Ellington Financial Inc. (EFC) Q1 2022 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial First Quarter 2022 Earnings Conference Call. Today’s call is being recorded. At this time, all participants have been placed in a listen-only mode. The floor will be opened for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the call over to Jason Frank, Deputy General 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, 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’m joined on the call today by Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, Co-Chief Investment Officer of EFC, and J.R. Herlihy, Chief Financial Officer of EFC. As described in our earnings press release, our first 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 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. As always, thank you for your time and interest in Ellington Financial. We'll begin on slide 3. During the first quarter, volatility spiked to levels not seen since the COVID liquidity crisis of 2020, interest rates rose rapidly and the yield curve flattened significantly. Yield spreads in virtually every fixed income sector widened relative to US treasuries and interest rate swaps, and nearly all of the major equity indices sold off. Despite this challenging market environment, Ellington Financial experienced only a moderate book value decline for the quarter, thanks to our hedging strategies, diversified portfolio, and careful attention to our leverage ratios together with the outperformance of several of our credit strategies. Although, we did have some strategies that were down for the quarter, the benefits of our diversification were again on full display as gains from other parts of the portfolio along with net gains from our hedges offset most of these losses. Mark will get into specifics of how we outperformed in credit. Overall, our economic return was around negative 1% in what ended up being a historically difficult quarter for the fixed income markets. We continue to benefit from our loan portfolios as they not only generated positive returns, but thanks to their short duration they also continue to supply a steady stream of recyclable capital through portfolio paydowns and payoffs. Between our residential transition loan, commercial mortgage loan and consumer loan portfolios, we received principal paydowns of $156 million during the quarter, which represented more than 17% of the combined fair value of those portfolios coming into the quarter. This is a great feature of our portfolio construction. Our short duration assets are returning a lot of capital right when we can put that capital to work at much higher yields and higher yield spreads. And speaking of just-in-time capital, right at the end of the quarter we completed a $210 million five-year senior unsecured note offering, which was single-A rated and priced at a fixed coupon of 5.875% which was a spread of 3.32% to the five-year treasury. I believe that the strong rating and excellent deal execution reflected Ellington Financial's long track record of book value stability and effective risk management attributes were -- which are as important today as ever. This senior unsecured note offering was clearly timely given the returns we are seeing on new investments. We expect this offering to be accretive to earnings in the months ahead. In addition, we have already completed three loan securitizations this year, which have locked in additional long-term non-mark-to-market financing on both our non-QM mortgage portfolio and our consumer loan portfolio. These stable sources of financing further diversify our balance sheet cushion against the potential impact of market shocks and put us in a position to react quickly to market opportunities. Putting it all together the steady return of capital from our loan portfolios, the capital raise from the senior note offering and multiple securitizations freeing up capital we have now amassed significant dry powder to deploy just as we see reinvestment yields rising rapidly and pricing dislocations emerging in various sectors. I'll now pass it over to JR, to discuss our first quarter financial results in more detail.

