Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial Fourth Quarter 2018 Earnings Conference Call. Today's call is being recorded. [Operator Instructions] It is now my pleasure to turn the floor over to Jason Frank, Corporate Counsel and Secretary. Sir, you may begin.

Thank you. 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. As described under Item 1A of our annual report on Form 10-K filed on March 15, 2018, 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 on the call with me today Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, our Co-Chief Investment Officer; and JR Herlihy, our Chief Financial Officer. As described in our earnings press release, our third quarter earnings conference call presentation is available on our website, ellingtonfinancial.com. Management's prepared remarks will track the presentation. Please note that any references to figures in this presentation are qualified in their entirety by the endnotes at the back of the presentation. With that, I will now turn the call over to Larry.

Thanks Jay. And good morning everyone. As always, thank you for your time and interest in Ellington Financial. On our call today, I'll start with an overview of the fourth quarter. Next, our CFO, JR Herlihy will summarize our financial results and then Mark Tecotzky, our Co-Chief Investment Officer, will discuss our portfolio positioning and performance, recent market trends and what our investment outlook is going forward. Finally, I will discuss our reconversion, which we've now completed, which is retroactive to January 1, 2019. Then we'll open up the floor to questions. During the fourth quarter, confluence of factors steadily wait on the markets, including fears of a looming trade war, recessionary and global growth concerns, and worries that the Federal Reserve and other central banks were finally ending their accommodated monetary policies. Market volatility spiked including interest rate volatility. All this led to a slide to quality. The ten-treasury declined 55 basis points over the last seven odd weeks of the year and yield spreads in virtually every fixed income sector widened relative to treasuries and interest rate swaps with many sectors finishing the year at or near their two-year widest levels. Despite this challenging market environment, Ellington Financial preserved its book value. Thanks to our hedging strategies and diversified portfolio. These two attributes are disciplined hedging and our diverse sources of income continued to be differentiators for EFC in the fourth quarter. We registered a slightly negative economic return of minus 20 basis points for the quarter, which we believe represents an outperformance in what was a very difficult quarter for the credit markets. During the fourth quarter, we had strong results from several of our loan strategies including consumer loans and non-QM loans, where we completed our second non-QM securitization in November. We believe that many of…

Thanks Larry and good morning everyone. Please turn to Slide 6 for a summary of our income statement. For the quarter ended December 31, 2018 EFC recorded a GAAP net loss of $2.2 million or $0.07 per share as compared to GAAP net income of $6.7 million or $0.22 per share in the prior quarter. Net investment income declined to $10.2 million or $0.33 per share from $11.7 million or $0.38 per share last quarter. Net income was down sequentially due to the decrease in net investment income, which was related to the issuance cost of our non-QM securitization and one-time cost associated with the reconversion. And also, because net unrealized losses increased quarter-over-quarter, driven by markdowns on our interest rate hedges and on several of our credit strategies connected to the market weakness of the fourth quarter. These net unrealized losses exceeded net realized gains in the fourth quarter and were also up quarter-over-quarter. After adjustments, net investment income was $0.41 per share up a $0.01 from last quarter and covered our quarterly dividend. Please keep in mind that while we view adjusted net investment income as a good proxy for our core earnings power, it does have its limitations as a portion of our capital will always be invested in assets that we hold for capital appreciation as opposed to generating current net investment income. Net investment income also does not capture much of the total returns that we generate with our opportunistic trading. Please turn to Slide 7 for details on the attribution of earnings between our credit and agency strategies. In the fourth quarter of 2018 the credit strategy generated gross income of $8.1 million, or $0.26 per share, while the agency strategy generated a gross loss of $4.9 million or $0.16 per share. These amounts…

