Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2023 Third Quarter Financial Results Conference Call. Today's call is being recorded. [Operator Instructions] It is now my pleasure to turn the floor over to Alaael-Deen Shilleh, Associate General Counsel. Sir, you may begin.

Thank you. Before we begin, 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 and 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. We strongly encourage you to review the information that we have filed with the SEC, including the earnings release, the Form 10-K for more information regarding these forward-looking statements and any related risks and uncertainties. Unless otherwise noted, statements made during this conference call are made as of the date of this call and the company undertakes no obligation to provide or revise any forward-looking statement whether as a result of new information, future events or otherwise. Joining me on the call today are Larry Penn, Chief Executive Officer of Ellington Residential; Mark Tecotzky, our Co-Chief Investment Officer; and Chris Smernoff, 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. Our comments this morning will track the presentation. Please note that any references to figures in this presentation are qualified in their entirety by the notes at the back of the presentation. With that, please turn to Slide 3 of the presentation. And I will now turn the call over to Larry.

Thanks, Alaael-Deen, and good morning, everyone. We appreciate your time and interest in Ellington Residential. The third quarter actually began on a constructive note. In July, inflation fell to its lowest year-over-year pace in 2 years, GDP growth beat expectations and U.S. equities and most credit fixed income sectors posted gains for the month. For Agency MBS, FDIC selling of specified pools continued to be well digested by the market and the U.S. Agency MBS Index generated a positive excess return for the month over Treasuries. EARN had a positive economic return in July as well. The quarter got considerably more challenging from there, however. Realized volatility remained high and long-term interest rates continued their upward march, which put significant pressure on Agency yield spreads. In particular, the Federal Reserve's hawkish messaging at its September meeting triggered a selloff in most fixed income sectors, Agency MBS included, while a possible government shutdown added to the uncertainty. The yield on the 10-year treasury rose 82 basis points between mid-July and September 30th. And the MOVE Index, which tracks expected short term interest rate volatility, remained elevated. Against this backdrop, Agency MBS very significantly underperformed the comparable U.S. Treasuries and interest rate swaps during the quarter, with lower coupon MBS exhibiting the most pronounced underperformance. On Slide 3 of the presentation, you can see that the dollar prices on Fannie 2.5s through 3.5s declined by more than 5 points sequentially. EARN generated an overall net loss of $0.75 per share for the quarter with net losses on our specified pools exceeding net gains in our interest rate hedges and delta hedging costs, which are tied to interest rate volatility, remaining high. On the positive side, our adjusted distributable earnings increased quarter-over-quarter, driven by further portfolio turnover capturing higher market yields, while our…

Thank you, Larry, and good morning everyone. Please turn to Slide 5 for a summary of Ellington Residential's third quarter financial results. For the quarter ended September 30th, we reported a net loss of $0.75 per share and adjusted distributable earnings of $0.21 per share. These results compare to net income of $0.09 per share and ADE of $0.17 per share in the second quarter. ADE excludes the catch up amortization adjustment which was positive $46,000 in the third quarter as compared to a negative $376,000 in the prior quarter. During the quarter, net losses on our Agency RMBS and negative net interest income exceeded net gains on our interest rate hedges, while our delta hedging costs remained high as a result of the elevated interest rate volatility. As a result, we had a significant net loss in the quarter. Our net interest margin increased to 1.24% from 0.93% quarter-over-quarter due to higher asset yields resulting from continued portfolio turnover. The increase in our NIM drove the sequential increase in ADE despite lower average holdings in the third quarter. We also continue to benefit from positive carry on our interest rate swap hedges where we receive a higher floating rate and pay a lower fixed rate. Pay-ups on our specified pools increased slightly to 1.02% as of September 30th from 0.98% as of June 30th. Please turn now to our balance sheet on Slide 6. Book value was $7.02 per share at September 30th as compared to $8.12 per share at June 30th. Including the $0.24 per share of dividends in the quarter, our economic return was negative 10.6%. We ended the quarter with cash and cash equivalents $40 million, down slightly from $43.7 million at June 30th. Next please turn to Slide 7, which shows a summary of our…

