Ellington Credit Q4 2024 Earnings Call Transcript

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March 13, 2025

There are 8 speakers on the call.

Operator

ladies and gentlemen.

Operator

Thank you for standing by. Welcome to the Ellington Credit Company twenty twenty four Fourth Quarter Financial Results Conference Call. Today's call is being recorded. It is now my pleasure to turn the floor over to Aladin Shalei, Associate General Counsel. Sir, 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 awards 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 Allentine Credit Company Mark Tekotsky, Co Chief Investment Officer Chris Smirnoff, Chief Financial Officer and Greg Bornstein, Head of Corporate Credit at Ellington Management Group. Upon effectiveness of our written conversion scheduled for April 1, Greg and Mike Vranos, Ellington's Founder and Head of all portfolio management activities, will officially be designated as EARNS to portfolio managers. Our fourth quarter earnings conference call presentation is available on our website, ellingtoncredit.com. Today's call will track that presentation and all statements and references to figures are qualified by the important notice and end notes in there in the presentation. With that, I'll turn it over to Larry.

Speaker 2

Thanks, Elodine, and good morning, everyone. We appreciate your time and interest in Ellington Credit Company. I'll start on Slide three. I am pleased to report that on January 17, shareholders approved our conversion to a closed end fund and we are now on track to complete that conversion on April 1, so in just a few more weeks. We have continued to expand our CLO portfolio in preparation for the conversion.

Speaker 2

And in the fourth quarter, we grew the CLO portfolio by another 18% to $171,000,000 Most of this growth came in CLO equity tranches where we currently see the most attractive opportunities. With CLO debt spreads tightening, the economics of both new and existing CLO equity investments are improving. Meanwhile, persistent pricing inefficiencies and heightened market volatility continue to create compelling relative value opportunities across the CLO market in both The U. S. And Europe.

Speaker 2

Since year end and including investment activity through Monday, the CLO portfolio now stands at around $235,000,000 In the fourth quarter, we also added more agency RMBS prioritizing highly liquid pools since those pools will be sold when we convert. Until our actual conversion date to a closed end fund, we need to keep buying more agency pools to balance out any growth in our CLO portfolio so as to maintain our exclusion from registration as an investment company under the 1940 Act. However, as we have been adding these liquid agency pools, we have also been adding short TBA positions. Short TBAs are a valuable risk management tool that hedge interest rate risk, while also mitigating exposure to higher interest rate volatility and widening agency pool yield spreads. As shown on Slide 13, at year end, our net mortgage assets to equity ratio, which takes into account our net short notional TBA position at year end, declined to 2.6 to one, down from three to one on September 30.

Speaker 2

This marked our lowest net mortgage assets to equity ratio for earn in at least a decade. And I'll highlight that it has declined much further since year end to nearly zero today with our TBA short positions now nearly offsetting our long agency pool assets. We were fortunate to have added these short TBA positions when we did given the recent spike in interest rate volatility in the last few weeks. Over the past year, when we've added agency pools, we've been prioritizing highly liquid sectors. And so our agency pool book, while it's always been liquid, is now as liquid as it's ever been.

Speaker 2

This portfolio rotation within our agency pool book, which really started over a full year ago, has been conducted in an orderly manner with Mark Dukovsky and his team focusing on minimizing friction. At this point, with just a few weeks to go until the conversion, the emphasis in our pool position is not on relative value, but rather on liquidity since those pools will be sold expeditiously after the conversion. We're no longer holding pools where we're betting on pay up expansion, but rather we're holding pools with low and stable pay ups. At December 31, the average pay up on our pools was just 20 basis points, down from 101 basis points one year prior. When we convert, we estimate that the sales of all these remaining agency pools together with the covering of our TBA short positions will have just a $0.01 effect on book value per share, which I consider minimal.