Thanks JR. Against the backdrop of extreme market volatility EFC performed very well in Q4. Despite a double-digit percentage dropped in the S&P and several point drops in high yield bonds and leverage loans, EFC’s credit strategies made money for the quarter. I attribute much of the strong performance of our credit portfolio first to the benefits of short spread duration relative our yields and second to the benefits of diversification with an asset mix that’s generally seasoned or low LTV and in many cases both. We consistently evaluate how assets will perform in good and bad markets before we invest. And that discipline in asset selection has given us a very stable portfolio. The asset mix of EFC’s credit portfolio is now largely a non-CUSIP investment, many sources through proprietary relationships. So the credit portfolio’s value has less correlation to liquid credit indices such as high yield. It is precisely for this reason that EFC has gradually reduced credit hedge over the last three years. We just don't need the same amount edge changes in book value as we use to have when our portfolio of mix was more correlated to liquid credit indices. If you look on Slide 23, you can see that quarter-over-quarter we did not need to make any major adjustments to our credit hedges to ensure their effectiveness this quarter. Q4 is a great example of how our current portfolio does not have a lot of price volatility that requires a lot of hedges to neutralize. Our current basket of hedges did a great job and is appropriately sized as is to be comfortably REIT compliant, which was one factor that shaped our thinking with the REIT conversion. Turn to Page 8 to see how our asset mix evolved during the quarter. The first thing…

Thanks Mark. Before we open the call to questions, I'd like to take a few minutes to discuss our tax conversion away from a publicly traded partnership to a REIT, which is now complete and effective retroactive to January 1, 2019. Our new tax structure should provide substantial benefits to Ellington Financial and its shareholders, and won't require us to materially change our investment or hedging strategies. Well management had from time to time in the past thought about the potential benefits of converting away from a publicly traded partnership. The changes in the tax law implemented towards the end of 2017, along with the evolution of our portfolio in recent years, made this the right time for Ellington Financial to take the strategic step. We've included a few slides on the REIT conversion as an appendix to our Q4 earnings presentation beginning on Slide 15. Here, we list the major benefits of operating as a REIT rather than as a publicly traded partnership, including an expanded investor base, better liquidity for our stock, simplify tax reporting for shareholders, as well as a 20% REIT tax deduction for domestic shareholders. Crucially, we will be able to maintain our core investment in hedging strategies as a REIT, which we view as a prerequisite to any conversion. Now I'll touch on each of these benefits in a bit more detail. Please turn to Slide 16. Converting to a REIT should expand our potential investor base and approve the liquidity of our stock over time. Historically, the size of EFC's potential investor universe was limited by the publicly traded partnership structure, and the K-1 it generated. As a REIT we solve this problem. We'll generate a 1099 instead of a K-1, starting with this tax year. And by doing so we can appeal…

Thank you. [Operator Instructions] Our first question comes from line of Doug Harter of Credit Suisse.

Hey guys, this is actually Josh on for Doug. Larry, now that the REIT conversion is behind you. Can you talk a little bit about the next steps needed in order to be eligible for inclusion in some of the indices that you've mentioned previously? And as a follow-up, what kind of timing could we possibly see until those additions? Thanks.

Sure. So, one prerequisite which we hope to complete shortly– it turns out actually change the state law structure or corporate structure some might call it, from a limited liability company, which we currently are Delaware limited liability company to a corporation for state law purposes to Delaware Corporation. So that's in the work and we plan to do that shortly in the next couple of weeks is our goal there. And the Russell Index just to name one, it goes through its rebalancing later in the second quarter so we believe that we should be on track for inclusion in some of the Russell Indices that exclude publicly traded partnerships or companies that are limited liability companies or partnerships for state law purposes.

Great, thanks Larry.

You're welcome.

Our next question comes from one of Crispin Love of Sandler O'Neill.

Hi Guys. Thanks for taking my question. I'm just curious about the trajectory of the credit portfolio that you would expect over the next couple of quarters. I understand the 8% sequential decline in the fourth quarter, mostly because of the non-QM. But, do you guys still think you have room to grow that portfolio or would it be kind of more repositioning within the credit portfolio?

