Ellington Credit Co Q3 FY2022 Earnings Call

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2022 Third Quarter Financial Results Conference Call. Today's call is being recorded. At this time, all participants have been placed on a listen-only mode. And the floor will be open for your questions following the presentation. 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 2022 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, 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. After a challenging first half of the year, the third quarter started off on a constructive note with interest rates declining and interest rate volatility subsiding in July. As has been the typical pattern this year, yield spreads followed the direction of interest rates, with both declining in July, and virtually all fixed income products benefited. Agency RMBS, investment-grade corporates, and high-yield corporates reversed most or all of their losses from the prior month and posted significant outperformance during July versus treasuries and interest rate swaps. Ellington Residential itself generated a positive economic return of nearly 6% in July. The good news proved short-lived, however. Continued elevated inflation led the Fed not only to raise the Fed funds target range by 75 basis points in both July and September, but also to accelerate its balance sheet runoff. Central Banks around the globe also continued tightening their monetary policies. Over the course of August and September, interest rates rose sharply, large segments of the yield curve inverted further, and volatility surged. The MOVE Index, which measures the yield volatility implied by short-term options on long-term treasury notes and bonds, reached its highest level since the COVID-related market volatility of March 2020. Market sentiment steadily weakened, and we saw widespread selling across asset classes, including forced selling by some asset managers to meet margin calls and redemptions, particularly toward the end of the quarter. Liquidity deteriorated and yield spreads widened in virtually every fixed income sector, including Agency RMBS, with many sectors hitting their widest levels of the year. Technical headwinds in the Agency RMBS market included not only the Fed's acceleration of the reduction of its MBS portfolio but also extremely weak bank demand. Turning to slide three. On the top half of the page, you can see just how large these yield curve moves were during the quarter. Then on the bottom half of the page, you can see the impact of these huge moves had on Agency RMBS yield spreads and prices. Both nominal yield spreads and option-adjusted yield spreads widened significantly across the coupon stack, and the combination of wider spreads and higher rates led to sharp price declines. You can see on this slide that Fannie 5.5s, which was still the current coupon at September 30, dropped by more than 4 points quarter-over-quarter, representing an absolutely massive 57 basis points of OAS widening on that coupon, according to JPMorgan's models. Meanwhile, for the longer-duration Fannie 3.5s, which was and is a fairly representative coupon within the 30-year portion of Ellington Residential's agency portfolio, that coupon dropped more than 6 points in price, representing substantial OAS widening. Since the primary mortgage market takes its lead from the secondary mortgage market, the mortgage rates that homeowners see served in sympathy with Agency RMBS yields. The Freddie Mac 30-year survey rate ended the quarter at 6.7%, which was its highest level in the past 15 years and even touched 7.08% two weeks ago, its highest level in over 20 years. As expected, following these recent mortgage rate increases, prepayments continued to grind to a halt, housing became much less affordable, home sale volumes were declining, and we were seeing the first clear evidence of declining home prices nationally. In summary, the market environment in August and September could hardly have been more difficult for Agency RMBS. Ellington Residential experienced a significant net loss for the quarter, as net losses on our specified pools exceeded net gains on our interest rate hedges and net interest income from the portfolio, and we incurred significant delta hedging costs as a result of all the volatility. Our net loss was significant on a mark-to-market basis, but our disciplined and dynamic hedging strategy, which included aggressive duration rebalancing throughout the quarter and positive contributions from our meaningful short TBA position, helped prevent even greater book value declines. Next, on slide four. You'll see that we're reporting $0.23 per share of adjusted distributable earnings for the quarter. As we mentioned on last quarter's call, our ADE faces near-term headwinds as the sharp rise in short-term rates is repricing our repo liabilities higher, and they're repricing higher very quickly at that. And while our asset yields are also increasing, that only gets captured in our NIM as we rotate our portfolio. We're being patient about turning over our deep discount pools given what we perceive as excellent relative value in that sector. As a result, our NIM is compressing in the short term, but we think it's important to prioritize maximizing total economic return while we're trying to maximize short-term ADE. It bears repeating that this all underscores the limitations of focusing too much on ADE, which is a backward-looking measure, particularly in market environments with large swings in interest rates and spreads, such as we're seeing today. The disciplined approach that we're taking with the portfolio turnover, combined with our sequentially lower book value, also meant that our leverage ticked up this quarter. As always, we remain focused on liquidity and risk management, and we continue to follow the same guidelines that have helped us manage past financial shocks effectively. Of note, we continue to hold a strong liquidity position at quarter-end, with cash and unencumbered assets representing 27% of our total equity at September 30. Finally, I'd like to point out that a significant portion of Ellington Residential's losses for the third quarter and indeed for the year resulted from yield spread widening, and I believe that the prospects of recouping many of these losses are strong. 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 five, where you can see a summary of EARN's third quarter financial results. For the quarter ended September 30, we reported a net loss of $1.04 per share and adjusted distributable earnings of $0.23 per share. These results compare to a net loss of $0.82 per share and ADE of $0.20 per share in the second quarter. ADE excludes the catch-up premium amortization adjustment, which was positive $1.4 million in the third quarter, as compared to a positive $1.6 million in the prior quarter. During the third quarter, as Larry noted, Agency RMBS significantly underperformed U.S. Treasury Securities and interest rate swaps, and that drove our net loss for the quarter. Our net interest margin decreased quarter-over-quarter to 1.28% from 1.66% as higher interest rates drove a significant increase in our cost of funds, which exceeded the increase in our asset yields. Our lower NIM combined with lower average holdings quarter-over-quarter caused the decline in ADE. Meanwhile, average pay-ups on our specified pools decreased modestly to 1.02% as of September 30 from 1.09% as of June 30. Please turn now to our balance sheet on slide six. Book value was $7.78 per share at September 30, as compared to $9.07 per share at June 30. Including the $0.24 of dividends in the quarter, our economic return was negative 11.6%. We ended the quarter with cash and cash equivalents of $25.4 million. Next, please turn to slide seven, which shows a summary of our portfolio holdings. In the third quarter, our Agency RMBS, interest-only securities and non-Agency RMBS holdings all decreased modestly. Agency RMBS portfolio turnover in the third quarter was 19%. Additionally, our debt-to-equity ratio adjusted for unsettled purchases and sales increased to 9.1 times as of September 30 as compared to 7.9 times as of June 30. The increase was primarily due to lower shareholders' equity quarter-over-quarter as the portfolio size was relatively constant. Similarly, our net mortgage assets-to-equity ratio increased to 7.5 times from 6.8 times over the same period. I'll note here too that repo financing has remained stable and available, despite the market volatility. On slide eight, you can see the details of our interest rate hedging portfolio. During the quarter, we continued to hedge interest rate risk through the use of interest rate swaps and short positions in TBAs, U.S. Treasury securities, and futures. Finally, we were optimistic with our capital management strategy during the quarter as we issued approximately 148,300 shares to our ATM at an average price of $8.43 per share and repurchased approximately 9,500 shares at an average price of $6.53 per share. I will now turn the presentation over to Mark.

