Ellington Credit Co (EARN) Q1 2027 Earnings Call Transcript

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Credit Company first fiscal quarter ended June 30, 2026 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. If you would like to ask a question at that time, please press star 1 on your telephone keypad. At any time, if your question has been answered, you may remove yourself from the queue by pressing star 2. Lastly, if you should require operator assistance, please press star 1. It is now my pleasure to turn the floor over to Aladeen Chalet, Associate General Counsel. Sir, you may begin.

Thank you. Before we begin, I would like to remind everyone that this conference call may include forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not historical in nature and involve risks and uncertainties detailed in our registration statement on Form N2. Actual results may differ materially from these statements, so they should not be considered to be predictions of future events. The company undertakes no obligation to update these forward-looking statements. Joining me today are Larry Penn, Chief Executive Officer of Allingen Credit Company, Greg Bornstein, Portfolio Manager, and Chris Mernoff, Chief Financial Officer. Our earnings presentation is available on our website, EllingtonCredit.com. Today's call will track that presentation, and all statements and references to figures are qualified by the important notice and end notes at the back of the presentation. With that, I'll turn the call over to Larry.

Thanks, Aladin, and good morning, everyone. We appreciate your time and interest in Ellington Credit Company, which we often refer to by its New York Stock Exchange ticker, EARN, or EARN for short. Please turn to slide three. The second calendar quarter marked an important inflection point for EARN's portfolio. The market sell-off earlier in the year widened credit spreads and significantly expanded the CLO opportunity set, and we moved quickly, issuing unsecured debt in late March, rapidly deploying the proceeds in April, and actively repositioning the portfolio throughout. Those actions proved to be well-timed. As the second quarter progressed, credit fundamentals improved, and active trading and rotation allowed us to further upgrade portfolio quality. For the quarter, we generated an economic return of 8.1% non-annualized, increased our NAV per share, and strengthened the portfolio's long-term return profile, even as we reduced leverage. Total equity also grew, adding to our balance sheet capacity and financial flexibility. We believe that we are well positioned to grow net investment income in the months ahead, as our NII for the full quarter did not yet fully reflect the earnings power of our expanded and repositioned portfolio as of the end of the quarter. The second quarter was about building earnings capacity, and the upcoming quarters are about converting that capacity into higher net investment income and earnings, while maintaining our discipline around credit quality, liquidity, and NAV preservation. We see three primary drivers of net investment income growth. First, deploying our excess liquidity. Greg will discuss the attractive investment opportunities we're seeing, and that's where we're putting our excess liquidity to work. Second, prudently adding leverage. Our strong balance sheet, larger equity base, and meaningful remaining borrowing capacity give us the flexibility to further expand the portfolio beyond its current size. We also have the ability to issue common equity above NAV when market conditions permit, providing another source of accretive growth capital. And third, portfolio rotation. We expect to continue rotating capital into higher-yielding investments, pursuing attractive CLO refinancings and resets, and actively trading across the CLO capital structure. These three drivers, all of which are largely within our control, give us a clear path to grow earnings in the coming months. To be clear, we do not need to reach for yield in order to grow earnings. As Greg will explain, the portfolio repositioning we completed during the second quarter allowed us to increase income potential while actually improving credit quality and, in many cases, reducing risk. With that, I'll turn it over to Chris. We'll walk through the quarter's financial results in more detail, including how our balance sheet and portfolio are positioned to support NII growth.

