Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2022 Fourth Quarter Financial Results Conference Call. Today's call is being recorded. At this time, all participants have been placed on a listen-only mode. The floor will be open for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to [indiscernible] with Associate General Counsel. Sir, you may begin.

Thank you. Before we begin, I would like to remind everyone that certain statements made during this conference call may constitute forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical in nature and are subject to a variety of risks and uncertainties that could cause the company's actual results to differ from its beliefs, expectations, estimates and projections. Consequently, you should not rely on these forward-looking statements as predictions of future events. We strongly encourage you to review the information that we have filed with the SEC, including the earnings release and the Form 10-K for more information regarding these forward-looking statements and any related risks and uncertainties. Unless otherwise noted, statements made during this conference call are made as of the date of this call. 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 fourth quarter earnings conference call presentation is available on our website, earnreit.com. Our comments this morning will track the presentation. Please note that any references to figures in this presentation are qualified in their entirety by the notes at the back of the presentation. And with that, I will turn the call over to Larry.

Thanks, Aladdin, and good morning, everyone. We appreciate your time and interest in Ellington Residential. During the fourth quarter, inflation continued to moderate, and the Federal Reserve ratcheted back the pace of its interest rate hikes. The market welcomed these developments and Agency RMBS rebounded sharply following three consecutive quarters of dismal performance. Volatility declined incrementally and investor demand for RMBS increased. Together, this drove nominal and option-adjusted yield spreads tighter, especially in November, and so the year ended on a more positive note. Turning to the investor presentation. In the bottom section of Slide 3, you can see the significant yield spread tightening that occurred across Agency MBS coupons in the fourth quarter, which caused MBS prices to rise, even though long-term interest rates were actually moderately higher. Meanwhile, short-term interest rates spiked for yet another quarter. You can see on this slide just how much short-term interest rates moved, not during the fourth quarter but also over the course of 2022, in absolute terms as well as relative to long-term rates. This trend has continued into 2023, and the yield curve is now the most inverted it's been since the early 1980s with a two-year tenure yield spread now more than 90 basis points negative. The inverted yield curve has pressured net interest margins industry-wide, and coupled with the extreme interest rate volatility that we've experienced since the beginning of 2022, it's really put the effectiveness of interest rate hedging programs under a microscope. For EARN, we've hedged along the entire yield curve, and we balanced our hedges frequently, both of which can be more expensive at times, but also more effective across a wider variety of market environments. As interest rates surged last year, we were continuously rebalancing our hedges. The delta hedging costs associated with this…

Thank you, Larry, and good morning, everyone. Please turn to slide five, where you can see summary of EARN's fourth quarter financial results. For the quarter ended December 31, we reported net income of $0.88 per share and adjusted distributable earnings of $0.25 per share. These results compared to a net loss of $1.04 per share, an ADE of $0.23 per share in the third quarter. ADE excludes the catch-up premium amortization adjustment, which was positive $658,000 in the fourth quarter, as compared to a positive $1.4 million in the prior quarter. During the fourth quarter, tighter Agency RMBS yield spreads and increased pay-ups drove significant net realized and unrealized gains on our specified pools, which combined with net interest income exceeded net realized and unrealized losses on our interest rate hedges. Our net interest margin increased slightly quarter-over-quarter to 1.37% from 1.28%, as higher asset yields exceeded the increase in our cost of funds, and that included the positive carry that Larry mentioned on our interest rate swap positions. Our higher NIM drove the sequential increase in ADE, even as our average holdings declined quarter-over-quarter. Meanwhile, pay-ups on our specified pools increased to 1.26% as of December 31 from 1.02% at September 30. As prepayment rates continue to decline market-wide, specified pool investors are increasingly focused on extension protection rather than prepayment protection. This has been a tailwind for the pay-ups on our specified pools, because the market is recognizing the significant extension protection they offer relative to their TBA counterparts. In addition, the pools that we did sell during the quarter had lower pay-ups relative to our overall portfolio. The combination of these factors led to the sequential increase in payouts. Please turn now to our balance sheet on slide six. Book value was $8.40 per share at…