Thank you, Chris. The third quarter was distinct, characterized by significant volatility across nearly all key fixed-income measures. Starting with interest rates, the five-year treasury fluctuated between 2.64% and 4.19% during this period, reflecting a 155 basis point change within just one quarter. The alteration in the yield curve was also notable, with the two-year to 30-year treasury yield spread showing a range of 87 basis points for the quarter, a variation greater than what is typically seen in an entire year. Additionally, the market CDX IG Index, which indicates perceived credit risk for investment-grade corporates, had a range of 37 basis points during the quarter, compared to only a 13 basis point range for all of 2021. This index moved nearly three times as much this quarter as it did in the previous year. Importantly for EARN, mortgage prices and yields were greatly affected by this volatility. During the quarter, Fannie 4s traded within a nine-point price range, while Fannie 5s experienced a remarkable 59 basis point yield spread range. This market is far from normal. The Federal Reserve has implemented four consecutive 75 basis point hikes, totaling more in the last four meetings than in the entire preceding decade. EARN sustained an economic loss of 11.6% for the quarter, with our peers facing even steeper declines. An agency mortgage REIT is not structured to provide favorable returns amid such significant interest rate rises and mortgage spread expansion. I believe much of our loss can be recovered if spreads normalize. October continued to see high volatility, but so far, our book value appears to be around breakeven for the fourth quarter. Considering October's volatility, this is a positive outcome, although an economic return of over 11% loss for the third quarter is certainly disappointing. On a brighter note, the widening spreads have created a promising opportunity for agency REITs that we haven't seen in years. Mortgage spreads are currently very wide by almost any measure. We now have a price range exceeding 20 points in the coupon set trade. While some coupons with poorer convexity characteristics are wider than others, all are experiencing widening. Unlike what we have previously become accustomed to over the last decade, most Agency MBS do not currently exhibit significant negative convexity, which alleviates the need for extensive delta hedging. At current prices, discount coupons are yielding high-quality net interest margins, allowing us to implement suitable hedges without sacrificing much of our NIM when market movements occur. MBS are also wide when considering close-to-worst-case assumptions on prepayment speeds. From a research standpoint, given the recent trend of pricing at a discount rather than a premium, our prepayment models and research approach have shifted from last year's strategies. For context, last summer, TBA Fannie 2s were priced at $102, TBA Fannie 4s at $107, with multiple points needed for loan balance protection on 4s. The focus was on identifying the slowest prepayments for the pay up. Today, for anything priced below $95—most of the MBS universe excluding current coupon production—we are seeking the lowest pay up to attract the fastest prepayments. Interestingly, many models are currently underestimating prepayment speeds compared to actual observations. We anticipate prepayments will be slow, but there's potential upside relative to some of the worst-case assumptions. Furthermore, certain pools can provide even greater upside as they are predicted to pay more quickly than projected models. On the technical side, supply in the Agency market has significantly decreased. Cash-out refinances are much lower as fewer borrowers are willing to refinance low-rate mortgages into ones above 6% just to access some cash. Moreover, Fannie Mae and Freddie are increasing their fees for cash-out refinances. Existing home sales have dropped substantially, which also diminishes net supply because, due to the significant rise in home prices recently, most home sales involve buyers taking out larger mortgages than what the seller is paying off. With housing affordability recently decreasing, this trend is also shifting. A notable distinction between this year's Agency MBS market and previous years is the reduced purchasing by banks. A great deal has been said regarding substantial losses in available-for-sale bank portfolios and sluggish deposit growth. The implications for the Agency MBS market have been significant. Banks have historically been major purchasers of MBS, but their presence this year has been minimal. It would be difficult for them to reduce their purchasing further from current levels. As rates stabilize and they begin to rebuild their capital, some banks might re-enter the market. Typically, during recession periods when banks are concerned about loan losses, we see increased purchasing by banks, which could serve as a significant boost for the sector. Additionally, during the September Fed meeting, Powell made clear statements regarding potential Fed asset sales. Although the Fed's strategy can always shift, Powell indicated they intend to maintain their current processes and are not currently considering MBS sales. This clarification further supports a favorable technical backdrop for the market. Q3 witnessed a substantial amount of selling that contributed to the underperformance of Agency MBS. However, in November, the supply appears to have balanced out more in relation to demand, and we are now observing healthier two-way flows. Now, regarding EARN's future adjusted distributable earnings, we are systematically rotating our portfolio into higher coupons. As we do this, we anticipate a lift in our net interest margin and adjusted distributable earnings, as our book asset yields typically align more closely with our original purchase yields than current market yields. What did we do with the portfolio in Q3? Given the extreme volatility, our priority was to maintain book value rather than increase adjusted distributable earnings. While we are not celebrating a negative economic return exceeding 11%, it's an outcome that is better relative to our Agency peers. The time for raising adjusted distributable earnings may come soon, but in this volatile market, preserving book value takes precedence. We did slightly increase the coupon during the quarter. In light of our equity decline, we also reduced the portfolio size a bit, but the spreads are exceptionally wide right now. They could widen further, but we believe having higher exposure to mortgages at this time is advisable. Looking ahead, while conditions have improved recently, it is premature to relax our vigilance. We must witness a tapering of Fed rate hikes and some progress on inflation to restore stability in the market. Notably, there are indications that demand for spread products is finally re-emerging, which bodes well for our book value. Now, back to Larry.