Thanks, Larry and good morning everyone. I'll continue on Slide 3 of the presentation. For the quarter ended March 31 2022, Ellington Financial reported a net loss of $0.17 per share on a fully mark-to-market basis and core earnings of $0.40 per share. These results compare to net income of $0.61 per share and core earnings of $0.44 per share for the prior quarter. The drivers of the sequential decline in core earnings were two-fold. First, we had a higher balance of undeployed capital in Q1; and second, we had higher corporate expense items some of which related to the prior year's operations. Moving forward, after we get fully invested and take advantage of today's much higher reinvestment yields, we expect core earnings to again cover our current quarterly dividend run rate of $0.45 per share. On Slide 4, you can see that we further increased our capital allocation to credit investments during the quarter with 85% of our capital allocated to credit as of March 31, which is up from 79% year-over-year. The capital allocated to agency at 15% is now at the low end of our historical range. Moving forward, we expect EFC's allocation to credit to continue to be toward the higher end of its historical range based on the continued growth of our loan origination businesses. You can also see on this slide, that the weighted average market yield on our credit portfolio increased by about 10 basis points sequentially which we expect to increase further as the yields on our portfolio adjust to wider yield spreads and rising rates while the blended yield on our agency portfolio increased a full percentage point quarter-over-quarter to 3.2%. Moving to Slide 5, you can see the attribution of earnings between our Credit and Agency strategies. During the first quarter the Credit strategy generated total gross income of $0.28 per share while the Agency strategy generated a gross loss of $0.34 per share. These results compare to gross income of $0.91 per share in the Credit strategy, and a gross loss of $0.03 per share in the Agency strategy in the prior quarter. During the first quarter, we had particularly strong performance in our CMBS non-Agency RMBS, residential re-performing loan, CLO and corporate debt and equity strategies. In addition, strong net interest income drove positive results in our short duration loan portfolios including small balance commercial mortgage loans, transition -- residential transition loans and consumer loans. Our portfolio of retained non-QM tranches also appreciated during the quarter driven by substantial appreciation of our non-QM credit IOs and excess servicing strips as rising mortgage rates led to lower actual and projected prepayment speeds. Finally, we had significant net gains on our interest rate hedges. In contrast, rapidly rising interest rates and widening yield spreads generated significant net unrealized losses on our unsecuritized non-QM loans, while also compressing gain on sale margins for our loan originator affiliates. LendSure, while still profitable for the quarter, revised downward its earnings projections for 2022 and Longbridge generated a net loss for the quarter. As a result, we experienced an unrealized loss on our strategic investments in loan originators in the amount of $7.5 million or about $0.13 per share. Importantly, Longbridge's net loss was due to reduction in the value of its MSR portfolio, whereas its origination segment was still profitable. And for LendSure we believe that the company is well positioned to emerge from the current market volatility with increased market share and stronger earnings prospects. In Agency RMBS, surging interest rates and heightened volatility drove significant duration extension and yield spread widening, which in combination caused sharp price declines. As a result, net realized and unrealized losses on our Agency RMBS exceeded net interest income and net realized and unrealized gains on our interest rate hedges and we had a significant net loss for the quarter in that strategy on a mark-to-market basis. Turning next to Slide 6. During the first quarter, our total long credit portfolio grew by 11% sequentially to $2.3 billion at March 31. The majority of the growth occurred in our non-QM residential transition and commercial mortgage loan origination businesses. You can see here that the residential and commercial mortgage loan slices grew in size. In commercial mortgages, our tactical focus on multifamily continued with our portfolio share of Multi increasing to 69% from 65% last quarter. Meanwhile, our portfolio of consumer loans declined sequentially due to the successful completion of a loan securitization during the quarter and opportunistic sales of CLOs decreased the size of that portfolio. On Slide 7, you can see that our long Agency RMBS portfolio decreased by 11% to $1.5 billion, driven primarily by mark-to-market declines. Please turn next to Slide 8 for a summary of our borrowings. On the final – on the final day of the quarter we issued $210 million of five-year 5.875% senior unsecured notes. Because we hedged the interest rate risk in these notes with SOFR swaps and those swaps are of course mark-to-market, we have elected the fair value option on the notes as this should give the most accurate calculation of our book value going forward. As a result, we expensed rather than capitalized the costs associated with the offering and the amount of $3.6 million or about $0.06 per share and that was an immediate hit to book value per share. You will see these senior unsecured notes show up as senior notes at fair value on our balance sheet. In addition to the notes offering, during the quarter, we also completed a non-QM securitization which increased non-recourse borrowings by $403 million. And we completed a consumer loan securitization, which removed $36 million of borrowings from our balance sheet Finally, we added an additional financing facility for our commercial mortgage origination business Our overall debt-to-equity ratio adjusted for unsettled purchases and sales increased to 3.2:1 as of March 31, from 2.8:1 at year-end, driven primarily by increased borrowings on our larger credit portfolio and by the issuance of the unsecured notes. Similarly, our recourse debt-to-equity ratio adjusted for unsettled purchases and sales increased to 2.3:1 -- excuse me 2.3:1 from 2:1 [ph]. Our weighted average borrowing rate increased by 54 basis points to 1.78% as of March 31, due to the combination of higher short-term rates the new senior unsecured notes and disproportionately more borrowings on our loan portfolios, which carry higher borrowing rates relative to agency. We also raised $38.5 million of common equity through our ATM program during the quarter right around book value. We believe that the ATM program provides an attractive low-cost path to growth and we plan to continue to utilize it as investment opportunities and market conditions warrant. For the first quarter, total G&A expenses increased sequentially by $0.03 per share to $0.17, while other investment-related expenses increased by $0.07 per share to $0.17 mainly due to expensing the costs associated with the senior note offering. Our book value per common share was $17.74 at March 31 down 3.5% from $18.39 per share at December 31. Including the $0.45 per share of common dividends that we declared during the quarter, our economic return for the first quarter was negative 1.1%. Finally, with respect to the acquisition of the controlling interest in Longbridge, we continue to work through the closing process and expect the transition to -- the transaction to close within the next few months. Now over to Mark.

