Good morning, ladies and gentlemen. Thank you for standing by, and welcome to the Ellington Residential Mortgage REIT 2020 First Quarter Financial Results Conference Call. Today's call is being recorded. [Operator Instructions].It is now my pleasure to turn the floor over to Jason Frank, Deputy General Counsel and Secretary. Sir, you may begin.

Thank you, and welcome to Ellington Residential's First Quarter 2020 Earnings Conference Call. 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. As described under Item 1A of our annual report on Form 10-K filed on March 12, 2020, 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.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 first 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 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. We appreciate your time and interest in Ellington Residential. The month of March will be remembered as one of the most challenging environments ever for leveraged mortgage portfolios. The COVID-19 pandemic and the associated measures to contain the pandemic led to extreme volatility and severe dislocations in virtually all financial markets. Economic activity plunged as countries around the world implemented social distancing restrictions. Unemployment claims surged, consumer spending plummeted and GDP growth rates turned negative. In March, equity sold off across the globe, yield spreads on most fixed income assets widened sharply, and a flight to safety drove record low yields on long-term U.S. treasuries. Portions of the yield curve inverted and interest rate volatility surged.On Slide 3, you can see the extraordinary quarter-over-quarter declines in treasury yields. Repo financing stresses alongside a drop in asset prices severely reduced liquidity and prompted forced selling across virtually all credit-sensitive fixed income asset classes, and the residential mortgage market was not spared. The selling pressure was severe, even in perceived safe havens like Agency RMBS.By mid-March, between the heightened interest rate volatility and the ongoing flight to the safe haven of U.S. treasuries, yield spreads on Agency RMBS had skyrocketed to levels not seen since the 2008/2009 financial crisis. In response, the Federal Reserve slashed short-term interest rates nearly to 0, injected liquidity into the repo markets, launched several credit facilities similar to what it had implemented during the financial crisis and stepped in with unprecedented levels of quantitative easing. All of which provided meaningful support, especially to the more liquid sectors of the market. The U.S. Congress passed 3 rounds of stimulus packages during March, culminating in the $2 trillion CARES Act on March 27, the largest emergency spending bill in history. These actions were…

Thank you, Larry, and good morning, everyone. Please turn to Slide 5 for a summary of EARN's financial results. For the quarter ended March 31, 2020, we reported a net loss of $16.7 million or $1.35 per share. Core earnings was $3.4 million or $0.27 per share. These results compared to net income of $9.7 million or $0.78 per share and core earnings of $2.8 million or $0.23 per share for the fourth quarter of 2019. Core earnings excludes the catch-up premium amortization adjustment, which was negative $0.7 million in the first quarter compared to negative $2.5 million in the prior quarter.As you can see on Slide 5, the loss in the quarter was primarily driven by net losses on our interest rate hedges as interest rates declined and were highly volatile during the quarter. A portion of these losses were offset by gains on our specified pools and also by net interest income on our portfolio, which increased significantly quarter-over-quarter with lower borrowing costs and a smaller negative catch-up premium amortization adjustment.TBAs outperformed specified pools during the quarter, as Larry mentioned, which depressed pay-ups on our specified pool portfolio. Despite the drop in mortgage rates during the quarter, average pay-ups on our specified pools decreased to 1.67% as of March 31 as compared to 2.05% as at December 31.Also on Slide 5, you can see that our net interest margin improved significantly during the quarter, increasing 20 basis points to 1.2%, driven by lower borrowing costs. The wider NIM led directly to an improved core earnings of $0.27 per share compared to $0.23 per share last quarter. Our small nonagency portfolio had a net mark-to-market loss for the quarter driven by substantial yield spread widening in that sector.Next, please turn to view our balance sheet on Slide 6. You…