Thanks, Larry, and good morning, everyone. Please turn to slide four. For the quarter ended June 30, 2026, we reported GAAP net income of $0.33 per share and net investment income of $0.16 per share. Adjusted net investment income was $0.15 per share. Our NAV increased to $4.18 per share at June 30, which, together with the $0.24 per share of distributions during the quarter, produced an economic return of 8.1%. As Larry discussed, significant capital deployment and portfolio repositioning occurred during the quarter. So the resulting increase in earnings capacity was not yet fully reflected in second quarter NII. Please turn to slide six for a breakdown of our quarterly results by investment category. Our CLO portfolio generated strong results across both debt and equity. NAII was complemented by substantial net unrealized gains in U.S. and European CLO debt and U.S. CLO equity as credit spreads tightened and underlying loan performance improved. We also generated trading gains on mezzanine debt and benefited from calls on several discounted positions. These gains were partially offset by losses on our corporate credit hedges as broader credit spreads tightened during the quarter. Most of that hedge drag occurred in April when the credit markets rebounded sharply and during the same period in which our long CLO portfolio generated substantial mark-to-market gains. Let's go over a few different yield measures since each tells us something different. The weighted average gap yield on the entire CLO portfolio was 11.9% during the quarter, while the weighted average yield on our incremental purchases during the quarter was higher at approximately 14.9%. As of June 30th, the weighted average yield projected on the portfolio measured using fair value rather than cost was approximately 16.6%, reflecting the stronger forward return profile of our repositioned portfolio. Meanwhile, attractive reinvestment yields have continued with our weighted average purchase yields so far in the third quarter at approximately 16.8%. Importantly, these higher reinvestment yields do not come from taking on more risk. Rather, they reflect in large part improving fundamentals in the underlying loan market, as well as attractive entry points created by technical selling and capital outflows. As these higher yields work their way through the portfolio, they should provide a tailwind for NII. Please turn to slide 7. We purchased $64.8 million of CLO investments and sold $35.1 million, growing the CLO portfolio to $334.1 million at June 30th from $307.9 million at March 31st. That 8.5% net portfolio growth actually understates the level of activity during the quarter. Significant cash distributions, calls and paydowns provided additional capital for reinvestment, while active portfolio rotation further increased turnover, including sales of positions where we believe much of the remaining upside had been realized. As you can see on this slide, our portfolio rotation mostly happened within sectors as opposed to cross-sectors, with CLO equity representing approximately 54% of the overall CLO portfolio at quarter end, up only slightly from 53%, and with the European investments remaining at approximately 10% of the overall CLO portfolio. Slides 8 and 9 provide additional detail on the corporate loans underlying our CLO investments. Our CLO collateral remains overwhelmingly first lien floating rate leveraged loans, representing roughly 95% of the underlying assets. These loans are well diversified across industries and issuers led by technology, financial services, and healthcare, with no single sector exceeding 11%. Loan maturities are spread over several years with the largest concentrations in 2031 and 2032 and the minimal near-term maturities, resulting in a weighted average loan maturity of 4.4 years. Facility sizes skew towards larger borrowers with a weighted average size of $1.9 billion, which supports secondary market liquidity. Please turn to slide 10 for an overview of our credit hedges. At June 30th, our credit hedge portfolio represented approximately $132 million of high-yield CDX notional equivalents, down from approximately $188 million at March 31st. Greg will discuss the drivers of that reduction. We also continue to maintain foreign currency hedges associated with our European CLO investments. Turning to slide 11, total net asset value was $159.7 million at June 30, up from $153.8 million at March 31, and that per share increased to $4.18 for $4.09. Cash and cash equivalents totaled $23.5 million. dollars. Reverse repo borrowings declined by nearly 9% to $151.9 million from $166.3 million, while unsecured notes outstanding remained unchanged at $54 million. Lower borrowing and a higher net asset value brought our leverage ratios down. Our debt to equity declined to 1.29 times at June 30th from 1.43 times at March 31st, leaving us with a stronger, more flexible balance sheet and additional borrowing capacity entering the third quarter. Together with the higher reinvestment yields I mentioned earlier, that additional balance sheet capacity reinforces our ability to grow NII. With that, I'll turn the call over to Greg to discuss the CLO market environment, portfolio positioning, and outlook. Greg?

Thanks, Chris. Q2 is a great quarter for EARN and provided a particular market volatility in Q1, driven first by and followed by disruption and our debt issuance. As always, we weighed opportunities across CLO, MES, and equity and actively maneuvered the book, not including hedges or deal calls. We found CLO specifically in the U.S., but defaults were not meaningfully elevated. In fact, default rates and distressed debt exchange activity both declined modestly in the quarter, and loan prices recovered. Further, despite the recovery in loan prices, the share of loans trading above par remained relatively low, and much of the strength in loans trading above par with robust, so welcome change from prior opportunities for CLO. In response to these developments, we continued shifting towards longer tenor while reducing exposures with greater sensitive COLO debt spreads recovered, COLO equity in deals that saw meaningful benefits from the opportunity to refinance liabilities that had originally been set at wider spreads. Earned COLO equity profile benefited from several dynamic heads per COLO debt spreads when we again purchased no new issue equity during the quarter. COLO MEZ has been a relatively steady performer for Earn, and that trend continued into the trading near or above par and into higher coupon, wider spread investments, Mez currently offers an attractive combination of yield, downside protection, and liquidity. Our Mez portfolio had a great quarter, led by high net interest margins, continuing to benefit from a double visa roughly two to three times that spread continue to offer. Furthermore, these are spreads that these bonds offer additional upside from deal calls or resets. As a result, higher quality, higher coupon double visa discounts to par, have been one of our favorite areas for incremental investments. Concerns about a tightening low market on the back of increasing what U.S. CLO equity experienced with an incompression and reduced equity cash. We completed our debt deal in March, one of our biggest risks before the market potentially given that the cost of the debt was already locked in. This motivated us to hold the primary driver of the decline in hedge notion. This reduced the run, and meanwhile, we continued to carry the CLO positions we'd previously acquired at wider yield spread. At the deployment of the proceeds during the quarter, this all helped minimize the earnings drag, looking forward to somewhat tighter levels. But loan fundamentals are in pretty market looks as attractive. We will continue to value liquidity and the ability to maneuver the book.

