Ellington Financial Inc. (EFC) Q4 2015 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial Fourth Quarter 2015 Financial Results Conference Call. Today’s call is being recorded. At this time, all participants have been placed in listen-only mode and the floor will be opened for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Jason Frank, Corporate Counsel. You may begin.

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 and they are based on management’s beliefs, assumptions, and expectations. As described under Item 1A of our Annual Report on Form 10-K filed on March 13, 2015, 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 have with me today on the call Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, our Co-Chief Investment Officer; and Lisa Mumford, our Chief Financial Officer. With that, I will now turn the call over to Larry.

Thanks, Jay. Once again it’s our pleasure to speak with our shareholders this morning as we released our fourth quarter results. As always, we appreciate your taking the time to participate on the call today. First some highlights, despite significant credit market turmoil, which started in the energy-sensitive corporate bond sectors but has now infected virtually all spread products, Ellington Financial was still able to generate a modest profit for the quarter. Our 2015 return on equity was approximately 5% for the full-year. Well that’s not what we would consider a great year we believe that it stacks up very well against the performance of other credit focused vehicles. On the one hand, we still made money while also reducing leverage at a time when the credit markets are cracking. But just as importantly, our proprietary pipeline loan businesses, consumer loans, non-QM origination, and distressed commercial mortgage loans, are not only performing well, but are now kicking into high gear from an overall volume perspective. We’ve been talking for some time now about our portfolio realignment and portfolio diversification efforts. We realize that investors have been eagerly awaiting this to be completed. And I'm pleased to say that we're now very close to where we want to be. So all the way around, I feel that we're incredibly well positioned for 2016. We will follow the same format as we have on previous calls. First, Lisa will run through our financial results. Then Mark will discuss how the MBS market performed over the course of the quarter, how we positioned our portfolio and what our market outlook is? I’ll follow with some closing remarks before opening the floor for questions. As a reminder, we have posted our fourth quarter earnings conference call presentation right on the home page of our website, www.ellingtonfinancial.com. Lisa and Mark’s prepared remarks will track the presentation. So if you have this presentation in front of you please turn to Page 4 to follow-on. I’m going to turn it over to Lisa now.

Thank you, Larry. And good morning everyone. As you can see in our earnings attribution table on Page 4 of the presentation, during the fourth quarter we earned net income of $1.8 million or $0.05 per share. Our credit strategy generated gross income of $6.8 million or $0.20 per share, our agency strategy generated gross income of $650,000 or $0.02 per share. And we had expenses of $5.6 million or $0.17 per share. For the full year, our total net income was $38.1 million or $1.13 per share. This equates to an ROE of approximately 5%. During the fourth quarter the results of both our credit and agency strategies were negatively impacted by the significant yield spread widening that it impacted much of the global fixed income market. Our interest rate hedges and net credit hedges, including our synthetic credit-trading strategies, offset some of the impact of net unrealized losses. While we had net unrealized losses in both strategies, we captured net realized gains as we selectively sold securities within each strategy. As you can see on Page 4, the main drivers of our credit results were, interest income and other income, net realized gains, income from our net interest rate hedges and net credit hedges and other activities partially offset by net unrealized losses, interest expense and other investment related expenses. Quarter-over-quarter, our interest income declined approximately $1million or $0.03 per share. This decline resulted from lower interest income on our non-agency RMBS as that portfolio has steadily declined in size through the year, partially offset by increases in interest income from our consumer and small balance commercial loans as these portfolios have grown. While spreads widened in non-agency RMBS and CMBS. We sold certain assets that were in a gain position, also contributing to our net realized gains or contributions from the resolution of small balance commercial loans and sales of REO acquired in connection with our non-performing residential loan portfolio. Net realized gains from our RMBS, CMBS, small balance commercial mortgage and non-performing residential loans, were partially offset by net realized losses and CLOs and distressed corporate debt, as we pared down some of those positions. Net unrealized losses came principally from our credit securities, including RBS, CMBS, CLOs and distressed debt. Over the quarter, our portfolio of credit securities declined, while our holdings of loans increased. You can see this on Slide 11 of the presentation. Our agency RMBS strategy generated gross income of $650,000 in the quarter. You can see that our interest income declined about $2 million quarter-over-quarter. This decline was the result of two factors. First, in the fourth quarter we had a negative premium catch-up adjustment – amortization adjustment in the amount of $700,000 as prepayment fees on our portfolio increased. Last quarter we had a positive assessment of approximately $900,000. When you excludes these two adjustments in each period our interest in comes declined by about $500,000 in the fourth quarter. Second, the size of our portfolio declined as we net sold assets during the quarter in order to increase our cash and generally be more defensively positioned. While both our credit and agency related averaged outstanding borrowings declined quarter-over-quarter. Our weighted average cost of repo increased, you can see the components of our repo costs on Page 21 of the investor presentation, compared to the third quarter, our weighted average agency repo borrowing rate increased five basis points. While our weighted average credit-related repo borrowing rate increased 24 basis points on an annualized basis. Both our credit and agency related repo costs were impacted by the increase in interest rates during the quarter. Our credit related repo costs were also impacted by the fact that some of our borrowing has shifted from security holdings – from our securities holdings to our loan. Borrowing facilities used to finance loans generally tend to be slightly more expensive than facilities used to finance securities, thereby causing our average borrowing cost to increase. As of December 31, 2015, we have financing and facilities in place for most of our consumer loans. And we recently executed a financing facility for our non-QM loan. Going back to Page 4 of the presentation, you can see that during the fourth quarter we had a meaningful increase in our operating expenses from the third quarter. Most of the increase was related to higher legal fees, and higher tax consulting and compliance fees. These increased fees were mainly related to costs incurred in connection with our newer borrowing facilities, as well as other transactional and corporate-related matters. Although our annualized expense ratio for the quarter increased to 3%, for the full year, it was 2.7%, which is more in line with what we expect going forward. We ended the quarter with a diluted book value per share of $21.08, down just 1.9% from that of September 30. Our diluted book value per share at December 31 includes the $0.04 per share accretive impact of our share repurchase activity. I will now turn the presentation over to Mark.

