Ellington Financial Inc. Q2 FY2020 Earnings Call

Good morning, ladies and gentlemen, thank you for standing by. And welcome to the Ellington Financial Second Quarter 2020 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 open for your questions following the presentation. 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 filed on March 13, 2020, and under Part 2 item 1A of our quarterly report on Form 10-Q as amended for the three months period ended March 31, 2020. 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 am joined on the call today by Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, Co-Chief Investment Officer of EFC; and JR Herlihy, Chief Financial Officer of EFC. As described in our earnings press release, our second 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. Over the course of the second quarter, we saw a significant rebound across most credit-sensitive fixed income assets, following that violent sell-off in March and early April. Thanks to our risk and liquidity management, EFC avoided forced or distressed asset sales during the market turmoil, and thus we avoided locking in losses at depressed prices. If you recall from our previous earnings call, we explained that when we had strategically sold Agency MBS in March and early April, we focused those sales on our most generic lower pay-ups specified pools, keeping our deep value pools with higher pay-ups in anticipation of an eventual market rebound. This selective selling in Agency MBS enabled us to get through the market crisis with our credit portfolio intact and our liquidity solid. After the worst had passed, we first resumed only very limited purchases and sales in credit. However, moving into May and June, markets had stabilized enough that we fully resume new investments, both in credit and agency. With many specialty finance companies still hobbled in the aftermath of the market-wide deleveraging events of March and early April, we are seeing compelling net interest margins on new loan originations and are exploring some exciting potential strategic investments in loan originators. As of today, our agency portfolio is about back to where it was on March 31st. But more importantly, our credit portfolio is already about 5% larger today than it was on June 30th, just a little over a month ago. To summarize, all the steps we took during the depths of the market stresses have not only enabled us to participate in the market rebound in our existing credit assets, but since then we've been able to add and continue to add credit assets at highly attractive prices. As you can see on slide 4, we had $0.85 per share of net income and $0.39 per share of core earnings. Since these both easily covered our $0.25 of dividends declared for the quarter, we rebuilt a nice amount of book value during the quarter, and we are demonstrating that there's ample room for us to grow our dividend. Our economic return for the quarter was 5.7%, which is around 25% annualized. Importantly, we had excellent performance from our loan businesses. In our non-QM business, we completed our fifth securitization in June with strong investor demand, and our non-QM loan production has now come roaring back. Our short duration loan portfolios, especially our residential transition loan and consumer loan portfolios, generated great ROEs this quarter. As with previous quarters, our short duration loan portfolios have continued to return principal quickly. During the second quarter, we received proceeds from principal repayments of about $70 million on our small balance commercial mortgage loan, consumer loan, and residential transition loan portfolios, which represented more than 11% of the aggregate size of those portfolios coming into the quarter. When the opportunity set for new investments is changing quickly, like it has this year for our loan businesses, short duration can be a huge benefit as we can redeploy our incoming stream of principal payments exactly in those subsectors where we see the best opportunities. Additionally, Longbridge Financial, the reverse mortgage originator in which we hold a minority stake, had one of its strongest quarters yet driven by strong borrower demand in the current environment and higher origination margins. Because the reverse mortgage business provides liquidity to borrowers without the need for them to make monthly principal and interest payments, that business has a countercyclical component to it. Not surprisingly, borrower demand for the product has soared in recent months amidst the economic pain and uncertainty brought on by COVID. Finally, we also had an exceptional quarter in our Agency RMBS portfolio, which Mark will discuss in more detail. On the liability side of the balance sheet, we took substantial steps during the second quarter to further improve and extend our sources of financing and leverage. The non-QM securitization deal we completed added yet another term non-mark-to-market facility to our balance sheet. We also extended the terms of several of our credit facilities and obtained term financing for numerous loan assets that were previously unfinanced. Furthermore, the market for standard repo financing of securities has now largely returned to pre-March levels. We finished the second quarter with lower leverage and more cash than we held at March 31. Thus, we continue to maintain ample dry powder to capitalize on opportunities and to withstand any future shocks. With that, I'll turn the call over to JR to go through our second quarter financial results in more detail.

