Ellington Financial Inc. Q3 FY2021 Earnings Call

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial Third Quarter 2021 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. Please follow the operator instructions. It is now my pleasure to turn the call over to Jason Frank, Deputy General Counsel and Secretary, please 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 16th, 2021, as amended, 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 J.R. 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. I'll begin on Slide 3. During the third quarter, Ellington Financial generated net income of $0.41 per share and core earnings of $0.46 per share. Core earnings continue to cover our dividend. Through the first 9 months of the year, we have now delivered an economic return of over 11% and a total return to stockholders of over 33%. Next, please turn to slide 11. During the quarter, we significantly grew our proprietary loan portfolios as we deployed the capital from our common equity raise in July. We had our second consecutive record quarter for originations in our non-QM business funding $297 million in the third quarter. We also had our second consecutive record quarter for originations in our residential transition loan or our RTL business funding a $106 million in the third quarter, as you can see here on this slide. Our RTL funding actually grew more than 50% from the prior quarter. Within RTLs, the fixed and flip business is a seasonal one, so I wouldn't expect us to see that kind of RTL growth for the next couple of quarters, but I'm hopeful that RTLs could be a big business for us in 2022. Overall, we grew our Proprietary Loan portfolios by 41% quarter-over-quarter to $1.26 billion. And keep in mind that the $368 million of growth was net of paydowns. I was extremely pleased with the pace and quality of our capital deployment during the quarter. Our proprietary loan pipelines continue to provide us with a robust supply of high-yielding investments and we absorbed that supply with relative ease. The new capital was both raised and fully deployed all within the third quarter and so we were able to avoid any material drag on core earnings. Looking ahead, the prospects for continued growth in earnings from our proprietary loan pipelines continue to be excellent. Thanks to its record origination volume during the quarter, our non-QM affiliate LendSure posted record profitability as well for the quarter. And thanks to our loan flow from LendSure, we were able to complete our third non-QM securitization of the year shortly after quarter-end. This represented the ninth non-QM securitization that we've completed. And we've now passed the $2 billion mark in total non-QM loans acquired from LendSure to date. This cycle of non-QM acquisitions, followed by securitizations, has several important benefits for EFC. We reap the benefits of a high-yielding, and we believe low-risk, asset class; we strengthened our balance sheet, and enhance earnings thanks to the superior long-term financing provided by the securitization market, and ultimately, we're able to manufacture highly attractive retained tranches at prices not available on the secondary market. Meanwhile, in addition to all the growth we're seeing in our residential mortgage loan businesses, we've also recently seen substantially increased loan flow in our small balance commercial mortgage bridge loan business. And last but certainly not least, we have now closed on 3 additional strategic equity stakes in loan originators in just the last six months, and we have several others in the works that we hope to complete before year-end. With these additional strategic stakes, we're continuing to fortify our vertically integrated loan origination business, which continues to supply a consistent flow of high-quality, high-yielding assets underwritten to our specifications. Our relationships with our originator affiliates are symbiotic as we not only provide them with a reliable outlook for their production, we also help them enhance their underwriting guidelines, we help them improve the terms and stability of their financing sources, and we help boost their overall visibility in the marketplace. I'm excited about these new strategic equity investments, and I believe that they will further expand and diversify our proprietary loan pipelines. Now, please turn to Slide 5 where you can see the net interest income in our credit strategies again led the way in the third quarter. This net interest income was driven by our growing loan portfolios, which by the way, also continue to exhibit excellent credit performance. Our credit strategies also delivered significant net gains during the quarter with significant contributions from our CMBS, CLO, and non-agency RMBS portfolios together with the gains driven by our share of LendSure's record profits for the quarter. As I mentioned, LendSure's third quarter was a record one, both for origination volume and earnings. LendSure originated $456 million of loans, which was a 39% increase in their second quarter's total of $326 million. LendSure is on pace to exceed, just in 2021, its origination volume for the prior 2 years combined. And critically, loan performance has continued to be excellent even as origination volumes scale. Most of LendSure's growth so far has been on existing products and channels. But the LendSure team is working on amplifying its momentum by rolling out new products and channels and are excited to see what 2022 will bring. I'll turn next to Longbridge Financial, our reverse mortgage originator affiliate. In the agency reverse mortgage market, continued high levels of home price appreciation together with low interest rates have led to elevated prepayment speeds as borrowers seek to refinance. In response to these higher speeds, we saw some acute downward repricing in the HMBS market, which is the market for agency reverse mortgage pools. While these market forces have boosted origination volumes for Longbridge, they also caused the decline in the value of Longbridge's portfolio of mortgage servicing rights or MSRs. This drove an overall quarterly net loss for the company. But importantly, Longbridge's origination segment was still profitable during the quarter. As a result, we see this quarterly net loss as an anomaly for Longbridge. The company had a monthly record for origination volume in September and year-to-date, Longbridge is actually number 3 in the industry in total HMBS issuance. Moving forward, we believe that Longbridge's earnings and growth prospects continue to be excellent. And in fact, the company has bounced right back to profitability in October. With that, I'll pass it to J.R. to discuss our third quarter financial results in more detail.