Thanks, Lisa. Most securitized products were lower in price in the fourth quarter, weighed down by concerns about China, declining commodity prices, and fears of slower global growth. Optimists were hoping that sentiment would rebound after year end with a typical January effect. Obviously so far we've gotten quite the opposite. However, despite all the headlines and the daily price volatility, the credit performance of our U.S. consumer-focused portfolio remains strong. Ironically, the big drop in oil prices that's causing so many losses in high yield and leverage loans is helping the U.S. consumer. The same is true with weaker emerging market currencies. Lower import prices mean lower costs for the U.S. consumer. So in any given day, if you see a big drop in the stock market, you invariably see lower prices on securitized products, even though fundamental credit metrics for the U.S. consumer have been stable or improving. For the fourth quarter, we made money with only a modest book value decline after paying our dividends. Importantly, in the Swiss [ph] moved, we didn't sustain material actual credit loss. We didn't see any credit performance degradation in our diversified MBS and consumer portfolio. When market prices move in the opposite direction of fundamentals, like they did last quarter in our non-agency RMBS portfolio, we need to mark things that way. We are and always have been fully mark to market. There are even a few parts of the portfolio where our cash flows increased. Seasoned non-agency adjustable rate mortgages and seasoned CLOs saw some increase in cash flows. The feds finally raised the feds fund rate, and LIBOR went up in tandem. You can see from Slide 11 that we shrunk our portfolio of securities and that we added to our consumer loans, our commercial mortgage loans, and our non-QM residential mortgage. Liquidity wasn't great, but by being diligent, we were able to sell securities at lower yields and where cash can currently be deployed. Our credit hedges, including our synthetic relative value credit trading, also helped our performance. Not every company is going to be able to say that. Like most large market moves, the moves last quarter and into this year have been in response to fundamental news that took the market by surprise. Fundamentals that credit investors didn't contemplate in price for when they took on credit risk that is now being impacted. The self-reinforcing negative feedback loop of declining commodities prices leading to slower growth among commodity-focused economies leading to even lower commodity prices was the root cause. And the credits impacted directly or indirectly are infecting many portfolios with much higher expected losses. Loans to energy and mining companies are sprinkled across post-crisis CLOs and post-crisis CLOs are sprinkled across many publicly traded BDCs and so on. It's now becoming clear that one big picture response to the enormous post-crisis fed balance sheet expansion in treasuries and agency mortgages was to crowd out investors from these giant asset classes that don't have any credit risk and push them into credit-sensitive assets, leverage loans, high yields, CLOs and CMBS. What has been great about the non-agency mortgage market is that it's a legacy market. Given the hundreds of billions in settlement payments that banks have made for pre-crisis mortgage underwriting violations, they have been generally unwilling to loosen underwriting standards post-crisis. In the high yield and leverage loans, that was not the case. The new issue mark was big, yield hungry investors competed for assets and predictably, underwriting standards slipped, resulting in limited covenants and higher leverage. Now these problems are coming home to roost. Many credit investors compromise their standards and stretched for yield in the last few years. That reach for yield at the expense of underwriting standards is now being reevaluated across the board. Overall, we feel very good about the credit trends we see in our portfolio. Most of it is U.S.