Thanks, Larry, and good morning everyone. Please turn to slide 6 for a summary of our income statement. For the quarter ended June 30, EFC reported net income of $0.85 per common share compared to a net loss of $3.04 per share for the first quarter. As Larry mentioned, prices in many credit-sensitive fixed income sectors rebounded in the second quarter generating significant net realized and unrealized gains on our credit assets, which reversed a portion of our losses from the first quarter. Core earnings for the second quarter were $0.39 per share compared to $0.46 per share in the first quarter and exceeded the common stock dividends declared during the second quarter of $0.25 per share. The sequential decline in core earnings per share was primarily due to lower average holdings period-over-period. Next, please turn to slide 7 for the attribution of earnings between our credit and agency strategies. During the second quarter, the credit strategy generated a total gross profit of $0.76 per share, while the agency strategy generated a total gross profit of $0.33 per share. These compare to a gross loss of $2.47 per share in the credit strategy and a total gross loss of $0.38 per share in the agency strategy in the prior quarter. Most of our credit strategies performed well during the second quarter. We recorded large gains on non-QM loans, non-Agency RMBS, and CMBS, all sectors that had experienced substantial distressed selling during the first quarter, followed by a sharp rebound in prices and liquidity in the second quarter. Our loan strategies also performed well, led by strong performance in the consumer loan and residential transition loan portfolios. In addition, our investments in loan originators generated solid returns during the quarter driven by an excellent quarter by Longbridge Financial. Conversely, our CLO holdings and Euro-denominated RMBS portfolio generated net losses for the quarter, and credit hedges were a drag on performance. Despite the partial market recovery in the second quarter, prices for many of our credit investments remain below pre-COVID levels, and we are still anticipating some principal losses in our credit portfolio. As has been widely reported, there has been a significant nationwide increase in loan delinquencies, forbearances, deferments, and modifications, and we are seeing effects of this on our own portfolios. Our agency strategy performed exceptionally well during the second quarter driven by significantly higher pay-ups on specified pools. In the first quarter, pay-ups had declined due to market-wide liquidity problems, as well as the implementation of the Federal Reserve's asset purchase program, which was focused on TBAs and generic pools as opposed to specified pools. In the second quarter, asset purchases by the Federal Reserve continued to be significant and the liquidity stresses of the previous quarter subsided. At the same time, mortgage rates declined and actual and projected prepayment rates rose significantly, which drove the expansion of pay-ups on our prepayment-protected specified pools. Average pay-outs on our specified pools increased to 3.3% as of June 30 from 1.47% as of March 31. Also, in our agency portfolio, our reverse mortgage portfolio performed well, with much of the yield spread widening from March reversing during the second quarter. Turning next to slide 8, you can see that the size of our loan credit portfolio decreased approximately 14% to $1.26 billion at June 30. The decrease in the credit portfolio was mainly due to the completion of our non-QM securitization in June. Otherwise, sales and principal repayments roughly offset purchases and net realized and unrealized gains during the quarter. As Larry mentioned, we've continued making new credit investments into the third quarter, and as of today, the credit portfolio is back above $1.3 billion. On slide 9, you can see the agency portfolio. As Larry mentioned, we continued selling Agency RMBS into April as markets remained choppy, but moving into May and June, markets stabilized and we began building the agency portfolio back up again. Overall, the sales in April and principal repayments during the quarter exceeded the new purchases, and the portfolio declined in size by 10% quarter-over-quarter to $913 million. As of today, the agency portfolio is back up to about $1 billion. Next, please turn to slide 10 for a summary of our borrowings. Primarily, as a result of agency sales, our debt-to-equity ratio declined to 2.7:1 as of June 30, from 3.1:1 at March 31, adjusting for unsettled purchases and sales. Our recourse debt-to-equity ratio also, adjusted for unsettled purchases and sales, decreased over the same period to 1.5:1 from 2.1:1. The decline in our recourse debt-to-equity ratio was also driven by the completion of our non-QM securitization in June, which converted about $215 million of repo borrowings into non-recourse term financing. Our weighted average cost of funds continued to decrease sequentially to 2.35% at June 30 from 2.58% at March 31. At quarter end, we had cash and cash equivalents of approximately $147 million along with other unencumbered assets of approximately $312 million. For the second quarter, our total G&A expenses were $0.15 per share, up slightly from $0.14 per share in the prior quarter. Other investment-related expenses increased quarter-over-quarter to $0.12 per share from $0.09, mainly because we incurred non-QM securitization issuance costs in Q2 but not in Q1. For the second quarter, we had accrued income tax expenses of $1.5 million as net taxable income in our domestic taxable REIT subsidiaries led to an increase in deferred tax liabilities. Finally, our book value per common share at June 30 was $15.67, up 4.1% from $15.06 at the end of the first quarter. Now, over to Mark.