Speaker 2

Please turn now to Slide four, where we'll take a look at the market backdrop. In the fourth quarter, strong credit fundamentals, robust demand for leverage loans and capital inflows into floating rate loan funds supported the CLO markets. As you can see here, credit spreads tightened, which drove record high corporate loan issuance, although net CLO issuance remained low due to a flurry of CLO deals being refinanced or called. CLO mezzanine debt generally performed well in the quarter, capping off an extremely strong 2024, while cross currents in the market again drove mixed results in CLO equity as portfolio manager Greg Borenstein will get into later on this call. Now let's review earnings performance for the fourth quarter.

Speaker 2

Please turn back one slide to Slide three. Our CLO mezzanine debt portfolio continued its excellent performance with sequentially higher net interest income helping support our adjusted distributable earnings as well as net gains resulting from several opportunistic sales, tighter credit spreads and redemptions of several of our discount season CLO mezzanine tranches. Our CLO equity investments also contributed significantly to our adjusted distributable earnings and they also delivered positive results, albeit with more modest total returns. Now over to our agency mortgage portfolio. Interest rate and yield spread volatility mainly around the presidential election in November drove underperformance in the agency pool market.

Speaker 2

This led to a loss in our agency portfolio, which in turn led to a small overall net loss per earn for the quarter. Again, we anticipate that we'll no longer have exposure to the agency pool markets shortly after we convert to a closed end fund on April 1. Importantly, the combination of portfolio growth and wide net interest margins on our CLOs continue to support adjusted distributable earnings, which at $0.27 per share again covered our dividends of $0.24 for the quarter. Our debt to equity ratio remained below three:one at year end and liquidity remained high with cash plus unencumbered assets totaling $111,000,000 or more than 50% of total equity. Of course, after we convert to a closed end fund, our debt to equity ratios will be far lower.

Speaker 2

I'll now pass it over to Chris for a more detailed look at our financial results for the quarter.

Speaker 3

Chris? Thanks, Larry, and good morning, everyone. Please turn to Slide six. For the fourth quarter, we reported a net loss of $0.07 per share and adjusted distributable earnings of $0.27 per share. Our overall net interest margin remains strong at 5.07% supported by our growing capital allocation to CLOs.

Speaker 3

On Slide seven, you can see the net income breakdown by strategy, which was $0.1 per share from CLOs and negative $0.12 from Agency. In our CLO debt portfolio, net interest income grew quarter over quarter and we also had net gains in our U. S. And European debt portfolios supported by several opportunistic sales, tighter credit spreads and redemption of several of our discount seasoned CLO mezzanine tranches. In our CLO equity portfolio, results were modestly positive with net interest income slightly exceeding net unrealized losses.

Speaker 3

Meanwhile, the agency strategy generated a net loss for the quarter as rising interest rates and intra quarter volatility drove underperformance of our agency RMBS relative to hedging instruments market wide. And finally, our non agency RMBS portfolio generated positive results driven by net interest income and profitable sales. We sold effectively all of our remaining non agency RMBS and interest only securities during the quarter at net gains. With an overall net loss for the quarter, we accrued a small income tax benefit. After our conversion to a closed end fundRIC next month, we will generally not be subject to corporate income tax.

Speaker 3

At December 31, our book value per share was $6.53 and combined cash and unencumbered assets totaled $111,000,000 Our economic return for the quarter was negative 1.2%. Our debt to equity ratio adjusted for unsettled trades increased to 2.9 times from 2.5 times at September 30. Over the same period, our net mortgage assets to equity ratio decreased to 2.6 times from three times driven by a net short notional TBA position at year end in contrast to a long notional TBA position at the end of the third quarter as well as higher shareholders equity. Slide 10 shows our CLO portfolio increasing by 18% to $171,000,000 at year end and capital allocated to CLOs expanded to 72% from 58% at September 30. At December 31, CLO equity comprised 58% of our total CLO holdings, up from 52% and European CLO investments constituted 14% of our total CLO holdings down from 17%.

