Earnings Call Transcript
Ellington Financial Inc. (EFC)
Earnings Call Transcript - EFC Q1 2022
Operator, Operator
Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial First Quarter 2022 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 opened 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.
Jason Frank, Deputy General Counsel and Secretary
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, 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’m 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 first 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.
Larry Penn, CEO
Thanks, Jay, and good morning, everyone. As always, thank you for your time and interest in Ellington Financial. We'll begin on slide 3. During the first quarter, volatility increased to levels not seen since the COVID liquidity crisis of 2020, interest rates rose quickly and the yield curve flattened significantly. Yield spreads across nearly every fixed income sector widened compared to US treasuries and interest rate swaps, and nearly all major equity indices declined. Despite this challenging market environment, Ellington Financial saw only a moderate decline in book value for the quarter, owing to our hedging strategies, diversified portfolio, and careful management of our leverage ratios alongside the strong performance of some of our credit strategies. While a few strategies experienced losses, the advantages of our diversification were evident as gains from other areas of the portfolio and net gains from our hedges mostly offset these losses. Mark will discuss how we excelled in credit. Overall, our economic return was about negative 1% during what proved to be a historically tough quarter for the fixed income markets. We continue to benefit from our loan portfolios as they not only generated positive returns but also provided a consistent flow of recyclable capital through portfolio paydowns and payoffs due to their short duration. During the quarter, we received principal paydowns of $156 million from our residential transition loan, commercial mortgage loan, and consumer loan portfolios, representing more than 17% of the combined fair value of those portfolios at the start of the quarter. This is a key aspect of our portfolio construction. Our short duration assets are returning a significant amount of capital right when we can invest that capital at much higher yields and wider spreads. At the end of the quarter, we completed a $210 million five-year senior unsecured note offering, which was rated single-A and priced at a fixed coupon of 5.875%, a spread of 3.32% over the five-year treasury. I believe that the strong rating and successful execution of the deal reflect Ellington Financial's track record of stable book value and effective risk management, which are crucial now more than ever. This senior unsecured note offering was timely considering the returns we are experiencing on new investments. We anticipate this offering to positively impact earnings in the coming months. Additionally, we have already completed three loan securitizations this year, securing further long-term non-mark-to-market financing for both our non-QM mortgage portfolio and our consumer loan portfolio. These stable financing sources enhance our balance sheet resilience against potential market shocks and enable us to respond quickly to market opportunities. In summary, the consistent capital return from our loan portfolios, the capital raised from the senior note offering, and multiple securitizations have given us considerable capital to invest as reinvestment yields rise rapidly and pricing dislocations appear in various sectors. I will now turn it over to JR to go over our first quarter financial results in more detail.
J.R. Herlihy, CFO
Thanks, Larry, and good morning everyone. I'll continue on Slide 3 of the presentation. For the quarter ending March 31, 2022, Ellington Financial reported a net loss of $0.17 per share on a fully mark-to-market basis, along with core earnings of $0.40 per share. This compares to net income of $0.61 per share and core earnings of $0.44 per share from the previous quarter. The decline in core earnings can be attributed to two main factors: a higher balance of undeployed capital in Q1, and increased corporate expenses, some of which were linked to operations from the previous year. Looking ahead, once we are fully invested and can leverage today's significantly higher reinvestment yields, we anticipate that core earnings will cover our current quarterly dividend rate of $0.45 per share. On Slide 4, you will see that we have increased our capital allocation to credit investments this quarter, with 85% of our capital allocated to credit as of March 31, up from 79% year-over-year. The capital allocated to agency, now at 15%, is at the lower end of our historical range. Moving forward, we expect EFC's allocation to credit to remain at the higher end of its historical range, supported by the growth in our loan origination businesses. This slide also shows that the weighted average market yield on our credit portfolio rose by about 10 basis points sequentially, which we expect to increase further as yield spreads widen and rates rise, while the blended yield on our agency portfolio increased by a full percentage point quarter-over-quarter to 3.2%. On Slide 5, the earnings contribution from our Credit and Agency strategies can be seen. In the first quarter, the Credit strategy generated total gross income of $0.28 per share, whereas the Agency strategy reported a gross loss of $0.34 per share. In comparison, the previous quarter showed gross income of $0.91 per share in the Credit strategy, and a gross loss of $0.03 per share in the Agency strategy. In this quarter, we experienced particularly strong performance in areas such as CMBS, non-Agency RMBS, residential re-performing loans, CLO, and corporate debt and equity strategies. Furthermore, solid net interest income boosted returns in our short-duration loan portfolios, including small balance commercial mortgage loans, residential transition loans, and consumer loans. Our portfolio of retained non-QM tranches also appreciated due to significant gains in our non-QM credit IOs and excess servicing strips, as rising mortgage rates caused actual and projected prepayment speeds to decline. Additionally, we realized considerable net gains from our interest rate hedges. In contrast, the rapid rise in interest rates and widening yield spreads led to notable net unrealized losses on our unsecuritized non-QM loans, while also compressing gain-on-sale margins for our loan originator affiliates. LendSure, although still profitable for the quarter, revised its earnings projections downward for 2022, and Longbridge reported a net loss for the quarter. Consequently, we incurred an unrealized loss of $7.5 million, or approximately $0.13 per share, on our strategic investments in loan originators. It's important to note that Longbridge's net loss was due to a reduction in the value of its MSR portfolio, while its origination segment remained profitable. We believe LendSure is well positioned to emerge from the current market volatility with enhanced market share and stronger earnings potential. In