Thanks JR. Q2 was a strong quarter for EFC with broad-based contributions from many strategies and strong core earnings. This was a quarter where our focus changed as the quarter progressed. Early in April, markets were still volatile. Credit performance was uncertain, and many investors were still being forced to sell assets. EFC was able to avoid having to sell into weakness, helped by our high credit quality short duration portfolio and low leverage that we brought into the COVID crisis. Even in March and April, we were still getting substantial loan payoffs at par across our various loan strategies which is the best way to delever a portfolio. In early May, we were starting to see green shoots of recovery and we began to focus on growing our portfolio and being an opportunistic buyer of distressed securities and loans. One of the first sectors we added was seasoned non-agency RMBS. You can see the growth of that strategy on slide eight. The legacy non-agency market bore the brunt of relentless REIT and mutual fund selling in March and April, which pushed prices to very distressed levels. Against the backdrop of aggressive Fed intervention, we were confident that housing would fare relatively well, which would support non-agency fundamentals. So that sector made a lot of sense to us early in the quarter and indeed has subsequently repriced higher since. When the recovery started in earnest, we were a little surprised by how quickly the credit markets rebounded without really any material good news about either containment of the virus or about any economic turnaround. It seemed that within a matter of weeks the market went from too many sellers to too many buyers. The QE playbook was working as designed. The Fed was buying more than what was being produced in treasuries and agency MBS, which was driving down yields; investors were selling these low-yielding safe assets to the Fed and receiving cash that pays them literally zero and so they were using that cash to buy riskier assets that still have some yield. While we were confident about the resiliency of housing during the pandemic, we believe that the impact of COVID on commercial real estate was going to be more significant and longer-lasting. Whereas the residential housing market is being helped by record low mortgage rates and generous forbearance programs, there are simply not the same amount of government programs that directly support commercial lending or offer relief to distressed commercial borrowers. That said, our CMBS and small balance commercial loan portfolios performed extremely well in the second quarter. Please turn to slide 12. You can see that we've expanded our small balance commercial loan disclosure in this quarter's earnings presentation. While our commercial mortgage portfolio will have some challenges, we are optimistic that these challenges will be limited. Meanwhile, you can see that we are well-diversified among property types and geography, and all our loans are first liens. One huge positive development for the commercial real estate sector this quarter was the return of an active securitization market. After the global financial crisis of 2008 and 2009, it took years for the securitization markets to reopen. In this crisis, the securitization market reopened in a matter of weeks. This is significant because securitization allows capital to flow, which means that real estate can be financed, so it can be bought and sold; commercial bridge loans can get termed out into conduit CMBS loans, and property owners can take advantage of record low interest rates. In fact, EFC has continued to have favorable resolutions on a small balance commercial loan portfolio. Moving to the residential market, aggressive Fed intervention lowered mortgage rates below 3%, which is very supportive of home prices. In addition, the widespread availability of forbearance is keeping any possible distressed mortgage supply off the market, and this should continue for a while. Given the economic uncertainty, you have seen a marginal tightening of the GSE credit box. As a result, we expect the non-QM sector to continue to fulfill an important role in the mortgage origination landscape for homebuyers that don't fit into what is now a narrower GSE box. Residential securitization markets also reopened this quarter, allowing EFC to price its fifth non-QM securitization. Due to the tremendous support from the Fed and the GSEs for the housing market, we're very aggressive about restarting our non-QM lending programs, and being an early mover is paying off for us now. Our non-QM volumes in June and July surprised us with their strength. As with many origination businesses, margins are healthy; like Larry mentioned with respect to the reverse mortgage sector as well. While we do expect the non-QM origination market to become more competitive over time, right now, we are enjoying strong market share and benefiting from being one of the first platforms to start originating again after the market stress in March. The non-QM business looks very attractive to us right now, as rates on new originations are similar or higher than prior to COVID, but both deal execution and financing rates have improved. While the Federal Reserve support helped our mortgage strategies, government stimulus through the CARES Act helped the performance of our consumer strategies. Between stimulus checks and enhanced unemployment benefits, many consumers that have suffered a COVID-related loss of income have been able to remain current on their debt obligations. Of course, we're closely monitoring the ongoing negotiations for a continuation of these benefits. We have seen strong collections across the board in our consumer loan portfolio. We have worked closely with our partners on deferment strategies, and the realized defaults that we are seeing have actually been quite modest. Another boost in that strategy is lower LIBOR rates. Our repo rates have dropped over 150 basis points this year, directly adding to our net interest margin. Turning to the agency portfolio, we had very strong performance, returning to double-digit ROE for the quarter non-annualized. Early in the second quarter, we saw some signs that the market environment was a very good one for Agency MBS. First, after an absolutely wild March, interest rate volatility was very low in the second quarter. That was the first indication that the Fed intervention was succeeding. As mortgage rates dropped and origination volumes increased combined with Fed front month buying, it was clear to us that current coupon rolls were going to be very attractive. In anticipation, EFC did something it rarely does. It positioned itself as long current coupon 30-year MBS. Roll levels in the current coupon mortgage are so high right now and the hedging costs are so low that rolling TBA provides a powerful earnings stream. One month of roll income can be 20 basis points, much more than the hedging cost for an entire year at current levels. Now back in March and April, EFC sold a portion of its agency portfolio after the Fed stabilized Agency MBS prices. We did that to increase our cash holdings, which was a much better alternative to selling credit-sensitive securities at distressed prices. As cash built up on our credit holdings with paydowns in consumer loans, residential transition loans, and small balance commercial mortgage loans, we have largely replenished our Agency MBS holdings and have continued to add to those holdings into Q3 as Larry and JR mentioned. Looking ahead, I think EFC is in a strong position for the rest of the year. Our origination partners really demonstrated their value through the credit shock this year, weathering the crisis and posting strong loan performance. In addition, controlling the pricing of our asset pipeline, which was such an important part of our success last year as credit spreads tightened, is becoming more and more important this year as massive Fed purchases are pushing investors out of government assets in a search for yield. Our ability to keep our asset acquisition yields high while maintaining discipline in credit quality, given the economic uncertainty, will be key ingredients for the second half of this year. Now back to Larry.