Speaker 3

On Slide 11, we show the Agency RMBS holdings increased by 11% to $512,000,000 at year end. Slide 12 details our interest rate hedging portfolio and Slide 13, our net RMBS exposure where you can see the net short notional TBA position at December 31, which has grown significantly post year end. On Slide 14, we illustrate that nearly all of the loans underlying our CLO portfolio are floating rate and as such have much lower interest rate duration than Agency RMBS. We also maintained modest credit hedge and foreign currency hedge portfolios at year end related to our CLO investments. With that, I'll pass it over to Greg.

Speaker 4

Thanks, Chris. It's nice to speak with everyone today. Overall, we saw strong performance in the CLO portfolio for the fourth quarter. Our CLO meds positions did particularly well. Spread tightening provided a nice tailwind and we were able to enhance our total return with some opportunistic sales and a few deal calls.

Speaker 4

CLO equity generally held in aided by a benign credit environment and continued strength in the leverage loan prices. However, similar to the prior quarter, the high prepayment rates in the loan market combined with loan coupon spread compression did lead to muted returns in some areas of the CLO equity market and in our portfolio as well. With the majority of the refinanced loans previously trading above par, that refinancing activity, coupled with some credit losses from lower quality loans underlying CLO portfolios, weighed slightly on equity NAVs in the market. Further, coupon spread compression in newly refinanced loans caused a decrease in net interest margins for many CLOs and thus a decrease in net interest distributions to the equity tranches for the equity tranches in those CLOs. These asset level dynamics created headwinds for CLO equity investments.

Speaker 4

This said, some of these headwinds were offset by refinancing and resetting CLO liabilities at tighter coupons, which improved net interest margins for many CLOs. We often talk about cross currents in CLO equity, and these are prime examples. Even some deals that did not benefit from the liabilities tightening did experience price appreciation as the option to refinance going forward gained value. These dynamics can also present us with trading opportunities. We do expect the repricing wave to relent as 2025 progresses.

Speaker 4

For the universe of loans backing U. S. Broadly syndicated CLOs, we have already seen the percentage trading at a premium decline from 63% at the January to 32% at the February, and this percentage has declined even further in March. Meanwhile, in Europe, many of these dynamics also exist, but to a lesser degree. As a result, our CLO equity in Europe has strong returns in Q4, outperforming our CLO equity in The U.

Speaker 4

S. I think that's a good example of the power of diversification. There was also far less CLO capital markets activity in Europe in 2024 and credit spreads have generally not tightened as much. As we move forward in 2025, credit spread tightening and monetization of discount debt tranches have seen us increasingly shift the portfolio to CLO equity. Despite year to date declines, interest rates remain relatively elevated and that continues to drive demand for floating rate loans and CLO debt tranches.

Speaker 4

However, we remain cautious given potential longer term fundamental stresses on corporate borrowers. We expect to see more opportunities in equity as the deluge of issuance is creating both ample supply and also pricing inefficiencies. We continue to focus on maintaining sufficient liquidity to enable us to remain nimble and tactically shift to new opportunities as we see them. In recent days, credit market volatility has surged once again. Outside of last August's flash crash and the sharp interest rate sell off triggered by inflation concerns a few months prior, implied volatility in the CDX high yield index recently reached its highest level since late twenty twenty three.

Speaker 4

As is often the case, heightened volatility brings greater market inefficiencies and a more dynamic trading environment. As a result, we are seeing an expanding opportunity set in CLOs as we deploy new capital. While this volatility has widened credit spreads in certain areas, creating a potential headwind to book value, our CLO equity positions are generally well positioned to capitalize on the shifting landscape. The risk of loan coupon spread compression has eased significantly as a smaller portion of the loan market is now trading above par. This structural shift benefits our CLO equity holdings, which are concentrated in profiles with locked in liabilities and extended reinvestment periods.

