Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2022 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 Jason Frank, Deputy General Counsel and Secretary. Sir, you may begin.

Thank you, and welcome to Ellington Residential's third 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 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 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. After a challenging first half of the year, the third quarter started off on a constructive note with interest rate declining and interest rate volatility subsiding in July. As has been the typical pattern this year, yield spreads follow the direction of interest rates with both declining in July, and virtually all fixed income products benefited. Agency RMBS, investment-grade corporates and high-yield corporates reversed most or all of their losses from the prior month and posted significant outperformance during July versus treasuries and interest rate swaps. Ellington Residential itself generated a positive economic return of nearly 6% in July. The good news proved short lived, however. Continued elevated inflation led the Fed not only to raise the Fed funds target range by 75 basis points in both July and September, but also to accelerate its balance sheet runoff. Central Banks around the globe also continued tightening their monetary policies. Over the course of August and September, interest rates rose sharply, large segments of the yield curve inverted further and volatility surged. The MOVE Index, which measures the yield volatility implied by short-term options on long-term treasury notes and bonds, reached its highest level since the COVID-related market volatility of March 2020. Market sentiment steadily weakened, and we saw widespread selling across asset classes, including forced selling by some asset managers to meet margin calls and redemptions, particularly toward the end of the quarter. Liquidity deteriorated and yield spreads widen in virtually every fixed income sector, including Agency RMBS, with many sectors hitting their widest levels of the year. Technical headwinds in the Agency RMBS market included not only the Fed's acceleration of the reduction of its MBS portfolio but also extremely weak bank demand. Turning…

Thank you, Larry, and good morning, everyone. Please turn to slide five, where you can see a summary of EARN's third quarter financial results. For the quarter ended September 30, we reported a net loss of $1.04 per share and adjusted distributable earnings of $0.23 per share. These results compare to a net loss of $0.82 per share and ADE of $0.20 per share in the second quarter. ADE excludes the catch-up premium amortization adjustment, which was positive $1.4 million in the third quarter, as compared to a positive $1.6 million in the prior quarter. During the third quarter, as Larry noted, Agency RMBS significantly underperformed U.S. Treasury Securities and interest rate swaps, and that drove our net loss for the quarter. Our net interest margin decreased quarter-over-quarter to 1.28% from 1.66% as higher interest rates drove a significant increase in our cost of funds, which exceeded the increase in our asset yields. Our lower NIM combined with lower average holdings quarter-over-quarter caused the decline in ADE. Meanwhile, average pay-ups on our specified pools decreased modestly to 1.02% as of September 30 from 1.09% as of June 30. Please turn now to our balance sheet on slide six. Book value was $7.78 per share at September 30, as compared to $9.07 per share at June 30. Including the $0.24 of dividends in the quarter, our economic return was negative 11.6%. We ended the quarter with cash and cash equivalents of $25.4 million. Next, please turn to slide seven, which shows a summary of our portfolio holdings. In the third quarter, our Agency RMBS, interest-only securities and non-Agency RMBS holdings, all decreased modestly. Agency RMBS portfolio turnover in the third quarter was 19%. Additionally, our debt-to-equity ratio adjusted for unsettled purchases and sales increased to 9.1 times as of September 30 as compared to 7.9 times as of June 30. The increase was primarily due to lower shareholders' equity quarter-over-quarter as the portfolio size was relatively constant. Similarly, our net mortgage assets-to-equity ratio increased to 7.5 times from 6.8 times over the same period. I'll note here too that repo financing has remained stable and available, despite the market volatility. On slide eight, you can see the details of our interest rate hedging portfolio. During the quarter, we continued to hedge interest rate risk through the use of interest rate swaps and short positions in TBAs, U.S. Treasury securities and futures. Finally, we were optimistic with our capital management strategy during the quarter as we issued approximately 148,300 shares to our ATM at a price -- an average price of $8.43 per share and repurchased approximately 9,500 shares at an average price of $6.53 per share. I will now turn the presentation over to Mark.