Thanks, Chris. I've been in the mortgage market for over 30 years, and I have never seen market illiquidity and dysfunction that characterize the second half of March and early April. That said, while every period of market disruption resulting volatility is unique, each crisis shares common features. For EARN, early recognition of what was happening, what was likely to come next and what the policy response could be, all allowed our team to substantially mitigate the extent of book value decline.The first step in understanding what happened to Agency MBS during March is to look at the markets during the first 2 months of the year, pre-COVID. Over January and February, we saw a 75 basis point rally in the 10-year note, and that rate rally unleashed huge prepayment fears into the market. Mortgage originations soared, spreads on TBAs widened and pay-ups on specified pools climbed to very high levels with many pay-ups exceeding 4 points. Then the uncertainty of COVID gripped the market. This was real uncertainty that caught the market by surprise, and this was the kind of frightening uncertainty that historical data and traditional models cannot quantify. Without facing the predictive power of models, the market quickly repriced to reflect fear and emotion and also repriced to perhaps the most important technical factor, the proliferation of too many market participants with an adequate liquidity and over-leveraged balance sheets.The next step played out as they haven't passed crises. The stock market cratered; investors redeemed furiously from mutual funds, including fixed income mutual funds; and repo lenders fretted about the safety and security of their loans. The balance sheet was in short supply. So any bond holdings that required balance sheet leverage had a target on their back as cash was king.To understand the behavior of repo lenders,…

Thanks, Mark. I am pleased that we emerged from the volatility of March with our book value largely intact. Our risk and liquidity management practices did what they're always designed to do: They protected book value, and they protected our shareholders. This past quarter, that meant protecting our shareholders, not only by avoiding any forced asset sales, but it also meant protecting our shareholders by avoiding any expensive or highly dilutive capital raises. And through it all, we were still able to end the quarter with a lot of cash on hand that should enable us to play offense going forward.The current investment opportunities look exceptional, given the continued dislocations in most sectors of the residential mortgage market. Even with pay-ups recovering strongly in April, specified pools are still attractively priced, and financing costs have come down considerably. Net interest margins in many RMBS sectors are the widest that we've seen in years, and I believe that we are in an excellent position to take advantage of these opportunities. Along those lines, we are currently considering increasing our capital allocation to our non-Agency RMBS portfolio.All that said, while the global government and central bank responses have provided a boost to liquidity and meaningfully improved market performance in the short term, the path forward for the economy generally and the credit markets, in particular, remains unclear. In light of this uncertainty, our disciplined approach to liquidity management, interest rate hedging and asset selection will continue to be critical. We will continue to strive to balance defense, that is building in a margin of safety to absorb additional potential market shocks with offense, that is the ability to capture some incredible relative value opportunities. These principles will continue to guide us moving forward.Before we open the floor to questions, I would like to take this opportunity to thank the numerous members of the entire Ellington team for their hard work over the past weeks despite difficult circumstances. And for all of those listening on the call today and to all of those in our communities and around the globe impacted, we hope that you and your families stay healthy and safe.With that, we will now open the call to your questions. Operator, please go ahead.

[Operator Instructions]. And your first question is from the line of Doug Harter with Crédit Suisse.

This is actually Josh on for Doug. We saw lower leverage in the quarter, not surprising. Curious how you're thinking about target net mortgage leverage, just given the uncertainty in the market. And then, I guess, follow-up to that would be, how does that translate into the ROEs you're seeing on incremental capital deployment? You mentioned increase -- possibly increasing allocation to nonagencies. So maybe just the difference in ROEs you're seeing the different buckets that you look at.

Mark?

Sure. So on the agency side, I think we can get ROEs 10% to 12%. Spreads are not as wide as they were earlier in the month, but there's also a lot less volatility, right, and the volatility comes with an increased hedging expense. So I mentioned in the prepared remarks, we've spent a lot of time understanding where we can get call protection without exposing the portfolio to very high pay-ups. And I think that's the sector we'll continue to invest in and where we think we'll see the best relative value.In terms of the ROEs on the nonagency market, right? The nonagency market came under a lot of pressure in March. There were tremendous selling, not only from mortgage REITS, but also from mutual funds. And so we've seen a substantial drop in those prices above and beyond what could be justified by higher loss expectations, longer time lines, et cetera. So there, I think, we'd apply certainly lower amounts of leverage because there's still tremendous uncertainty, and so you can't rule out the possibility of asset prices declining. But with modest amounts of leverage there, I think we can get sort of ROEs 10% to 14%.

Your next question is from the line of Mikhail Goberman with JMP Securities.

Congrats on a very good quarter in difficult circumstances. It's kind of strange saying that given a 12% book value drop, but considering what other firms have posted, that's fantastic.

Appreciate that. Thank you.

Yes. Absolutely. Could you possibly give a book value update thus far through April and what we have in May?

We're not prepared to do that. Meaning that -- yes, it's just -- yes, if -- yes. We do have those numbers internally, and we did put out, obviously, a lot of information in our early April release. And we will continue to consider whether we think it's appropriate to put out intra-quarter releases, but generally, that has not been our practice.