Yes, I think – we think that we still have room to grow the portfolio and certainly replacing that 8%. But, we think that our leverage is prudent and we can continue. We certainly have access to ample financing. We have our assets that we're not currently financing, that we could finance. So we think that we have continued room to grow the portfolio. The agency part of the book also has room to grow, that's a little bit higher leverage obviously, but we think the credit part of the book also has room to grow as well.

And are you expecting any more REIT conversion expenses in the first quarter?

Yes. So we – I think JR already mentioned that, we're projecting $1.2 million of expenses that have not yet been included in the financials that you've seen, namely the Q4 that we just released that showed a few cents of expenses. We think that there's about $1.2 million left as of December 31 of last year.

Yes. Hey, Cris this is JR. That's right. And I would expect a good portion, not all, but a good portion of those to come in Q1, I think that’s our estimate right now.

Okay, sounds good. And then, can you just talk a little bit more about the consumer strategic relationship, I know it's been a relationship since 2015, that you've been getting loans from, but is it personal loans, home improvement, auto and then do you have any kind of equity partnership relative to size Longbridge and LendSure?

Okay. So I'll – I'm only going to comment, I'm not going to give you all of that detail. The size of the investment was more comparable to the LendSure investment. So it's small relative to the Longbridge investment for example and under $5 million. In terms of the space that it's in, I don't want to get into details there, even it's been a steady partner of ours as we – as I said since 2015 but – or as I said earlier in the call, but the size of the flow have not been - it's not our biggest consumer loan provider by any stretch. So we're certainly hoping that with partly with this capital from us and with other plans that we have and they have that the flow is going to grow substantially over time, but I am not in a position right now to provide any more details on that new investment of ours.

Great. Thank you for taking my questions.

Thank you.

Our next question comes from line of Eric Hagen of KBW.

Thanks. Good morning and congrats on the conversion, that's excellent.

Thanks.

The minority investments that you have in companies like LendSure, as a REIT will there be anything preventing you guys from acquiring the entire company if you wanted to ever do that down the road?

Yes. So the answer technically is no. We can do that. They're just like with all the other REIT tests right, you would have to satisfy, you have to continue to satisfy the REIT test and generally, an investment in an operating company would be held in taxable REIT subsidiary and so – as I'm sure you're familiar, the size of your taxable REIT subsidiary in aggregate can't exceed certain limits. So not 20% basically, so that would a long way to go and I like the financial to grow then that would increase all these limits. So I don't see the REIT test is really getting in the way they are, obviously given the size of these investments. But we certainly have no plans and there had been no discussions about – just to be clear about acquiring any larger interest than the minority interests that we currently have in any of these companies.

I didn't mean to suggest that there was anything like that taking place in the future. Just…

Yes.

Maybe just an option.

Right. But – and we do have some options can actually come with some of these investments, but again it would never be to acquire majority interest. At least at this point, that hasn't been discussed that's not on the table.

Got it. Okay, great. And then just a market based question on the non-QM side, how deep is the market for whole loan sales? Are you guys engaging in any whole loan sales or is it really just – is that not the intention of that strategy?

So this is Mark. By and large when we have sold loans by far the dominant outlet has been securitizations, from time-to-time, we have been involved in some smaller whole loan sales, but if you think about the market broadly, there are – there is whole loan sale activity going on. There are certainly banks that are interested in this shorter duration, higher coupon, higher yielding long-term securities. And I would say that we're also seeing a broadening and a little deepening in the investor base for long-term securitizations. The volume of securitizations was up last year, there's been – I would call it robust issuance this year. So non-QM and other post-crisis mortgage securitization vehicles say, Jumbo deals that are getting done is getting a burgeoning sponsorship from a lot of investors that have seen the legacy, not agency market shrink, that market has gone from $1 trillion down to $350 billion, $400 billion. So between the credit risk transfer deals, non-QM, RPL deals, Jumbo 2.0 deals, mortgage originations post-financial crisis, with more credit enhancement, more considerate underwriting that's getting to be a bigger and bigger part of the market.

Great. Yes, that's helpful color. Thank you very much.

Our next question comes from the line of Tim Hayes of B. Riley FBR.