Thanks J.R. Last quarter was a period of absolutely historic volatility not only for interest rates, but really for most of the important fixed income metrics. Consider a few examples. The two-year note moved to 160 basis points its highest quarterly move since 1984. The spread between two years and 30 years flattened by more than one percentage point to just 12 basis points at quarter end. In MBS credit spreads, while high yield widened by 70 basis points, which is a pretty big move even non-QM AAA-rated tranches also widened by 70 basis points and parts of the CRT market widened by over 400 basis points. So what does all this mean? Well, basically everything except IOs and mortgage servicing rights went down in price and many things went down a whole lot. 10-year note futures dropped by seven points, Fannie 2s dropped by seven points and residential mortgage loans dropped multiple points in price. At this point in the earnings cycle, a lot has already been said about the hows and the whys of these historic market movements. So instead, I want to focus specifically on how we managed to keep our economic return at just negative 1% thereby protecting Ellington Financial's book value. And then I'll get into what this massive repricing of yields and spreads means for the opportunity set going forward. You generally don't see this much red ink in the market without also seeing some really good opportunities created. Here is what worked to help protect book value during the quarter. First, interest rate hedges helped across the board. And for certain of our assets with levered credit exposure our credit hedges also helped. You can see on Slide 17 the credit hedges that we had both coming into and coming out of the quarter. We have included this slide in the earnings deck for years and though it doesn't -- though it, generally doesn't get a lot of airtime we still included. These credit hedges were important and profitable during the quarter in offsetting some of the sell-off and helped drive some incredibly strong performance in our CMBS and CLO portfolios even though these two market sectors really struggled during the quarter. But the biggest area where our hedges helped was with interest rates and not just in our agency portfolio. We owned a lot of fixed rate non-QM loans coming into the quarter and they declined in price a lot. But the interest rate hedges helped soften the blow as did our retained tranches from our previous non-QM securitizations. These retained tranches have a lot of moving parts, but many of these tranches are essentially credit IOs and excess servicing rights, which means that they should increase in value when interest rates rise. And in fact, they did appreciate considerably in the first quarter. We have kept these tranches on all our non-QM securitizations only exiting them, if and when we call the deals. So much of these retained tranches helped hedge the non-QM loans that we've been purchasing in much the same way that mortgage servicing rights helped hedge mortgage pools and diversify the earnings stream in our non-QM business. So our non-QM securitizations not only lock in very low financing – very low long-term financing rates and reduce our mark-to-market volatility, but they also generate valuable credit IOs and servicing strips which we retain and which is a good balance to the profits from non-QM origination. Our portfolio also greatly benefited from the fact that many of our holdings are floating rate or short duration or both. Our commercial mortgage bridge loans are built for example, they are floating rate assets with a short average life. Last year, we had to endure LIBOR essentially at zero so that suppressed the coupons on our floating rate bridge loans. But on Wednesday, Jay Powell gave our coupons a 50 basis point boost across the board. The forward curve projects LIBOR increasing to over 3.5% a year from now. So bridge loan with a floating rate spread of 550 basis points could have a yield over 9% a year from now. Our commercial mortgage bridge loan portfolio was able to generate solid annualized returns this quarter despite all the volatility we still really like this sector. On slide 9 you can see our consistent preference for multifamily in our commercial loan portfolio. A lot has been written about how America is under-resourced with affordable housing and while valuations have run way up on multifamily rent growth has been very strong. And unlike office and retail, multifamily isn't vulnerable to big shocks from individual lease rolls. Our residential transition loan portfolio was also a strong contributor this quarter. These loans are even shorter in duration so price volatility was nothing like what we saw in our non-QM loans and they continue to pay off rapidly. It was a similar story with our consumer loans. Even though these are very short duration loans, they are still fixed rate albeit with high fixed rates and we have hedged a portion of their interest rate risk. That portfolio also generated strong returns as did our non-Agency RMBS and RPL strategies. This past quarter, was brutal for levered agency portfolios and our Agency MBS portfolio did suffer losses as a result. Interest rate hedges cushioned some of the blow, but yield spread widening was massive and it really hurt. And that strategy was down $0.34 per share. But the yield spread widening has really improved the going-forward opportunity in agency. Keep in mind that, our smaller agency portfolio quarter-over-quarter doesn't reflect any significant downsizing of that strategy on our part, but rather, it primarily reflects the mark-to-market declines in that portfolio. One interesting dynamic of Q1 was the surprising lack of volatility in funding spreads, funding markets for all our assets, whether it be agency pools or loans functions consistently throughout the quarter. Oftentimes spread and price volatility is a consequence of changes in funding availability. That wasn't the case this quarter. If anything, given the higher absolute rates we will be paying our lenders as short rates rise, we are seeing increased interest from multiple funding providers. As I mentioned, the part of the portfolio that hurt performance was obviously the Agency strategy and to some extent non-QM. For most mortgage originators, it's a very challenging time, as rates are rising rapidly and volumes are declining. In contrast, last year was really great time for originators, characterized by high volumes and high loan prices. Right now, it looks like non-QM origination volumes will be down somewhat, although, not nearly as much as agency originations and loan prices for new production are currently much lower than they were for much of 2021. Many times you have spoken about the benefits of being both a loan buyer and a loan originator, as the pendulum swings between the two for where the profits are. With much of the non-QM originator competition hobbled, I see opportunities as both an originator and a loan investor going forward. As a result of all the turmoil, we think we'll be able to buy some great non-QM packages from a wider range of originators. And in fact we've bought a couple of pools already. Many non-QM originators have been burned by the big market swings, so now they are just looking to move their product quickly to reliable outlets. So, lots of moving parts in many different directions, but our diversification really helped this quarter. Some sectors where we've had smaller capital allocations really had fantastic performance CMBS, CLOs, RPLs and non-Agency RMBS all contributed. You put it all together and performance was only down 1% overall. I'm really pleased with that overall performance. So what is our outlook from here? Generally, when you see huge moves down in price and lots of losses, it recharges the opportunity set. That's certainly the case for Agency MBS and non-QM. I think it's really important for us to position and manage their portfolio without preconceptions about what is going to happen. The forward curve is certainly pricing in a lot of rate hikes, but a lot of what is causing inflation may be only marginally impacted by these rate hikes. So we need to consider a wide range of possible outcomes, be flexible in our approach. Although, funding markets are functioning well, liquidity is way down and we need to run our businesses with ample cash in the bank. Being forced to raise cash in a short period of time in a weak market, can lead to a lot of value destruction. Nevertheless, the yields and spreads we are seeing are the best opportunity set we have seen since the market recovered from the depths of COVID. Now back to Larry.