-consumer focused. The CLO exposure we do have is only 7% of our portfolio. Almost all our deals are pre-crisis, and they are static. So few new credits can get added to the portfolios. Our CLO debt investments are highly enhanced, and we can hedge credit risk with high yield indices. To our models, which adjust for expected credit losses, our CLOs are hundreds of basis points cheap to their high yield hedges. Substantially lower interest rates in response to all this turmoil should also benefit our non-agency portfolio. Almost everything we own is seasoned. This portfolio may be poised to increase in yield no matter what happens to the economy. The fed has hiked once already, which raised our average coupon and most of our holdings. Now the big drop in interest rates this year has made it economical for many of these borrowers to prepay. Many of them can refinance into a new settlement mortgage at an approximate rate of 2.875. Faster prepayment speeds on our legacy jumbo all-day securities increased their yields since we own this portfolio at the end of the year at a 30 point discount to par, as you can see from Slide 13. On a very high level, for several quarters we have structured our portfolio to be long consumer credit risk and short high yield corporate credit risk. Our thesis has been that these two debt cycles are out of phase. Ever since the financial crisis, consumers have been forced to deleverage. Mortgage standards – consumers have been forced to deleverage. Mortgage standards have remained tight, home prices are still below pre-crisis levels, and banks have been fined so massively for their mortgage transgressions, they are currently very reluctant to relax funding standards. And the consumer is the winner from low energy and commodity prices from a strong dollar relative to emerging market currencies. The same two big trends that are causing so many of the problems for other high yielding parts of the bond market. The consumer is also winning with higher wages. We saw evidence of this in the last employment report, and the lack of wage growth for the middle class in the last decade has been a widely discussed topic in the presidential campaign. Consumer balance sheets are strong and improving. Corporate balance sheets, on the other hand, tell a completely opposite story. Years of easy corporate debt fueled by near zero interest rates courtesy of the feds have left us with too many companies that issue debt merely to buy back stock, pay dividends to their private equity owner, or grow out commodity businesses that are now unprofitable. Loan covenants are down, corporate balance sheet leverage is up, and corporate earnings are getting squeezed. One sector where we have exposure that might see deteriorating credit metrics is CMBS, but here we have been disciplined with hedges. Take a look at slide 14. Our CMBX hedges grew this quarter and have protected us so far in the 2016 swoon. Our CMBS strategy, where we acquired newly issued B-pieces, is focused on tight hedging, and with the help of CMBX hedges, we construct portfolios where we think we are left with lots of upside and very little downside. Our strategy of buying new issue B-pieces and hedging with CMBS indices actually gives us positive credit convexity. Said another way, we can win in big moves to the upside or the downside. This results in a portfolio with low dollar prices on the loan position and high dollar prices on the short position. So our loan positions have more room to rise than fall, and the opposite is true of our shorts. So when you get a big credit shock and losses go way up, the shorts should go down in price because they will trade like distressed debt, or the lower dollar priced loans should drop much less in price since they start out at such a low price to begin with. We don’t have a crystal ball, so we didn’t know this turmoil was coming. But there were plenty of warning signs, way too many crests to ignore, which led us to position conservatively in the fourth quarter. We sold assets, we deleveraged, and we raised cash. We want to be able to play offense when market moves are most extreme, and we want to be buyers when others panic. We aren’t there yet. But this year we have seen a little bit of panic and have been able to selectively buy some assets at substantial discounts to 2015 prices. We’re hoping to do more of it. Actual underlying credit losses haven’t come through yet in many structured credit sectors. Once they do and downgrades in losses wreak havoc on deal waterfalls, some banks could get their cash lifts completely shut off, both principal and interest. That’s why we shrunk our agency portfolio by over 20% last quarter. That was in no way a comment on value. We just viewed it as a prudent portfolio move to raise cash in front of potential market dislocation. Our agency portfolio is very liquid, so it was very easy to shrink. In Slide 14, you can see that we dramatically increased our core credit hedges in the fourth quarter. We saw enough signs of credit stress to give us cause for concern. We also sold more legacy non-agency bonds that created lower yields to both make room for higher-yielding assets like consumer loans and to raise cash from future distressed investments. With that, I’ll turn the call back to Larry.