Thank you, Larry. Good morning, everyone. Please refer to Slide 3 of the presentation. For the quarter ending September 30th, Ellington Financial reported a net income of $0.41 per share and core earnings of $0.46 per share. These results show a decrease from a net income of $0.75 per share and core earnings of $0.51 per share from the previous quarter. Last quarter's core earnings included several resolutions of small balance commercial mortgage loans that involved the payment of past due interest and recovery of previously paid expenses. Excluding these specific asset resolutions, our core earnings per share remained approximately the same from quarter to quarter and were actually slightly higher than the estimated core earnings run rate we discussed in the last quarter's call. During the third quarter, we issued $6.3 million shares of common stock through a follow-on offering in July and another $1.55 million shares through our At-the-Market program. Overall, we boosted our equity by $141 million, or about 15%. Notably, the funds from these issuances were fully invested by the end of the third quarter. Moving to Slide 4, you’ll observe that we concluded the third quarter with over 80% of our deployed capital directed towards credit strategies and 19% allocated to our agency strategy, consistent with our position last quarter. Our credit portfolio increased by 24% compared to the previous quarter, and I will explain where that growth took place shortly. Next, turn to Slide 5 for the breakdown of earnings between our credit and agency strategies. In the third quarter, the credit strategy produced total gross income of $0.66 per share, while the agency strategy generated gross income of $0.03 per share. These figures contrast with $1.25 per share in the credit strategy and a loss of $0.30 per share in the agency strategy from the previous quarter. We experienced strong performance across most of our main credit strategies this quarter. Our loan strategies, including non-QM, residential transition, small balance commercial mortgage, and consumer loans, yielded high returns on equity primarily driven by net interest income, while returns in the CMBS, CLO, and non-agency RMBS strategies were also strong, fueled mainly by net realized and unrealized gains. Additionally, we successfully resolved several larger commercial mortgage non-performing loans. After the quarter ended, we completed the sale of one of the largest commercial real estate REOs in our portfolio at a substantial profit. On the downside, Longbridge Financial reported a net loss for the quarter, attributed to mark-to-market losses on its MSR portfolio, adversely affecting Ellington Financial's results. In terms of agency RMBS performance, results were mixed during the quarter. In July and early August, interest rates continued to decline and increased volatility led agency RMBS to underperform compared to treasuries. Moving into the latter part of the quarter, interest rates began to rise, and volatility decreased. Towards the quarter's end, agency yield spreads narrowed as market clarity improved regarding the Federal Reserve's tapering plan. The rise in mortgage rates, especially in September, led to lower expectations for prepayment rates and favored higher-coupon RMBS, while the anticipated reduction in Fed purchases negatively impacted lower-coupon RMBS. Our net interest income on the agency portfolio, strong performance from our interest-only securities, and net gains on our higher coupon specified pools surpassed net losses on our lower-coupon holdings and reverse mortgage portfolio. On the hedging front, net losses on TBA short positions, particularly concerning higher coupons, slightly outweighed net gains from interest rate swaps and U.S. Treasury hedges. Moving to slide 6, our total long credit portfolio grew by 24% to $1.69 billion in the third quarter as we deployed the proceeds from our July equity issuance. The majority of this growth was seen in the non-QM and residential transition loan strategies, which are represented in the residential loan section on this page. Our small balance commercial mortgage portfolio also experienced growth, although opportunistic sales of CMBS, where we secured notable gains, led to a sequential reduction in the overall commercial real estate section. On Slide 7, it's evident that our long Agency RMBS portfolio also rose by 4% to $1.54 billion as of September 30th. Turning to Slide 8, our debt-to-equity ratio, adjusted for unsettled purchases and sales, fell to 2.9 to 1 as of September 30th, down from 3.2 to 1 as of June 30th, since borrowings for new purchases were partially offset by paydowns on non-recourse borrowings associated with non-QM securitizations and total equity growth. Our recourse debt-to-equity ratio, adjusted for unsettled purchases and sales, remained steady at 1.9 to 1 as of September 30th, as borrowings for new purchases grew roughly in line with total equity. Lastly, our weighted average borrowing rate increased slightly to 1.27% as of September 30th, compared to 1.24% at June 30th. For the third quarter, total general and administrative expenses decreased by a penny to $0.16 per share, while other investment-related expenses were $0.06 per share compared to $0.11 per share in the previous quarter, mainly due to costs associated with non-QM securitization that were incurred in the prior quarter but not in this one. During the quarter, we recorded an incentive fee of $5.3 million as we exceeded our net income hurdle for the trailing four-quarter period and recognized an income tax benefit of $2 million primarily due to a decrease in current deferred tax liabilities associated with a drop in the unrealized gain on our investment in Longbridge Financial. Finally, our book value per common share was $18.35 at September 30th, down slightly from $18.47 at June 30th. Including the $0.45 per share of common dividends declared during the third quarter, our economic return for the period was 1.8%. Now, I will hand it over to Mark.