Thank you, Chris. Q3 was a unique quarter, whose defining characteristic was an enormous level of sustained volatility in almost every important fixed income metric. Beginning with interest rates, the five-year treasury traded in a range of 2.64% to 4.19% during the quarter. That is a 155 basis point swing within just one quarter. The change in the shape of the yield curve was also dramatic. The two year to 30-year treasury yield spread had a range of 87 basis points just for the quarter, which is a bigger range than you'd expect to see for an entire year. Meanwhile, the market CDX IG Index, which reflects the market's perception of credit risk for investment-grade corporates, had a range of 37 basis points for the quarter, whereas for all of 2021, it only had a range of 13 basis points. So this benchmark index moved about 3 times as much just this past one quarter as it did all of last year. And most important for EARN, mortgage prices and mortgage yields were not spared at all from this volatility. During the quarter, Fannie 4s traded in an nine point price range and Fannie 5s traded in an incredible 59 basis point yield spread range. This is not a normal market by any means. The Fed has now implemented 4 75 basis point hikes in succession. They've now hiked more in the last four meetings than they had hiked cumulatively in the preceding 10-years. EARN had an economic loss of 11.6% for the quarter and the rest of our peer group fared even worse. An Agency mortgage REIT is simply not designed to deliver good returns in the face of that magnitude of interest rate increases and mortgage spread widening. I do believe that much of our loss is reversible…

Thanks, Mark. 2022 has proven to be a challenging year so far. And while the market conditions have obviously hit our book value significantly, we have also recharged the opportunity set. The so-called mortgage basis, the spread between yields on Agency RMBS and treasuries or swaps looks extremely wide on a historical basis today. And with net mortgage supply likely be much lower going forward, as well as so much bad news already priced into the market, we think that Agency RMBS offer excellent investment value today. In addition, recession could actually be a boost for the sector because Agency RMBS have no credit risk. And because in a recession, the Fed might pause or even reverse the steps it has taken to tighten its monetary policy, which would be a support of technical. That said, we're near the upper end of the range where we've typically set our leverage. And referring back to slide nine, we're also near the upper end of the range, where we've typically set our net mortgage assets to equity ratio. The upshot is that it wouldn't expect us to be significantly adding to our net RMBS exposure from here. Finally, Ellington Residential has a broad mandate, and we think that there are currently many opportunities in the non-Agency mortgage markets that offer even more compelling value than agencies. Therefore, we are planning to significantly increase our capital allocation to the non-Agency market, perhaps to 25% or more. The last time we did that was right after the COVID market shocks in early 2020. And we ended up benefiting handsomely from that reallocation, which helped drive EARN's outperformance in 2020. As we've pointed out before, EARN smaller size should enable us to be nimble as market conditions evolve. And with that, we'll now open the call up to questions. Operator, please go ahead.

Thank you. [Operator Instructions] We'll take our first question from Crispin Love of Piper Sandler. Please go ahead.

Good morning, everyone. First, Larry, on the comments that you just made on increasing non-Agency exposure, maybe up to 25% or so, can you talk about -- just give a little bit more detail on that? And what kind of time frame you could do that? Is that something that would happen relatively quickly? Or thinking more over the next couple of quarters just because you're -- I think you're in the very low single-digits right now? So I was just a little bit surprised by that.

Yes. No, I think it can happen relatively quickly. I mean we're a small company. We're nimble. We're talking about mortgage-backed securities that are fairly easy to access. So yes, I would say, maybe even by year-end. Year-end is often a good time to be buying, as you know.

Right, right. Absolutely. No, that makes sense, and then just looking at the relative yield spreads that you have on slide 10, no surprise, but pretty eye-popping there just with everything near or a lot of the agency market near 24-months wide. Do you have any outlook on widening versus tightening, kind of, over near to intermediate term, because you could have some pretty big tailwinds to book value if we do see some tightening there?