Thanks, Mark. Ellington Financial started in 2007, and we preserved shareholder capital through the depths of the 2008 financial crisis so that we were able to capture the huge upside of the 2009 recovery in financial assets. The founding principles of Ellington have been in the business since the early to mid-1980s, and Ellington itself has been in business for over 21 years, since 1995. I firmly believe that our long history in these markets allows us to pick up patterns in credit cycles as we have seen similar dynamics play out before. At Ellington, we’ve been battening down the hatches for the last couple of quarters in anticipation of possible stresses in the financial system and stresses in the credit markets in particular. On our website, www.ellingtonfinancial.com, you’ll see a link to a white paper that Ellington published in early November of last year. The White Paper was entitled The Ninth Inning of the High Yield Bubble. In the White Paper, we noted that the corporate credit market in the beginning of the fourth quarter resembled the peaks of the number of past credit cycles. I encourage you to read that White Paper, and if you do, I think you’ll appreciate that we anticipated much of the turmoil that’s taking place and is continuing in many of the credit markets. At Ellington, we know how important it is to resist stretching for yields and over leveraging when the risk reward ratio just isn’t there. We believe that the key to long-term success in these markets is to preserve capital through times of stress so that you can take full advantage of the fantastic and often long-lived opportunities that arise when bubbles burst. We saw these long-lived opportunities that arise when bubbles burst. We saw these long-lived opportunities in the aftermath of the S&L crisis, we saw them in the aftermath of the bond market debacle of 1994, and we saw them in the early 2000s following the bursting of the tech bubble, and we saw them, of course, in the aftermath of the 2008 financial crisis. You can see tangible evidence of our market outlook in our fourth-quarter portfolio maneuvers. We continued to reduce our leverage from an already low 1.81 to 1 at the end of the third quarter to an even lower 1.59 to 1 at the end of the fourth quarter. And remember, those leverage figures include the leverage on our agency portfolio. We also extended the average term of our credit portfolio borrowings from 194 days to 271 days. We increased our cash holdings, and as Mark described on Slide 14, we increased our high yield credit hedges. We reduced our CLO portfolio and continue to pare down our legacy non-agency RMBS portfolio, often at near peak price levels. Of course, the plan is to reinvest this excess cash and add back leverage as we see more attractive entry points in the coming months. During the fourth quarter, we continue to build our proprietary investment pipeline. Our consumer loan portfolio continues to be a key growth area for us. Our portfolio currently includes unsecured consumer loans, as well as auto loans. We continue to carefully add to our portfolio underflow agreements with originators. We added an additional flow agreement with yet another originator in the fourth quarter, and we are continuing to evaluate other originators where we see opportunity. As Mark just described, we continue to believe that macroeconomic conditions are very supportive for U.S. consumer loans. In the third quarter, our consumer loan portfolio was about 12% of our credit portfolio. At the end of the fourth quarter, it was nearing 20% and heading towards 25%. Not only are these consumer loan assets high yielding on their own, but we now have established financing lines for these assets on favorable terms. So this portfolio is quickly becoming a core generator of our dividend. Another area where we are building our proprietary investment pipeline is non-QM loans. While it took a little longer than I had hoped to get here, monthly pipeline that will have a meaningful impact on the overall composition of our portfolio, and it should only grow from there. Meanwhile, in the fourth quarter, we invested in a fourth mortgage originator. We are excited by all the opportunities we are seeing in the non-QM space and are continuing to look for investments where we can establish strategic relationships and enterprise value for the long-term. In our small balance commercial mortgage portfolio, we are continuing to broaden our investment sourcing capability and again, are very pleased with the performance of our portfolio in the fourth quarter. Looking ahead, we estimate that there are approximately $250 billion worth of these kinds of loans maturing in 2016 and 2017 that were originated in 2006 and 2007 when underwriting standards were much lower and property values in many cases much higher. A significant number of these loans will not be able to refinance their maturing, and as been the pattern, the smaller loans will often be sold in the secondary market, or upon default, they will be short refinanced under duress. So we’re expecting a lot of upcoming investment opportunities here as well. Slides 12 and 13 in the presentation read together illustrate the great success of our portfolio realignment and portfolio diversification efforts over the past two years. On Slide 12, on the right-hand side, you can see that at the end of 2013, RMBS represented 82% of our portfolio – of our credit portfolio. On the left-hand side, you can see at the end of 2015, RMBS represented only 34% of our credit portfolio. We invested heavily in both people and businesses to get to this point, but we believe that we are now extremely well-positioned, not only for the opportunity that exists today, but also for those opportunities that we anticipate will continue to unfold later this year and in the coming years. Meanwhile, on Slide 13, you can see that the average yield of our credit portfolio was 10.32% at year-end 2015. It was only 7.29% at year-end 2013 as you can see by pulling up our 2013 fourth-quarter earnings call presentation on our website. Now I would like to turn briefly to slides 28, 29 and 30. Slide 28 we’ve had for a long time, showing how we built value for shareholders over time through a combination of book value stability and high cumulative dividends. We introduced slides 29 and 30 last quarter, demonstrating on Slide 29, the stability of Ellington Financial’s book value per share in relation to the hybrid mortgage REITs. And on Slide 30, demonstrating how Ellington Financial’s Sharpe Ratio, which is basically volatility adjusted compounded economic return, compares to the hybrid mortgage REITs. Once again, you can see that Ellington Financial has had the most stable book value per share and the best economic returns per unit of risk. Finally, a word on our share repurchase program. In accordance with the guidance we provided last quarter, we repurchased around $5 million worth of our shares, and we entered into a 10b5-1 plan to maximize the number of trading days available to implement these repurchases. Our guidance remains unchanged here, and so we would expect to continue to repurchase approximately $5 million worth of our shares each quarter until our price-to-book ratio recovers or other significant conditions change. This concludes our prepared remarks. We are now pleased to take your questions.