Thanks Mark. I'm pleased with how we navigated the market volatility in the first quarter. We did what we've done so many times before. First, we relied on our disciplined hedging and liquidity management to protect book value, even building up excess liquidity to capitalize on the better investment opportunities. Second, we maintained a diversified relatively low leverage portfolio. Third, we dynamically rebalanced our hedges in response to the fast-changing market conditions. And fourth, we were opportunistic in our timing to raise capital, both through our common ATM program and through our senior unsecured note deal. I'm excited about how our portfolio is positioned today, as well as with all the dry powder we have on hand, in light of the rich investment opportunity set that we're seeing today. So far this year, we've been able to ratchet up, not only yields but also yield spreads in most of our loan origination businesses, while also adding some attractive loans and securities in the secondary market, including even some secondary purchases of discounted non-QM loan pools, as Mark mentioned. Ellington Financial's strong balance sheet and liquidity position have also provided valuable support to our loan originator affiliates. As both JR and Mark mentioned, rapidly rising interest rates and widening yield spreads have compressed gain on sale margins for loan originators. And many originators have been forced to scale back operations in the face of losses, especially those who did not properly hedge their locked loan pipelines or were under-capitalized or both. While we do expect loan origination volumes to moderate in the higher interest rate environment, we have also seen a number of competitors break their rate lock agreements. I think that this represents a golden opportunity for our affiliate lenders to add market share and enhance their visibility in the marketplace. Finally, since quarter end, interest rate volatility has continued to be elevated and we've seen further yield spread widening in many sectors. While that's another headwind on a mark-to-market basis, it's a great time to be putting all our dry powder to work. With that, we'll now open up the call to questions. Operator?

[Operator Instructions] And we'll take our first question from Crispin Love with Piper Sandler. Please go ahead. Your line is open.

Thank you. Good morning. And you touched on this a little bit during the prepared remarks, but just hoping for a little bit more color. So, given the significant rate moves and spread widening we're seeing and have seen for a bit, how are you seeing the new reinvestment yields compared to the impact you would expect from the cost of funds side? Would you expect the NIM to widen from where we are right now given the rate backdrop? And then also just what are the ROEs you're seeing on new investments?

Mark, do you want to handle that?

Yes. Sure. So, I think you are going to see the NIM widen primarily because we're seeing wider spreads, right? So if just yields rise, then presumably our financing costs are going to increase roughly sort of order of magnitude similar to how the yields on the assets increase. But what you saw in Q1 was not only a rising yields, but also a big increase in spreads. So I think, you're going to see -- you're going to see net interest margins increase my expectation. And I think there was a second part of the question I missed, Crispin.

