Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2022 First 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. . 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 2022 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, 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. To begin, please turn to Slide 3. The challenging operating environment of late last year intensified during the first quarter of 2022, as it became increasingly evident that the hiking cycle and quantitative tightening will be faster and more severe than previously expected as the Federal Reserve combats surging inflation. During the first quarter, the Fed made the first of what are expected to be many interest rate hikes, concluded its final month of net purchases of Agency MBS and signaled that balance sheet runoff would likely commence soon. Geopolitical instability and recessionary concerns further contributed to a risk-off sentiment in the market and yield spreads in virtually every fixed income sector including Agency RMBS. And yield spreads in virtually every fixed income sector including Agency RMBS widened relative to U.S. treasury securities and interest rate swaps. Here on Slide 3, you can see the meteoric rise of the intermediate term interest rates in particular. The two-year note yield rose a remarkable 160 basis points during the first quarter. And as of March 31 was up a full two percentage points since September 30 and was an equal yield with the benchmark 10-year note. The 160 basis point move for the two-year was its largest quarterly increase since 1984. Mortgage rates have similarly soared. The 30-year fixed survey rate has risen by more than two percentage points since November and today sits at 5.1%, which is the highest it's been in more than a decade. This sharp increase has suddenly eliminated the refinancing incentive for most borrowers and so prepayment speeds are plummeting. The full ramifications of the new mortgage regime are just starting to play out, whether in terms of deteriorating housing affordability, the…

Thank you, Larry, and good morning, everyone. Please turn to Slide 5, where you can see a summary of EARN's first quarter financial results. For the quarter ended March 31, 2022, we reported a net loss of $17.5 million or $1.33 per share and core earnings of $3.9 million or $0.30 per share. These results compared to a net loss of $2.8 million or $0.21 per share and core earnings of $3.7 million or $0.28 per share in the fourth quarter. Core earnings excludes the catch-up premium amortization adjustment, which was a negative $488,000 in the first quarter as compared to a positive $169,000 in the prior quarter. During the first quarter, as Larry noted, Agency RMBS significantly underperformed U.S. Treasury Securities and interest rate swaps. For EARN, net losses on the Agency RMBS exceeded net interest income and net gains on our interest rate hedges, non-Agency RMBS and interest-only securities, which resulted in a significant net loss for the quarter on a mark-to-market basis. Core earnings increased sequentially by $0.02 per share to $0.30, which was in line with our dividend for the quarter. This increase was driven by higher average holdings in the first quarter. Our net interest margin did decrease marginally quarter-over-quarter to 1.76% from 1.81% as higher cost of funds more than offset higher asset yields. Since our specified pools are relatively seasoned overall, they offer both prepayment protection and extension protection relative to their TBA counterparts, which now include newer issue, more prepayment-sensitive pools. While the surge in mortgage rates during the quarter caused the value of prepayment protection to fall substantially, it also enhanced the value of extension protection. After taking into account these partially offsetting factors, payouts for our existing specified pool portfolio declined over the course of the quarter. However, we net…

Thanks, Chris. The rate and spread volatility in the first quarter was absolutely historic. The yield on the two-year treasury jumped a 160 basis points Fannie 2s dropped seven points and Fannie 4s dropped over five points. In terms of volatile quarters for the bond market, this one is going to stand out for a very long time. The massive change in the Fed's messaging led to a huge repricing of yield spreads across all our fixed income. When the dust settles, and it has not all settled yet, the opportunity set after these historic moves should make for a phenomenal backdrop for an agency mortgage REIT. What you have now is Agency MBS, an asset with good liquidity and no credit risk, priced at very wide spreads and with most of the market no longer exposed to the risk of fast prepayments. So you can see a clear path to low teens levered returns on pools and TBA, where you more or less know what you're getting on prepayments, which should now be limited to cash out refis and turnover. This is a completely different opportunity set than what we had in the second half of 2020 and all of 2021. Those were periods where current coupon rolls were strong because of the Fed buying and spread volatility was manageable because of the Fed's backdrop. But once you ventured into coupons that the Fed wasn't buying, you either had premium TBA-like pools, paying blazing fast because of the efficiency of the nonbank mortgage companies or you had specified pools that nose bleed pay-ups. You can make returns, but a lot of it was really drafting off the Fed. Now we have a market that has a much richer opportunity set and much wider spreads. You don't have to take…

