Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2021 Third Quarter Financial Results Conference Call. Today's call is being recorded. It is now my pleasure to turn the floor over to Jason Frank, Deputy General Counsel and Secretary. Sir, you may begin.

Thank you, and welcome to Ellington Residential's Third Quarter 2021 Earnings Conference Call. Before we begin, I would like to remind everyone that certain statements made during this conference call may constitute forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical in nature. As described under Item 1A of our annual report on Form 10-K filed on March 16, 2021, forward-looking statements are subject to a variety of risks and uncertainties that could cause the company's actual results to differ from its beliefs, expectations, estimates, and projections. Consequently, you should not rely on these forward-looking statements as predictions of future events. Statements made during this conference call are made as of the date of this call, and the company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Joining me on the call today are Larry Penn, Chief Executive Officer of Ellington Residential; Mark Tecotzky, our Co-Chief Investment Officer; and Chris Smernoff, our Chief Financial Officer. As described in our earnings press release, our third quarter earnings conference call presentation is available on our website, earnreit.com. Our comments this morning will track the presentation. Please note that any references to figures in this presentation are qualified in their entirety by the end notes at the back of the presentation. With that, I will now turn the call over to Larry.

Thanks, Jay, and good morning, everyone. We appreciate your time and interest in Ellington Residential. To begin, please turn to Slide 4. In the third quarter, Ellington Residential generated core earnings of $0.31 per share, which continued to cover our dividend, and we had a modestly positive economic return during the quarter in which the performance of Agency RMBS was mixed. Turning back to Slide 3. In the first shaded green column, you can see that interest rates ended the third quarter, not far from where they started, but that comparison masks significant intra-quarter movements. In July, interest rates continued to decline as they had done during the second quarter, as investor concerns increased around the Delta variant, economic growth outlook, and potential Fed tapering. Between June 30 and August 3, the yield on the 10-year U.S. Treasury declined by 30 basis points to 1.17% and interest rate volatility picked up. In response, Agency MBS yield spreads widened during July, particularly for lower coupon MBS. Moving into the latter half of the quarter, interest rates began to rise, while volatility declined and Agency yield spreads tightened as the market got more clarity on the Federal Reserve's tapering plan. Following its September meeting, the Fed signaled that it could begin asset tapering late this year, with new purchases decreasing incrementally through midyear 2022. Even though this timeline was a bit more accelerated than some market participants had previously anticipated, this was mitigated by the lack of signaling of any change to the Fed's policy of reinvesting all paydowns on its existing portfolio. Overall, the market welcomed the update, and most Agency MBS yield spreads tightened in response. Clearly, the Federal Reserve is trying hard to avoid another market taper tantrum such as was seen in 2013. The late quarter Agency MBS spread tightening was not uniform across all coupons and was most pronounced for higher coupon MBS, which also benefited from reduced prepayment expectations, driven by incrementally higher mortgage rates. Meanwhile, lower coupon MBS lagged around concerns of the anticipated withdrawal of Federal Reserve purchases that would disproportionately impact the current coupon Agency MBS that the Fed exclusively buys. All in all, higher coupons significantly outperformed lower coupons over the course of the third quarter and showed a sharp reversal of second quarter performance. This is illustrated in multiple ways on Slide 3. Fannie Mae 3.5 and 4.5 prices increased nicely in contrast to the modest price declines of Fannie Mae 2.5s. And you can see that OASs and Z-spreads of Fannie Mae 3.5s and 4.5s have tightened far more than those of Fannie Mae 2.5s. For Ellington Residential, net interest income on our portfolio more than offset net realized and unrealized losses, which came mostly from our lower coupon holdings. On the hedging side, net gains on interest rate swaps and U.S. treasury hedges roughly offset net losses on our TBA short positions, which were concentrated in higher coupons. Meanwhile, our debt-to-equity ratio declined slightly to 6.7x from 7.0x at the end of the prior quarter. Finally, in October, we announced our shift from a quarterly dividend to a monthly dividend. We believe that this shift will further enhance our appeal to income-oriented investors and increase the breadth of our investor base. I'll now pass it over to Chris to review our financial results for the third quarter in more detail. Chris?

