Please standby. Your program is about to begin. Good morning, ladies and gentleman. Thank you for standing by. Welcome to the Ellington Financial Third Quarter 2022 Earnings Conference Call. Today’s call is being recorded. [Operator Instructions] It is now my pleasure to turn the call over to Jason Frank, Deputy General Counsel and Secretary. Sir, you may begin.

Thank you. Before we start, I would like to remind everyone that certain statements made during this conference call may constitute forward looking statements within the meaning of the Safe Harbor provisions of The Private Securities Litigation Reform Act of 1995. Forward looking statements are not historical in nature. As described under Item 1A of our annual report on Form 10-K, forward looking statements are subject to a variety of risks and uncertainties that could cause the company’s actual results to differ from its beliefs, expectations, estimates and projections. Consequently, you should not rely on these forward looking statements as predictions of future events. Statements made during this conference call are made as of the date of this call and the company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. I am joined on the call today by Larry Penn, Chief Executive Officer of Ellington Financial, Mark Tecotzky, Co-Chief Investment Officer of EFC; and J.R. Herlihy, Chief Financial Officer of EFC. As described in our earnings press release, our third quarter earnings conference call presentation is available on our website, ellingtonfinancial.com. Management’s prepared remarks will track the presentation. Please note that any references to figures in this presentation are qualified in their entirety by the end notes at the back of the presentation. With that, I will now turn the call over to Larry.

Thanks, Jay, and good morning, everyone. As always, thank you for your time and interest in Ellington Financial. After a challenging first half of the year, July started the third quarter on a constructive note, with volatility, interest rates and most yield spreads reversing much of their second quarter increases. The rally proved short-lived, however. Over the course of August and September, continued elevated levels of inflation and hawkish messaging from the Fed drove interest rates sharply higher. Volatility shot up to record levels, fears of a recession intensified and the yield curve inverted, stressing equity and fixed income markets alike. Market sentiment steadily weakened and we saw widespread selling across sectors, particularly towards the end of the quarter. In some cases, this included forced selling by asset managers to meet margin calls or redemptions. Liquidity declined and yield spreads widened in virtually every fixed income sector, with many sectors reaching their widest levels of the year. Against this difficult backdrop, Ellington Financial generated a net economic loss for the quarter of 3.4%, driven by losses on non-QM, Agency RMBS and originator stakes. Nevertheless our diversified portfolio, stable sources of financing and dynamic hedging significantly limited the magnitude of that loss. During the quarter, we had strong performance in our residential transition loan, small balance commercial mortgage loan, CLO and CMBS portfolios. And we benefited from significant net gains on our interest rate hedges and non-QM interest-only securities. We also completed our third non-QM securitization of the year during the quarter. Turning now to the investor presentation. On slide three, you will see that we are reporting adjustable distributable earnings of $0.44 per share, which is a $0.03 sequential increase and which nearly covered our dividend. The increase resulted from our continued rotation of capital into higher reinvestment yields and…

Thanks, Larry, and good morning, everyone. I will continue on slide three of the presentation. For the quarter ended September 30th, Ellington Financial reported a net loss of $0.55 per share on a fully mark-to-market basis and adjusted distributable earnings of $0.44 per share. These results compared to a net loss of $1.8 per share and ADE of $0.41 per share for the prior quarter. On slide four, you can see that we further increased our capital allocation to credit investments during the quarter to 88%, up 1% point from June 30th. Based on the opportunities that we are currently seeing in credit, including the recently closed Longbridge transaction, I expect this allocation to continue growing slowly relative to agency. You can also see on this slide that average market yields are up on both our credit and agency portfolios considerably as compared to last quarter. As Larry mentioned, the purchase yields on many of our assets still reflects a much lower interest rate environment that we had earlier this year. As we continue to turnover our assets, we expect that the gap between our purchase yields and market yields will narrow and that should be supportive of our net interest margin. On slide five, you can see the attribution of earnings between our credit and agency strategies. During the third quarter, the credit strategy generated a gross loss of $0.19 per share, while the agency strategy generated gross loss of $0.17 per share. These results compare to gross loss of $0.80 per share in the credit strategy and a gross loss of $0.20 per share in the agency strategy in the prior quarter. Net interest income on our credit portfolio increased significantly quarter-over-quarter, driven by the larger portfolio, while we also had strong performance from our CLO and CMBS…