Yes. Just do you have any color on ROEs that you're seeing on your new investments?

I think a lot of -- we're diversified, so there's a range of ROEs depending on the sector, but we see a lot of things that are in the teens now.

Yes, definitely mid-teens. And yes, the -- it's -- in terms of the NIM and where we see it going. So first of all, you really need to separate the credit portfolio from the agency portfolio right as opposed to looking at the overall NIM. I think in each portfolio, you'll see a wider NIM. In credit, as Mark said, the funding market is still very strong. So, if anything I think we've got good momentum there in terms of keeping our funding costs lower on a spread basis, right? And then in terms of on the asset side, one thing which again you have to keep in mind it's sort of a weird moving average, right? You've got -- if you look at sort of the money we put to work in the fourth quarter and even early in the first quarter, we had some spread compression in some of our businesses, small balance commercial for example, even the residential transition loan business, we had a little bit of spread compression. So the money that we put to work there probably was at a slightly narrower NIM. But now that we have all this dry powder as we've spoken about and the opportunities in some of these markets like non-QM are so much better than they were just a few months ago, you'll see gradually on this moving average basis if you will as we put the new money to work I think you'll see our credit NIM widen very nicely. And you'll see our leverage tick up as well given the unsecured note deal, right? That gives us a lot of room to very prudently increase our leverage and credit.

Great. Thank you. That's all helpful. And then just one more for me. Do you have a -- an update to book value around book value through April or just any qualitatively comments there?

Yeah. Just -- I'm just going to stick to what we said, which is that you've got to see mark-to-market decline since quarter end. We have a schedule that we keep to here, which is around the middle of the month is when we put out our book value estimates. We're going to stick to that. I think you see what's going on in the market. And look we've got -- this is not an agency-only portfolio. So there's a lot of moving parts and I'd rather not put a number out there now.

Understood. Thanks for taking my questions.

Thank you Crispin.

We'll take our next question from Eric Hagen with BTIG. Please go ahead. Your line is open.

Hi, thanks. Good morning. I think I just have one. I think you alluded to it in your prepared remarks; a lot of what has been securitized in non-QM this year is really you can say a backlog of collateral on the balance sheets of investors with lower coupons. Do you have any perspective on how spreads could respond or evolve as newer collateral gets securitized in non-QM, and what you think that means for the returns to the levered investor holding on to the residual risk? Thank you.

Do you mean spreads on the tranches, the liabilities? Is that what you mean?

Right.

Okay.

I think that's a great question. So, yes, thanks Eric. So what I think is this part of the reason why spreads on non-QM tranches widened so much in the first quarter, it was in part a consequence of the market generally sticking to a pricing speed convention of 25 CPR, irrespective of the note rate on the underlying collateral, the underlying loans and, sort of, irrespective of what the note rate of the underlying loans is relative to the current note rate a non-QM borrower would expect to be offered, right? So we priced a deal second quarter April 14th where we slowed down our pricing speed a little bit to in deference to those considerations, but that really hasn't been the norm. So I do think when you see higher note rate non-QM loans get securitized, I think maybe 6.25% note rate and higher. I do think spreads will be tighter, because I think investors are going to recognize the 25% CPR pricing speed they might think that's a more accurate estimation and they might perceive less extension risk on those tranches. So, yeah, I do think that is a bit of a tailwind for the retained yields on newer securitizations. I would just say that it also is going to mean that if the economy tips into recession and short rates come down and mortgage rates come down in that scenario then you as a holder of retained pieces now going to have to -- you're going to have to accept the possibility of faster prepayment rates, faster deal pricing speed. But I think you're exactly -- I think it's a good point you raise. And I do think my expectation is that you will see tighter securitization spreads when sort of the current set of loans being originated in non-QM market comes to securitization.

That's helpful color. I appreciate it.

Sure.

And we'll take our next question from Doug Harter with Credit Suisse. Please go ahead. Your line is open.

Thanks. Can you talk about, what size the amount of kind of excess liquidity or excess capacity you have to kind of take advantage of the wider spreads, kind of keeping in mind I know you said that you probably hold excess liquidity in the current environment?

Sure. So I think there are a few different ways to answer that question. I'd first point to cash and cash equivalents and unencumbered assets at quarter end which in combination was about $1 billion about 1/3 of that was $360 million of cash and $630 million of unencumbered. Not that we would necessarily encumber all of those assets in the box but that gives an indication of I'd say additional borrowing capacity plus, we -- plus the cash that was I guess unusually high you could say because we closed on $210 million literally on the final day of the quarter. So I think those measures indicate that we have additional kind of cash and borrowing capacity available to the tune of $1 billion. Those amounts have been higher kind of been periods post-COVID, than they were pre-COVID. So we have been keeping excess liquidity and lower leverage. But we certainly have well and above those measures excess to spend as of quarter end.