As Greg's comments make clear, we continue to see plenty of opportunities to actively manage and improve the portfolio. We are already seeing the benefits in our third quarter results. I encourage investors to review the July portfolio update that we posted last night to our website. As reflected in that update, EARN's positive momentum continued into July. We generated an economic return of approximately 3.1% for the month, or $0.13 per share. This more than covered our $0.08 monthly distribution and enabled NAV per share to increase by approximately $0.05 in July, using the midpoint of the NAV range reported in that update. I can also report that adjusted NII for July was approximately $0.06 per share, representing a monthly run rate that's about 20% higher than our second quarter figure. This shows that the earnings capacity we build during the second quarter is beginning to translate into incremental NII. And as mentioned, we still see significant upside from there as we deploy our remaining balance sheet capacity and continue to rotate the portfolio. On the topic of rotation, we have remained highly active in the third quarter, executing 38 CLO trades in just the past six weeks. This activity reflects the same portfolio discipline we've applied consistently. We've exited positions where we believe we've already captured most of the value, and we've redeployed that capital into investments that we believe offer better yields, stronger structures, and better risk-adjusted returns. Our overall portfolio size is roughly unchanged so far in the third quarter, as new investment activity has roughly offset stronger-than-projected deal call activity, natural return of investment on CLO equity, and opportunistic sales. In conclusion, we believe that the current investment environment is ideally suited for earned to keep growing net investment income and generating attractive total returns. Even if volatility returns, we believe that our active trading, flexible balance sheet, and disciplined hedging strategy will once again allow us to capitalize on market dislocations and create value for shareholders. In either case, we believe that EARN is well-positioned to generate attractive long-term risk-adjusted returns across a wide range of market environments. Thank you again for your continued interest and support of Ellington Credit Company. Operator, please open the line for questions.

Thank you. If you'd like to ask a question, press star 1 on your keypad. To leave the queue at any time, press star 2. Once again, that is star 1 to ask a question. And our first question today comes from Crispin Love with Piper Sandler. Your line is now open.

Thank you. Good morning, everyone. So you definitely took advantage of some of the dislocation in the prior quarter. And you did comment that the June quarter didn't fully reflect the expanded reposition portfolio. And Larry, You just called out the, at this extent, run rate and adjusted net investment income in July. Can you just discuss a potential trajectory as you look forward, as you talked about you could add some leverage, could continue to tap the ATM, and then just with all that in mind, how comfortable you are with the current dividend level?

Yeah. Start with the dividend. Comfortable with the level. And I'm going to reiterate what I think I said on last earnings call, which is, you know, we see us getting into the low 20s on net investment income, adjusted net investment income.

Okay. So getting to the low 20s over the next couple of quarters?

Yes. Sure.

Okay. And then just looking at the July update, the CLO portfolio is down a little relative to June. The debt portfolio down, a CLO equity up slightly. Can you just share some of the thinking there, some of the drivers of the portfolio? Is that more timing of selling more than anything else? You did call out some recent caution. And then just how close are you to being fully invested today?

Greg, you want to talk about our sort of timing strategy there?

Sure. I mean, some of it, you know, a deploy and just strategy going forward from a performance I mean, we're going to start to rotate things that maybe we played for more of a total return that were maybe at more of a price discount rotating out of things that had more total You know, I think one thing to remember with this portfolio is obviously we referenced on the MEZ end. Not everything is. And so I think that we're probably going to rotate it. We do like equity into stronger, higher cash flow. And I think on the MEZ side, longer dated.

Great. Thank you. And I could just kind of squeeze in one last one just on leverage. You did comment a couple of times just potentially selectively adding leverage. I think you've been in the one three to one four times range in recent quarters. Can you just share a little bit more color there, just how, where you could be comfortable getting to on a leverage side? Sure. Hey, Kristen, it's JR. So, leverage is also a function of what kind of credit hedges we have in place as they all kind of go together. We mentioned debt equity was 1.43 at March 31, and it was 1.29 at June 30, debt equity. I could see it getting back closer to the March 31st level as we take, we have, you know, ability to grow the portfolio another 5%, 10% from the June 30 numbers.

Yeah, I would just add a little bit on what I, with a lot of the distributions, again, the amount of.

Yeah, and those are lumpy. Things like deal calls, you know, spreads will tighten, we'll have an opportunity. So, you know, the, I think you're going to see, it's going to be the kind of two steps forward, one step back, right? So this is just going to be some natural variation. We see it on a daily basis, obviously, but just when you're looking at the month end snapshots. But we think we're definitely headed in that direction. We mentioned we have excess liquidity, so that's obviously the first source of increasing the portfolio size and leverage.

Perfect. Thank you. I appreciate you taking the question.

Thank you, Rissa.

Thank you. That was our final question for today. We thank you for participating in the Ellington Credit Company first fiscal quarter ended June 30, 2026 results conference call.