Thanks, Mark. I'm very pleased with Ellington Financial's performance, both for this past quarter and so far this year. We protected book value during extreme market stresses and then participated in the upside of the market recovery. Besides some strong strategy-level performance, the key to our successful second quarter was the fact that we avoided forced sales in the first quarter and could benefit from the rebound. All of this was thanks to our adherence to liquidity management, risk management, and hedging principles that have served us well over the years. Please turn to Slide 13, which is our usual slide, where we show the stability of EFC's returns over time, as well as those of the other hybrid mortgage REITs. I'm really proud of Ellington Financial's performance so far this year both on an absolute basis and relative to the other hybrid mortgage REITs. I was especially excited to restart new credit investments as quickly as we did, especially in our loan businesses. We're seeing a great opportunity to grab a larger market share in several of our lending programs, especially in non-QM. Moreover, we're seeing much wider net interest margins in these programs than we saw pre-COVID. In our residential transition loan business, while we're not seeing a resurgence of supply yet in that market, and while we don't expect a resurgence right away, we're gearing up anyway. My personal belief is that in the medium term, the opportunities in that market will actually be much greater than they were pre-COVID. Sadly, one of the negative effects of COVID will be an increase in foreclosures, but one of the positive effects of COVID will be an increase in remote working and therefore the mobility of the workforce. Both of these aftereffects, foreclosures and mobility, will contribute positively to housing turnover. Some of the highest and best use of that housing stock, especially the older housing stock, will be in the hands of fix-and-flip and fix-and-rent operators. At Ellington Financial, we plan to be ready to supply even more capital to these markets when the time comes. As you can see from our balance sheet, we have lots of room to add assets from any and all of our loan pipelines, which could drive significant core earnings expansion going forward. In the second quarter, the Board increased our monthly dividend to $0.09 per share. As I mentioned before, there's ample room for future dividend growth as we move into the back half of the year. All that said, a fair degree of caution is warranted, as it's still too early to predict the length and severity of the economic downturn, not to mention that there's always uncertainty associated with the upcoming presidential elections. With these risks in mind, we will continue to depend on our core risk management principles and disciplined investment approach to protect shareholder capital and drive returns. Before we open the floor to questions, I would like to thank the entire Ellington team for their hard work over the past few months despite difficult circumstances. For all of those listening on the call today, we hope that you and your families stay healthy and safe. And with that, we'll now open the call to your questions. Operator, please go ahead.