Thanks, J.R. This is truly an extraordinary quarter, given the magnitude of the moves in interest rates, the twist of the yield curve and the widening of spreads. What made it unprecedented is how long the volatility lasted. We have certainly seen more violent market moves before, for example, in March 2020 and at times during 2008, but during those periods, the volatility didn’t last day-after-day for months on end as it did this quarter. I think an economic return of down 3.4% for Ellington Financial is pretty good given what we had to manage through. We saw bouts of forced selling in the third quarter, especially in September around the U.K. turmoil, where managers weren’t selling because they wanted to, but rather because they were forced to. And while I don’t think all of the market volatility has passed us by any means, things are starting to feel marginally better in some sectors. Agency MBS, for example, is against functioning as a relative value market, not just the market absorbing forced liquidations and unlike some days in the third quarter, there is good two-way flow now, spreads are moving predictably, with liquid credit indices and balance sheet constraints no longer seems to be the overriding concern, and with spreads extremely wide, the forward-looking opportunity looks attractive. However, we have not yet achieved that balance in other structured product sectors. Non-QM was clearly one of those strategies near the eye of the storm in the third quarter. Rapidly rising mortgage rates have caused prepayments to plummet in non-QM and AAA bonds issued any time before Q3 face a lot of extension risk. Along with changes in call assumptions, we saw a substantial price declines in non-QM AAAs. But we don’t own those in EFC, we own loans and we own…

Thanks, Mark. As we move into the final weeks of 2022, I think, you can tell that we are excited about the ample investment opportunities in both securities and loans. But we continue to weigh the deployment of additional capital against maintaining adequate liquidity buffer to guard against a deeper market downturn. We also sense an opportunity to help our loan originator affiliates to continue adding market share just as many of their competitors withdraw from the market. Finally, with recession fears looming, I will note that the credit performance of our loan portfolios, as measured by delinquencies, defaults and credit losses, continues to be strong. But with the increased risk of an economic slowdown, we are focused on tightening our underwriting guidelines, with a particular emphasis on keeping LTVs low and being even more selective about geography and property type. For our residential transition loan and commercial mortgage bridge loan borrowers, sharply higher interest rates are stressing re-financings and takeouts, so a lower starting LTV point helps insulate against property value declines. We are now seeing clear evidence of home price weakness, given deteriorating housing affordability and so we are preparing for meaningful price declines in some regions of the country. With that, we will now open the call up to questions. Operator, please go ahead.

[Operator Instructions] Our first question comes from Bose George from KBW.

Hey, guys. This is actually Mike Smith on for Bose. My first question, can you just help us get a sense for run rate, core earnings kind of relative to that $0.44, just given your outlook for capital deployment and then the addition of Longbridge?

Okay. Sure. Thanks for the question. So to the second point, the addition of Longbridge, I did mentioned that, ADE will start to be captured from Longbridge beginning in Q4. We are going to present that as a separate operating segment and also give detail of how we are calculating it. The components of ADE at the originator are different than the components of EFC, given that its core business is origination oriented and gain on sale oriented, whereas we exclude that portion from realized and unrealized from EFC side. So the components will be different but we will show them both. As a consequence of the gain on sale component at Longbridge, their ADEs tends to be a bit more volatile than EFCs. But again we think it’s -- we project it to be accretive over time and so just adding that incremental piece to EFCs today looks very good relative to our current dividend. So that’s the second part. And then the first part, the run rate, I think 44 is, probably, which is almost 12% of our book value is a pretty good run rate estimate from here. There are different pieces that I guess a lot of moving parts into the calculation. One is the overall size of the portfolio and so we talked about this quarter, part of the sequential increase was because the credit portfolio increased in size even as Agency declines. That was a big driver. We also have the asset yields. We are talking about how as purchase yields turnover into higher reinvestment yields, that will lead to -- it should lead to topline growth on the NIM. Cost of funds have been marked to market much more quickly and so we have had a short -- what we think will be short-term contraction of NIM and then we have the swap component, which is also adjusting with interest rates. So I guess that’s a longwinded answer to your question, that I think 44 is probably a good run rate. But we think that we are going to be covering the dividend, which is $0.45, we are kind of right on top of it now. And then you are going to have the additional effect of folding in Longbridge to the equation.