Thanks, Mark. Despite the Fed's initial intentions for a smooth and well telegraphed tightening cycle, surging inflation has forced our hand to move faster and at times, the market's reaction has been reminiscent of the taper tantrum in 2013. The reduced Fed support was obviously a headwind for Agency RMBS in recent months, and the extreme interest rate volatility has widened yield spreads and made it a lot more expensive to hedge. In April, interest rates continued to increase, yield spreads widen further and volatility remained elevated. As Mark mentioned, our preliminary estimate is that our book value at April 30 was in the $9.40 to $9.60 range. In light of our recent book value declines, last night, we adjusted our annualized dividend back to the way it had been sized previously, namely to an approximately 10% yield on book value per share. We believe that this adjustment was prudent in light of recent circumstances, but we are also optimistic that we can start rebuilding that dividend given that much richer opportunity set that Mark spoke about. As we've seen in the past, big pricing dislocations tend to be the source of opportunity. With significantly wider yield spreads and lower pay-ups, agency-specified pools are more attractive than they've been in a long time. Repo financing terms continue to be very favorable. And putting it all together, higher reinvestment yields are outpacing rising borrowing costs. So core earnings in the coming quarters is actually looking very strong. And from a price performance perspective, which has been by far the biggest component of recent underperformance, new Agency RMBS supply is declining significantly, given the much higher mortgage rates. And this should help mitigate the negative effects of Fed balance sheet reduction. In fact, back in 2013, this is exactly what happened after severely underperforming during the taper tantrum, Agency MBS actually rallied significantly during the second half of that year. With that, we'll now open the call to questions. Operator, please go ahead.

. And we'll take our first question from Crispin Love from Piper Sandler. Your line is open.

Thanks and good morning. So first off, thank you for the book value update here. But just based on the recent volatility and your outlook, do you believe that we've started to see some stabilization in mortgages in April? And then just also what are your expectations for near-term volatility continuing and then coupled with the investment opportunities you're seeing?

Hey Crispin, it's Mark. So I would say that the second half of April, there was more spread stability than there was in the first half. So while the entire month was a volatile month, you certainly saw some stability in the second -- second part of April.

Great, thanks Mark. And then one on the dividend, and I know it's a Board decision here, but -- and Larry, I know you had some comments on it. But just thinking about the dividend, would you view that the new $0.08 monthly run rate just a resetting of the dividend here on recent book value? And then just also, how are you thinking about the dividend relative to core earnings going forward? Because recent commentary and then commentary you just had seems that the $0.30 run rate in core isn't in question, but perhaps with a slightly lower portfolio that we saw, you might fall a little bit below there? So just kind of thoughts on the dividend and also compared to core earnings.

Sure. Thanks, Crispin. Yes, so as I said, we resized the dividend basically to a 10% yield on our new book value per share. As I mentioned, core is outstripping that and in fact is expected to expand further in the coming quarters. So -- but because of the particular tax situation that we're in, we're not required, if you will, to distribute all of our core in our dividend. So even with core exceeding the dividend as we project, for the next few quarters, we would not be required to do that. And we just thought, as I said, given the circumstances, we thought it was prudent to resize that to the 10% yield where it had been probably the last time that we resized, frankly.

Okay. Great and then just so I'm clear, so are you saying that you think over the next few quarters, core should be at least $0.30?

Yes.

Our next question comes from Doug Harter from Credit Suisse. Your line is open. Doug, your line is open.

Can you hear me now?

Yes. Sorry, Doug. Thanks.

You mentioned that the latter part of the month, you started to see volatility slowdown. I guess as you think about kind of the risk, how do you kind of size the risk to future spread widening versus kind of the potential for spread tightening kind of in the market now?

Yes, so that's a good question, Doug. So one thing is we kind of contextualize mortgage spreads versus other competing fixed income spread products. So investment-grade corporates, high-yield bonds. Those sectors have widened a lot, too. So while we see very clearly wide spreads on Agency MBS versus the hedging instruments. And that is -- we use the term high-quality NIM. So it's a NIM where you don't have a lot of prepayment uncertainty to it, and it's a NIM where we think rates up, rates down, the NIM will hold up. It won't degrade a lot, and it won't require a lot of delta hedging. So we see very wide net interest margins on Agency MBS, but we also see competing products have also underperformed materially this year. So what happened with competing products doesn't really change the fact that we can capture a high net interest margin now. But I think what happens with competing products does have something to say about entry point and price volatility. So we want to see -- and you're starting to see it a little bit now, stability in rates, stability in mortgage spreads, but also stability say in investment-grade spreads for other asset classes. And you have a lot of bad news got priced into the market in Q1, it led to the book value decline, but the book value decline has created a much better opportunity set than we've had in the last few years. But there's still a few hurdles left for the market, right? The Fed's got a meeting this week. Expectation is for a 50 basis point hike, expectations they announced the tapering. So I think we also want to see a little bit how the market absorbs with daily mortgage supply without the Fed being a buyer, right? They're buying a lot less now than they did last year, but they're still buying, right? So it's a little bit of an adjustment. So I think that the net interest margin right now is very wide, but we want to be thoughtful about entry points. And that -- and thoughtful about entry points has something to do with other asset classes and sort of overall market tone.

Our next question comes from Eric Hagen from BTIG.

Hi, thanks. Good morning. How would you say a long-short MBS portfolio is in a better position to outperform a portfolio hedged exclusively with interest rates? Like when the Fed is about to start tightening more aggressively, what are investors getting by being long short versus some other approach, levered approach?

