Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2017 Third Quarter Financial Results Conference Call. Today's call is being recorded. At this time all participants have been placed on a listen-only mode and the floor will be open for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Maria Cozine, Vice President of Investor Relations. You may begin.

Thanks, Lori. 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-K filed on March 13, 2017, 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 statement whether as a result of new information, future events or otherwise. I have on the call with me today: Larry Penn, Chief Executive Officer of Ellington Residential; Mark Tecotzky, our co-Chief Investment Officer; and Lisa Mumford, our Chief Financial Officer. As described in our earnings press release, our third quarter earnings conference call presentation is available on our website, earnreit.com. Management's prepared remarks will track the presentation. Please turn to Slide 3 to follow along. And as a reminder, during this call, we'll sometimes refer to Ellington Residential by its New York Stock Exchange ticker E-A-R-N, or EARN, for short. With that, I will now turn the call over to Larry.

Thanks, Maria. It's our pleasure to speak with our shareholders this morning as we release our third quarter results. As always, we appreciate your taking the time to participate on the call today. For yet another quarter, volatility persisted at or near historic lows and spreads across many fixed income asset classes remained at or near their 2-year tights. Once again, the yield curve flattened and long-term interest rates remained range-bound. However, a key difference in the third quarter, which really separated this quarter from the first half of the year, was that Agency RMBS finally participated in the spread tightening that most other fixed income asset classes had already benefited from earlier this year. In September, when the Fed provided more clarity to investors by announcing the specific timeline to begin the tapering of its balance sheet, we saw a rush of investors adding Agency RMBS exposure. Going forward, as the Fed continues to reduce its footprint in this space, we expect a lot of the slack to be taken up by mortgage REITs. In fact, residential mortgage REITs have raised over $8 billion of new capital so far this year, which after leverage translates into around $40 billion of the Agency RMBS buying power. EARN was well positioned to take advantage of the tightening that occurred in the third quarter. Not only had we reduced our TBA short position in advance of the tightening, but we had also completed deploying the proceeds from our second quarter equity raise. We are extremely pleased with the timing of that equity raise as we were able to fully deploy the proceeds and then benefit almost immediately from the strong Agency RMBS performance. Our strong third quarter results once again demonstrate that our strategy is adaptable to diverse market environments. Our second quarter equity raise has also delivered another great benefit, namely to our expense ratios. The larger equity base resulting from the raise lowered our annualized expense ratio by a full 60 basis points to 3%. Along with the strong portfolio performance, our lower expense ratio helped us achieve an annualized economic return for the quarter of a robust 12.8% and GAAP net income for the quarter of $0.48, which more than covered our $0.40 dividend. We'll follow the same format on the call today as we have in the past. First, Lisa will run through our financial results. Then Mark will discuss how the residential mortgage-backed securities market performed over the course of the quarter, how we positioned our portfolio and what our market outlook is. And then finally, I'll follow with closing remarks, and then we'll open the floor to questions. Over to you, Lisa.

Thank you, Larry, and good morning, everyone. In the third quarter, we had net income of $6.3 million or $0.48 per share. The main components of our net income were: core earnings of $5 million or $0.38 per share; net realized and unrealized gains from our securities portfolio of $4.5 million or $0.34 per share; and net realized and unrealized losses from our derivatives of $3 million or $0..23 per share. By this measure, net realized and unrealized gains from our derivatives excludes the net periodic cost associated with our interest rate swaps since they are included as a component of core earnings. Our core earnings includes the impacts of catch-up premium amortization, which in the third quarter decreased our core earnings by approximately $667,000, or $0.05 per share. After backing out the catch-up premium amortization from interest income in both the third and second quarters of 2017, we arrive at our adjusted core earnings of $0.43 per share and $0.47 per share, respectively. The primary factor driving the net decrease in the quarter-over-quarter adjusted core earnings per share was compression in our net interest margins. In the third quarter, our net interest margin, adjusted to exclude impacts of catch-up premium amortization, was 1.45% as compared to 1.63% in the second quarter. While the average yield on our portfolio also adjusted to exclude the impacts of catch-up premium amortization remained constant at 3.01% quarter-over-quarter, our average cost of funds increased to 1.56% in the third quarter from 1.38% in the second quarter. This increase was mainly driven by the increase in our repo borrowing costs with a partially offsetting slight decrease in our cost of swaps and U.S. Treasury hedges, which are also included in our cost of funds. On a per share basis, the quarter-over-quarter increase in our cost…