Any expectation there.

Yeah. A few -- and that -- and I am sorry, that could also be a few cents per share per quarter at least.

Great.

Yeah.

That’s helpful. Thanks. And then maybe just one on book value, do you guys have a sense for how much of the decline over the last few quarters has been realized versus unrealized? Just kind of wondering how much potential for recovery there is in your book?

Sure. So I think the unrealized -- a portion -- I can give you better numbers, but big picture, a good chunk of our losses to date have been unrealized year-to-date, whether that’s in the agency strategy, where there is a component that’s unrealized, whether it’s on our originator stakes, where we took those stakes down to the point, Longbridge’s mark, below book representing the transaction value of LendSure, we took down, which the company has big cash -- sizable balance sheet with cash balances and I think there’s upside there. And then non-QM has been another source of losses year-to-date, where there is a significant unrealized component. If you look at our income statement year-to-date, you can see that through the nine months ending September 30th, we had unrealized losses of almost $2.50 per share, compared to realized losses of about a $1.18 per share. So just that proportion there, two-thirds or so, that combined is unrealized and we think the prospects of recovering a good portion of that are high if spreads tightened from here, which we think they can even if yields stay high.

Great. That’s really helpful color. Thanks for taking the questions.

Thank you.

And the next question comes from Doug Harter from Credit Suisse.

Thanks. Can you just talk a little bit about how you are thinking about balancing deployment of cash versus kind of holding liquidity for volatility in the near-term and kind of what you are looking for that might move you one way or the other in that decision?

Mark, do you want to take that?

Sure. So that push and pull between taking advantage of high yields, but managing the portfolio so that you are prepared for whatever lies ahead tomorrow, be it another Fed statement or something from the Bank of England, that was a big part of, really like high level discussions we had on managing the company in Q3. I don’t think things have changed a lot. I mean there is certainly, maybe some green shoots, right? If you look at market expectations and if you follow what the Fed said, but just looking sort of just at -- just what market expectation is telling you is that, the magnitude of the hikes is supposed to come down a little bit and I think the market will perceive that as good news. I mentioned in my prepared remarks that some markets are starting to function with a better balance of supply and demand. I think I pointed to the agency market, we are now like daily spread moves are sort of following more closely credit indices, investment grade indices and high yield indices, which is sort of I think to us, we take it is an indication of a better balance, that you are not just absorbing for selling. Now if you look back at Q3 and even into October, you had certain parts of securitized product market, let’s say, if you look at legacy non-Agencies, where you would have days where liquid credit indices tightened and the bonds actually wide, right? To us, that is indicative of markets that supply and demand is not in balance and you are still seeing forced selling from money managers. So think we look at a lot of those indicators. I think things certainly feel a little bit better than how they did in parts…

Yeah. So if I could just elaborate on that. We only grew the credit portfolio by around 3% last quarter. I think looking forward in the near-term, it’s going to be more about replacing the assets that are running off with higher yielding assets. We have a lot of different strategies as you know. RTL is definitely one of our higher yielding ROE strategies right now. So I think we are going to continue to see flow there, very healthy flow. On the other hand, as we mentioned in the prepared remarks, small balance commercial mortgage that we have slowed down quite a bit and so more sort of just as loans payoff, sort of replacing that, so not really growing that portfolio. So we can be very selective in terms of where we are deploying those dollars of capital as other dollar of capital are coming in. We mentioned that the agency portfolio, we think is going to continue to shrink a little bit. We think that makes sense. We always try to keep our cash positions typically in that, I will say, $100 million to $200 million range. Recently, obviously, that’s a wide range, sometimes it’s been a little lower, little higher depends upon the nature of our unencumbered asset portfolio. But the other factor would be non-QM securitization, right? We did one in the third quarter, but we mentioned that -- Mark mentioned that we have been choosing to hold more loans on repo, while we haven’t like the spreads that we have seen in the non-QM securitization market. So that could be a catalyst for certainly bringing in more credit assets should we completed securitization there. So there’s a lot of factors, but bottomline is, I wouldn’t expect huge overall growth in the gross size of the credit portfolio in the near-term.