Thanks, J.R. Q3 was interesting in that we saw a lot of interest rate volatility as the treasury market seemed to grapple with attention between the spread of the Delta variant and high inflation. In contrast, credit spreads were relatively calm. In the third quarter, we got a lot of clarity from the Fed about the pace of taper and we know further specifics on the plan based on the timeline discussed in last week's Fed meeting. Starting this month, the markets are entering a new phase of diminished Fed support. The Fed has gone out of its way to provide clarity about its plans, but that doesn't mean the taper is a non-event. Growth in the Fed's Agency MBS and Treasury portfolios has provided support for all financial markets by putting cash in the system. And during the taper period, which is expected to end next June, it will continue to put cash in the system, albeit at a slower pace. So, we think that means over the course of 2022, we may see somewhat wider credit spreads in yields. So, for EFC, those are welcome changes as wider spreads will drive higher core earnings plus we have dry powder to deploy from our capital raise in October. Already in September, and continuing into October, we started to see some spread widening. Spreads on investment-grade non-QM, CMBS, and CLOs have all widened in an orderly fashion. We've talked on previous calls about how loans had not compressed as much as security yields in the past year. Well, that has partially reversed since quarter-end as spreads have widened so far into Q4. But the spread widening is not the result of any hiccups in credit performance. Rather, it's the result of a market demanding wider spreads because of an influx of new issues. The other thing we're paying close attention to is supply and demand and affordability trends in the housing market. Since COVID, the housing market has been appreciating at an incredible pace. If mortgage rates drift higher without robust wage growth, affordability may become an issue. So, for EFC, we can't get complacent about the strength of the housing market. We will be monitoring it quite closely. Since quarter-end, we have also seen lower loan prices in some sectors, which inevitably happens when securitization economics are squeezed by wider spreads in higher yields. I like the balance we have at EFC, achieved by owning both originators and securitization machines. When loan prices are high, like this quarter, EFC benefits through robust gains on sale. As loan prices come off and loan sale margins compress, that benefit accrues to the securitization business. We believe that by being more vertically integrated in the loan-to-security supply chain, EFC can thrive whether the economics favor the loan originator or the securitization sponsor. In fact, we've already made 3 additional equity investments in originators so far this year. We plan to use the same playbook with these new investments that we've used successfully for LendSure. We make small investments, so we don't have a lot of capital at risk, we secure loan volume for EFC, and we look for situations where EFC's financial strength and Ellington's data science and industry relationships can give our partners a competitive advantage over peers that lack those resources. We also give new partners the benefit of experiencing growing origination platforms. Turning to third-quarter results, overall credit performance for our portfolio was very strong. Consumer balance sheets remain in good shape. Home price appreciation has surprised to the upside, and the continued rebound in commercial real estate values and deal activity drove solid performance in our commercial loan portfolio. Core earnings covered the dividend, and I think that's great given our increased capital base. You can see on Slide 6 that we had significant growth in our credit portfolio. The residential mortgage strategies grew most significantly this quarter, driven by non-QM and RTL. The commercial real estate portfolio actually shrunk sequentially, but that was due to opportunistic CMBS sales. Nonetheless, our small balance commercial mortgage holdings actually increased quarter-over-quarter, and we continue to see a lot of attractive deals in that sector. You can see on slide 9 that we have 95% of our credit portfolio in our three primary sectors: residential mortgage, commercial mortgage, and consumer. We also had modest growth in our Agency MBS portfolio during the quarter. We are positioned to increase our net agency mortgage exposure should diminishing Fed support in year-end liquidity issues present us with opportunities. On slide 10, you can see that our small balance commercial mortgage loan portfolio; we are well diversified across many dimensions and are in first-lien positions on every loan with the vast majority being floating-rate loans that benefit from interest rate floors. We issued stock in Q3. It's great that our portfolio companies and other loan sourcing relationships have grown and matured to the point where it was relatively easy for us to deploy the additional capital. I've also been really happy to see the greater liquidity in our stock. Despite substantial portfolio growth this quarter, with our growing capital base, we have a lot of room to take advantage of market opportunities. Consistent Fed purchases have been a great source of stability in 2021, as the Fed has grown its agency MBS portfolio by over $400 billion. As that support wanes, we think that private capital may be able to demand even more attractive yields. Now, back to Larry.