Thanks, Chris. After a challenging nine months for Agency MBS, it's nice to be able to report a strong quarter and to make back some of the prior quarter's losses. Unlike most parts of securitized products, where investors take on credit risk, and the possibility of principal loss in exchange for excess yields, the Agency MBS market is unique in its ability to offer high yields without credit risk. Most agency mortgage REITs hedge a good deal of their interest rate risk. So the primary driver of quarter-by-quarter economic returns for a hedged agency mortgage REIT is the relative total return of Agency MBS compared to hedging instruments, which are usually treasuries and interest rate swaps. The total return of Agency MBS starts with the carry on MBS assets compared to the carry-on hedging instruments. But as interest rates and yield spreads move around, you also have to factor in delta hedging costs and the relative price performance of MBS assets, both pools and TBA, compared to hedges. In quarters where yield spreads are very volatile, as we've seen for the past four quarters, economic return tends to be driven primarily by the relative MBS price performance, whether outperform or underperformance. For the first three quarters of 2022, the relative price performance of Agency MBS was negative. Agency MBS dropped in price a whole lot more than a basket of similar duration treasuries in the face of heavy investor liquidations and soaring weights and volatility. But in Q4, that reversed dramatically. So what happened in Q4? Well, you finally saw some evidence that inflation is responding to the Federal Reserve hiking cycle and a higher interest rate environment. These green shoots put the potential end of this hiking cycle insight and that changed the direction of fixed income capital flows…

Thanks, Mark. 2022 was, by many measures, the worst year for MBS in at least 40 years and perhaps ever. In Ellington Residential's long-standing sector of focus, the agency MBS sector, it was truly nowhere to hide as the Bloomberg MBS index had its worst yearly performance on record on an absolute basis and its second worst year ever relative to treasuries. Throughout 2022, we had to navigate periods of extreme volatility and market dysfunction with interest rates rising rapidly and yield spreads widening along the way. Despite these challenges, our risk and liquidity management enabled us to avoid realizing even larger losses. As a result, we were able to buy into extreme weakness late in the third quarter and then sell into strength in the fourth quarter. By doing so, we entered 2023 with reduced leverage and strong liquidity, which is now allowing us to play offense once again. On last quarter's earnings call, we discussed that we are planning to selectively rotate a portion of our capital from Agency MBS to other residential mortgage sectors. And that's still very much on our radar screen. As we pointed out before, earn smaller size should enable us to be nimble as market conditions evolve. And as usual, absent a big yield spread widening event, where we want a pound, we plan to be patient and opportunistic picking our spots. So far this year, January started the year off on a positive note with Agency RMBS enjoying an excellent month as agency yield spreads tightened further. The tide has turned a bit since then, with interest rates and volatility up both in February and so far in March, especially with Powell's comments this morning. Year-to-date, through the end of February, we estimate that earns book value per share was up close to 4%. With that, we'll now open the call to questions. Operator, please go ahead.

Thank you, sir. [Operator Instructions] Our first question comes from Eric Hagen with BTIG.

Hey, thanks. Good morning guys. I've got a couple here. I mean how are you thinking about volatility in the market, especially connected to a recession and the impact that it has on the flexibility from banks to support repo financing. Like are there good ways do you think, to hedge against the kind of credit risk at banks because of the transition to SOFR from LIBOR over the last couple of years? And then as a smaller cap mortgage rate, are you concerned about the access that you have to repo and banks as the Fed continues to raise? And then, how do you think mortgages would respond to any further backup in rates at the long end of the curve as well as the short end? I mean, we all know that most of the sensitivity is concentrated at the long end, but how sensitive do we think the basis is if Fed funds are meaningfully higher than what the forward curve currently projects? Thank you guys.

Hey, Mark, why don't I take the repo portion of that, and then you'll address the -- how the mortgages should react to what's going on in the yield curve?

Sure.

Yeah. So we're not really concerned about repo. Repo and especially in agency pools has just been incredibly resilient, including most notably through the financial -- global financial crisis. We have a lot of -- very large diverse set of repo counterparties. We explicitly limit, our exposure to smaller counterparties, and we – most of our repo is through the very large banks that are – again, since the global financial crisis is extremely well capitalized. It's something that we watch. I mean, there's been a couple of banks that have been in the news, and you've seen there the credit spreads and their own debt be a little bit volatile. But again, we limit our exposure there into residential to those counterparties, and it's just not something that, we're worried about, whether it be from a counterparty credit risk of our repo counterparties, or from a repo availability perspective. I mean, we've just seen absolutely no blips in terms of that availability. Mark, do you want to handle the second part?

Sure. So, I think the first question, Eric, was about volatility. Volatility has been pretty high this year, but the – realized volatility is certainly down from last year. And like to me, I think about sort of two types of volatility. One is what's the volatility in treasury yields, right? So how many basis points a day are they realizing versus what's kind of built into market expectations. And you've been sort of realizing about what it – what market expectations are priced in, which it sort of means that, if you think about things in OAS terms that your delta hedging costs are about what the OAS you thought you were buying is predicated upon. So that has been definitely manageable. It's been more manageable than last year. Now the other part of volatility that, I think a lot about is, what's the volatility of mortgage spreads relative to treasuries and that's where you've really seen things come down. The amount by which mortgages outperform or underperform treasuries on sort of a given day this year versus last year, it's a lot less. So you've had kind of mortgages they've had this modest outperformance this year, but the oscillation has been between sort of their best performing days and the worst performing days are lot – there a lot closer than what they were last year. And I attribute that to the flows in mortgages are a lot more balanced. So sort of like, anyone who needed to shed a lot of duration in response to Fed hikes last year, or outflows they have, let's say, it's a mutual fund or pension fund basing cash, I think you've seen those big outflows occur. And if you look at ETF data in mutual fund data, you've seen kind of…

Yes. Appreciate the color from you guys as always. Thank you.