Great. Thank you.

Our next question comes from Trevor Cranston from JMP Securities.

Hey. Thanks. You guys talked a little bit about seeing some forced selling towards the end of September. Can you talk a little bit about kind of what you guys are seeing in terms of secondary market investment opportunities and how you are evaluating deploying capital there potentially versus the more proprietary loan you guys have come in?

Hey, Trevor. It’s Mark. That’s a great question because that’s very topical. We -- you saw it in 2020, how we saw a big drop in security prices in 2020. In many instances, the drop in securities is greater than the drop in loan prices. So we added securities to the portfolio. We are always looking at the relative value trade-off between securities and loans. And yes, securities look interesting to us. We think in some cases, if you are selective, they can -- they are very compelling relative to loans. The other thing about securities that is, matters a lot in this market is that, when you are originating loans, you are locked into November 2022 property valuations, right? When you buy securities, you are buying season securities. I think credit risk transfer is a good example. You can buy CRT bonds that were originated in 2018, 2019, where the borrowers could have been 30%, 40% of home price appreciation since they took out their loans. So they are at a substantially lower LTV than what they were at origination. So we think about all those factors. And yeah, we have seen instances where we believe that prices in securities have dropped to the point where it makes them very compelling versus loans. So I would say, we are actively looking at both sectors. On the loan side, it’s been about tightening guidelines and we sort of went through a list of some of the metrics that we have been -- we become more cautious on. And so, yeah, I think, the securities are a really big opportunity for EFC right now.

Got it. Okay. Thanks for that. And then you also mentioned you are utilizing repo financing more for loans, while the securitization market is somewhat dysfunctional. Can you remind us sort of how much available repo capacity you have for loans and I am sort of, if there is any -- and if there’s any sort of limitations in terms of how long loans can be held on those lines or anything like that? Thanks.

Yeah. No. There is no limit on how long loans could be held on those lines. But sort of total capacity is not something that we disclose. But we do have now a wide variety of facilities and we are not concerned about capacity at this point.

Okay. Fair enough. Thank you, guys.

Our next question comes from Eric Hagen from BTIG.

Hey. Thanks. Good morning. I hope you as well. I think I just have maybe three questions here. Can you say what the balance of non-QM retained tranches including the IO strips that you have on the balance sheet is? And can you maybe talk about the repo financing for those subordinate tranches and other subordinate non-Agency RMBS and how stable the haircut looks there? Can you also say what -- give a sense for how your dividend will be characterize this year, like a break down between the return of capital in many ordinary dividend that you accept to pay? I think I heard you guys mentioned that you are going to shrink the agency portfolio, what’s the reason for that?

No. No. Just in terms of we are -- I mean, we think that the agency relative value is excellent right now. Spreads are very wide and especially if you look at discounts for example there, they are not really subject to extension risk at this point. And in fact, if anything, specified pools, we think we can find and we have been trying to accumulate specified pools that should have faster turnover speeds. So, the opportunities in agencies are very good, nothing against agencies. Just…

Okay.

Just where we see the better leveraged ROE and also just keeping our cash position healthy. And as Mark mentioned, taking -- quote unquote, taking the page out of our COVID playbook, that’s just always a good source of liquidity to keep and we like to keep our liquidity up high.

Okay.

Yeah.

All right. Thanks for clarifying that. Hopefully my…

Thank you.

…Hopefully my other two questions came through. Thank you, guys.

Yeah.