You're saying a long short MBS portfolio versus, say, like high-yield portfolio or investment grade bond portfolio?

No an MBS portfolio?

Long short MBS portfolio versus just long MBS portfolio.

Right. The second thing you said, a long MBS portfolio hedged with swaps and treasuries?

Right. So I think what you get is less volatility sensitivity. So a lot of the mortgage market now, say, kind of Fannie 3.5s and lower are sort of fully extended and the prepayment speeds versus -- if you believe the forward curve gets played out, the prepayment speeds are going to be largely determined by turnover and cash-out refis, right? And when you get above that, then you start getting into things that can get in the money and have refinanced -- have increase in prepayments if mortgage rates drop, right? So I think that you have -- and it depends what coupons you long, but coupons are short. But one thing and you saw it in the first quarter is that being short some mortgages reduced how much increase in volatility hurts you. Now I think that given how much TBAs and spec pools underperformed. It's a weaker case now than it was at the start of the quarter for sure.

Okay. That's helpful color. Thanks. How does home price appreciation --

Hey, I just want to add one other thing is that to the extent you have a research effort and modeling efforts that can do a good job of identifying discount pools that are going to have elevated prepayments. So you kind of predict levels of cash out activity and levels of turnover. Then long short in some of these coupons can add a fair bit of excess return. There's parts of the mortgage market now that are 13 points below par. So getting -- so pick in the pools with faster prepayment speeds -- if you can pick pools up faster prepayment speeds and buy those versus TBA and if TBA is priced at the same prepayment speeds, that adds a lot of excess return.

Yes, that's helpful. I think that actually leads into maybe my next question, which is how does home price appreciation and inflation factor into the outlook for prepays? I mean, do you feel like there's the potential for faster speeds to develop and the lower coupons simply as a matter of faster turnover and cash out refi demand against the current backdrop?

Yes, it's a great question and something we have been doing a lot of data analysis on, right? So what you have now is a whole bunch of borrowers with 3.5%, 3.25% 3% mortgage rates. So they're anywhere between 150 to 200 basis points below the current mortgage rate. But they're also sitting on a mountain of home equity, right? So what we've seen in the past is that how likely you are to do a cash out is a function of how much cash you can actually take out, i.e., how much equity do you have in your property, but also what's the rate differential between your mortgage rate and the current mortgage rate. So the strong HPA, we think is supportive of cash-out activity. And it's interesting because while there's a borrower component to it, there's also an originator and a servicer component to it. And some of the non-banks have been very aggressive in making borrowers aware about cash out refi opportunities. So strong HPA is definitely something that we think is supportive of higher turnover speeds. You're just now -- it's really only been -- you maybe have two months of data to really look and see what's going on. But because there's the amount of equity you have in your home, there's a little bit of a geographic component, right? So you've had on aggregate 20% HPA, but it hasn't been -- it's not like every area went up 20%. So there's certainly some high flyer areas. So there's that's support of a turnover speed. And it's also something that -- it's hard for models to capture, right? You're at a moment now where the amount of HPA borrowers have is a lot higher than what they've historically had in the data set. So you…

Yes, if I can add. Yes, it's really fascinating place where we are right now in the mortgage market, where there are so many securities now. Mark mentioned that I think it was Fannie 2 is trading with an 87 handle, where the difference in value, a, at current rates, if they prepay, say, at 6 CPR versus 10 CPR is massive. And in terms of how they'll respond in an upgrade environment, again, 6 CPR versus 10 CPR, a lot more modest price drop if the market sees consistent speeds of 10 CPR instead of 6 CPR. So the value of a lot of the mortgage market right now is going to be, I think, highly dependent. But as Mark said, really probably mostly just on the upside. I think the market is pricing in a pretty slow speeds, but there's tremendous upside if speeds end up being faster, which, as Eric, you implied, could be very dependent on home price appreciation, the economy mobility all sorts of things. So it's fascinating, and it will unfold over the coming months and quarters. But of course, the longer-term trend is going to be really important, too, because you're talking about -- these are very long mortgages right now.

Our next question comes from Mikhail Goberman from JMP Securities.

Hi, Good morning gentlemen. Most of my questions have already been touched on, if I may just ask you, what kind of opportunities are you seeing in the reverse mortgage market? Seems to be a space that is attracting more interest these days?

I'll just say, Mikhail, that there was widening and sympathy in that market. And so just the -- not surprisingly, it looks like a good entry point there. It's not a big focus, as you can tell, looking at our portfolio of the company. We're focusing on the more liquid sectors, but just -- we do think that it's an excellent entry point right now for Hacken Pools as an investor they have widened.

We -- the portfolio is roughly flat too, last quarter versus this quarter.

In terms of size.

Yes.

That was our final question for today. We thank you for participating in the Ellington Residential Mortgage REIT 2022 first quarter financial results conference call. You may disconnect your line at this time, and have a wonderful day.