Thanks, Mark. I'm very pleased with Ellington Financial's performance so far in 2021, and particularly with the progress that we've made growing our origination businesses and loan portfolios. Following quarter-end, we again accessed the capital markets to continue driving this growth. In October, we raised just over $100 million of common equity, again at around book value. We've already invested the majority of this new capital, but in addition to fueling continued loan portfolio growth, the additional capital should provide us with additional economies of scale, in our portfolio, in the capital markets, and operationally. This additional capital also positions us to be opportunistic should we see any pockets of volatility around year-end whether they be related to macro concerns around inflation or COVID, tapering concerns, or even just typical year-end balance sheet pressures. So, we're in a strong position to play offense as we move into the final weeks of the year. Meanwhile, we will continue to work on cultivating and expanding our proprietary loan pipelines while also being opportunistic with our security strategies and staying disciplined on risk and liquidity management to protect and preserve book value. Finally, I'd like to point out that with our latest capital raise, Ellington Financial has now passed the $1 billion mark in total common equity market capitalization. That's a significant milestone for EFC. And it's one that we believe will further increase our visibility in the market, increase the liquidity of our stock for our stockholders, and enable us to access both the debt and equity capital markets more efficiently. In fact, if you look at our capital structure, you can see that at this point, we're especially well-positioned to add debt or preferred equity to our balance sheet. In particular, our $86 million of senior unsecured notes will become freely refinanceable on March 1st. And with the additional equity on our balance sheet following our recent stock issuances, that could be a good time to both lower the cost of and increase the size of our outstanding unsecured debt, thereby leveraging up our balance sheet and helping drive core earnings higher still. With that, we'll now open the call to questions.