Thank you, Larry, and good morning, everyone. Please turn to Slide 5, where you can see a summary of EARN's third quarter financial results. For the quarter ended September 30, we reported net income of $860,000 or $0.07 per share and core earnings of $4 million or $0.31 per share. These results compare to a net loss of $4.5 million or $0.36 per share and core earnings of $4.6 million or $0.37 per share in the second quarter. Core earnings exclude the catch-up premium amortization adjustment, which was a negative $1.2 million in the third quarter compared to a positive $2.6 million in the prior quarter. During the third quarter, as Larry mentioned, net interest income more than offset net realized and unrealized losses, which were concentrated in our lower coupon holdings. Also during the quarter, we had positive results from our interest-only securities and non-Agency RMBS portfolio and negative results from our reverse mortgage portfolio driven by widening yield spreads in that sector. And in the interest rate hedging portfolio, net gains on interest rate swaps and U.S. treasury hedges roughly offset net losses on our TBA short positions. You can also see towards the bottom of that slide that our net interest margin decreased quarter-over-quarter to 1.88% from 2.04%, largely driven by lower average asset yields. In addition, average pay-ups on our specified pools decreased to 1.44% from 1.55%, primarily because new purchases during the quarter consisted mainly of lower pay-up pools. Please turn next to our balance sheet on Slide 6. The book value per share was $12.28 at September 30 compared to $12.53 at June 30. Including the $0.30 third quarter dividend, our economic return for the quarter was positive 40 basis points. Our debt-to-equity ratio decreased to 6.7x as of September 30, as compared to 7x as of June 30. We continue to maintain higher liquidity and lower leverage as compared to periods prior to 2020 and the onset of the COVID-19 pandemic. Next, please turn to Slide 7, which shows a summary of our portfolio holdings. In the third quarter, our Agency RMBS holdings increased slightly to $1.2 billion as of September 30, and our non-Agency RMBS holdings decreased slightly to $9.1 million. Turnover in the agency portfolio was 23% for the quarter. Please turn now to Slide 8 for details on our interest rate hedging portfolio. During the quarter, we continued to hedge interest rate risk for the use of interest rate swaps and short positions in TBAs, U.S. Treasury securities, and futures. Similar to recent quarters, we ended the third quarter with a net short overall TBA position on a notional basis but a small net long overall TBA position as measured by 10-year equivalents. On Slide 9, you can see that our net long exposure to RMBS was 6.4x at September 30, down from 6.7x at June 30, primarily due to a larger net short notional TBA position quarter-over-quarter. I will now turn the presentation over to Mark.