Okay. Fair enough. And you mentioned that spec pools are still pretty attractive. You also mentioned, I think, that you like TBAs at this point as well. Could you maybe talk about your appetite for one versus the other as we move forward?

Sure. So this is Mark. In regards to TBA, we're in with the Fed support that to us is a material change from the market 3 months ago, 6 months ago. So we spoke a lot on earnings calls we did when we reviewed 2019 performance about improving technology in the mortgage space, how we thought that was adding to negative convexity. And the big increase in WACC -- the big increase in WACC and coupon that you saw for 2019 and how all those things sort of pointed in the same direction, which is essentially the erosion in the convexity of TBA and the erosion in TBA. The quality of TBA is a cash flow that you can effectively hedge at a low cost with interest rate swaps or treasuries. There was just a lot of negative convexity that got introduced into the TBA market in 2019. And you didn't have any Fed buying to absorb the cheapest lever, right? So remember, 2019, the Fed was solidly in portfolio reduction mode, and they were letting the portfolio run off by $20 billion a month, right?So now two important things have changed that we see. First is obviously Fed support, right? So the Fed is now buying certain coupons. And if you look at the implied roll -- the implied financing costs as that you can infer from the roll market, for the coupon that the Fed's aggressively buying, Fannie 2.5s, Fannie 3, 15-year 2.5s, some of the Ginnie coupons, roll levels are very attractive now. So now the rolls are not priced to the worst quality TBA they were in 2019, now they're priced to the fact that the Fed is hoovering up the worst pools and they're buying in such size that they're creating a little bit of…

Thank you, Mark, for that answer. It's very detailed. One more, if I may. I'm looking at Slide 11 of your deck, which shows a negative spread of 3-month LIBOR versus repo of about, I guess, 20, 25 bps at April 1. I believe in your prepared comments, you were saying that 3-month LIBOR should be settling at around 40 basis points. So what are you currently seeing for repo? And is there -- could you see that spread sort of turn positive not like it did back in 2018, of course, but basically, what are you seeing for that spread going forward?

Yes. So I think in the prepared remarks, what we said was that we think 3-month repo is going to settle in before -- below 40 basis points. Now if you look at 3-month LIBOR, it's had some extraordinary volatility in the past couple of weeks. 3-month LIBOR had been shockingly high 2 or 3 weeks ago and very high relative to OIS, and now it's starting to come down. So where I think 3-month LIBOR is going to be versus 3-month repo, I think they're going to be similar, right? So we're not going to get that big tailwind we've had from time to time when 3-month LIBOR was very high relative to 3-month repo. And then the floating leg you're receiving on your swap is more than covering the repo expense. So I think we're going to be in a period of time where those two numbers are roughly equivalent. But an equivalence would be better than what we had for a lot of 2019.And the other thing is that just the yield where we can buy assets, if we're really thoughtful about what we select in the agency mortgage market, that relative to the financing costs, and then adding on the additional costs on the pay fix swaps, that's a very healthy net interest margin. And if we do that in a way where we're not exposing ourselves to tremendous pay-up volatility, the net interest margins are really healthy right now.

Yes. And if I could just add that our interest rate swaps right now, Mark, correct me if I'm wrong, but they're either exclusively or almost exclusively LIBOR-based swaps.

Yes. No, exclusively, I think.

Exactly. So now there are, as I'm sure you know, there are other types of swaps that some other market participants in our sector have been using so-called OIS swaps. And that's something that we're -- we've looked very closely at. And I would say that it was obviously very good for us that we were exclusively in LIBOR swaps throughout the stress of March, LIBOR got very high. And so we were receiving higher rates on our swaps on the floating leg of our swaps. But at the same time, that was helping us with the stress, whether it was -- and whether you want to call that the stress in the repo market or even just what was going on with asset prices, right?So that was a tailwind, a small tailwind, obviously, during March. But it does show that in times of stress, right, it does make sense to have these LIBOR swaps on when the markets are very stable. So this is, again, it's hard to have a crystal ball, but looking forward, if the markets become very stable, then our financing costs probably will be more correlated or maybe slightly more correlated with these more OIS based swaps, which don't have the type of credit risk -- as much credit risk embedded in them as the LIBOR swap. So your -- it's a little bit a function of what's going to serve you better in a time of crisis versus what's going to correlate better with your funding costs in normal -- in more stable normal times.

And we have no further questions. This will conclude today's meeting. You may now disconnect.