The floor is now opened for questions. [Operator Instructions] Your first question comes form the line of Douglas Harter of Credit Suisse.

Thanks. Can you guys talk about the outlook for the dividend as you see increased opportunities in the horizon versus not covering it from spreading comp currently and how you think about how you want to deliver the total return to shareholders?

Yes, I think that as we are looking at the higher yields we're seeing, the opportunities we're seeing this year, we feel as good about the dividend as we ever have. Where at this point we are at a level where we think that based upon the proprietary investment pipeline that we are seeing, which is becoming a bigger and bigger share of the portfolio, we think that we're actually going to be able to cover that dividend through carry essentially. And so we see no reason to change that dividend, and granted you are always going to have your mark-to-market, you're going to have some volatility around the quarter-to-quarter earnings. But we're feeling very confident about our ability to meet our dividend in 2016.

Great. And did I hear you guys say that you were spending more time on auto finance and investments there? Could you just talk about your outlook there given that there's been some negative press around subprime auto finance lending?

Yes, we have a very, very small investment there. We have not been as excited about that space as the consumer loan space. We also, like you mentioned, have been closely following some of the concerns in that market about underwriting, the length of the loan given out relative to the expected life expectancy on the cards that the loans are giving out. So I would say that our investment there is very small. We are watching it, but right now we don't have anything in front of us that looks interesting to us.

Great thank you.

Your next question comes in the line of Bose George of KBW.

Good morning, guys. It’s Eric on for Bose. Has the net short TBA position changed at all since the end of the quarter?

We typically don’t talk about portfolio moves post quarter end on the earnings call. There’s obviously been a lot of volatility in the market, and if you look at how we’ve managed the agency side of the portfolio over time, we have always liked some portion of the portfolio to have – to be – we would like some portion of our hedges to be in TBAs. We favor a mix of TBAs, swaps and treasuries. One of the reasons why that is sort of our default position is that by having a short TBA position, it allows us to buy back some of the negative convexity that we are short – being long on specified pools versus swaps and treasuries. So that was certainly the case in the fourth quarter. We haven’t deviated from that substantially. And the one thing I would add is, if you look at the refi index, it came out again today, not just the level of it, but also the – if you look at the average balance of the loans getting refinanced, you can see that these larger loans are aggressively taking advantage of these lower mortgage rates, which we think is going to cause a much bigger spike in prepayments than what we saw in the second half of last year to create more opportunities for us in the specified pools side.