Thanks, Chris. For the third quarter, if you only consider the starting and ending points of interest rates, it doesn't look like much happened. But it was actually a fairly volatile quarter for interest rates and the yield curve. The market oscillated between fears of a spreading Delta variant slowing down the economy and concerns that inflation would prove both larger and more persistent than the Fed's assessment that higher inflation will likely be transitory. So even though the 10-year only changed by 2 basis points quarter-over-quarter, it hit a high and a low of 1.54 and 1.17 intra-quarter, which is a much wider 37 basis point range. During the third quarter, we also got significantly more clarity from the Fed on its plan for tapering. Of course, the Fed meeting is today, and we'll be getting an additional update soon. The tapering plan that the Fed articulated following its September meeting is very similar in structure to the previous taper in 2013, although this taper is going to happen at a faster pace than the previous one. And unlike 2013, it's coming at a time when the mortgage market has been growing rapidly. I think there are a few ways to think about the upcoming taper. On the one hand, the Fed is expected to continue net buying Agency MBS through the summer of 2022. What net buying means is that they are buying Agency MBS in addition to reinvesting paydowns. The portfolio of Agency MBS will continue to grow for the next several months, even as tapering ramps up. Right now, it looks like taper is scheduled to end sometime in Q3 2022. So between now and the end of taper, the Fed should still net buy approximately $180 billion more MBS. The word net is important because the Fed will probably buy 2 to 3x that amount just reinvesting paydowns, but that reinvestment size is a function of prepayment speed. So the portfolio is going to grow by another $180 billion, and that's obviously a lot of projected growth on an absolute basis. On the other hand, however, that projected growth is not so big on a relative basis. For example, the Fed's MBS portfolio has grown by approximately $400 billion so far just this year. Meanwhile, the Agency MBS market is still growing at its fastest pace ever. Home prices are up, cash-out refinance activity is strong, and the agency conforming loan limits are about to increase significantly. In 2021 alone, the residential mortgage market is expected to grow by about $860 billion. For 2022, estimates are for about $635 billion in net growth. So that still leaves plenty of incoming mortgage supply that will need to find a home in private hands. The MBS sector had mixed performance in the third quarter; prepayments for higher coupon flows from the elevated levels that we saw during the first half of the year. This prepayment news was encouraging for higher coupon seasoned vintages and a gradual slowing of speed. And as a result, price performance of higher coupon MBS was better than production coupons. High coupon outperformance has reversed so far into Q4, however, as the flattening of the yield curve has pressured high coupon MBS prices with the shorter duration. In October, the spread between the 2-year and the 10-year swap rate there by 26 basis points. We continue to be cautious on our outlook for higher coupon MBS as we remain concerned about the rise in prominence of large public nonbank mortgage lenders, which bring increased efficiencies to the mortgage market, and should continue to keep prepayment speeds elevated relative to historical patterns. Roles in production coupon TBAs were strong during the third quarter. So these positions effectively generated much more positive carry. Production coupon rolls in both 15- and 30-year remain quite strong today, and the Fed will continue to buy a lot of production coupon MBS should they stick with their taper schedule. In addition, as you can see on Slide 10, the Agency MBS sector continues to look attractive on a relative basis versus other sectors of fixed income. QE has been a rising tide that has lifted the valuation of almost all fixed income sectors, including MBS. But despite Agency MBS being the direct recipient of Fed buying, in most measures, they don't look expensive relative to investment-grade corporates. MBS investors can get the direct benefit of very high TBA roll levels the Fed buying has created. There is no analogous fed benefit in the corporate market. Ellington Residential, we were actively trading in the third quarter, but on a net basis, we only grew the portfolio slightly quarter-over-quarter. We had a drop in portfolio CPR consistent with the overall decline in MBS prepayment speeds. We also switched to a monthly dividend in October, which we believe is generally preferred by investors. Our core earnings continue to cover our dividend. We have ample room to grow our leverage and net mortgage exposure, which could be even more supportive of core earnings going forward. What we did mention on our previous earnings call is that we did not expect clarity on taper to cause a big MBS spread widening; we do expect to see pockets of spread volatility. And given current MBS valuations, we prefer to set up our portfolio with lower leverage and higher liquidity, which enables us to be opportunistic should that spread volatility occur. Looking forward to the final months of the year, Fed support is still large and ongoing. We continue to expect production coupon TBA roll levels to be strong, but then to diminish gradually over time. That incremental 25 to 50 basis points of roll benefit, when added to the current yield on production coupon, makes them relatively attractive compared to other asset classes. But we see two headwinds. The first headwind comes from the technology-driven nonbank mortgage lenders. The brick-and-mortar operations of traditional banks are being supplemented by call centers, email and text message marketing, and increasingly online underwriting and loan processing, all of which can be much more efficient and effective. This is creating heightened prepayment sensitivity as a function of refinance incentive. As long as the Fed is actively buying, it is still gobbling up the worst pools via the TBA market. And so TBA pricing does not need to fully reflect clearing levels where private investors see value. That can still be the case even after tapering is over, if, as expected, the Fed continues to reinvest paydowns. But this dynamic is going to be greatly impacted by the level of mortgage rates. The most recent Freddie Mac survey mortgage rate was 3.15%. We believe that an increase in mortgage rates just to 3.50% may materially slow down refinance-generated supply. On the other hand, if mortgage rates drop back below 2.90%, refinance supply will continue, and it may produce an increase in net mortgage supply at a time of diminished Fed support. The second headwind is the shape of the yield curve. Agency MBS typically have stronger performance in a steeper yield curve environment. A flatter curve typically leads to diminished Agency MBS demand from CMO issuance and exacerbates negative convexity. So far in the fourth quarter, there has been a substantial curve flattening, which has weighed most heavily on higher coupons. So we have kept our net mortgage exposure relatively low and have lots of room to add mortgage exposure should we see spreads widen in the last two months of the year. That would not be uncommon at all; market liquidity has gotten worse, as many participants have diminished risk appetite coming into year-end. Slightly diminished Fed support, when properly managed, can be a great thing for EARN. This year, we have been in a market dominated by one giant investor, the Fed, whose objective is not motivated by investment returns. As the Fed's footprint shrinks, however, and return-seeking investors gradually become the marginal buyers of Agency MBS, we believe potential investment returns will increase. We don't necessarily expect a large widening event, but we do expect some investment opportunities to emerge at attractive entry points. So far, we're off to a good start in Q4. Now back to Larry.