Speaker 4

The current market conditions align well with our expertise in active trading and relative value assessment, reinforcing our ability to capitalize on market inefficiencies and drive strong risk adjusted returns. Also, keep in mind that we will have lots of dry powder to deploy once we sell off our remaining agency mortgage pools. So our anticipated April 1 conversion date may prove to be well timed. Now, I'll turn it over to Mark to discuss the agency strategy.

Speaker 5

Thanks, Greg. We had a small loss in our Agency MBS portfolio for the fourth quarter. That was largely a result of very high levels of interest rate volatility and general underperformance of Agency MBS versus hedging instruments. I'd like to highlight how we've changed the composition of our hedging portfolio since year end. As Larry mentioned, we have substantially derisked our Agency MBS portfolio recently by significantly increasing our short TBA hedging positions.

Speaker 5

Today, our short TBA position essentially offsets all of our Agency MBS basis exposure. So if we were to update the bar chart on Slide 13 as of today, you would see a TBA short offsetting almost all of our long pool exposure. With this positioning, we are keeping our pool investments in place for nineteen forty Act compliance reasons up until conversion, but we're also significantly limiting our overall exposure to the agency sector. I am pleased with how we were positioned at year end, which enabled us to generate strong profitability in our MBS portfolio in January. I am also pleased that we increased our TBA hedges earlier this quarter, especially in light of the volatility we've seen so far in March.

Speaker 5

The last step following the conversion will be to sell our pools and buyback the TBA shorts, at which point we will no longer have any MBS related positions. Now back to Larry.

Speaker 2

Thanks, Mark. These past fifteen or so months have been extraordinary for Ellington Credit Company as we undertook the highly complex task of converting from a mortgage REIT to a CLO focused closed end fund. Achieving this breakthrough was only possible through extensive planning and collaborative efforts since late twenty twenty three involving our Board, our management team and our expert advisors. Above all else, it was extremely rewarding to see the overriding support that our shareholders showed all along the way. Over the course of 2024, we transformed our portfolio by increasing our capital allocation to CLOs from just 11% on January 1 to 72% by year end, achieved through a tenfold expansion of our CLO holdings, a careful but steady reduction of our Agency RMBS portfolio and a deliberate rotation of our Agency RMBS portfolio into extremely liquid sectors.

Speaker 2

Through strategic timing of pool sales by Ellington's MBS portfolio management team overseen by Mark Takotsky combined with the success of Greg Borenstein's team in sourcing attractive CLO investments allowed us to minimize bid ask costs and efficiently add CLOs without disrupting earnings along the way. This smooth transition not only supported our earnings and boosted our net interest margin in 2024, but it also reduced our overall leverage and hedging requirements. And the market took notice of all of these metrics. Our stock, which began the year trading at a discount to book value per share finished 2024 at a premium, helping generate a 24.6% total return for our shareholders. Each step of the way, our risk, operations and accounting teams worked in harmony, adjusting hedges dynamically, optimizing financing and ensuring continued 1940 Act compliance, all to facilitate the rotation.

Speaker 2

With the closed end fund conversion approved, we expect to effectuate the transition on April 1, finally selling our remaining Agency RMBS pools. Looking forward post conversion, we project that we'll be starting the second quarter with the CLO portfolio not much larger than our total equity base. But of course, we plan to add some leverage from there, consistent with the constraints applicable to closed end funds. We will be focused on balancing a swift ramp up with careful asset selection and we expect to have a fully ramped CLO portfolio around mid year. We are excited about the new opportunities that lie ahead.

Speaker 2

The conversion marks a momentous event for the company positioning us to drive strong earnings and unlock greater value for shareholders over the long term. As outlined on Slide five, we anticipate improved risk adjusted returns, enhanced access to capital markets and greater tax efficiencies as a CLO closed end fund. Finally, as Greg mentioned, recent market volatility in the credit markets may be generating a wave of compelling investment opportunities, which would set the stage for a robust deployment environment following our conversion. Now let's open the floor to Q and A. Operator, please go ahead.