Hey, good afternoon everyone. Mark, you made some comments around the credit hedges and we saw the increase in the quarter a little bit. Just wondering how you see this portfolio trending as you allocate more capital to non-mark to market loan strategies?

I think for some of the loans strategies like the consumer loan strategy, we typically don't do credit hedges there, where you're more likely to see some credit hedges is when we retain investments from the Ellington-sponsored, Ellington-managed CLOs and also some of the CMBS investments, CMBS B-pieces, sometimes we think it's optimal to have a credit hedge on those. So I would say that as the portfolio grows non-QM that is solo LTV and has had really no losses that we typically don't have credit hedges on, same thing with the consumer loans. CMBS B-piece and the CLO equity that you might see credit hedges go on through just really pro rata with the investments.

I'd like to just add one thing, which is just to clarify. Our loan strategies, in fact all of our strategies are mark-to-market. We mark-to-market through the income statement and that's just very important to know, obviously when you've got a concept like core earnings or adjusting the net investment income which we historically we're publishing, that doesn't take into account on generally speaking, unrealized gains and losses. But when we have, for example, a loan that becomes nonperforming hasn't happened at non-QM but it certainly has happened for example, in consumer loans we absolutely do take a mark-to-market hit on that through the income statement. So I just wanted to make that clarification and that won't change just because we are a REIT now. We're going to continue to use mark-to-market GAAP accounting through the income statement. So I just wanted to clarify that.

Okay. I appreciate the clarification there and the color around that. And then just since you touched on adjusted NII, you covered the dividend this quarter with adjusted NII and you've made some comments around your outlook for NII and portfolio growth going forward. Is your expectation you'll be able to cover the dividend with NII going forward?

Yes.

Okay, got it. And then just a quick housekeeping question. On slide five, you gave the weighted average market yields for the different asset classes within your portfolio and they seem to jump around a decent amount, I’m just wondering, this quarter if that was related to the market volatility or if there's any impact from portfolio repositioning or leverage in there at all?

Yes. Hey Tim, it's JR. So, some of that dynamic will be the mix of assets within a given row. So as an example, CMBS as a first one, CMBS and personal mortgage loans, it varies point of time that will have different portion of CMBS versus small balance of commercial. And then within commercial loans, sometimes those will be origination, sometimes there'll be NPL. So I think a lot of the movement quarter-to-quarter you're seeing is probably related to the composition of these usual categories. Residential mortgage loans has non-QM, they’d also have some resi NPLs, RPLs. So I think you've probably seen that dynamic across few different roles. If there’s specific role you noted that you wanted to talk about, we can get into the detail there as well.

Yes, I'll save that for – I'll take it offline, but I appreciate the color there and I'll hop back in the queue. Thanks.

Great.

Our final question comes from the line of Mikhail Goberman of JMP securities.

Hi, good morning gentlemen. And congrats on the REIT conversion well done.

Good morning.

Good morning. Just a two part question kind of related, within the credit space, given the spread widening that we saw in the fourth quarter, where do you guys see the most attractive returns in that space? And also kind of within that, what's your outlook on growth and non agency residential loans for the year?

So, non-agency residential loans, if I think about just what we expect out of LendSure, I'd expect, we'll see their volumes probably grow 40% to 50% this year. They've been adding staff, they've been adding market share. That's our projection there. In terms of where's the best, what's sort of risk adjusted ROE? I'd say that we value diversification. So when you look at how the portfolio changes quarter-to-quarter, it's generally incremental. We certainly saw in Q4 a lot of interesting opportunities on commercial real estate side. So I think that's likely to persist. JR talked about how we've been ramping up the non-QM portfolio, so that has an attractive ROE right now. Consumer loan strategy has been performing very well. And you know Larry talked about our fourth CLO, so all those sectors I expect are going to contribute assets.

Okay. Thank you very much.

Thank you, Mikhail.

Thanks.

And Ladies and gentlemen, that does conclude our Q&A session and today's conference call. Thank you for your participation. You may now disconnect and have a wonderful day.