Why don’t I…

Yeah. So why don’t I -- I will hit on the first two and then maybe Mark, if you could comment on the financing on the retained tranches after I go? So you are your second question about the guidance on return of capital versus taxable income on our re-dividend. It’s an interesting quite, I don’t have a good answer on guidance for you. We haven’t really given current estimates of taxable income on a regular basis. But I will give you a little color. The first one is, we make a 475 election on our securities. None of the loans run on securities, which in a normal a normal market, keeps taxable income somewhat close to the GAAP earnings component coming from those investments. I am caveating though because this is not necessarily in the ordinary market that we have seen so far this year. One thing that’s happening is, we have our domestic blocker, which contains our originator investments, where we have had some unrealized losses that impacts the provision. We also securitize for the most part, through that blocker, where there have been some losses. So there have been some losses of the domestic blocker that won’t necessarily be reflected in our re-taxable income. So put it another way, we might have some re-taxable income at the top level that doesn’t take into account losses that we have in our corporate blocker, if that makes sense? So there could be a dichotomy this year between GAAP income and taxable income, more so than it than in a normal functioning market, right?

I would still expect that our dividend will have a return of capital component. It just won’t be as great as you might think given the spread between our GAAP and our tax, taxable income. Does that make sense?

Yeah. That’s helpful detail.

Okay.

That’s good.

Your first question.

Yeah.

Yeah. So the retained non-QM tranches, the fair value of those at September 30th was $138.5 million. That -- we detailed that on our portfolio summary slide and we break out that component versus non-QM.

Slide four. Yeah.

Slide four. Mark, do you want to -- he asked about how financing on those retained tranches has changed haircut wise and I guess availability this year, do you want to comment on that?

I think -- this is Larry. I think Mark tell me if, correct me if I am wrong, but I believe that the haircuts are still around that 50% level in terms of what’s available in the market and I -- and we -- still we haven’t had any issue in terms of continuing to finance those. So I haven’t seen any material change in sort of the terms that we are seeing in terms of haircuts or availability.

Yeah. The point I wanted to make though is that, while the haircuts cuts can be stable, they are haircuts to your current market levels, right? So you still have to, you still have to live with and manage through the mark-to-market volatility even with stable haircuts and stable repo spreads, right, because they are essentially lending you, let’s say, they are lending you 50%, 60% of fair market value and the fair market value changes, you are either going to get margin call if it goes down, you are going to be positioned to margin called lender, if it goes up. So the retained pieces, it’s interesting, what we had going into this year was sort of IO heavy and we think about that by figuring out sort of what’s the dollar price relative to principal. And so we mentioned in the prepared remarks, that sector -- that part of the overall portfolio has done well this year. There has been a dramatic slowdown in non-QM speeds. So it hasn’t been -- so to us the issue in the non-QM market this year, it hasn’t been one of financing costs, it’s been a really big changes in spreads, really big widening in spreads on investment grade bonds, AAA, AA, A and BBB. It’s probably, you are seeing that across the Board in fixed income, you are seeing that in BSL CLOs and you see it in NPL RPL securitizations that, top of the capital structures have widened out a lot this year, a lot more than investment than IG indices or things like that. And so that movement in investment grade spreads, primarily AAA spreads they have widened a lot relative to repo. And so while repo spreads have come up a little bit, they haven’t come nearly as much as the spreads on securities. The spreads on securities, there’s been you know, money managers and banks are typically supporters of top of the capital structure. As I mentioned before, we were talking about the banks earlier, when Trevor had a question about their role in the market, how it’s been diminished this year on the security side and money managers have had a lot of redemptions. So top of the capital structures had to widen out to attract some new buyers. It’s done it, it’s functioning, but it has moved a lot. And so that was sort of why for us, we are living with or managing the portfolio with more loans on repo than we normally do. At -- it’s at a time where the term financing that’s available to us through the securitization market is its spreads were slightly wider than what we think we will be able to achieve in the future.

And let me just add one more thing, which is something we really haven’t talked about before, but you can actually get even higher haircut or, sorry, lower haircuts higher advance rates on retained tranches, if you do vertical retention, right, because then you are getting a strip that consists of a lot of the rated securities as opposed to just the bottom horizontal piece. So that’s actually something that we are considering for our next deal may or may not do it. Obviously, it’s been a few months. So I think July was the last time that we did a non-QM securitization. But our next one, we could see vertical retention there being the way to go and that would also give us the ability to even sell some of our IOs that we produce from that securitization, right? And that could be interesting, too, because the market, especially in a high rate environment could be very receptive to buying IOs at strong levels. So this is -- there securitization market gives you a lot options. Obviously, right now it’s not giving us as many given that it’s in this strange state. But we could see -- bottomline we could see higher advance rates, lower haircuts on vertical retention and other participants have done that.