Right. And I'm going to let Mark answer that question. But I would say that it's interesting. So everybody's got a different prepayment model, right? And we've talked about how research and prepayments are so important. So slide, I think it was three, we show some OASs based upon JPMorgan's models. And on this slide, I believe this is Morgan Stanley's OAS models. So you can see that Morgan Stanley's model, I mean, on Fannie 3s, and I think on the other slide, it was 2.5s and 3.5s, but you get the idea, as obviously a much slower prepayment model than many of the others. So it really is very model dependent on the mortgage market. But we do think that OASs are very wide. We think that perhaps Morgan Stanley model is a little bit too much on the pessimistic side. So I just wanted to point that out before Mark addresses the question about where, I guess, you're asking really where you see spreads heading ultimately?

Yes, yes.

Yes, Crispin, so you can see that given our historical track record, our mortgage basis exposure is relatively high now, which that is an indication that we do think it's more likely that spreads tighten from where they are then widen. And it also is even if they stay where they are, they're very wide. You generate a very wide net interest margin. In the prepared comments, I did mention some of the things that I thought could be supportive of the mortgage basis. Supply is way down, I think some of the deleveraging selling that weighed on the market in Q3, some of that feels as though it's behind us. And I mentioned that banks that are normally huge buyers throughout the course of the year have been noticeably absent from the securities market this year. So I think I said it's sort of hard for them to buy less. You've seen some overseas buying as well. So I think it's -- this number today has moved the market a lot, but it does feel to me that given the backdrop of greatly reduced supply that any, kind of, incremental buying from new pools of capital, be it banks or money managers of the redemption stock, can really move the basis a lot, because you're not dealing with a lot of supply coming into this market, given how high mortgage rates are. And obviously, geopolitical forces or other economic numbers can be gorgeous shocks that can change that. But I would say we sort of think it's more likely than not that spreads will recover from where they were at the end of the quarter. And so that was sort of the thought process behind our positioning.

Sorry, just to add one thing to that. Often what you see, right, when you've got good news like we saw today, look, why no one swallow does not a but we could -- this could be the sign that we're moving in the right direction. Often, you see the liquid markets like the agency markets move first in terms of spread tightening, let's just say. And that could really, from a timing perspective, work out very well, right? We'll recapture some of those losses from the spread winding earlier on our agency portfolio and the portion and then we'll rotate out some of that. Granted, there still may be more upside left in that. But if the non-Agency and the less liquid markets lag in terms of spread tightening, it could work out really well to our advantage.

Great, thanks. Larry, Mark for those comments. Just a final clarification question from me. So Mark, you made some comments about book value so far in the quarter. I think you said breakeven. So is book value at around $7.78 or so. Is that as of the end of October? Or is it even more recent than that?

Yes. We're -- this is Larry. We're -- yes, we're talking really through today, I guess, as you know, And yes -- and I don't want to sort of get into putting an estimate as of November 10, that's not our style. But yes, I think we meant book value, just to be clear, taking into account any interim dividends. And so we think book value is around breakeven.

Perfect. Thanks for taking my questions.

Thanks, Crispin.

Thank you.

Thank you. Our next question comes from Doug Harter of Credit Suisse.

Thanks. Can you just talk about how you are continuing to think about leverage in light of volatility today being kind of volatility to the good? But kind of moves continuing to kind of be very large and kind of how you think about positioning into that type of market?

Yes. It's Larry, hey Doug. So I think -- so let's talk about the two types of leverage. One of them actual technical leverage in terms of our financial leverage, our repo borrowings, et cetera, there quarter end at above 9:1, I mean, that's really -- I don't know if we've ever gotten about 10:1 at a quarter end, I don't think so. We've been here before though. So this is really the upper end of the leverage range. And so I wouldn't expect us, as I said, don't expect to see that go up much. In fact, if we do start this rotation, from some agencies to some non-Agencies, then you'll see that come down, right, because we obviously will leverage the non-Agencies a lot less. I mean, then from a mortgage exposure, Mark, you want to address that, we ended the quarter at 7.5:1 also sort of near the upper end of our range and spreads have tightened a little. What do you think, Mark?