Thanks, Mark. 2022 has proven to be a challenging year so far. And while the market conditions have obviously hit our book value significantly, we have also recharged the opportunity set. The so-called mortgage basis, the spread between yields on Agency RMBS and treasuries or swaps looks extremely wide on a historical basis today. With net mortgage supply likely be much lower going forward, as well as so much bad news already priced into the market, we think that Agency RMBS offers excellent investment value today. In addition, a recession could actually be a boost for the sector because Agency RMBS has no credit risk. In a recession, the Fed might pause or even reverse the steps it has taken to tighten its monetary policy, which would be a supportive technical. That said, we're near the upper end of the range where we've typically set our leverage. And referring back to slide nine, we're also near the upper end of the range, where we've typically set our net mortgage assets to equity ratio. The upshot is that I wouldn't expect us to be significantly adding to our net RMBS exposure from here. Finally, Ellington Residential has a broad mandate, and we think that there are currently many opportunities in the non-Agency mortgage markets that offer even more compelling value than agencies. Therefore, we are planning to significantly increase our capital allocation to the non-Agency market, perhaps to 25% or more. The last time we did that was right after the COVID market shocks in early 2020. We ended up benefiting handsomely from that reallocation, which helped drive EARN's outperformance in 2020. As we've pointed out before, EARN's smaller size should enable us to be nimble as market conditions evolve. And with that, we'll now open the call up to questions. Operator, please go ahead.