Got it. And then, can you talk about how you think that the agency versus credit mix might trend as you see kind of -- the relative opportunity you see in each day?

Sure. So I mean, historically agency has been at the low-end 15% of the capital allocation at the high-end 22%, 23% which really we hit for a brief amount of time a few years ago kind of 2019. So we're currently 85-15, so 15% being the low-end of the agency range. I think the part of the capital allocated agency there will always be an Agency strategy. It helps us comply with three tests and 40 Act tests and the like. It also provides liquidity and diversification. So we talked a lot about the benefits of having that Agency strategy which we also operate on a more risk-adjusted basis with the TBA short. And it's pretty heavily hedged. So I think there will always be an allocation to agency. This 85-15 is probably a good split to think about going forward though, because credit has been growing even before this quarter. Over the last 18, 24 months, credit has been growing relative to agency as we grow our origination businesses. And I would kind of expect that to continue on the margin. Larry you'd like to add anything?

Yeah. I'd just add. I think if agencies recover on a spread basis as we think, they will then you might see that 85-15 even tick a little bit lower in terms of agencies. Right now, the agency opportunity looks very good, but you could even see us tick below 15%, once we get the recovery that we're expecting in spreads on agencies, right? And the upcoming Longbridge closing, I mean, that's going to be credit, right? So that will also affect the split to credit.

We'll take our next question from Brock Vandervliet with UBS. Please go ahead. Your line is open.

Thanks. Good morning, everybody. On LendSure, if you could just talk through the lower earnings guide for the year? Obviously, tons of cross-currents around non-QM. But just wondering if you give more color there?

Mark?

Sure. Hi, Brock I think it – look last year and I sort of mentioned this in my prepared remarks you had a combination of very high volumes because the housing market was on fire very high volumes and very high loan prices right because you had relatively tight securitization spreads from the yield curve was at low levels, which is where you price a lot of the non-QM bonds off of. So last year was really a good market backdrop for non-QM originators. And so you have this year is you have mortgage rates a lot higher. So there are going to be some borrowers that would have qualified for mortgage at the rates they could have gotten a year ago that now when you figure out their debt-to-income calculations at the current rates their payments are higher and they might not qualify. So I think you're going to see – I think it's logical to see lower volumes. And the other thing I think is that because of all the volatility and the spread widening loan prices are lower. So even when you get to sort of current coupon non-QM loans now they're trading at lower prices than where they traded last year. And really total dollar of profits for these originators is pretty much the product of volume times gain on sale over their expenses. And I just think you have – you have some amount of lower volume across the board, presumably some amount of lower gain on sale. And I think it makes sense that that sort of translates into lower earnings. So I think their projections are sort of just a realistic assessment of market – what the market conditions are now versus when they did this exercise previously. Now the thing I'm optimistic about or I think there is also an opportunity to grow market share, right? And I mentioned it in my comments I think is that you've seen some real pain out there among originators and it's been an issue of honoring rate locks and things like that. So I feel like LendSure has really gone out of their way and they always do to comport themselves in a way that has a lot of sensitivity to their clients right mortgage brokers and the ultimate home purchasers that they serve, right? So I think that we have a good opportunity to grow market share. So I think the overall pie is shrinking a little bit but I think it's completely realistic and it's our hope we're going to – they're going to work really hard to achieve this is that we can get a little bit slice bigger slice of the pie.

And if I could just add, we still think they're going to be LendSure is still projecting a nice profit not nearly what it was last year but a nice profit for 2022 still a very decent return on equity in terms of our investment in LendSure. The important thing, I think that we're doing for LendSure, which we kind of alluded to earlier was that we're trying to buy as much from them on a forward basis to kind of remove the hedging complexities and other kind of pipeline, potential pitfalls sort of move them over to Ellington Financial where I think it's sort of a more logical place for us to be hedging and taking that risk on the pipeline and letting LendSure just do what it does well, which is to originate products. And as Mark said, you're going to see lower gains on sale. And I don't think that's going to change until the backlog of non-QM product by some of these weaker hands, some of the lower coupon stuff, which is still overhanging the market. Until that's cleared up, I think you'll definitely continue to see lower gains on sale in non-QM even for current production. But it's still profitable and we still think they're going to deliver a nice return on equity for us in 2022.

