple of quarters. So I think a direct answer would be that kind of reiterating what we said on last earnings call.

Speaker 5

Great. Appreciate that. Thanks.

Operator

We'll take our next question from Eric Hagen with BTIG. Please go ahead. Your line is open.

Speaker 2

Hey, thanks. Good morning, guys. Good to hear from you. Going back to

Speaker 6

the agency portfolio and the allocation there, can you share why that maybe isn't more attractive to you at these valuations? And if you guys had maybe more incremental capital like what you would potentially do with that? Thank you.

Speaker 4

Sure. Yes. For the last, I'd say two or three years, one of the sort of high level decisions we thought about at Ellington Financial is to really have it more credit focused, really have it take advantage of vertical integration, which we think gives us a big competitive advantage versus just going out there and buying CUSIPs in these sectors. And so to do that, it's fairly capital intensive between originator stakes and bulking up loans for securitization and having the risk retention obligation. So the opportunity in agencies has been pretty good and had a good '24 and the start of this year broadly speaking for agency portfolios has been good.

Speaker 4

So we don't it's not that we don't think it's an attractive sector, it's just over cycles. The advantage you have in a permanent capital vehicle to invest in credit, we think is substantial. And that the agency strategy is a good strategy, but it doesn't need to be done in a permanent capital vehicle. And for the capital we have in EFC, we think it can be put to better use taking advantage of being able to go down in liquidity and sort of going down in the mortgage food chain and getting closer to borrowers controlling underwriting and that's done on the residential side and the commercial side. We didn't really talk about it on this call, but we made the investment in a commercial mortgage originator that we've partnered with for years and they've been very helpful for us on overseeing property management and construction.

Speaker 4

Those kind of investments need permanent capital. And so while we have that permanent capital on Ellington Financial, it's just our conclusion that over cycles we're going to generate better returns and more stable returns doing this vertical integration on the lending side. And it's just we think it's sort of a superior return than we'll get on the agency side. You can get massive dislocations in the agency market. You saw them in 2022 and we have the ability to be opportunistic there and we retain that ability and we'll do it and it's certainly a core competence of the firm.

Speaker 4

But for right now, when you're seeing this growth in non agency securitizations, you're seeing Fannie and Freddie retrench a little bit and more parts of the mortgage market that they used to dominate are now going, are getting a credit enhanced by private capital. We just think right now that's the more exciting opportunity.

Speaker 6

Yes, definitely makes sense. I appreciate that. So following up on the non QM delinquencies, is there a read through in managing the securitization trust? Like is there an expectation from investors that you buy those loans out of the trust even if you don't expect an eventual credit loss? And do you need to maybe temporarily manage your liquidity any differently as a result of that?

Speaker 4

No, I don't think there's that expectation. By and large, we've been risk retainers and we've kept a lot of the credit risk on our deals. And we can it's a little bit different than like what you see in the CRE CLO market that I think you're talking about not chunky loans, right? So I think we have I think our expectation now is to work those out and resolve those while the loans are in the securitization.

Speaker 6

Got you. Thank you guys.

Speaker 4

Thanks Eric.

Operator

We'll take our next question from Uzi George with KBW. Please go ahead. Your line is open.

Speaker 7

Hey guys, good morning. Hi. Actually first on the net interest income, so you guys noted obviously the work you've done on the liability side. Is the net interest income this quarter kind of a good run rate to think about going forward?

Speaker 3

Sorry, I missed the middle

Speaker 2

of the question. We just say net interest income, are we going to Yes, it's a good run rate.

Speaker 7

Yes, so I was just checking if there was a good run rate since it was up around 0.05 I guess on the improvement you've had on the liability side. So just

Speaker 2

Yes, I mean that should be remember those improvements are ongoing and didn't take place at the beginning of the quarter. So yes, I think that we should be seeing something better.

Speaker 3

Yes, I think that's I would echo that. I mean, we mentioned that the NIM on the credit portfolio widened and the weighted average cost of funds declined, which is okay, which is what you're pointing out, declined by 50 bps plus during the quarter. That's a combination of negotiating tighter spreads with several financing providers and the drop of short term rates. So I do think that it's also a function of product mix, but I do think it's representative what we saw in Q4 in terms of the portfolio composition adding more resi loans, adding more commercial bridge loans. So yes, I think it's I think it's a good run rate to.