Instructions] And your first question is from Crispin Love of Piper Sandler.

Hi. Thanks for taking my questions. So first, the release mentioned the potential for new investments in mortgage originators. Would any of these potential investments be similar to your LendSure and Longbridge relationships? And are there any specific asset types that you are most interested in right now for originators?

Yes. I think, well yes, I think Longbridge right now is not an investment yet where we are kind of directly buying assets from them. But it's a business that we believe in. There are lots of potential areas of growth, and it does give us exposure to a unique asset class which is reverse mortgage MSRs. Now our investment in LendSure and some others where we are getting a pipeline, we are actually looking at making investments in other loan originators which would include getting access to their origination capabilities that would include RTL. In a couple of cases, we're looking at non-QM as well to diversify our sources there. So yes, I would say that at least as of now we're looking at minority stakes as we've had before. And in originators that are originating product that is similar to the product that we have now. We're also looking at, nothing that's late-stage or anything like that. But we're also looking at some completely different products as well that we think could over time gain traction.

Okay. And then looking at the slide 12 where you have the detail on the small balance commercial portfolio, how are those loans performing currently? And how has that trended over the last few months, especially among the hotel and retail segments?

The first point to make is that repayments and paydowns on small balance commercial loans have been strong since March and April, continuing into the current period. We’ve experienced favorable resolutions and paydowns, which have helped reduce our leverage. Regarding forbearance and deferment activity, it's had a broad impact on the portfolio and specifically on small balance commercial. We have granted some forbearance agreements in this segment. Overall, performance has been robust, bolstered by repayments, with 90-plus delinquency rates remaining relatively stable. Forbearance is an important factor to consider in this context. We will provide specific statistics in the Q, but performance has been strong. As for the property types you inquired about, hotels make up 16% and retail accounts for 11%. These figures are limited to about a quarter of the unpaid principal balance. We haven't detailed how performance varies among different property types, but the diversification by property type and geography is evident. Additionally, having everything as first lien is advantageous.

Yes. I just want to mention that we believe, hopefully, that we're in a good position in the hotel sector. We have our properties well-backed with sufficient first liens, as shown in the slide. All of them are first liens. Even after COVID, we feel very positive about the equity still present in these properties, even based on current market evaluations. Therefore, we are optimistic that these assets will ultimately resolve in our favor.

Okay. Great. Thanks. That’s all very helpful, and congrats on the greater quarter, Larry.

Thank you.

Thanks, Crispin.

Thank you. And your next question is from Doug Harter of Credit Suisse.

Hi, guys. This is actually Josh Bolton on for Doug. Larry, you mentioned in your prepared remarks and in the press release that you see upside to the dividend. Just curious any more context around that as you're looking at the 'run rate earnings potential' of the portfolio as it sits today? Thanks.

I don't want to provide any further guidance on timing. However, I personally believe there is potential for improvement. Ultimately, that will be a decision made by the Board. At this moment, we are focused on rebuilding our book value. As we've previously indicated, due to certain tax decisions we've made, we do not face significant pressure regarding our dividend in the near term. We will continue to assess when might be the appropriate time for adjustments. For now, our priority remains on rebuilding book value, especially since our stock price is currently quite low. The recently announced book value highlights the disparity between our stock price and its actual worth. Presently, we still offer a decent yield, approximately 9%, which is considered healthy. As our stock price improves, this should increase pressure on us to sustain that dividend yield, which is another factor to keep in mind.

Great. That makes sense. Then I guess, given the increased liquidity you guys have built up in the first half of the year, how are you thinking about the pace of asset growth? Appreciate the detail about current asset levels, and how you've grown the book since June 30th. Following up on what you just said, how are you thinking about asset growth versus share buyback, given where the stock trades versus book value? Thanks.

Yes. We mentioned in the last call that we lowered our target for buybacks; before we had been buying pretty aggressively anything below 80. We've clearly lowered that, and you can see that in our share count. But I think that we are seeing great production in IQM now. I think we could be in store for some record months there in the near future. As I mentioned in my remarks, I think we're going to see resurgence of RTL product and maybe not in the very short-term. On the commercial side, we're starting to see our origination, bridge loan origination capabilities there really come into play. As you can imagine, that's going to be a sector where we're going to be able to really pick and choose geographies, property types, and individual assets that we're going to want to lend against. I think that business is going to grow a lot too. So we want to keep a lot of room for what we see as a pretty healthy pipeline for the remainder of the year, especially in our loan businesses. So unless our stock really drops a lot back to, well certainly, I think I mentioned in the last call, above 75% price-to-book, we're probably not buyers now either even though we were in the past. So hopefully that gives you some color there.