Thank you. A – Chris Smernoff: Thanks, Eric.

Thank you. Our next question comes from Crispin Love with Piper Sandler.

Thanks. Appreciate you guys taking my questions. Just first on looking at potential buyers of Agency MBS over the near-term. Mark, you talked about this a bit, but with banks stepping back in the sector in 2022, do you still view that there's an opportunity there for banks to be a meaningful buyer in agency in 2023 if bank loan growth pulls back, or could that be delayed into kind of 2024? And then just any other potential tailwinds for agency think are worth calling out?

Sure. So I think what -- what really turned the dial on Agency MBS performance in Q4 as opposed to quarters one, two and three was really money manager buying in response to inflows, right? Like investors like long-term pools of capital, pension funds, insurance companies are seeing yields they haven't seen since 2007, right? So that has been enough to get people when they see some modicum of stability in rates to commit capital to fixed income. So I think that was -- it was really money managers are the -- the type of buyers that really have driven performance in Q4 and so far this year. Banks so far has still been on the sidelines. You've seen them basically sell some of the Fannie Freddie's. The buying they're doing is mostly in Ginnie's because it's a different capital weighting. And they've also been preferring loans over securities for lower mark-to-market impact on their balance sheet. So I -- you did see some bank buying. Banks typically buy after they've seen a little bit of a rally. So they generally like -- they're not the kind of catch a falling knife type of buyer. They're, sort of, like they'd rather buy the bounce type buyer. So you did see a little bit of bank buying in earlier this year when we had valued some, but I think that's dissipated a lot. So I don't think you're going to see material bank buying unless rates sort of stabilize, start going back down? And if concerns about credit performance or significant -- credit performance and loan portfolios is significant enough to cause them to favor securities over loans for credit reasons. You typically see that happen in a recession. You know, right now, the economic numbers have been strong. The other thing which can also drive some of the bank behaviors, now everyone is under this CECL regime, right? So if you do have weaker credit performance in the consumer or credit performance in mortgage loans, then that can drive a revision to the capital you need to hold against loan portfolios for CECL. And if that starts happening, that's certainly something that would cause them to favor securities over loans.

Thanks Mark. And then just one other for me. It's more of a numbers question from the quarter, but looking at core other income after making all the adjustments for ADE was pretty sizable in the quarter versus the previous quarter after backing out the adjustments, you still got to core other income about $2.7 million. I'm just curious if you can comment on the key driver in the change there and what's in there that drove the significant increase versus the previous quarter?

Sorry, can you repeat the question? This is Chris.

Yeah. So looking at core other income after making all the adjustments for ADE was about $2.7 million, which was a significant increase over the previous quarter after making the adjustments for different realized and unrealized gains. I'm just curious if you can comment on the key driver in what drove the higher core other income in the quarter? And we can definitely take this offline if you don't have it handy.

Yeah, yeah. Cris, it's the swap payments, the swap benefit that we were talking about before.

All right. Perfect. Thank you very much.

Thanks, Crispin.

All right. Thank you.

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

Hi. Good morning, gentlemen. Congrats on a solid quarter and appreciate the book value update. Just a quick question from me on what kind of opportunities are you guys seeing in the non-Agency space, I guess, you're mentioning here number two on your list of the annual objectives is to continue to rotate a portion of capital into that space. So I'm just curious about that. Thanks.

Yes. So the two sectors in non-agencies that look to us most attractive right now are some of the more seasoned credit risk transfer bonds and the other one is the legacy non-Agency market. So that's sort of the pre-crisis bonds, 2007 and earlier, people have been in their homes for 15, 16 years. It's a fragmented market. It's a lot of smaller pieces. There is a lot of securities where you're back by maybe 15, 20 loans, so cash flows are lumpy. But our analytics are very strong in that area. And because you really need to take a granular approach to looking at the individual loans, it's deterrent to people that just want to buy beta. So we see that sector as attractive now. It's now it's -- you have to counterpunch a little bit there. You have to wait for sellers because -- it's not like the non-QM market or another new issue market where there's new issue deals and you can just put in your order on new issue and get invested that way. This you need to respond primarily to bid-list but those are the two sectors that we see the best relative value. And we're not looking to -- that portfolio is not designed to, or it's not contemplated taking a lot of credit risk. So what we're going to put to work there are securities that we think you can shop home prices like a great financial crisis shock, and you're going to get your capital back. So it's not going to be way down the capital stack and things that are subject -- where small changes in loss expectations really change your expected returns things higher from the capital structure. It's not -- it's very similar to what we did in 2020 at a COVID, right? 2020 out of COVID, we raised cash once the Fed started buying and Agency RMBS tightened, and Agency RMBS, their tightening cycle preceded the tightening cycle in credit-sensitive assets. So after the Agency CMBS we are started to perform well. Post-March 2020, we rotated into some of the non-agencies and it worked out really well.