Speaker 2

Yes, I mean, look, on the other hand, on some of the loans that we're buying now, for example, we've seen some spread compression in RTLs, so and other products. So I think as the portfolio turns over, you may see some tightening on the asset side. So it's there's kind of currency, counter currents, I guess you could say. But I think for certainly for the first quarter, I don't see any reason why that's not a good guidepost.

Speaker 7

Okay, great. Thanks. And then actually on the expense side as well, it went up last quarter, it's kind of a similar level. I think you guys have suggested it might tick back down, but is this kind of a decent run rate, Virgins?

Speaker 3

Yes, I think it's a good it's a decent run rate. We did have some one time option related tick up last quarter that you identified I think that you're referencing. The quarter over quarter now is it's just a small percentage increase with no real movement in any of the individual line items. Yes, I think in short, I think it's a good run rate to use going forward, that kind of the Q4 results.

Speaker 2

Yes. And I just wouldn't say I'd like to add a little bit of color to that option line. So before we had owned basically half of Longbridge until a few years ago. And our partner owning the other half was a private equity firm. And there was some thought back then of potentially having a sale of the company and a realization of it.

Speaker 2

I mean, I'm going back several years. And ultimately, we actually so sorry, so the way that employees had been compensated back then, especially senior management was partially through granting options in the company, again, anticipating some sort of a realization event down the road. When we bought the other half and basically owned all the company at that point and had no intention or let's just say, no specific plans to ever sell the company, which we think works really well within Ellington Financial for all the reasons that we've said so far. Those options didn't really make as much sense, right, to have an option in a subsidiary that those employees can never monetize, right? So we basically bought them out at a fair price given what had happened in the ensuing years between when the options were granted and when we repurchased them.

Speaker 2

So that's why it was a one time thing. And now there are no more options outstanding. And sorry to go ahead, JR.

Speaker 3

Yes. No, I think that covers it.

Speaker 7

Okay, great. Thanks. And actually just a follow-up on the Agency MBS discussion. Actually, where do you see current levered yields or sort of ROE? And also just in terms of spreads, do you look at nominal spreads, Z spreads, OAS, just what's kind of what's the spreads you look at mainly on the math for that?

Speaker 2

On the agency space?

Speaker 7

Yes, on the agency space.

Speaker 4

Yes. So I would say this, right, we've always run it a little bit differently than some of the peer group. So we've liked the use of TBA hedges. So when we have mortgages hedged with swaps or treasuries, so not versus TBAs, There's a few things we look at. So on the specified pools, we look a lot at OAS.

Speaker 4

I do think that is the best measure to capture sort of value you're going to capture over market moves. So we look at OAS. We also look a lot and we think a lot about sort of optionality and pay ups, right? Like there's sometimes you can buy pools with a very low payup and in certain market environments the payup can go up substantially, right? So I'd say it's primarily OAS, it's less zero vol spread.

Speaker 4

Now when we have pools versus TBA, then it's a lot of well, okay, how does that pool carry versus what the role is on the TBA? That's a big part of it. And what's the convexity of our pool going to be like with TBA? Are there market moves where we think pay up can go from a handful of ticks up to maybe like 24, 20 five ticks and that could be half point of outperformance. So they were looking a lot of sort of we kind of call it pay up convexity, but so what kind of volatility and what kind of upside do you have in the pay up?

Speaker 4

And the other thing is, when we have TBA longs versus rate hedges, then we care a lot about what the roles are. And there are sometimes where roles can be so compelling over a long period of time that far superior than being long specified pools. And that sort of like it definitely hearkens back like 2021 when these discount roles like Fannie 2s and Fannie 2S were consistently and the hedging costs. So I think it depends a little bit on is it pools, how are they hedged, but zero vol spread versus OAS. We're firmly in the camp that you need to really look at OAS.

Speaker 4

We're reluctant to buy things to have a very low zero vol spread because I just think you have fewer other participants that want them, but gun to our head, we're going to pick a higher OAS and a lower zero vol spread than something that's the reverse.

Speaker 7

Okay, great. That's helpful.

Speaker 2

Hey, Bose.

Speaker 7

Thanks, Bose. Yes.

Operator

Hi.