Great. Thanks, Larry.

Thank you. Your next question is from Trevor Cranston of JMP Securities.

Hi. Thanks. A question on the incremental deployment into new credit assets, I think Mark mentioned that earlier in the quarter you found some pretty compelling opportunities on the security side. I was curious if you guys are seeing any areas in the securities market where prices sort of lagged and there are still distressed opportunities or if the incremental deployment is really primarily just going to be focused on the whole loan opportunities? Thanks.

Mark?

Hi, Trevor.

Hi.

I would say when I think back about March and April, what created the opportunity in securities was the fact that COVID from a financial perspective quickly morphed into a balance sheet crisis. You had mutual funds and some levered investors that were forced to sell assets in a short period of time. Typically, the turnaround time for selling loans is much longer than it is for selling securities. The price drop in securities was exaggerated relative to the risks we saw in March and April. Hence, we bought some non-agencies early on. We were constructive on housing, and that worked out very well because we wanted to get EFC more invested. We wanted to take advantage of the opportunity. We've built up cash, and we knew starting our loan origination partnerships was going to take a little time. So we were aggressive on the security side. That worked out as well. It was in residential as well as also selectively in CMBS. Now you've seen a pretty strong recovery in legacy non-agency securities to the point where we don't necessarily view them as more attractive versus some of our loan strategies. There have been some other sectors of the securities market that aren't as big where we found some opportunities, so single-family rentals are one. I would say selectively opportunistically we're still finding opportunities in securities. It's just not on a beta basis the way it was earlier in the quarter.

I just wanted to add to that, Mark, that I think on the commercial side in CMBS; we're hopeful that there are good opportunities. As you may know from time to time, we've been a substantial B-piece buyer in that market. As you can imagine, many of the B-piece buyers that were traditional B-piece buyers have been hobbled by COVID and are now not in the mix in terms of new purchases. I think we've got less competition there, and there are going to be some distressed opportunities, obviously especially in certain deals versus others. So I think that's one market where we've had really great performance in the past. It's a long/short strategy for us. We are not afraid to dial up and down our CMBX hedges in that product; we can put on relative value trades, and take off the hedge when it makes sense. That’s a market where I think from a security standpoint we’re hopeful that we’ll be able to add a lot for the remainder of the year at much better levels than pre-COVID.

Okay. Got it. That's very helpful. I was interested in the comment you guys made about securities repo being pretty much back to pre-March levels. I think that might be the first time we've heard anyone say that on calls this quarter. Can you comment on if you guys are seeing availability of repo on all the same types of collateral you were previously interested in using it on or if you were really primarily referring to sort of haircuts in rates when you made the comment?

We're talking about...

I was curious if you are utilizing any repo on the retained bonds from the June securitization.

Yes, that statement was specifically related to securities. On the security side, for non-distressed securities, we are seeing rates that are comparable to what we observed before COVID. However, on the loan side, things have not fully returned to previous levels. We have made significant progress in getting closer to those levels, and we continue to do so. It may take some time for lenders to become more aggressive in that market, but we anticipate that it will happen, even though we are not there yet in terms of loan repo compared to pre-COVID levels.

Yes, I wanted to add a couple of things. One is, if you look at agency repo by any measure spread to LIBOR absolute levels that's better than what it was pre-COVID. I think that's because there's just been tremendous appetite among money market funds for agency collateral. So that repo is probably better than what it was pre-COVID. I talked about the importance of a restart of securitization markets. One thing I didn't mention in the prepared comments is that one other benefit of the restart of securitization markets is that it gives lenders transparency on dollar proceeds of securitization. By that I mean, when you were going through March and April, lenders that were lending against non-QM loans, it wasn't clear to them what securitization proceeds these loans would generate. Well now you've seen several deals get done, and securitizations have ranged from as high as 95%, 96%, I think down to as low as 90%. For lenders, it's a much better metric they can use for thinking about how much they want to lend against assets. The fact that there’s been the securitization market restart and there haven’t been one or two deals, but many deals where pricing has been consistent, has improved the availability of non-QM lending both on terms, advanced rates, and tenor of these facilities, but also the spread to LIBOR.