Thank you, Lisa. The third quarter saw mortgages substantially outperform both swap and Treasury hedges, putting in their best performance of 2017. During the second quarter or doing the same quarter, we had both the North Korea scare that took 10-year yields down to about 2% and the Fed finally announced that they would be allowing their MBS and Treasury portfolios to start running down. That process started in October. So how do you explain this great mortgage performance in the face of what many pundits would consider both a challenging macro and technical backdrop? One of our main points on our last call was how poorly MBS had previously performed relative to other spread products. Investment-grade and high-yield corporates as well as structured products had all been tightening throughout the year. But MBS investors seemingly wanted more clarity from the Fed about potential balance sheet reduction before allocating to this space. Well, once we got the clarity on both timing and quantity of the Fed's balance sheet reduction, mortgages really began to outperform. You can see on Slide 5 that despite the strong performance this quarter, Agency MBS still has room to catch up to most other fixed income asset classes. Putting the direct effects of Fed policy aside, mortgages continue to benefit from a low volatility environment and tame prepayment rates. These tailwinds helped performance in the third quarter as they had in the previous two. We added mortgage assets, thinking that any widening in front of the Fed would prove to be a good buying opportunity, and since we added mortgages, have indeed done very well. We have taken a portion of this additional leverage off since then and plan to wait for some type of systemic widening before adding more. That said, our view of mortgages…

Thanks, Mark. Markets are currently pricing at an additional Fed rate hike in December and changes in the tax code now look a bit more likely. But with Janet Yellen's term coming to an end in February and with the economic and geopolitical landscapes each full of conflicting signals, the path forward for both short-term and long-term interest rates is unclear. It's impossible to predict how long this low volatility environment will last or whether long-term interest rates will finally break out of their recent range. Meanwhile, the entire fixed income market is priced assuming that volatility remains low. So if all we did was buy generic mortgages to leave them unhedged, we'd have way too much downside. So what can we do? We have to continue to focus on insulating our portfolio from headline risks and unexpected changes in policy. On the asset side, this means continuing to focus on prepayment-protected specified pools, which can better withstand prepayment shocks. On the liability side, it means continuing to hedge along the entire yield curve, trading actively and continuing to make substantial use of TBA short positions. It's that substantial use of TBA short positions which sets EARN apart from the other agency mortgage REITs. And remember, in the fourth quarter of 2016, during the most volatile quarter for the interest rates since the financial crisis, it was that substantial use of TBA short positions which enabled EARN to generate the only positive economic return in the entire peer group. As Mike discussed, the Fed's tapering leaves a big hole for private capital to fill. However, since the Fed has always focused its purchases almost excessively on TBAs, we expect that if the mortgage market does come under some pressure, that pressure will be felt mostly acutely on the prices of…

[Operator Instructions] Your first question comes from the line of Steve Delaney of JMP Securities.

Good morning, everyone and congratulations on a really solid quarter.

Morning, Steve.

Hi, Larry. So a number that jumped out at me in Lisa's remarks was the cost of funds increase in 3 quarter of about 18 basis points to 1.56%. And it would appear that most of that related to the June Fed hike. I'm curious as you look out into first quarter of next year, Mark commented on MBS technicals probably holding up well through then. But thinking about the looming December Fed hike that, I think, we have to assume, is your position today -- how should we think about starting out in the first quarter, the impact on cost of funds? How much of that 25 basis points from the Fed, how much is built into repo today? And how much do you think the benefit of your hedging will limit the increase in your current 1.56% cost of funds?

Steve, it's Mark. So the first thing I would say is that, us, like every other REIT, when you enter into a pay fix swap, you're paying fix on one leg, the order -- on the leg that you receive, you're getting 3 months' LIBOR. So what you see typically is if LIBOR goes up, and we've already had -- since last year and change, we already had 3 or 4 hikes already. The repo cost go up, but the net cost you're paying on your swaps goes down, right, especially….

Correct….

Curve, so that's why if you look at broadly a lot of the metrics on not just EARN but the other REITs. You haven't seen a net interest margin decay as a function of rate hikes. Now this month, I know there was some net interest margin compression. But that's because mortgages sort of tightened relative to their hedging instruments. They yield less now relative to their hedging instruments than when they did at the start of the quarter. But just having the rate hike, most of that is neutralized by the fact that we're paying our repo lenders 3 months' LIBOR, but we're receiving the 3 months' LIBOR from our swap counterparties. So in terms of how much of that is priced into the market now, I think almost all of it is. And so when people look at roll levels going over year-end, so December, January, will market expectations be that you'll have higher LIBOR levels as a result of the Fed rate hike? Those roll levels are priced to the assumption of higher financing costs.