Larry, I just want to add one thing. So the –we reduced our TBA hedges slightly from the third – end of the third quarter, the end of the fourth quarter reflecting what we viewed as more attractive mortgage bases. So that’s going to definitely inform where we have that – what portion we are hedging with TBAs. But we tend – in Ellington Financial, since really the core generator of our earnings is the credit side, we tend to keep a substantial TBA short, and as you know, this portfolio is important for our 40F tests, it’s been a good generator of earnings but on a fairly small amount of capital relative to the rest of the stuff that we do. Obviously, this is portfolio that we leverage much more. You can see that in one of the slides towards the end where we show the leverage that we employ in any strategy. Think it’s on page 24. You can see that even though leverage has come down in that portfolio, it’s still a relatively small amount of capital relative to what we do otherwise. And that TBA is going to move around, but it’s generally going to stay – it’s not going to get to zero. In theory it could even get to 100%, if we really, really didn't like the mortgage basis. But the mortgage basis for the last several months has been looking relatively attractive. Of course, it's not – given what we're seeing in the credit markets, it's not going to be where we focus our capital deployment.

Great. Yeah, that's fair. I think that leads into the next question. The way I model you guys, the agency portfolio still generates quite a bit of earnings and leverage that you guys take is pretty sensitive to that earnings that you are originating the loans in a way that makes them liquid and you are complying with all the state and local laws.

No, that's not something that we would typically provide guidance on. So that's – we certainly don't have it at our fingertips. We could look into that after the call, but as I said, it's a small – it's only been typically about – now it's about 13% of our capital as of year end. So you are not talking about something that is going to be a huge mover of the needle.

Yes. And how about the percentage of the entire portfolio that has experienced a great step-up since the fed raise in December? Do you have that figure?

Its right like a adjustable rate mortgages.

Yes, mortgages and I guess just the entire portfolio generally, even though I know you guys traded around quite a bit.

Most of our portfolio is not directly – going to be directly be affected by a rise and LIBOR or things like that from the coupon perspective. So we do have some adjustable-rate products obviously in the non-agency portfolio, and I think Mark alluded to that as something where you will see probably higher yields going forward. Some of the CLOs are floating-rate, but some of the leverage loans might be floating-rate. But in general we are – that's not going to be a material – going to cause a material increase in our yields. And, in fact, long-term interest rates have fallen certainly since the end of the quarter. So in terms of where we are reinvesting capital, that's going to reduce probably the yield in our assets, all other things being equal. Of course, spreads have widened quite a bit. Credit spreads, that's going the other way, and our financing costs – our long-term financing costs in terms of where we put on, for example, five-year or 10-year swaps is going to go down. So that is going to also improve our net interest margin, if you will. So you have all these competing factors. But I don't want to imply that a lot – so much of our portfolio is adjustable-rate coupons, that that is going to have a material effect on our run rate.

Thanks, Larry, and to all you guys, I really enjoyed the White Paper. I thought that was really, really great.

Thank you.

Thanks.

Your next question comes from the line of Stephen Laws of Deutsche Bank.

Hi, good morning.

Good morning.

Apologize if this has already been covered, but I wanted to touch on the non-committed loans. Can you give us a little color on how that may ramp through the year? Do you have a target mix? Do you have an opportunity you see today? And then on the financing side, what type of leverage or costs of the financing or advanced rates do you think you’ll be able to get on those assets?

Sure. This is Mark. So what we are originating is all seven-one mortgages; so fixed for seven years and then they float. We are targeting to get a gross coupon right around 7%. As Larry mentioned on the call, we do have financing in place. I think the haircut is roughly about 30%. We would not leverage them to that extent. We will reserve something in addition to the haircut. We started that Company with very well regarded mortgage credit investors that had had other mortgage companies in pre-crisis that we thought are very thoughtful about credit and looked at credit the way we did, which we think is sort of the right approach for the market right now. But we are focusing on borrowers that for any number of reasons don’t fit into the Fannie/Freddie/Ginnie box, but still have a very strong credit and very strong ability to repay. We thought it was prudent to start slowly. Ellington Financial’s equity stake in this Company was very modest on the order of a few million dollars. So for us, it gives Ellington Financial a tremendous amount of options. So right now we are portfolioing loans and financing them and earning an interest spread on them. Going forward, there’s any number of things we can do. We can sell them as whole loans. We can securitize them. We’ve had other large institutional investors approach our mortgage company with an interest in potentially purchasing loans from them. It’s a very attractive asset for a lot of different money managers in this space. So I think you could see that ramp up to a pipeline of somewhere – $15 million to $20 million per month towards the end of the year, if everything goes well. We are at a substantially lower pace than that right now. I think what’s important for us is to get the credit right, is to make sure that we have a really airtight process. You know, mortgage origination, especially with all the regulations is something that – it comes with a lot of compliance challenges, and you really need to devote a lot of resources to making sure that you are originating the loans in a way that makes them liquid and you are complying with all the state and local laws.