Thanks, Chris. Larry already articulated many of the challenges for Agency MBS for the quarter that led to our negative return, a violent rate move, fears of money manager and mortgage REIT selling, and lots of daily rate volatility that had to be delta hedged, just to name a few of those challenges. Following quarter end, the underperformance of Agency RMBS continued for the first 3 weeks of October, but markets have since reversed course quite a bit. As of Friday, EARN’s fourth quarter to date economic return at approximately negative 1.7%. You only need to look at Slide 3 to get a sense of just how big the price movements in the quarter were. Some 30-year coupons were down over 5 points. It's important to remember that when you get into a real bear market for anything, prices often get to places that have nothing to do with fundamental value. After extreme downward price movements, certain investment vehicles become forced to sell assets to handle redemptions or margin calls, which can cause prices to spiral downward to distressed levels. And since Agency MBS are a lot more than almost anything else structured products, they're often the first thing these vehicles sell. As an investment manager in a situation like this, your top priority is to preserve value by avoiding becoming a distressed seller yourself. EARN did just that in the third quarter. This allowed our portfolio to participate in the significant market recovery the last two and a half weeks. But in any quarter with a lot of price volatility, the returns on the levered Agency strategy are driven by price changes and not spread income and we had significant unrealized losses. On Slide 10, you can see that we kept our mortgage exposure roughly constant during the quarter.…

Thanks, Mark. The third quarter was one of the toughest quarters we've seen for Agency RMBS in recent times. Following quarter end, market conditions actually worsened in October. But so far in November, markets have again reversed course with long-term rates dropping and Agency MBS spreads recovering somewhat. From an economic return perspective, we estimate that EARN is down approximately $0.12 so far for the fourth quarter. The Fed Funds futures market now predicts that the Fed won't increase rates for the next few meetings. And if as expected, that leads to more normal levels of volatility, the prospects look good for capital flow back into Agency MBS. Moving forward, I like having a lot of dry powder in this market given the opportunities we are seeing not only in Agency MBS, but also in CLO, mezzanine debt and equity. I'd like to reiterate how excited I am for EARN to have added to its mandate the secondary market corporate CLO strategy, which Ellington has been so successful in deploying over the years in other investment vehicles. Since quarter end, we have continued to add high yielding CLO assets to EARN's portfolio, and I expect us to continue to add more CLO assets to EARN's portfolio in the coming quarters. We will continue to be opportunistic as we think about sector allocation. As always, we will rely on our dynamic hedging strategy and active management to protect book value. With that, we'll now open the call to questions. Operator, please go ahead.

[Operator Instructions] And we'll take our first question today from Crispin Love with Piper Sandler.

First off on the CLO investments, are you putting on any leverage here with those investments? And can you just detail the growth and levered returns you might expect? And then, just over time, how large do you think CLOs could become as a percent of your total investment portfolio?

Sure. Okay. So, I don't think we've put on any leverage against the CLOs yet, explicitly, although, we certainly would intend to put modest leverage on those. I think as we mentioned in the prepared remarks, we can, just borrow a little bit more against our Agency portfolio for now and that would help finance even some of the incremental CLO purchases at a much lower cost of funds. So I think that's in the near-term probably what we'll do more of. But whatever -- you'll see, I think -- by the time the fourth quarter is over, I think you'll see a little bit of leverage in that portfolio. In terms of how big an allocation we can make to the sector, I think if you look at the current constraints that we're operating under, I mean, you could -- in theory, you could get to even a 30% risk capital allocation, I mean -- and I'm talking about risk capital, which is a term that we use here internally. Obviously that's not assets, given that these are so much less leveraged in terms of how you would finance those. But, yes, I could see -- theoretically, I think we could go that high. Now, of course, we just started, so we'll just take it slowly and see how it goes. Mark, do you want to elaborate on that?