Okay. That's helpful. And then...

Hold on one second. JR, did you want to…

Yes, just the second part of that question about, I think you specifically asked had we financed the retained tranches of our last non-QM deal, and the answer is yes.

Okay. Great. And then a question on the agency portfolio. You guys made a point in one of the slides about the biggest risk being a drop in pay-ups. I was curious if you could talk about how you think about the risk of that in light of the potential for mortgage rates in the primary-secondary spread to maybe continue compressing over the balance of the year in prepay speeds either remaining very fast or potentially even moving higher going forward?

Pay-ups are currently high for valid reasons, primarily due to actual prepayment speeds being elevated and projected speeds being even higher. Although we did not mention it during this call, we previously discussed technological adjustments to social distancing that the GSEs have implemented, and we believe these will be integrated into mortgage origination. The use of online notaries and the ability to refinance or purchase properties without an appraiser physically visiting the home will enhance the S curve. We are focused on the higher coupons to identify the best prepaid protection for our investments. Typically, the best prepay protection comes from the loan balance, but there are instances where the pricing might suggest weaker prepay protection despite a lower price. Effectively managing pay-up risk is a crucial aspect of overseeing a leveraged agency mortgage portfolio, a principle that has always held true. The market has adjusted to the long-term low interest rates, reflecting J. Powell's well-known statement about not considering rate increases. The current pay-ups reflect the expectation of maintaining a 3-percent mortgage rate environment for the foreseeable future, which should lead to relatively swift prepayments for mortgages incentivized by that rate. We are confident in our tools for managing this through hedging and research. We recognize that with pay-ups having increased significantly, there is a potential for them to decrease. However, a notable reduction would likely require a shift in interest rates that is not currently factored into the forward curve. While this scenario is possible, the market assigns it a low probability.

If I could just add to that. There are two ways that pay-ups drop. One of them is when you've got a liquidity crisis, and people are just paying up for the liquid TBAs and not paying up for the value in specified pools. That's one way that payoffs can drop. The other way that they can drop, as you said, is just by across-the-board increases in prepayments. If that happens, for example, you mentioned the primary-secondary mortgage rate spread narrowing. You’ll see that affect not only specified pools but also TBAs. If you go back to where we were at the end of the year, you look at our presentation, and you can see that as of June 30, we had a pretty modest TBA short measured by 10-year equivalents in terms of our hedging portfolio. Our TBA percentage of our hedging portfolio, as measured by 10-year equivalents, was 44%. If you look at our next short TBA position that it was over $1 billion. We can dial up and down that TBA short a lot; it helps control our prepayment risk. It'll address, it won’t necessarily address the compression of pay-ups due to liquidity crises, but I think it will address across-the-board increases in prepayments of the type that you also mentioned.

Yeah, okay. Appreciate your comments. Thank you guys.

Thank you. Your next question is from Eric Hagen of KBW.

Hey. Hope you guys are doing well. Following up on your comments on the benefits of a short duration portfolio, how much do you expect the portfolio to pay down over the next couple of quarters? Can you get specific on how fit the spreads are that you're seeing in the loan strategies? And how much of your runoff you think might be redeployed into those new originations?

Those are some tough questions. It's hard to predict. JR, do you have the number? I think it'd probably be better if we just reiterate what the number was in the first quarter and the second quarter.

Sure. That'd be helpful too.

Yes. So we had $70 million of paydowns for the second quarter across consumer, residential transition loans and small balance commercial, and we said that was about 11% of where we started in the quarter. The previous quarter, I believe that number was $55 million for the same set of strategies. I can look that up as we talk but…

Yes, I believe that's the right scale.

Yes, it was 185. It was 155.

Great. Yes. So I think that's a good range to think about. In terms of exactly where we would deploy it, I think our most predictable pipeline right now is non-QM and consumer. But as I mentioned, I'm certainly hopeful that our commercial mortgage bridge loan business is picking up. We can see some increases there. It's really hard to know. It's very asset-specific. But certainly, we will see an increase in non-QM from the second quarter where we're really able to start getting going in the latter part of that quarter.

Got it. And the spreads on non-QM right now versus where they were say pre...

Yes, the yields are better. They are not significantly different, perhaps slightly lower than they were before COVID, but the financing costs are much lower. This applies whether you look at it through repo or securitization execution.