Got it. And just similarly on the resi transition, which seems to have been a sector gold mine. Just thinking of that as a bit of an operator or borrower I'd probably be more concerned about home price appreciation. I've got to worry more about that exit when I sell the home. I'm more worried about the cost of renovation, given wage and product price escalation. Doesn't that market slow too? Does it even matter for Ellington given your size and how do you think about that?

Yeah. I would say that we haven't seen it slow. So, there's all the housing numbers you've seen since COVID, have been aberrational, in the sense, they don't like -- they don't look like any of the housing numbers for the previous 25 years, right? Like sort of the last year and a half or going on two years had one set of housing numbers and then before that you had a different set in terms of warehouses sell versus where they're listed time on the market. So, for the residential transition loan originators what's good about this market is that once they're done with renovations and they list the house for the markets we're in they're able to sell it very quickly right? And when we track very closely, and it's something that we review monthly in a lot of detail is where are they selling properties versus what we thought was going to be the as-repaired value of the property before they -- when we made the loan right? And that involve the rehab costs and...

Yeah. The performance, yes.

Yeah, exactly. And so, on that metric as a metric, I'm very interested in tracking monthly, sales are going well. And the other thing is that time on the market and the markets where we're on with markets where we're active is still staying short. So we're watching that closely. Now the other point you raised, which is something, I've been working with our partners a lot is supply chain issues. And so now what's happened is the way most of them are thinking about renovations is they look at what's available in terms of windows, doors, all that kind of stuff they're going to need from a Lowe's or a Home Depot before they buy a house, and before they put together their rehab budgets. And that's sort of a little bit of a different mindset from what you would have seen a couple of years ago, when they didn't have to worry about supply chains. And so they've accommodated that. I think it constrains the scope and the -- how elaborate they can do on the renovations, but they're doing it so they can secure all the materials they need when they purchase the house and they don't run the risk of having a house completed except for the windows and you're waiting three months for windows, right? So they've accommodated that. So that market has -- is doing very well. Like with all things housing-related after a big run-up, you certainly need to -- you can't normalize that, you have to be concerned about retracing things. But for now that market has been good. I'd say the only negative and Larry kind of alluded to it is that we have not been able to push note rates on what we buy there, the same you're setting note rates have been pushed in other sectors, right? So as our financing costs are going up and they went up 50 basis points this week with the Fed meeting, the net interest margin there is coming in a little bit, but financing is good that's probably going to improve. And I think it's an area where we have a real opportunity to grow market share by signing up some new partners.

Yeah. We're just a tiny fraction, right? Even though this has been a big growth area for us, we're a tiny fraction of a big market that we think is here to stay right especially -- and we could also pick our regions like places like Texas where we're very active in fix-and-flip and RTL. The demographics are great. As Mark said, these are -- well these are short loans, right? So in terms of worrying about kind of the terminal value of your collateral, it's just a much shorter time frame. These loans are generally less than one year from start to finish. So yeah, we still really like this market. And it's been -- from a NIM perspective, it's been one of the widest areas for us. And yeah, we'll see some compression, but it's a very fragmented market and I think we can continue to grow our market share there. And we feel good about the credit risk we're taking because of all those factors the short duration and the just -- well mostly a short duration and also the regions that we're focused in.

Got it. I appreciate the color.

And we'll take our next question from Bose George with KBW. Please go ahead. Your line is open.

Hey, guys. Good morning. In terms of investment opportunities, just given the fallout with mortgage originators, do you think there's opportunities there to acquire other companies or is the focus more on growing the existing companies taking share?

There probably will be opportunities. And I wouldn't say we're very far advanced on anything at this point. We certainly are showing things. But I think we're -- if I had to predict that say we're just focusing on the companies that we have. And we're if anything maybe hoping to pick up some teams and some personnel or branch offices whatever it may be from some of the companies that may be struggling here.

Okay. That makes sense. Thanks. And then actually on the Longbridge MSR, did you guys say you took a negative mark? And I was wondering what drove that? Yes, just curious, what drove that?

Yes. So what's been driving the -- what drove the negative mark on the Longbridge MSR is continued widening in the HECM market. So the MSR -- a lot of the value of the MSR, some of it is from just a straight servicing strip. But where you'd expect that prepayments would slow, and therefore, that aspect of it would increase in value as rates go up. But a very significant value is from the so-called tail where the HECM servicer has the right to basically fulfill the draw request of the borrower on the undrawn amount of the HECM. And basically, your profit when you do fund those additional draw request is going to be a function of what price you sell to Ginnie Mae in the open market. So as the Ginnie Mae have widened and therefore, there are some prices have dropped, that's basically compressed the gain on sale on these tail draws, if you will.