Speaker 2

Yes, I actually wanted to follow-up a little bit on your expense question because we were just looking at some of the numbers offline here. So there are a few things going on. So we're look, we're always looking to make sure we're efficient on expenses. And we've definitely made some improvements even so far this year. But when you think about the fact that we're more and more focusing on loans versus securities, obviously not credit versus agencies, but even just loans versus securities, those are going to require more people.

Speaker 2

And so compensation costs, again, I think when you look to the extent that they're rising versus what our income has been in these sectors, it's not a question that this is what we need to be doing. Longbridge, by the way, also in particular, right, as we're growing that proprietary business, as they've increased their servicing portfolio. I mean, all these things that are making us a lot of money, they've been also growing in terms of headcount as well. And again, we're always going to look at efficiencies there. And but I think that these investments in what are really been modest increases, I think, in compensation personnel costs have been absolutely more than rewarded in terms of what you've seen in Longbridge and what you've seen in terms of what we're doing on the loan side of our portfolio.

Speaker 2

So, yes.

Speaker 7

Okay, great. No, it makes a lot of sense. Thanks a lot.

Operator

We'll take our next question from Trevor Cranston with Citizens JMP. Please go ahead. Your line is

Speaker 5

open. Hey, thanks.

Operator

Question on related to Longbridge, I know a lot of the focus there is on the proprietary side of things, but I was wondering if you guys could comment on whether or not you guys have seen or you foresee any impact on the HMBS market and the rollout of HMBS two point zero related to staffing cuts at HUD and other places and what the overall impact of that could be on Longbridge? Thanks.

Speaker 2

Yes. Look, it's an important question. And I wish I had a better answer than to tell you. We'll have to see just like with a lot of things going on right now. On the other hand, we do have the prop business, which has really been driving the earnings.

Speaker 2

So I think we'll just have to wait and see on the Hekim side. The Hekim side did have the agency side basically has been seeing improving results as well. But we're just going to have to wait and see. I mean, look, there were a lot of questions in the first Trump administration and there'll be questions in this administration exactly where they're going to and HMBS two point zero, I can't can't remember whether you referred to that, but sort of we were anticipating a change in some of the regulations that would actually be a further boost to Peckham profitability. But we'll just have to wait and see.

Speaker 2

Maybe this won't materialize. That'll just be the absence of a positive. But again, we're just going to have to wait and see. Yes.

Speaker 8

And I would just add

Speaker 3

it, it's hard to read the tea leaves on the regulatory change front and the like, but you could also see if there is an interruption on the Hekim and HMBS product, it could drive demand to prop. That's right. And we have large we believe we have larger market share in prop than

Speaker 2

we do in Hekim even though we have a very large market share in Hekim. So, yes, so we'll just have to wait and see.

Operator

Okay. Yes, that makes sense. Thank you, guys. Thanks. We'll take our next question Thanks.

Operator

We'll take our next question from Randy Binner with B. Riley. Please go ahead. Your line is open.

Speaker 9

Hey, thanks. Actually, just on the HUD, that's a really interesting area. So, understood that there's a lot to monitor with the new administration, but I believe they've already had some pretty significant staffing cuts at HUD. So is there just kind of real time? Are you all feeling anything just from a procedural perspective in dealing with the government?

Speaker 2

I haven't heard anything, no.

Speaker 9

Okay. So, yes, I think my question this has all been very comprehensive, appreciate it. But just on the REO workouts, in the prepared script, you provided some details on a couple of loans. It sounds like they're in the kind of last stages of negotiation. Have you quantified how much capital gets freed up?

Speaker 9

What the timing of that would be as a result of these REO workouts?

Speaker 2

Yes. I'm just going to say it's not it's probably not as much as you think, but go ahead JR.

Speaker 3

Yes. So the short answer, Andy, is we've not quantified it. At year end, we had less than $100,000,000 invested in commercial, in REOs and delinquent loans altogether. About more than half of that is of the three loans that we talked about, those three constitute more than half of that $95,000,000 call it. So beyond that, we haven't quantified it.

Speaker 3

Right.

Speaker 2

I'd say so. But if you just assume for argument's sake that it was something in the high 40s, then I mean, again, this is not

Operator

Got it.

Speaker 2

It's great, it's great, don't get me wrong. We want to see these resolved quickly and move on, but you're not talking about anything game changing.