Thanks, Mark. As we move into the final weeks of 2021, I think Ellington Residential is well positioned to capitalize on pricing dislocations that Fed tapering or even just fear of Fed tapering could generate. We finished the quarter with a debt-to-equity ratio of 6.7x, which is significantly lower than pre-COVID periods such as 2018 and 2019 when our debt-to-equity ratio averaged around 9x. With this lower leverage, we've also maintained higher liquidity. So moving forward, we have plenty of room to add assets and be opportunistic should spreads widen and pockets of volatility return. Our smaller size also enables us to move nimbly in and out of positions and redirect capital opportunistically, as we did in the spring of 2020 when we rotated aggressively into non-Agency RMBS in response to the COVID-related market sell-off. Time and time again, we have demonstrated our ability to protect book value through diligent hedging and liquidity management, but we've also demonstrated our ability to capitalize quickly on investment opportunities, such as by dialing up or down our mortgage exposure based on changing market conditions. The day finally seems to be coming when the Agency RMBS market will have to reckon with the impact of Fed tapering. And we expect our portfolio of specified pools, long TBAs, and short TBAs to outperform. The Fed's constant buying of current coupon TBAs has put steady pressure on pay-ups for many specified pool sectors. Since TBA short positions represent a significant component of our hedging portfolio, we believe that a rise in pay-offs will flow right through to our bottom line. We are positioned this way not because we're making a bet on interest rates or Fed policy, but because we believe that this strategy will outperform in a wide range of possible near and medium-term outcomes. Finally, the prepayment landscape continues to evolve as we see more signs of prepayment burn-out. I believe that this is a competitive advantage for Ellington Residential as we draw on Ellington's 26-plus years of experience modeling prepayments and trading these markets. As the Fed withdraws support, even while mortgage rates remain very low by historical standards, we think that there will be compelling opportunities in the Agency MBS sector for those who can successfully navigate the crosscurrents of prepayment risk and extension risk. We believe that we are best in class when it comes to Agency MBS asset selection and portfolio construction. We view Ellington Residential as an all-weather REIT, able to thrive in a diversity of market environments. And with that, we'll now open the call to questions. Operator, please go ahead.

We'll take a question from Doug Harter of Crédit Suisse.

This is John Kilichowski on for Doug Harter. Just going back to your comments on leverage. I understand that you brought it down a little bit last quarter. And from some of your agency peers, we've seen the appetite to take it up a bit this quarter. And I wanted to see what you sort of need to see in the market in order for you to bring leverage up this quarter.

Yes. So look, we get big news today from the Fed. The market has performed reasonably well in front of that. We viewed that as still consistent with our expectations. But I guess a quarter ago, if we had said, what's more likely underperformance or outperformance right in front of the Fed? We would have said, we think performance will be steady, but out of those two scenarios, probably underperformance is more likely. So I think you're coming into year-end. Balance sheets are generally reduced. You see a pullback in liquidity; you're going to get news today. So I think you're going to get pockets of volatility. You're also going to get a big increase in projected mortgage supply when Fannie and Freddie's loan limits are updated for the really extraordinary HPA we saw. So I think a modest pullback would increase our leverage.

Got it. And I guess my second question would be just some color around TBA performance versus spec pools this quarter, and what we've seen as being more attractive so far in the quarter where you're thinking about spending incremental dollars.

It's a great question. A lot depends on the coupon. So far this quarter, there has been some weakness in the spec pool compared to TBA. In the last couple of weeks, we have been adding to both sides—adding some pools in production coupons and some in higher coupons, while actively trading TBA. Our view is that for at least the next three months, the trends from the second and third quarters are likely to continue, specifically a high value for production coupon roles, which have been beneficial to performance, weakness in higher coupon roles, and increased mortgage sensitivity to prepay incentives. It’s interesting that many nonbanks have been gaining market share, doing so at the expense of traditional banks. This change in prepayment responsiveness is something we believe will persist. If there is a significant sell-off in rates and a large portion of the market lacks refinance opportunities, the differences in sensitivity may not be apparent in prepayment reports. We see this as a lasting shift in mortgage responsiveness that has occurred over the past two years and is unlikely to reverse.

Got it. I have just a quick last question. Do we have an update on the book value today?

We typically don’t give specific estimates intra-quarter. But I can just tell you the quarter is off to a good start for us.

And we'll take our next question from Crispin Love of Piper Sandler.

Can you discuss what led to the lower yields in the quarter and your expectations for the near to intermediate term? In particular, do you anticipate yields in the fourth quarter and the upcoming quarters to move closer to the levels we saw in the second quarter or remain at the lower levels experienced in the third?

Yes, we did observe a decline in yields, which can be attributed to several factors. Firstly, there was an increase in our portfolio turnover this quarter. We are open to replacing some of our higher yielding assets if we believe they have reached their peak. We see potential for more upside even with a slightly lower net interest margin. Although our net interest margin decreased from the previous quarter, it remains quite high historically. Additionally, we are comfortably covering our dividend despite the low leverage. As we approach the year-end, we anticipate opportunities and volatility that may allow us to increase our leverage back to more typical levels for us. We believe there is significant room to grow even if our net interest margin contracts on a dollar-for-dollar basis. Therefore, I wouldn't be overly worried about the slight drop in overall asset yield.