Okay.

So unfortunately, it's not a very hedgeable risk. There's no TBA market for HECM’s. So we -- Longbridge and therefore, we indirectly are kind of riding that up and down over time down recently based upon some widening in the HECM market.

That’s okay. No, that makes sense. And then just when the Longbridge deal after it closes, have you decided, how you're going to report that just given the consolidation of securitizations and I guess that inflates your balance sheet?

Yes. Sure. So it's a work in progress and the timing of the consolidation will depend on when the transaction closes. So if it closes prior to June 30, and the consolidation in the financial statements will start on Q2. And I think the tentative plan is we'll certainly be reporting detail on Longbridge itself and the continued EFC portfolio probably in a segment type format.

Okay. Its great. Thanks.

Yes. And if you look at Long Bridge's balance sheet, you'll see that there's one very large asset and one very large liability basically that represents the underlying loans in the Ginnie Mae that have been issued and Ginnie Mae themselves on the liability side. And so we certainly would encourage people to -- when they think about the consolidated entity to look at the net of those two in terms of really -- the MSR representing the MSR that's retained from those securitizations. And then the balance sheet will look like in your fraction of what for GAAP, it's going to look like.

Yes, yes, yes. Makes sense. Great. Thanks.

And we'll go next to Mikhail Goberman with JMP Securities. Please go ahead. Your line is open.

Hey. Good morning, Guys.

Good morning.

Just a couple of questions from me. Where are you seeing loan rates on newly originated loans? And how much would you expect higher rates to impact non-QM volumes over the remainder of this year?

Sure. So -- and thank you for the question. For non-QM now most of the production is somewhere between, let's say, 6.5% and 7% it depends obviously on type of loan it is and borrower credit attributes, but it's sort of somewhere in that range. And so, in regards to how it's going to impact volume, I think, it's hard for me to say now, because you really only have six weeks or seven weeks of data from the substantially higher rates. So far, the volumes are holding up well, but it's always hard for me to tell, is that reflective of the overall market or is that also some component of us gaining market share or losing market share? And I think in this market it's likely that we're gaining market share, because I do think relative to some of the competition, we have been sort of a steady hand at the wheel in terms of LendSure in terms of servicing its clients. So, I mean, I think it's natural that volume should come down a little bit, home prices are up, rates are higher, it's a much higher payment, I discussed that before, but -- so now things are holding up. And I think, given where things are now, you're looking at note rates somewhere, 6.5% to 7%. The one thing I think is possible that, we -- and it sort of came up with the question that Eric asked about securitization spreads, right? You've seen securitization spreads come in. So they're definitely tighter than where they were in March. I think March was kind of the wides, and they're tighter even on the sort of same note rate loans. So the market has a better tone, buyers are showing up in bigger size for securitizations. And a lot of the lower note rate loans that were probably originated or locked in Q4 of last year, or the first month this year, before rates really moved a lot of that risk has already been distributed. There's certainly more to go, but we're well into that process. I think, we're well over 50% done with that process. So one thing you could see is securitization spreads tightened and non-QM note rates come in a little bit without sort of a corresponding change in sort of two - three- five-year treasury yields which I think that would be sort of a little bit more constructive note rate for volumes.

Yes. And if I could just add, Mark. So first of all one big difference right between agency volumes and non-QM volumes is non-QM volumes were already that market is already primarily a purchase market right? So as opposed to the agency market, which until recently of course was a vast majority refi market. So the drop in volume that you're going to see is a lot less in non-QM. And the other thing I would say is, with the curve a lot flatter and given the certainly the short-term dynamics of what's going on in non-QM market I think that the you're going to see 7% note rates real soon. The market is always a little slow to react. It takes a little bit of time. But I think 7% note rates is given where yields are right now in the market treasuries et ceteraI think that's I think we're going to get there pretty soon.

Great. And if I can just squeeze in one more. Would you expect additional unrealized losses on originator investments in the second quarter based on how rates have moved?

Yes. I would say in the case of LendSure, I would say not necessarily no. I think in the case it's hard to know. But I think in the case of Longbridge, given again some weakness in the Hakam market I think we could see -- yes we could see a further unrealized loss there. But we think that long-term spreads will revert. But on a mark-to-market basis yes I do think so on the -- from the MSR. The origination platform is still extremely strong.

Great. Thanks a lot. Happy weekend

Thank you. too

And that was our final question for today. We thank you for participating in the Ellington Financial first quarter 2022, earnings conference call. You may disconnect your line at this time and have a wonderful day.