Speaker 3

Yes, some is finance, some is not. But also we have it it doesn't contribute to ADE as we mentioned in the prepared remarks and in some cases it has negative AD implications during a quarter. So it can have a despite the smaller size relative to the overall pool of capital, it can have a disproportionately negative impact on ADE both through not generating ADE, but also being a drag in some cases. Right.

Speaker 2

So we're looking forward to getting past that.

Speaker 9

Okay. Yes, I understand. So not going to add that to the model. And then, I guess, on reverse, it's you doubled your guide and you have this demographic wave of the boomers. And I mean, seemingly, aging in place would be preferable for a number of different reasons.

Speaker 9

And so I mean just taking a step back, are you this has been it's a tremendous business, I think, and it's generally underappreciated. Do Do you get the sense that you're going to get more mainstream competitors in that area? Or do you think this can kind of still stay kind of a niche market where you can have a lot of share, reverse mortgage kind of that large?

Speaker 2

Yes. And by the way, the other thing I just want to mention, I think it addresses your question to some extent is that Longbridge is actually we're actively working with some other partners to create some other products for seniors that may not technically be reverse mortgages, but have a lot of similar characteristics. So I don't want to sort of give away too much, but there's just yes, there's a lot of ways with the relationships we have with the compliance program that is, I would say, unique to the reverse mortgage originators that have to do so much more when dealing with seniors, for example. So yes, so we're excited and we're hopeful that we can even announce some interesting new products in the near future.

Speaker 9

Would that be like in partnership with Life Insurers

Speaker 4

or more banks?

Speaker 2

No, no, with other types of loan originators.

Speaker 9

Okay.

Speaker 6

Yes.

Speaker 9

All right. Very good. Thank you.

Operator

Thanks. And we'll take our next question from Crispin Love with Piper Sandler. Please go ahead. Your line is open.

Speaker 8

Thank you. Appreciate taking my question. Can you just dig a little bit deeper into closed end second HELOCs and the opportunity there? It looks like you've more than doubled the portfolio there in the fourth quarter. Is that rate driven along with affordability and HPA moves?

Speaker 8

And was that growth mostly through acquisitions? And just curious on how demand could be in that space if rates do come down? Meaning, is there still a bunch of runway if rates do come down just with where rates are today? Thank you.

Speaker 2

Hi, Mark.

Speaker 4

Yes. Hey, Crispin. Thanks for the question. So that opportunity set for what we've been buying, we've been buying just loans, second liens where the first lien is from Fannie, Freddie, Ginny and the borrower has a low note rate first, three point five or 3.25 note rate first. And they've amortized down the first little bit.

Speaker 4

They've had home price appreciation. So most of these things are now FICO is in the $740,000,000, 7 50 million dollars type range, the combined loan to value ratio. So the first lien plus the second lien, typically high 60s, so you got a lot of equity. And it's borrowers that have in some cases been in their house eight, ten years because a lot of the activity in 2021 as you remember were refi activity, right. The guy's person has been in his house, family has been in the house eight, ten years.

Speaker 4

They got a really valuable first rate mortgage, right. If you're paying 3.5 or 3.25 on a first, that's an asset, right? So you don't want to part with that, but yet maybe you want to renovate your kitchen, maybe you want to do some landscaping and you want to borrow against your home, right? Because it's a heck of a lot cheaper than credit cards, heck of a lot cheaper than unsecured. So you take out a second lien, nine odd percent or whatever it is.

Speaker 4

And it's a smart way to tap some of the equity in your home. So that's a big opportunity set because even though it's been years since we've had those super low rates, most of the Fannie Freddie Ginnie market is still that really low coupon stuff. So we see it as a big opportunity set. I would expect over time you're going to see people doing more adventurous things in second liens. That's not what we've been participating in.

Speaker 4

So for us, it's been a chance to get a higher note rate loan from a borrower. We think the borrower is an excellent borrower as evidenced by like long pay strings and the borrower that even with the second lien, even after you take into account this additional loan obligation, this additional debt obligation to put on their home, it's still very low loan to value ratio. So it's been that combination of things that has drawn us to the sector. And it's similar things about HELOCs. And then in addition with the second liens, there is an active securitization market.

Speaker 4

So we're ability to term out Larry talked about liability side of the balance sheet. And so when you do a securitization second lien, it's just like non QM. You're replacing repo with fixed rate debt that matches the cash flow on the assets. And as debt spreads have come in, we found issuing the securitizations is more profitable to us than just keeping loans on repo. And so I think it's a pretty big opportunity set.