Yes. So I guess what I would say is that today is, kind of, an interesting day, something Larry and I were discussing really right before the call that while you're having this enormous move in interest rates like a 30 basis point move and a big move in credit spreads, we talked about that IG Index that thing about six tighter today, it was something we talked about in the prepared comments. So while you're getting a 30 basis point move in interest rates, which is -- I mean you see moves that big maybe once a year or once every other year normally. So implied volatility is actually down today. So while this is an enormous move for today, at least what implied volatility is telling you that having seen a little bit of inflation seem to respond to the progressive hiking cycle of the Fed is, sort of, implied all saying that, that's going to usher in maybe less volatility going forward that you don't -- if you start to see economic numbers that are reflective of what the Fed has done, and I think the big comment in Powell's last statement that the market picked up on was this notion of long and variable lag. So there's a lag between when the Fed hikes rates and when it flows through the economy, and there's sort of like different sectors occur at different times. So the most responsive one to interest rates is generally housing, and you've seen housing really make 180-degree move, right? It had been up 20%-plus in 2021, then up 10% in the first six months of this year. And now you've seen in the last few months, some of the biggest one month declines you've seen in a very long time, right? So…

Got it. Thank you.

Sure. You’re welcome.

Thank you. We'll take our next question from Eric Hagen of BTIG.

Hey, everyone. You have Ethan Saghi on for Eric today. Thanks for taking my questions. First one, just how do you see dollar roll financing evolving? And what conditions will it be most sensitive to?

So this is Mark. Thanks for the question, Ethan. Dollar rolls right now -- so people think about the dollar roll market a few different ways. So one way, a lot of people think about it. And one way we think about it is we kind of know what the repo rates are. So one month repo rates right now are about 3.9%, right? So you can look where dollar roll is and you can say, okay, what is the implied prepayment speed on that dollar roll for me to be indifferent between doing the dollar roll or having a pool on repo? And when dollar rolls are cheap, they're not special, there's not a lot of demand for them, you see the CPRs, now we're talking about discounts at very, very low numbers, right? So there are a bunch of rolls now with the implied CPRs are 1% to 3%. And you can find pools that pay above that. So that's sort of a little bit what I was alluding to when I was answering Doug's question. So dollar rolls for all the discount coupons are trading relatively poorly. So it's the opposite of what you saw in 2021 when the Fed was buying so many Fannie 6s and so many Fannie 2s, so many Fannie 2.5s, so many to 4.5s, so many to 2s that -- those rolls were consistently special. Those rolls were higher each month than what you would have earned from having a pool and taking it on balance sheet. And this year, it's kind of been the opposite. The rolls have not been special in the discounts. And I don't think that's surprising given that you don't have the Fed involved buying these things. And you don't have other players like banks involved in…

Got it, that all makes sense. And then just another question, kind of, piggybacking off the last question on leverage. Just how much net mortgage leverage do you feel comfortable with? And kind of if you can just talk about the relationship between the net mortgage leverage and debt to equity, that would be helpful.

Yes. So we're comfortable with where we're at now. I don't think we'd bring that up unless spreads were to take another leg wider. And so basically, if you take our mortgage exposure, right, you can think about the company is having, okay, if we just own a bunch of pools and we're paying fixed on a bunch of sulfur swaps, that's our mortgage exposure. And then on top of that, if we own some pools that are hedged with TBA, that won't change our mortgage exposure, because the mortgage exposure from the pool we own is netted against the mortgage exposure, we're short in shorting TBAs. So having pools versus TBA doesn't increase our net mortgage exposure, but it does increase our repo borrowings. So you can look at what we report from net mortgage exposure and what we report for the total repo borrowings, you can kind of partition the portfolio as some large portion of the pools hedge with SOFR swaps and then another portion of the pools hedged with being short TBA.

Yes. So if you refer to slide nine, right, you can see that as -- well, our leverage ticked up, but it's not on this slide from the second -- end of the second quarter to the end of the third quarter, but our net mortgage assets-to-equity ratio also ticked up. And that mid-7s, as Mark says, that's towards the high-end of the range for us. So I wouldn't expect that to tick up much from there.