Please follow the operator instructions. And we will take our first question from Doug Harter with Credit Suisse.

Thanks, I was hoping you could talk a little bit more about the 3 investments you made in originators. What type of products do they make and how would you think about that adding to the pipeline of loan opportunities?

Yeah, we're not going to provide any additional color on that other than just to say that they are all in the residential area. We are working on at least one of the commercial areas as well now, but those were just in the residential area there. As we said, they're small investments and it's probably going to be a little while before you see very meaningful growth portfolios, but markets like non-QM and a little bit of everything in the residential space.

Can you discuss where you see returns and how the execution of the securitization impacts those returns today, especially in light of the spread widening in securitizations?

Sure, it's Mark. So, you saw just a tremendous amount of supply in a lot of sectors in October. You had a lot of mortgage 2.0 supply, some of that non-QM, some of that agency-eligible investor deals. You saw a lot of CLO supply. You saw a lot of CMBS supply. And so, you've seen a little bit of widening investment-grade bonds and now I think that's being matched by slightly lower loan prices. So, when I net the two together, I don't see a big difference in securitization economics. Other than that, it means with lower loan prices, we're retaining less prepayment risk, which I think is generally a good thing.

Great. Thank you.

We'll go next to Crispin Love with Piper Sandler.

Thanks. Good morning and thanks for taking my questions. First, looking at Slide 9 with the credit portfolio breakout. I can't recall a time where the residential portfolio was near this 64% level that you are now. So, is that largely due to the opportunities you're seeing in non-QM and RTL and the flow you're getting, or are you at all incrementally more negative on the commercial mortgage market? And also, in the presentation, it looks like you might have increased your CMBS hedging a little bit. So just a little color there would be great.

Sure. Hey, Crispin. It's J.R. Yeah, I think the first thing you suggested is spot on. Namely, it's driven by a larger non-QM portfolio quarter-to-quarter. Just to put some numbers on it, that at September 30th, our non-QM portfolio was about $585 million of the around $1.007 billion of the credit portfolio, so about 35%, whereas at June 30th, those numbers were about $300 million and 22%. So, by far the biggest driver there is non-QM, followed by residential transition loans. Larry mentioned that those two strategies were record quarters for Ellington Financial in terms of origination volume, so that's directly reflected on this pie chart. I would say that the point about commercial mortgages, we're definitely, and Larry mentioned it as well in his prepared remarks, we're definitely seeing growth there. The slide also has CMBS where we had opportunistic sales. So, you have some offsetting sales and pay-downs, offsetting growth in the small balance commercial mortgage sector. So, I would say we are very excited about the loans we're seeing in commercial real estate. We would expect to see continued portfolio growth there as well.

Thanks, J.R. And then did you also mention that LendSure is looking at adding some additional products in addition to non-QM, and is there any color that you could give there or would you expect to get flow from the new products as well, should they happen?

Sure, it's Mark. I believe LendSure has a lot of potential. The senior management team possesses extensive experience and is very considerate regarding mortgage credit. There may come a time when they venture into the RTL space. They have been engaging in numerous internal discussions and are beginning to establish a foundation for potentially entering the prime jumbo market. I would say those two segments are currently the closest to them actually starting to originate loans. We have shown interest in non-QM, as it has been favorable for us due to the limited bank presence in that area. There are aspects to evaluate, including an IO component. Overall, many factors align with our core expertise, making non-QM a primary focus for us.

And then just one quick clarifying question on the originator stakes. Could you disclose any updates on your previous statements? I believe last quarter you mentioned you added 2 and now I saw the commentary you've added I believe it's 3 in the last six months. So, is there one additional one or all three new?

No, you're right. It's one additional one during the third quarter. And so, it's three in total over the last six months, so one incremental in Q3. And then we have several others that are, I would say, in discussion that we're hoping to close by year-end.

Great, thank you.

Thank you.