And I just want to add one more thing which is that not only that we partner what we think the best credit people out there, but we also have somewhat at Ellington Financial who is basically our internal credit expert from an underwriting standpoint, and he is overseeing our origination efforts there. Mark, of course, is the ultimate overseer of that origination pipeline as well. And as Mark mentioned, if there are – is demand for product out there from consumers that doesn’t fit with our underwriting guidelines are for investment criteria are, then we will also be establishing sales to third parties who do want to buy that product. So this company, we believe, is going to generate income not only on its own for originations, but then also for Ellington Financial through the pipeline that it supplies for it.

Great. I appreciate the color on that. Thank you.

Our last question comes from the line of Jim Young of West Family Investments.

Yes, hey, as a follow-up to the non-QM question, as you get to the $15 million to $20 million per month level that you expect by the end of 2016, what kind of an ROE business would this non-QM be generating?

Let’s talk about the line we have in place and all that, yes.

Yes, so with coupons right around 7% and the financing rate a little over 3%, say 3.5% including [indiscernible].

With the turn of leverage, we’re getting right around 9% to 10%. And then on top of that, we think there are opportunities to profit from whole loan sales or, if we choose to, to securitize some of our production. In addition to that, as we build out the capabilities and the volumes and the infrastructure in this Company that Ellington Financial owns a minority but a very significant stake in, we’re going to create value in that Company, which is another thing that is going to – that it’s also going to benefit Ellington Financial. So I think there’s a lot of ways that this initiative is going to generate not only earnings but also create franchise value for the Company. And what’s nice about it is we have our seat at the table with a very small equity investment and the people we partnered with have been very cautious about how they spend money. So I feel like we’re at a good place. We’re not quite break-even yet, but we’re getting close to that. I think we are building some potential to have some real value down the line.

Yes, and let me just add one thing to that, which is that Mark mentioned with one turn of leverage. The line that we have actually affords us in theory more than two terms of leverage, but we always – we don’t take full advantage of that because, just the way we manage liquidity, we want to have money for a rainy day, so to speak. So as – the other thing that I wanted to add was that the – we’ve seen as opposed to what we are seeing in the agency repo space, in the non-agency financing space for credit instruments, because that’s where the banks – the big banks are going to actually get a decent ROE taking into account all the requirements of Dodd Frank and Basel III in terms of capital requirements. If anything, we’re seeing pressure for financing rates to – spreads, I should say, to come down and so, in other terms, to get better. So we could, depending upon how those financing terms fall over time and competition that comes in, we can see spreads going down, we can see our leverage going up there, if the terms that we get are more favorable in terms of being able to add more leverage safely. So that’s the ROE that we have now. We don’t see right now the securitization market as offering us a good ROE, but again, that securitization market is just getting going, and the ROE that we can earn on this business in the meantime is certainly fine and will cover the dividend. But we see this business as getting bigger and better from an ROE perspective, not worse as time goes on.

Great. And as a more general question, as you continue to evolve and transform your portfolio allocation and increasing your exposure to consumer loans for example, and Larry, as you had indicated, you are kind of – you are very close to where you want to be, when you get to where you want to be, what type of the growth ROE do you think that the overall portfolio can generate in this environment and with your asset allocation as you have deemed fit?

Yes, well, I think certainly the dividend, which is $2 per year, we think will be comfortably covered from that carry, and we believe that with everything that’s going on, we still believe that something in the 12%, 13% is kind of our target in terms of our overall ROE. Now that’s going to depend upon making the right moves at the right time, but I think over time, I think we’ve shown ourselves as being able to do that. And obviously we’ve had years where it’s been much higher. So – but that’s certainly our target, I would say, for this year is the – in that 12% handle range, if you will.

And in that 12% handle range, is that a growth or net ROE?

That would be net, and that would, of course, be ROE on book, not – it has nothing to do with our stock price, just to be clear.

Thank you.

Okay.

Ladies and gentlemen, that concludes Ellington Financial’s fourth quarter 2015 financial results conference call. Please disconnect your lines at this time. And have a wonderful day.