Got it. All right. Thanks for answering my questions.

Thank you. Our next question comes from Mikhail Goberman of JMP Securities.

Good morning, gentlemen. Hope everybody is doing well?

Thanks, you too.

Most of my questions -- thanks -- most of mmy question have already been touched upon. But I was just kind of wondering, in the sort of hypothetical scenario given the CPI print today and the market reaction, if we continue to get more favorable CPI prints in the months ahead and the Fed say decides to do 50 in December and then cuts to -- comes down to 25 early next year and then stops, at some point maybe in the later spring, I guess the biggest wildcard is do we get a recession around the same time. But I guess my question is --

My question to you is, do you know something that we don't.

Like I said, a hypothetical scenario, I'm just kind of talking. What would the ideal sort of portfolio construction be in an environment where the Fed has stopped hiking? Forget about the potential recession. Just the Fed is that is no longer a hiking, they've achieved their neutral rate or so, they think. And you guys have gone with your portfolio rotation from now to that point, what would an ideal portfolio look like? What would that process kind of look like?

So I guess I would say we don't -- we have a great research effort here, but it's not about predicting what the Fed is going to do. So we really try to position these portfolios agnostic to the direction of interest rates and respectful exogenous things or surprise numbers that can move the market a lot. So just with that said, I think that if you get more good news on inflation, and it looks like the Fed is near the end of their hiking cycle, I think what you'll see is we have comments with a lot of our clients at Ellington, not having to do with the public companies, our perception is that there is a lot of capital that is getting interested in fixed income and getting into credit and has been waiting, because the market has been too volatile and they want to see how far the Fed goes and they want to see -- because this year, it's basically been a year of the market inflation numbers being running generally higher than predictions. And the Fed responding and the Fed dots going higher and higher, so there's been a lot of people that have been patient and their patience have been rewarded. So I do think there is a lot of cash that is available for the Agency MBS market and the credit market. So I think if you get some stability on if you get some better 2s on inflation and people's perception of the Fed is that the larger hikes are behind us, then I do think that money will get deployed. I don't think it will wait any longer. So then in that case, I think it's good for spread product, right? It's good for Agency MBS. It's good for the…

Thank you. Yes --

Thanks, Mark. Yes, just I can't resist I'm going to take the bait on that question, too. So I think if you look at where a lot of the credit markets are priced right now and frankly, even some of the noncredit markets like the agencies when you look at how wide spreads are and implied volatility and all that, I think the market is still pricing in a decent chance of rates going a lot higher from here, right? You could have wage price spiraling inflation, all sorts of things that are not off the table yet. Today, obviously, is very helpful. So in your scenario where, let's say that's off the table, and we're not going to get to a 6% 10-year or something like that. So that takes a lot of very specific risks off the table, right? So I think one thing that the market is very concerned about is what's going to happen to real estate prices, not just residential, but also commercial if rates were to go much higher. And if you're a debt holder or a lender like we are, you don't really worry about that so much about that first 5% or 10% drop in real estate prices. But you worry a lot about a drop if you got a 80 LTV or 75 LTV is sort of being a typical lending level. You worry a lot about a drop, that's 15%, 20%, 25%, right, because it's never going to be uniform anyway. So I think if you take that kind of risk off the table of really spiraling inflation, then I think you will see strong moves in the credit markets. You'll see real estate prices, kind of, stabilize. We think there's a big difference, right, between if -- I think in your scenario, if you got mortgage rates settling in more in that 5%, 5.5% area, let's just say, as opposed to 6.5%, maybe where they are now or possibly even lower now, it just makes a big difference. So I think that it just take -- would take a lot of risks off the table and tightened spreads quite a bit in all sectors because it would take -- even in the Agencies, it would take a lot of extension risk off the table on current coupons.

Thank you very much, gentlemen. That’s great detail. Thank you.

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