Speaker 4

I think it will be pretty long lived. I mean, I think what changes is rates going up won't change it. I think rates going up, you'll still see good volumes. I think where it changes if rates were to drop precipitously, then some of these borrowers where it's smarter to take a second lien than refinancing the first lien, that's where you could see the market dynamics change. Right now, if you have a three point five first and you want to borrow $60,000 it just doesn't make sense to pay off your three point five first and take a bigger seven percent first.

Speaker 4

But if rates were to come down a lot, then all of a sudden maybe you get to three point five first, you can borrow at a five then the math then it's the scales are more in balance.

Speaker 8

Great, Mark. I appreciate that. All really helpful. And then just last one for me. Just big picture question on the potential for GSEs coming out of conservatorship and the new administration.

Speaker 8

Just how do you view the probability of that happening and impacts the EFC as you'd see it? And is there any way for you to position and on that maybe occurring over the next few years?

Speaker 4

I think it's a great question. I think it depends on leadership at FHFA, but it's certainly a possibility. It was certainly on the radar for the first Trump administration and they've been talking about it now. So I definitely think it's possible. I definitely think, you've had a lot of comments from the Treasury Secretary that it needs to be done in a way that does not raise the cost of homeownership.

Speaker 4

I think they're very focused on that. So I think it could certainly happen whether there is an ultimate backstop to the government or not, I don't know. And I think what I think it does create though is the possibility of some short term volatility. So in the end, whenever it happens, maybe it's done in a way where agency mortgages still have a backstop and they're extremely liquid and they really do compete with investment grade corporate bonds and treasury bonds for the investment grade dollars the way they are now, they're a big part of the ag. But going from where we are now to what finally happens, you can certainly get comments made and suggestions put out there that can cause some short term volatility.

Speaker 4

So I think the opportunity set is short term volatility. I think the bigger picture that we've been focused on for a couple of years and which I think is a very substantial opportunity set for Ellington Financial is the fact that and it sort of I think this trend is accelerated with the current administration is that Fannie and Freddie Ginnie are gradually shrinking their footprint. And it's clear with Fannie and Freddie, they have a mentality of cross subsidies where certain loans they know they're charging way, way above expected losses for guarantee fees and loan level price adjustments because they want to be able to subsidize other loans that are more mission driven, maybe higher LTV loans. And so you've seen Fannie and Freddie now willing to let portions of the market that they used to guarantee fee and used to make a lot of money on get credit enhanced in the private label market. In years past, when Fannie and Freddie would see that they're losing market share to the private market in certain areas, then they would oftentimes adjust their G fees, adjust their loan level price adjustments.

Speaker 4

But it seems like where we are now, I think they're less likely to do that. So I think private capital's role in the housing market, I think that's going up as a result of all this. And how it ends in GSE reform, I don't know. But you're certainly seeing the loans that could go to Fannie and Freddie right after the financial crisis, one hundred percent that could go to Fannie and Freddie went to Fannie and Freddie. And that was by and large the case for many, many years.

Speaker 4

And now you're starting to see loans that could go to Fannie and Freddie, increasing numbers are finding better execution in the private label market?

Speaker 2

Mark, I'm just going to I don't usually make predictions, but I think that the odds of course anything is possible. I think the odds are lower than people think. But I think if there is going to be an eventual release, I think it's a lot more complicated than a lot of people think. So I think you're talking about something that could take a really long time. Meanwhile, the agencies are actually through the CASM stacker programs, right, CRTs.

Speaker 2

They're actually reinsuring a lot of their risk. I believe they model to global financial crisis type levels in terms of what could happen to housing. They are generating massive profits that are going right to the treasury. And those obviously you've got a lot of things on the table now that are going to increase deficits potentially. I think even though there was a lot of talk of this in the first administration again.

Speaker 2

And I think it's much more complicated than people think to sort of disentangle them as well from the markets. So I think it's going to take a very long time. I think the odds are lower than people think.

Speaker 8

Great, Bill. I appreciate you both taking my questions. The detail is great. Thank you. Thank you.

Operator

And that was our final question for the guys. We thank you for participating in the Ellington Financial fourth quarter twenty twenty four earnings conference call. You may disconnect your line at this time and have a wonderful day.

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Earnings Conference Call
Ellington Financial Q4 2024
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