Thank you. We'll take our first question from Crispin Love of Piper Sandler. Please go ahead.

Good morning, everyone. Larry, regarding your comments about increasing non-Agency exposure, possibly up to 25%, could you provide more details on that? What time frame are you considering for this increase? Would it happen relatively quickly, or are you thinking it might take a couple of quarters since you're currently in the very low single digits? I was a bit surprised by that.

Yes. No, I think it can happen relatively quickly. I mean, we're a small company. We're nimble. We're talking about mortgage-backed securities that are fairly easy to access. So yes, I would say, maybe even by year-end. Year-end is often a good time to be buying, as you know.

Right, right. Absolutely. No, that makes sense, and then just looking at the relative yield spreads that you have on slide 10, no surprise, but pretty eye-popping there just with everything near or a lot of the agency market near 24-months wide. Do you have any outlook on widening versus tightening over near to intermediate term, because you could have some pretty big tailwinds to book value if we do see some tightening there?

Right. And I'm going to let Mark answer that question. But I would say that it's interesting. So everybody's got a different prepayment model, right? And we've talked about how research and prepayments are so important. So slide, I think it was three, we show some OASs based upon JPMorgan's models. On this slide, I believe this is Morgan Stanley's OAS models. You can see that Morgan Stanley's model, I mean, on Fannie 3s, and I think on the other slide, it was 2.5s and 3.5s, but you get the idea, as obviously, a much slower prepayment model than many of the others. So it really is very model dependent on the mortgage market. But we do think that OASs are very wide. We think that perhaps Morgan Stanley's model is a little bit too much on the pessimistic side. So I just wanted to point that out before Mark addresses the question about where, I guess, you're asking really where you see spreads heading ultimately?

Yes, Crispin, so you can see that given our historical track record, our mortgage basis exposure is relatively high now, which that is an indication that we do think it's more likely that spreads tighten from where they are than widen. It is even if they stay where they are, they're very wide. You generate a very wide net interest margin. In the prepared comments, I did mention some of the things that I thought could be supportive of the mortgage basis. Supply is way down, I think some of the deleveraging selling that weighed on the market in Q3, some of that feels as though it's behind us. I mentioned that banks that are normally huge buyers throughout the course of the year have been noticeably absent from the securities market this year. So I think I said it's somewhat hard for them to buy less. You've seen some overseas buying as well. It does feel to me that given the backdrop of greatly reduced supply that any incremental buying from new pools of capital, be it banks or money managers of the redemption stock, can really move the basis a lot, because you're not dealing with a lot of supply coming into this market, given how high mortgage rates are. Obviously, geopolitical forces or other economic numbers can provide shocks that can change that. But I would say we sort of think it's more likely than not that spreads will recover from where they were at the end of the quarter. And so that was the thought process behind our positioning.

Sorry, I just want to add one thing. When we receive good news like today, it doesn't mean everything has changed, but it could indicate that we are heading in the right direction. Typically, we see liquid markets, such as the agency markets, react first with spread tightening. This could work out favorably for us from a timing standpoint. We could potentially recover some of the losses from earlier spread widening in our agency portfolio and rotate out some of that as well. There may still be some upside left, but if the non-agency and less liquid markets lag in terms of spread tightening, it could benefit us significantly.

Great, thanks. Larry, Mark for those comments. Just a final clarification question from me. So Mark, you made some comments about book value so far in the quarter, I think you said breakeven. So is book value at around $7.78 or so. Is that as of the end of October? Or is it even more recent than that?

Yes. This is Larry. We are discussing things today, as you know. I don’t want to provide an estimate as of November 10; that’s not our approach. However, just to clarify, we were referring to book value, considering any interim dividends. We believe book value is close to breakeven.