Operator

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

Speaker 6

Thanks. I was hoping you could help, size the amount of capital that gets freed up April 1 when you're able to sell the agency portfolio? Should we think about that as the other 28% that's not in CLOs or is there a portion that's kind of held back for liquidity? So if you could just help us frame that.

Speaker 2

No, you got it right. Hey, Doug, thanks. Yes, no, you got it right. I think 28% is a very reasonable estimate. Obviously, we got a few weeks to go before the end of the quarter.

Speaker 2

But absolutely, I think that's the right way to look at it. And that timing could end up being it looks like it's being very fortunate, right? Because with all the volatility, equity markets, credit markets, it looks like we're going to potentially have some very good entry points in the second quarter as we take that roughly 28% and deploy that what will be fresh capital shortly after the beginning of the quarter. So yes, and we'll be, I think, appropriately patient. I said earlier that I estimate that we'll be fully ramped by mid year and I still think that's probably about right.

Speaker 2

But in terms of how quickly we get there, how quickly we want to pounce on the opportunities that may be there at the beginning of the quarter, we'll see. But it could be some could be very exciting the timing here.

Speaker 6

And I guess just on the recent market volatility, just any way to frame kind of how different parts of the CLO market have reacted and where returns might be today versus, call it, three months ago?

Speaker 2

Greg?

Speaker 4

I'm happy to take that one. It's Greg. You've certainly seen things react and move back. It depends upon the capital structure. I think that you've seen AAAs, not that we're holding any of those in here, move back about $0.5 But these types of things come through and affect the overall ARB and the securitizations.

Speaker 4

I think that you've seen equity generally down several points even for cleaner stronger profiles. MAS, it's really manager dependent, but you've certainly seen things ease off and back up even for the better quality names. And then obviously the tiering has become a little bit more pronounced. But the market's been functional, and trading. And so, it's been pretty transparent what's happened.

Speaker 6

And I guess how much obviously, it's still early and there's a lot of uncertainty, but how much of like the change in equity prices do you think is is it increase in maybe expected losses versus just a kind of increase or widening of the discount rate?

Speaker 4

I think, it's probably more the latter. I think there's certainly some concerns, right? If you talk about the fundamental side, tariffs will create winners and losers. And if you create a series of losers in a portion of, the corporate market, will that hurt potentially the fundamentals of some of these companies, right? So that's certainly a concern, about what could be happening, in a portion of the loan market.

Speaker 4

That being said, I think you're seeing a technical push on the rate side of the market. If we're looking at growth slowing and potentially cuts, the demand for floating rate instruments you've started to see potentially could be lessening. You've seen, NAVs, for example, on equity start to back up a little bit, right, as loan prices drop and as floating rate demand maybe eases, that will filter its way through too in terms of the spread widening. We could get into a lot of different dynamics. I think as we've mentioned sort of through earnings and on the call, the loan market had a negative convexity problem where, you had spread compression because things were so strong and above par in refinancing.

Speaker 4

While prices will drop off and widen, you'll also see prepayments slow down. And so these are some of the dynamics at play, which, depending on the duration and the structure of the CLO deal, it really does separate out, how it will affect different deals in different tranches.

Speaker 6

Great. Appreciate the answers.

Speaker 7

Hey, Doug. Yes.

Speaker 2

Hi, it's Larry. Yes, I just wanted to maybe add a little more color along the lines of your question. So you can call this a little informal guidance here. So the first quarter, we're going to have that 28% as of roughly as of year end, we're still going to have that mortgage portfolio through the entire quarter. And so I think in terms of if you're thinking in terms of our adjusted distributable earnings, we were $0.27 in the fourth quarter.