We'll go next to Brock Vandervliet with UBS.

Hey, good morning. Could you just talk generally about competitive dynamics in resi transition and in non-QM as well? Are you seeing other much larger organizations take another look at those sectors, look to move in and broaden the market? And if and when that happens, do you see that as any competitive threat to your program or a rising tide that just boosts the profile of these loan niches?

Hey, Brock. It's Mark. I would say there has been an increased focus on the RTL space recently, garnering more publicity than it has in the past year. There are larger pools of capital targeting this area, but it remains quite fragmented. Our approach relies on careful underwriting of projects and a solid understanding of the local housing market. Therefore, I don't view it as a threat. As Larry mentioned in his prepared comments, we believe there is significant long-term growth potential for us. The median age of homes in this country is quite old, and there is considerable deferred maintenance that needs addressing. I think we have ample opportunities to increase our volumes there, but from what I've observed, there seems to be a heightened interest in this sector from larger pools of capital compared to what we saw before COVID, like in 2019.

Okay, and just rotating over to Longbridge and the MSR, looking at the yield curve now, it seems like the pan trade may be on here in terms of lower rates and a flattening. Any changes contemplated in terms of their hedging methodology?

No, it's Larry. There are no expected changes to our hedging methodology. It's a bit different from the forward MSR market, which is closely linked to the absolute level of mortgage rates compared to the existing stock of mortgages. Yes, rates have been low, but low rates alone weren't the trigger. It was also due to ongoing home price appreciation, which allows many borrowers to take out larger loans against their homes. Essentially, they are replacing their old loan with a bigger one. This situation isn't very hedgeable, and there isn't a TBA market to sell HMBS forward either. However, the positive news is that we believe this situation is past us. HMBS prices were at their lowest in a long time during the recent write-down. Additionally, originations continue to be exceptionally strong, and our market share keeps growing, so we feel very optimistic about the company's future.

Okay. Thanks for taking my questions.

Thank you.

We'll go next to Bose George of KBW.

Good morning, everyone. I have one more question regarding Longbridge. Could you discuss the trends in gain on sale in the reverse business, especially in light of the positive home price appreciation? What are the fundamentals looking like?

Longbridge itself doesn't have significant credit exposure because they primarily originate FHA guaranteed mortgages. The main challenge regarding gain on sale was due to having loans in the pipeline that they were committed to and had sometimes already closed. Selling these loans as HMBS takes time, leading to lower gain on sale figures. In some instances, losses occurred after the HMBS market experienced spread widening. However, once those closed or in-process loans were cleared from the system, profit margins improved. There is elasticity in the market, especially in the wholesale sector, allowing them to reduce prices. They are purchasing loans in the wholesale market, which has helped to recover most of the gain on sale profitability they previously experienced. October proved to be quite profitable, and we believe origination volume will remain robust. As you may know, there are few players in this market, with Longbridge as a prominent participant, being the third largest HMBS issuer. Thus, we are optimistic about the prospects for gain on sale moving forward.

And then the spread widening that you saw there; was that caused by the pickup in prepayments or was that the main driver?

Yes.

Thank you. Now, regarding the capital and operating companies, can you discuss the incremental allocation? Is there a target allocation level you are considering as you continue to invest in new operating companies?

We are going to continue to pursue opportunities as they arise. We have been actively looking into various options. For instance, when we purchase loans from an originator, we later assess the quality of their business and may approach them about acquiring a stake in their company. In return, we offer several benefits, including additional credit lines and the data and analytics previously mentioned. We do not have a specific budget in mind for how large we want this portfolio to grow, as we believe we can achieve significant growth while still meeting the required retests. The TRS test is based on gross assets, which allows for ample growth potential. Initially, we have focused on smaller investments. For example, our original investment in LendSure was below $5 million, but its value has since increased significantly. We prefer to make these investments with less capital at risk, especially considering fluctuations in the origination business. Our goal is to minimize exposure while also increasing origination and our flows, which benefits everyone involved, as demonstrated by the success with LendSure and the growth of our loan portfolios.