No, I think that was a good summary, Larry.

And then, Mark, can you just give us an update on your outlook for Agency spreads here? Definitely remain cheap, but were volatile in October, have tightened a bit since kind of October 25th, 26th range, but curious on your outlook just in this environment.

Yes. So I think long-term, there's some pretty significant tailwinds for Agency MBS. One is that, if the Fed Funds futures market is right and you have a Fed that's kind of sitting on their hands for a few months, then you might get lower levels of interest rate volatility, which I think will be a catalyst for more capital to flow into the sector. Also, too, we mentioned banks, which are typically significant buyers of Agency MBS have been net sellers this past year. Now a lot of that came in March with the seizure of the Silicon Valley Bank. And if you look at what happened, recently, what you've seen is just kind of pay downs on their Fannie Freddie portfolio, so not really net selling, but shrinking through pay downs, for instance on the Ginnie portfolio. So I think that you might get -- and we mentioned this in the prepared remarks, I think it's probably more likely not you're going to see better plan sponsorship in Q4 than what you saw in Q3. The spreads are wide, fixed income yields while were off the high the year, you only got to 10 year 5%, They're still pretty high, so I think that's going to be supportive of fixed income flows. So I think over a longer term, I think Agency MBS on a levered basis are going to deliver significant levered ADE as well as price appreciation. So we're constructive on them and the -- but with the CLOs we see an opportunity to add diversification in a sector that we're very good at. It has significant yield to it. There's a lot of opportunities. And for all the reasons I mentioned in my prepared remarks, it's a very good complement to Agency MBS. They're sort of like the 2 things are sort of like parallel universes, the risks that drive them, the leverage acquired, the interest rate risk they have, so I think it's a good complement.

And I just wanted to add, Chris, I think, I didn't answer your question about expected returns in that sector. So, one thing that I think with -- in Agency MBS, the way we typically manage portfolio and many others as well is that you lever up net interest margin and we hedge interest rate risk. And then depending upon the level of volatility, you give some of that levered NIM back in the form of, you call it, delta hedging costs or other types of volatility related frictions, right? So, one nice thing about CLOs is that the durations don't move around a lot. So the returns that we're seeing, which are with just a modest bit of leverage in the high-teens, if not higher, I think. Now, there could be some erosion there, but we really think that those -- that's what we're hoping for in the sector. And that can make a very significant difference obviously as that allocation increases in that sector. So -- and I think we mentioned that the bit of money that we put to work already. We are projecting that it's going to achieve that, those types of returns as well. Currently, projecting over 20% on a lot of the investments we've made so far. And it's small, it's nimble. It can buy -- accumulate smaller pieces. So I think I'm very optimistic.

And just one last question for me. Just looking at the end of period and average share count in the quarter, you issued some shares here. So can you speak to the strategy there just with the stock trading at a discount to book, and just kind of…

Right. We're trying to maintain $100 million of equity. And this was a really tough quarter, and we gave some of that back. So think of that as kind of replacing the equity that we lost and if, I think as long as we can maintain -- have some quarters going forward, including this quarter, they aren't as brutal as the last quarter, I don't think you'll necessarily see as much of that. Keep in mind also though that with our expense ratios, which are not -- they're certainly not high for the sector, but -- and given our size, but given those expense ratios, it does make a lot of sense to raise capital through ATM modestly with some degree of dilution. Because when you look at it in terms of the accretive effect it has on earnings per share through reduction of your G&A expense ratios, it's a relatively short payback period.

Thanks, Larry and Mark, I appreciate you taking my questions.

That was our final question for today. We thank you for participating in the Ellington Residential Mortgage REIT Third Quarter 2023 Earnings Conference Call. You may disconnect your line at this time and have a wonderful day.