Right. Yes, that actually kind of ties into my follow-up question which is what is the net loss that you're expecting on the non-QM portfolio? And what was the loss adjusted yield on the retained tranches and the securitization from June and the repo rate that you're funding those securities there?

Not even sure we have a year-to-date loss in non-QM.

So the expectation for losses the forward expectation?

Oh, I see. In terms of our...

The aggregate loss in the collateral over the life of the asset. What is that number?

Yes, when I mentioned a yield quote, I was referring to our current production efforts. We are being selective with our borrowers as part of our underwriting process, taking into account employment status post-COVID. We are optimistic that our new originations will experience minimal losses, perhaps just a few basis points a year moving forward. Regarding the existing portfolio, there are some forbearances. Mark, do you have an estimate on the expected annualized loss rates for our pre-COVID non-QM portfolio?

Yes. I wouldn't want to do that off the top of my head. I would say one thing is you have to separate out the very unfortunate situation that some borrowers may have had a COVID-related loss of income that they won't fully get back. They might need to seek lower shelter costs. That situation, which is terrible, given what home prices do, and given the LTVs of our loans it doesn't necessarily translate into a loss for us. There's nothing I would want to quote off the top of my head. Other than broadly speaking, if you look at what's been going on with forbearance, forbearance numbers have been coming down, and many borrowers that originally opted for forbearance in anticipation of potentially a loss of income have been making payments on those plans.

Yes. And we've been very LTV focused right for the entire life of that program. There have been other originators that captured larger volume and wider yield spreads, higher coupons on their product by going after higher LTV product. That was just never our MO and it still isn't.

I apologize for asking for specifics after a long week, but could you estimate the loss adjusted yield on the securitization from June to be around 10%, with a 70% advance rate and a repo line at about 4%? Would that be accurate?

JR, do you have that handy or off the top of your head?

Yes. I mean to the second point, I think repo spreads for non-QM home loans are in kind of the 200, low-200s range.

Okay.

Yes. We…

Are there or more depending on what line you're talking about.

Yes. Spreads have compressed even more, right? And securitization execution has gotten even better since we did that deal, not surprisingly. When we did that deal the execution was not as good as it was pre-COVID, but we were very happy because as Mark mentioned, the securitization market bounced back even more quickly than we had expected. So we were happy to jump on that for lots of reasons. The securitization is even tighter now market, and the yields that we can get on new assets are hanging in there. So I think, yes.

Right.

So as you said, maybe not the mid-teens that we had seen before in terms of the yield on our retained tranches, but certainly something that's respectable.

Yes. No, I mean it looks like a fantastic return on equity. I just wanted to make sure I had the kind of the right numbers there. So, thank you guys. Enjoy your weekend.

You too. Thanks.

You too.

Thank you. Your next question is from Tim Hayes of B. Riley.

Hey, good afternoon guys. Hope you are doing well. Just one for me. You had a small balance commercial focused competitor today say that they expect asset values broadly to decline by 10%. And then they also kind of highlighted that they expect a lot more acquisition opportunities towards the end of the year as maybe some kind of bank capital ratio forbearance periods start to expire. Just wondering how you feel about those comments, if that's consistent with the view internally and if you're seeing any opportunities to execute on portfolio acquisitions today?

Yes, we're observing a situation where the 10% decline in asset values will vary significantly based on geography and property type. I don't want to speculate on an overall figure. Clearly, New York office space and some hotels will face greater challenges. Although we haven't yet experienced a surge in supply, similar to discussions about the residential transition loan market, I firmly believe there will be considerable supply available. Before we expanded into bridge loans and commercial mortgages, our primary focus was on non-performing loans (NPLs), which we acquired from banks and special servicer deals. We expect to see both of those types of activity increase. When crises occur, bank workout groups are typically overwhelmed and often focus on larger assets, which allows us to target the $20 million and under segment, where we excel in NPLs. I believe there will be ample supply, and while banks are not currently under significant pressure to sell, this will change. Additionally, CMBS deals will also enter the market eventually, and I think this will represent a strong opportunity for us, as our foundation is in the NPL market, and we only ventured into bridge loans when that sector became more favorable.

Got it. Thanks for the color, Larry.

You have no further questions at this time. We do thank you for joining today's Ellington Financial conference call. You may disconnect at this time and have a wonderful day.