Speaker 2

I think there's no reason for us to think at this point that it's going to be much different from that in the first quarter. So I think that would be considered reasonable guidance. But now in the second quarter, as you pointed out, we're going to be basically converting all that adjusted distributable earnings that are coming out of our mortgage portfolio into cash. And then we're going to methodically, we'll see, it may be slow, it may be fast, but deploy that into CLOs, which as you can see on the numbers here, eight fifty four basis point net interest margin on credit. These are very wide net interest margins, right.

Speaker 2

So but nevertheless, right, having that 28% -ish of the portfolio undeployed at the beginning of the quarter, we're definitely not going to be able to have the same level of ADE, so for that second quarter. I think by the end of the second quarter and then looking into the third quarter, we'll be back to covering our dividends. But I would just I would expect and I think it's well worth it in terms of ramping up the CLO portfolio, getting the best investments in the portfolio that will probably miss by a few pennies versus the dividend in the second quarter. I just wanted to add that color. But the third quarter, there's no reason to believe why we won't be back covering dividend.

Speaker 6

Thank you.

Operator

We'll take our next question from Matthew Ertner with Jones Trading. Please go ahead. Your line is open.

Speaker 7

Hey guys, thanks for taking the question and congrats on the update or the upcoming conversion. So when you think about the liquidity that you guys are going to get and how to deploy it, you mentioned the shift a little more into equity this quarter from the debt on the CLO side. How do you view those opportunities? And I know you want to remain diversified there, but I guess given the environment right now, would you kind of lean towards that equity side over the debt side?

Speaker 4

I think it's Greg. We had when we first started buying CLOs in late twenty twenty three, we were buying a lot of mezz positions. It was more heavily in mezz and it was mezz at real discounts. As time went on and those positions sort of drifted up towards par, we shifted more into equity and then eventually more into specifically new issue equities sort of creating opportunities there. If the market becomes more dislocated and continues to sell off more, new issue markets may be tougher.

Speaker 4

You will see more and more of the sourcing come from secondary. I mean, we are very comfortable historically trading more and doing it in the secondary market. In terms of if we start to shift back towards mez, I think you would see that if more stress sort of came into the market. I think the sell off in mez has been not overly pronounced to this point or I think it would cause me to say that we would expect, more double Bs to enter the portfolio relative to equity than we maybe otherwise would have claimed a month or two ago. But overall, it's something that becomes probably an increased probability with more stress looking at these opportunities in secondary.

Speaker 4

The other thing to consider too is if this is coming because rates are being cut, that obviously will affect coupons on the Mezz as well, right? And so it's something else to consider how the widening occurs.

Speaker 7

Yes, got it. That makes sense and that's helpful there. And then I guess kind of as a follow-up to that, say look at the end of 2Q, 3Q in terms of leverage, I guess what are you guys able to work with? And is there a target range that you guys are expecting to kind of I guess, sit in once you're fully invested in CLOs?

Speaker 2

Sorry, could you repeat that? I didn't catch that.

Speaker 7

Sorry about that. Leverage, once you're fully invested in CLOs, is there a range that you want to sit in? And I guess what's the upper bound of your limitations given as an investment company there?

Speaker 2

Right. Okay. So it's a little nuance, the answer. I would say that half of turn of leverage is a reasonable estimate. And I would also say that looking forward again, this is really looking forward past the second quarter, maybe at some point in the third quarter, we could consider doing a debt deal.

Speaker 2

One other advantage, I mentioned access to capital markets being better as a closed end fund. So when closed end funds tap the unsecured note market, they get better financing than, for example, mortgage rates have done. So, yes, so really looking forward, we could even go higher than that. We plan to be what's called a fully compliant derivatives user. I don't want to get into all the details there, but that gives us a little more flexibility on leverage than some other nineteen forty Act companies.

Speaker 2

So, but I think just out of the gate, I think half the total leverage is kind of a reasonable benchmark to think of. So for every say $100,000,000 of common equity, think of $150,000,000 worth of CLOs.

Speaker 7

Got it. That's very helpful. Thank you guys.

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