Perfect. Thanks for taking my questions.

Thanks, Crispin.

Thank you.

Thank you. Our next question comes from Doug Harter of Credit Suisse.

Thanks. Can you just talk about how you are continuing to think about leverage in light of volatility today being kind of volatility to the good? But kind of moves continuing to kind of be very large and how you think about positioning into that type of market?

Yes, it's Larry. Hey Doug. Let’s discuss the two kinds of leverage. One is actual technical leverage regarding our financial leverage, repo borrowings, and so on. At the end of the quarter, we were above 9:1, and I’m not sure we’ve ever exceeded 10:1 at a quarter-end. We've encountered similar situations before, and this is really at the higher end of our leverage range. I wouldn't anticipate it increasing significantly. In fact, if we start transitioning from some agencies to non-agencies, we would expect that figure to decrease since we typically leverage non-agencies much less. Mark, would you like to address our mortgage exposure? We finished the quarter at 7.5:1, also near the top of our range, and spreads have tightened a bit. What do you think, Mark?

Today is quite an interesting day. Larry and I discussed how there has been a significant movement in interest rates, specifically a 30 basis point shift, along with notable changes in credit spreads. The investment-grade index has tightened by about six basis points, which we mentioned in our prepared comments. Such a large adjustment in interest rates is rare, occurring perhaps once a year or every other year. Despite this significant change, implied volatility has actually decreased today. The large movement indicates a response to inflation and the Federal Reserve's consistent rate hikes, suggesting that we may see reduced volatility going forward as economic indicators reflect these actions. Powell's recent remarks about the long and variable lag between rate hikes and their effect on the economy resonated with the market. Different sectors respond at varying times, with the housing market being the most sensitive to interest rates. We have seen a complete reversal in housing activity, which rose over 20% in 2021 and saw an additional 10% increase in the first half of this year, but recently experienced some of the most significant one-month declines in a long while. As interest rates affect buyers' ability to qualify based on their debt-to-income ratios, existing home sales have dropped to 20-year lows, and new home sales are also slowing, with builders reporting order cancellations. While there was considerable volatility today, there is potential for interest rates to stabilize, leading some market participants to feel more comfortable committing capital. As for our mortgage exposure, it is currently at the upper end of our typical range, and repo borrowings are also on the higher side. However, many of the pools we own are characterized by relatively low pay-ups. Though there is financing involved, the risk is limited, unlike the higher pay-ups seen by other companies during COVID. Many pools are even generating positive returns. If market conditions are favorable and valuations align, we may reduce our agency mortgage exposure, which would consequently lower our repo borrowings as well. Those figures are already somewhat outdated, nearly six weeks behind.

Got it. Thank you.

Sure. You’re welcome.

Thank you. We'll take our next question from Eric Hagen of BTIG.

Hey, everyone. You have Ethan Saghi on for Eric today. Thanks for taking my questions. First one, just how do you see dollar roll financing evolving? And what conditions will it be most sensitive to?

So this is Mark. Thanks for the question, Ethan. Dollar rolls are viewed in a few different ways. One way to approach it is to consider the current repo rates, which are about 3.9% for one-month repo. You can compare this with the dollar roll and determine the implied prepayment speed that would make you indifferent between doing the dollar roll or having a pool on repo. Currently, when dollar rolls are cheap and not in high demand, the conditional prepayment rates are quite low, with some rolls reflecting implied CPRs of 1% to 3%. There are pools available that offer returns above those figures. This situation contrasts sharply with 2021 when the Fed was actively buying a large quantity of Fannie Mae securities, making those rolls consistently valuable. This year, the scenario has flipped, as rolls for discount coupons have not been special, which isn't surprising considering the absence of the Fed and participation from other buyers like banks in lower coupons. In higher coupon areas, such as Fannie 6s, there has been some roll volatility, but overall financing has been stable this year. The significant fluctuations in the market have made participants wary of holding large balance sheets, which explains why we aren't seeing primary dealers or investment banks engage heavily in these rolls, even if the economics appear favorable; their balance sheet costs weigh heavily on their decisions. Consequently, the lower coupons have not been particularly interesting for us, and so we are short TBAs while holding some pools in that space. In terms of higher coupons, we anticipate continued roll volatility. If banks begin to enter the market in large numbers, especially buying Fannie 6s, the limited floating supply in this coupon could lead to increased roll volatility, a trend we've started to observe over the last few months.