Okay. That's helpful. Just one more for me. So looking at the interest rate sensitivity slide, Slide 19 in the deck, it looks like there were some changes in the quarter? And I'm especially focused on the 50 bps increase in rates side compared to last quarter's deck. So can you walk through some of the changes and what caused the changes relative to last quarter, if there's anything important to really point out there, whether it's changes that you saw in your portfolio or the assumptions that go into the interest rate sensitivity?

Yes. I think you're right; it is a little different than it was in the prior quarter, but I wouldn’t read too much into it, frankly. Where it was – if you look at the overall duration – remember, this is on a leveraged basis, still quite low. So I wouldn’t read like we had some sort of market call in mind or anything like that. And I would imagine that if you look at it today or next week or whatever, it might have reverted back to the levels where it was even before in terms of closer to 0 duration. So I wouldn’t read much into it.

We'll move next to Mikhail Goberman of JMP Securities.

So the agency MBS portfolio has been pretty steady over the last few quarters. I'm wondering what sort of spread widening would you need to see to begin to meaningfully add to the MBS portfolio, assuming we start to see that in the near future?

It's Mark. Thank you for the question. I would say that it depends on the current interest rates. In the past year, the agency mortgage market has changed significantly, leading to many Fannie 2s and Fannie 2.5s being created. As a result, numerous borrowers have taken advantage of refinancing opportunities. If mortgage rates rise to around 3.5%, we anticipate a slowdown in supply. In that case, spreads may remain the same or widen by 5 basis points, prompting us to consider increasing our leverage. However, if we see a rally to an important mortgage rate level of 2.90%, more borrowers might seek refinancing at a time of reduced Fed support, leading to a larger widening. It's interesting to note that many major nonbank lenders, such as Rocket and Loan Depot, have become public companies and are growing their market share not at the expense of one another, but at the expense of traditional mortgage origination platforms. Therefore, if mortgage rates rise, we expect a reduction in supply, but refinancing will likely focus on higher coupons, benefiting borrowers who can take advantage of today’s lower mortgage rates. Ultimately, our decision to increase net mortgage exposure will depend on the spread levels and the current interest rate environment, which will guide us on the supply we can expect, given the reduced Fed net buying.

Right. Please continue.

The other thing even within a quarter, we'll move around our mortgage exposure, right? So what you get on these earnings calls and our earnings presentations are sort of snapshots at the end of the quarter, but sometimes things can be fairly dynamic within a quarter.

If I could direct you to Slide 20, it illustrates our positioning in TBAs. As Mark mentioned, we are maintaining a defensive stance on higher coupons. This is due to nonbanks becoming more efficient in refinancing higher coupons. If rates increase, which is a distinct possibility, those higher coupons will receive even more attention from these companies in terms of their marketing efforts and related strategies. It's important to keep this in mind regarding our focus areas.

I appreciate that. I have one more question. You mentioned that there was a lot of activity during the quarter. As analysts, we don't typically receive much insight into what happens over three months and between quarters. Was there any change in your hedging strategy during the period when rates fell to their lowest level in early August?

No, I was going to say, no, that’s a good point. And I talked about the interest rate volatility in the script, but I didn’t really connect the dots. So what we do is we look at our interest rate exposure every day, right, and mortgages are negatively convex relative to Treasury. So when you get a decline in interest rates, to mitigate interest rate risk, we have to buy back some of our hedges or add to duration to the portfolio. And then if interest rates make a turn and go back to where they started, you have to unwind that. And there's a toll in that round trip. And that expected toll is built into mortgage spreads, right? So mortgages have this yield advantage versus Treasuries because there's this expectation that there are some delta hedging costs associated with it. Now in some quarters, the delta hedging costs are more than what’s implied by market levels of volatility. In some quarters, they’re less. So yes, that was certainly a – there was a cost that quarter. Our strategy, though, didn’t deviate at all from how it’s always been that when you get a material move in interest rates that has had a significant change in portfolio duration, you need to take portfolio steps to mitigate that and to bring things back into the guardrails. So that was certainly a component this quarter. But the way we approached it is the way we’ve always approached it.

And this does conclude our question-and-answer session, as well as our conference for today. You may now disconnect your lines, and everyone, have a great day.