Yeah. Great perspective. Thank you guys very much.

Thank you.

Our last question comes from Crispin Love from Piper Sandler.

Thanks. Mark, you talked about the opportunity in securities, but I am curious on the potential for distressed loan acquisitions, is this an area that you would expect to be more active in the next couple of quarters. And I guess have you started to see banks start to shed some CRE and non-core assets and are there any other areas where there could be an opportunity here for you in early 2023, if not already?

No. It’s a great question. So I would say, yes. So the first thing is commercial loans,, right? When we started the small balance commercial strategy in Ellington Financial, it was 100% non-performing loans and it was buying things that came from the old Washington Mutual portfolio, the old GreenPoint portfolio that had big -- those companies, those banks had -- were both acquired during the financial crisis and they both had a lot of headaches in their fall balance commercial portfolio and the acquirers, we are selling a lot of delinquent loans and so. So that was a great strategy for us and we loved it and we probably started that in 2010, but then it dried up, right? There just wasn’t any distress. So I do think and we kind of talked about it in the prepared remarks, this issue that debt service coverage ratios on new loans are going to limit balance of new loans. And in many cases, the balance of a new loan could be smaller than the balance of a loan that wants to get paid off despite a property performing well. So, yeah, I think, we will see more of those opportunities. We are just starting to see it now. The other area, when you talked about on the bank side is, I think you are going to see it in unsecured consumer loans, uncon financially used to buy a fairly -- we used to have fairly consistent acquisition programs on unsecured consumer loans. That’s not what we are -- it’s not something we have been doing the last several quarters. So I think -- and we kind of -- the reason why we stopped buying the unsecured consumer loans is we were essentially getting priced out of the market by credit unions…

Thanks, Mark. All very helpful there. And then just one last question from me, so you are CMBS hedging position increased from about $15 million or so to over $50 million, if I am looking at the chart on slide 17 correctly, I am just looking at that. Are there any cracks that you are beginning to see in any CRE sectors, where you have worries or is it more just general uncertainty right now in the current environment?

I think, there’s been a lot written about office, right, with work-from-home. There’s certainly been for years, issues with retail. I just think it’s more of an issue that to get a new loan, operators are looking at interest rates in some cases up 400 basis points from what it was when they first bought the property if you took out a bridge loan, right? If you didn’t turn out your loan with conduit with a 10-year loan and you were living with a floating rate loan, you could have been paying, if you look at CRE CLOs, people are paying LIBOR SOFR plus 350 and our bridge the spreads are higher. But you are taking those things out when LIBOR was essentially zero and now you might get to a point where you know, SOFR, LIBOR is 4.5%, 5% net. So it’s just your debt costs are going to double or in some case -- double in some cases. And so if that property -- if you haven’t been able to grow the income side of that property proportionately with your increasing debt cost, then your debt service coverage ratio is going to drop and it can drop to a point where when you come up to the maturity date on your existing loan, lenders might not be willing to lend you the full amount of the existing loan and that is -- it’s something, the market is going to have to grapple with. I think it’s opportunity for us and it’s something that we are very focused on.

Yeah. And I think you should view that hedge -- CMBS hedge as against our small balance commercial portfolio, which is sizable and it has been steady in terms of its size. Now look close to 70% of that I believe is multifamily and we still think that there is good support for multifamily values, but you have got the other 30%, right? And you have got some things like against smaller categories like office and things like that, that could see some challenges. So, it’s a hedge, largely a hedge against that portfolio and it’s something that I think again differentiate Ellington Financial, in terms of our willingness to put on credit hedges like that against the portfolio when in the face of an uncertain environment.

Thanks, Larry, Mark. I appreciate the comments there.

Sure. Thank you.

That was our final question for today. We thank you for participating in the Ellington Financial third quarter 2022 earnings conference call. You may disconnect your line at this time and have a wonderful day.