Got it, that all makes sense. And then just another question, kind of piggybacking off the last question on leverage. Just how much net mortgage leverage do you feel comfortable with? If you can just talk about the relationship between the net mortgage leverage and debt to equity, that would be helpful.

Yes. So we're comfortable with where we're at now. I don't think we'd bring that up unless spreads were to take another leg wider. If you take our mortgage exposure, right, you can think about the company as having, okay, if we just own a bunch of pools and we're paying fixed on a bunch of SOFR swaps, that's our mortgage exposure. If we own some pools that are hedged with TBA, that won't change our mortgage exposure because the mortgage exposure from the pool we own is netted against the mortgage exposure, we're short in shorting TBAs. So having pools versus TBA doesn't increase our net mortgage exposure but does increase our repo borrowings. You can look at what we report from net mortgage exposure and what we report for the total repo borrowings; you can kind of partition the portfolio as some large portion of the pools hedged with SOFR swaps and then another portion of the pools hedge with being short TBA.

Yes. So if you refer to slide nine, right, you can see that as well, our leverage ticked up, but it's not on this slide from the second end of the second quarter to the end of the third quarter, but our net mortgage assets to equity ratio also ticked up. That mid-7s, as Mark says, that's towards the high-end of the range for us. I wouldn't expect that to tick up much from there.

Got it. All right. Thanks for answering my questions.

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

Good morning, gentlemen. Hope everybody is doing well?

Thanks, you too.

Most of my questions have already been addressed. However, I was curious about a hypothetical scenario considering today's CPI print and the market's reaction. If we continue to see more favorable CPI prints in the coming months and the Fed decides to raise rates by 50 in December, then reduce to 25 early next year, before pausing possibly in late spring, the main uncertainty is whether a recession will occur around the same time.

My question to you is, do you know something that we don't?

Like I said, a hypothetical scenario, I'm just kind of talking. What would the ideal sort of portfolio construction be in an environment where the Fed has stopped hiking? Forget about the potential recession. Just the Fed is that is no longer hiking, they've achieved their neutral rate or so, they think. You guys have gone with your portfolio rotation from now to that point, what would an ideal portfolio look like? What would that process kind of look like?

I would say we have a strong research effort in place, but our focus isn't on predicting the Fed's actions. Instead, we aim to position our portfolios without bias towards the direction of interest rates, while also considering unexpected events that could significantly impact the market. If we start to see positive news regarding inflation and it appears that the Fed is nearing the end of its rate hike cycle, there seems to be considerable interest from our clients at Ellington in fixed income and credit markets, which has been held back due to market volatility. They want clarity on how far the Fed will go. This year has seen inflation figures generally outpacing expectations, prompting the Fed to respond with increasing rate projections. Many investors have been patient, and their patience has begun to pay off. There is substantial cash available for the Agency MBS and credit markets. I believe if we achieve stability with improved inflation and a perception that the most significant rate hikes are behind us, that capital will be deployed quickly. This scenario would be favorable for spread products, Agency MBS, and non-Agency MBS. As we mentioned in our prepared remarks, one strategy we consider for EARN is reallocating some capital into non-Agency securities, similar to what we did in 2020, as different sectors tend to recover at varying paces. Since our book value has remained mostly unchanged since the end of September, it reflects the movement in mortgage spreads. In the non-Agency securitized products sector, credit risk transfers, legacy non-agency bonds, and non-QM bonds, despite a good recovery in liquid credit indices, cash credit bonds have generally suffered due to heavy selling. Various factors contributed to this, including the pressure on U.K. pension funds utilizing liability-driven investment strategies, which caused them to liquidate positions when margin calls occurred. There was a disparity between the pricing of structured products and cash bonds, particularly in the Agency MBS, IG, and high-yield indices throughout October. This trend was also observable in the CLO and CRT markets, indicating a significant gap between cash and synthetic indices. In an environment where the Fed pauses, everything tends to perform well. However, if we face a mild recession, I believe this would still benefit Agency MBS, as it is a spread product that carries no credit risk. Concerns about credit could make Agency MBS more appealing. If banks become more anxious about a recession and feel the need to allocate more capital under CECL, securities could be favored over loans. This was evident post-COVID when banks, worried about a recession and loan obligations, favored securities. These are some considerations we've been reflecting on.

Thank you very much, gentlemen. That’s great detail. Thank you.

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