So what is like a 60-day roll in early January look like now on the repo side?

Well, you mean on that TBA side?

Yes. So it depends a lot on the coupon. So some of the coupons that roll the best, it might be 2-month LIBOR minus 20 basis points. They have a funding advantage. And some of the higher coupons, where there's some sort of bad and fast pools out there, depending on what you assume for your TBA assumptions, it can look like -- a lot of the pools we own, they can make 3 or 4 ticks of positive carry versus where the roll trades.

Got it, okay. No, that's helpful. I mean, we have heard all year long that basically that repo has been barely efficiently priced, so the market has been fairly liquid and that the spread between 1- and 2-month repo versus 3-month LIBOR has been very beneficial to the mortgage REITs. And it sounds like you still see that today.

Yes, the key metric we look at is we typically do a 3-month repo, where is 3-month repo relative to 3-month LIBOR. And so that tells us whether the financing costs we're paying to our repo lenders is offset by the 3-month LIBOR lag we receive on our swaps. And the big benefit for REITs, and you really saw their prices react to this, was with that money market reform, right, where all of a sudden, agency -- you had all this money come out of high-money markets and the government money markets, and the agency mortgage repo is a good asset for the government money market fund.

Right. And what percentage of your repo you have that covered by fixed pay swaps would you roughly estimate?

I think it's something like 60-plus percent. And then another big chunk of it will be covered with TBA shorts, where the roll levels are also highly correlated to levels of 3-month LIBOR.

Yes, just a process of TBAs. So if the curve flattens, right, then -- and let's just say, long rates don't move, but short rates continue to go up, you're going to see a -- you'll see a price drop in TBAs as well because mortgages have exposure to the whole yield curve. So short side, I mean, in an efficient market, that would have just as much of an impact as it would have on the swap side. And I just want to add one more thing. If you look at the Slide 17, it just shows, and obviously there's a table in our earnings release that shows this for 100 basis points as well, but it shows what happens to our portfolio based upon our models in a 50 basis point increase or decrease. And this is a parallel shift, but -- so I'll say two things about this. Number one is in terms of net interest margin compression in the peer group, in the agency mortgage REIT space, I think that you'll find very few companies, if any, that have this type of relatively equal exposure to a decline and an increase and small numbers at that, especially on an increase. I think in terms of if you look at our actual performance when rates have moved, and I think there's been some -- even publications by some people that have document this that our estimations of our moves have been closer to what actually happened to our book value than in other cases. And this is -- and we don't just hedge for a parallel shift, we hedge along the whole yield curve. So if the curve flattens, this type of a graph -- this type of a table should hold as well in terms of our -- what we think our book value exposure is. So I think that to the extent that you're worried about what's going to happen today in net interest margin compression, whether it will be for us or in the peer group, I think that looking at a table like this will help you get one step of the way there at least in terms of what an impact could be. And we don't think that at least -- it should impact us from a GAAP earnings perspective. But there's no question that from a core earnings perspective, it could have an impact and it has had an impact on us.

Well, I was just going to add one thing. Q3 was the flattest curve REITs have dealt with in a long time. And in terms of economic performance, it was the strongest quarter in a long time. And the other thing I think is interesting, and Larry alluded it in his prepared comments, that $8-odd billion in capital raises for REITs, common and preferred included. If you think that translates into $35 billion to $40 billion at least of agency mortgage buying, that's the first 6 months the Fed tapers. So 6 months ago, people were thinking, oh, the Fed is going to taper, who's going to be able to supply, what's going to happen to it? Well, REITs, which are not -- part of the markets that are $40-odd billion in equity capital or something, they were able to absorb October, and then the next 5 months of net supply is from the Fed. So I thought that was interesting, that sort of -- in the flattest curve, you saw REITs putting the best performance but also become a much bigger marginal buyer for agency MBS than what they've been in the previous 4 years.

No, no question. And we did notice the OAS come in over the course of the summer, the REITs were deploying all that capital for sure. So thank you for the comments, guys.

Thanks, Steve.

Thank you for participating in the Ellington Residential Mortgage REIT 2017 third quarter financial results conference call. You may now disconnect your lines, and have a wonderful day.