Great. Thanks. And Mark, just kind of curious, obviously, it's not an issue at the moment, but kind of looking forward, at what point could prepay speeds start to spike, or what kind of environment would we have to get to rates keep on rising. Like I said, obviously, not an issue at the moment, but what could happen down the road.

It's a great question. It's a great question. We actually just got the new -- get these monthly prepayment reports, fifth business day of the month, so we got the prepayment report last night, and it showed a very modest up-tick, maybe 10% from extremely low-levels. So I think about it two ways. There's some very small portion of the mortgage market, where people have note rates, 7.5%, 7.25% bigger loans. We think those borrowers are going to be very responsive to refinance opportunities if the forward curve is borne out, and you see mortgage rates drop. And you have still -- there's been, layoffs industry-wide on mortgage originators, but you still have excess capacity. So if you saw 20, 30, 40 basis point drop in mortgage rates, you're going to see that very small portion of the market that has high note rates. So, people that took note rates Q4 last year those are going to be responsive. And this actual -- this recent prepayment report yesterday, you saw a little bit of that behavior, because this prepayment report referenced mortgage rates a little bit lower than where we are now. But now, if you think of it the market in aggregate, to get a real prepayment wave you need to get big portions of the market re-financeable. And I don't think you see that, until you get well below 5%. Even you move things 75, 100 basis points here the percentage of loans that have a refinance incentive is very low. The first thing I think you'd see is that, if you got mortgage rates, let's say, to 5.25%, and all of a sudden, people with four, 4.5, 4.75 note rates, they're going to be more willing to do cash out refinance. So -- so that can happen. That would be sort of incremental. But to get a real -- a big portion of the market re-financeable with straight rate refis, you're going to have to be well under 5%. But I think you'll see, sort of you have little pockets of faster speeds along the way. And if you hold those pools, you can get hurt on those pools, but it doesn't change the supply demand dynamic for mortgages until you get significantly lower rates.

Got it. Thank you for that. And thank you very much guys. Best of luck going forward.

Thank you.

Thank you. Our next question comes from Jason Stewart with JonesTrading.

Thanks guys. I just wanted to know a little bit further on your thoughts on investing across the Agency coupon stack, vis-à-vis the dividend.

I guess, kind of where we see the most value now is like a sweet spot, like it's coupons that are high enough where you're getting enough coupon that you're sort of like going to be close or getting close to your financing costs, but aren't so high that a little bit of drop in mortgage rates, you can see a big pickup in speeds. So I would say 4, 4.5, 5, even 5.5. That to us looks, I think, that's where you want to be. I think you want to be positioned such that if you have a drop in rates, if the forward curve turns out to be right, you have at least a few points of room before you get to par, before you really have to start worrying about prepayments. So I'd say that those coupons kind of fit that bill, but they also -- you also had the nice property that you're not seeing new production, say, in 4 and 4.5. So each month, if you own pools or even if you own TBAs, it's sort of you own pools, everything season month-by-month. But even if you have a TBA exposure there, the assumptions to what's deliverable is getting older each month. So you're getting kind of the benefit of the seasoning there. And I think that -- it serves a very higher coupons, you have really big loan balance that are in small drop in rates, you're going to have an army of people trying to refi those loans. That to me is, I think, an area that will have a challenging performance if the forward curve is borne out, and you do have lower rates second half of this year and next year.

And if I could just add, if you look at our net interest margin, and you leverage that given you can look at our debt to equity, you can look at our net mortgage exposure, which we dial up and down, you can see that the dividend should be well covered from that perspective, especially given where short-term rates are, because that's a tailwind as well. But it's really a -- spreads have been so volatile lately. I mean, we talked about how that gapped out in September, tightened in November. Now obviously, this year, we saw sort of a similar thing January tightening in February and March widening. So it's definitely a market where we feel that by dialing down -- up and down that mortgage exposure, we can generate incremental earnings. And so I think with that as well, which obviously came into play in a big way in the fourth quarter, we can absolutely cover the dividend.

Got you. Great. Thanks, guys.

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