Okay, great. Thanks.

We'll go next to Trevor Cranston with JMP Securities.

Thanks. Question on the couple of the recent changes we've seen from the FHFA specifically in terms of bringing back CRT issuance and removing the caps on the GSE investor loan purchases. But just curious, you guys have any thoughts on how bringing back CRT and potentially reducing some of the private-label issuance of the investor loans impacts the overall supply depend on the credit sector?

It's a great question, Trevor. It's Mark. I would say for the caps on the investor loans, I don't think that's going to have a big impact on private-label issuance in that sector. Currently, private-label issuance is economically advantageous if private capital is willing to underwrite the credit risk at better levels than what the GSEs have done and take on some of the aggregation risk. Therefore, I believe you will continue to see private capital involved in the agency-eligible sector. Regarding CRT, we viewed the recent pause as an anomaly rather than a trend. CRTs have been crucial for the GSEs in mitigating shareholder risk related to the guarantee fee business, and we expect this to continue. However, with the changes in leadership at the FHFA, we wouldn't be surprised to see further adjustments. There are plenty of opportunities for the GSEs to support affordable housing and first-time homeowners, but there have been challenges from some existing business lines. There has been criticism of the single-family rental market, which has affected first-time home buyers, indicating we can expect dynamic policy changes moving forward.

Okay. That's helpful color. Thank you, guys.

We'll go next to you Eric Hagen with BTIG.

Hey, thanks. Good morning. Maybe just one. How sensitive do you guys expect the cost of repo in the credit segment might be that changes at the short end of the yield curve, including the haircut that gets applied on that collateral? And can you remind us of the collateral that is pledged there right now? Thanks.

Yeah. Hey, Eric.

I can take, go ahead, Mark. Go ahead.

I would say we don't anticipate significant changes in haircuts, and that's because you've had stable credit performance and you've had relatively stable asset prices. Increases in haircuts are normally a consequence of either weakness in performance and/or weakness in asset prices. Yeah, we think that the changes in repo costs, we think they're going to track what the Fed is going to do on the short end. One thing we've done on the agency side of the portfolio where you have a little bit more dynamic financing markets as we have extended the term of our repo because we thought it was advantageous. So, we've done some one-year repo and we think that the one-year repo rates are certainly going to go up because now they're spilling into close to a period of time where people think the Fed could be active. So, in terms of net interest margin, if you have assets priced off the front end of the curve like a lot of the non-QM loans or floating-rate assets, I think our net interest margins are going to hold up very well because we don't expect a change in repo spreads or a change in haircut. But I do think just the overall levels of LIBOR are going to affect our financing costs.

To build on what Mark mentioned, historically the haircuts in agency repo have remained remarkably stable and resilient since the 2008 financial crisis, typically in the 5% to 6% range. This provides sufficient leverage; being able to leverage 16 to 20 times with a 5% or 6% haircut is ample. We do not anticipate any significant increase in agency haircuts, even if rates rise due to tapering or the conclusion of easing. Regarding spreads, they have generally tracked closely with treasury collateral markets, with only minor fluctuations. In our recent materials, we highlight repo costs, which also show this close correlation. The credit sector presents an interesting scenario, as we engage in repo financing not only for agency mortgages but also for non-agency RMBS and other investments, including loans. In this area, we've observed consistent compression in haircuts and spreads. Typically, after a market event like the liquidity crisis during COVID in early 2020, haircuts and yield spreads on the assets increased, followed by a rise in financing spreads. Historically, asset movements tend to lead financing adjustments, and since then, we’ve seen haircuts and spreads gradually decline, albeit not as quickly as asset yields. We remain optimistic that this trend will persist, leading to further compression in spreads on credit assets and possibly some reduction in haircuts.

Thanks a lot. Appreciate it.

Thank you.

Thank you, Eric.

That was our final question for today. We thank you for participating in the Ellington Financial third quarter 2021 earnings conference call. You may disconnect your line at this time and have a wonderful day.