Agency RMBS, rising interest rates and increased volatility caused significant duration extension and yield spread widening, resulting in sharp declines in prices. As a result, net realized and unrealized losses on our Agency RMBS surpassed net interest income as well as net gains from our interest rate hedges, leading to a notable net loss for the quarter in that strategy on a mark-to-market basis. Moving to Slide 6, our total long credit portfolio grew by 11% sequentially to $2.3 billion as of March 31. Most of this growth occurred within our non-QM residential transition and commercial mortgage loan origination businesses. You can see that the slices of residential and commercial mortgage loans have increased in size. In commercial mortgages, we maintained our focus on multifamily properties, with our portfolio share of Multi increasing to 69% from 65% last quarter. However, our portfolio of consumer loans decreased sequentially, attributed to the successful completion of a loan securitization during the quarter and opportunistic CLO sales which reduced the size of that portfolio. On Slide 7, our long Agency RMBS portfolio declined by 11% to $1.5 billion, primarily due to mark-to-market declines. Please refer to Slide 8 for a summary of our borrowings. On the final day of the quarter, we issued $210 million of five-year senior unsecured notes at a rate of 5.875%. We hedged the interest rate risk on these notes with SOFR swaps, and since these swaps are marked to market, we chose the fair value option for the notes to ensure accurate calculations of our book value moving forward. Consequently, we expensed the costs associated with the offering, amounting to $3.6 million or about $0.06 per share, which resulted in an immediate decrease in book value per share. These senior unsecured notes will be recorded as senior notes at fair value on our balance sheet. In addition to the notes offering, we completed a non-QM securitization during the quarter that raised non-recourse borrowings by $403 million and a consumer loan securitization that reduced our borrowings by $36 million. We also established an additional financing facility for our commercial mortgage origination business. Our overall debt-to-equity ratio, adjusted for unsettled purchases and sales, rose to 3.2:1 as of March 31 from 2.8:1 at year-end, primarily driven by increased borrowings on our larger credit portfolio and the issuance of the unsecured notes. Similarly, our recourse debt-to-equity ratio, adjusted for unsettled purchases and sales, increased to 2.3:1 from 2:1. Our weighted average borrowing rate rose by 54 basis points to 1.78% as of March 31 due to a combination of higher short-term rates, the new senior unsecured notes, and disproportionately higher borrowings on our loan portfolios which have elevated borrowing rates relative to agency. Additionally, we raised $38.5 million of common equity through our ATM program during the quarter at approximately book value. We believe this ATM program offers an attractive, low-cost pathway for growth and we plan to keep utilizing it as investment opportunities and market conditions allow. For the first quarter, total G&A expenses rose sequentially by $0.03 per share to $0.17, while other investment-related costs increased by $0.07 per share to $0.17, mainly due to the expenses tied to the senior note offering. Our book value per common share stood at $17.74 as of March 31, down 3.5% from $18.39 at December 31. When factoring in the $0.45 per share of common dividends declared during the quarter, our economic return for the first quarter was negative 1.1%. Lastly, regarding the acquisition of a controlling interest in Longbridge, we are continuing to work through the closing process and expect the transaction to finalize in the coming months. Now over to Mark.
Mark Tecotzky, Co-Chief Investment Officer
Thank you, J.R. Last quarter saw unprecedented volatility, not just in interest rates but across many key fixed income metrics. For instance, the two-year note experienced a movement of 160 basis points, marking its largest quarterly shift since 1984. The gap between two-year and 30-year notes flattened by over one percentage point to just 12 basis points at the end of the quarter. In terms of MBS credit spreads, high yield widened by 70 basis points while even non-QM AAA-rated tranches experienced the same increase, and parts of the CRT market widened significantly, by over 400 basis points. So, what does this imply? Essentially, everything except IOs and mortgage servicing rights saw a decline in price, with many assets dropping sharply. The 10-year note futures declined by seven points, Fannie 2s also fell by seven points, and residential mortgage loans decreased multiple points in price. At this stage in the earnings cycle, lots has been discussed regarding the reasons behind these significant market movements. Therefore, I would like to specifically highlight how we managed to maintain our economic return at just negative 1%, thereby safeguarding Ellington Financial's book value. Following that, I will discuss the implications of this significant repricing of yields and spreads for future opportunities. Typically, one does not witness this degree of market red ink without also encountering some strong opportunities. Here’s what helped us protect our book value during the last quarter. Firstly, interest rate hedges were beneficial across the board. For certain assets with leveraged credit exposure, our credit hedges also proved effective. Slide 17 illustrates the credit hedges we maintained both entering and exiting the quarter. This slide has been part of our earnings deck for years, and while it doesn’t always get a lot of attention, we still include it. These credit hedges were crucial and profitable during the quarter, offsetting some losses and significantly enhancing our performance in the CMBS and CLO portfolios, despite these market sectors facing challenges. The greatest benefit from our hedges came from interest rates, not just in our agency portfolio. We owned many fixed-rate non-QM loans at the start of the quarter, which dropped considerably in price. However, the interest rate hedges mitigated the impact, along with our retained tranches from previous non-QM securitizations. These retained tranches, characterized as credit IOs and excess servicing rights, tend to increase in value when interest rates rise, which they did markedly in the first quarter. We have retained these tranches in all our non-QM securitizations, only exiting them if we call the deals. Thus, these retained tranches helped bolster the non-QM loans we've been buying, in a manner similar to how mortgage servicing rights support mortgage pools and diversify our earnings in the non-QM sector. Our non-QM securitizations not only secure very low long-term financing rates and lessen our mark-to-market volatility, but they also produce valuable credit IOs and servicing strips which we hold onto, serving as a solid complement to profits from non-QM origins. Our portfolio also gained significantly from the fact that many holdings are floating rate or short duration, or both. For instance, our commercial mortgage bridge loans are designed as floating rate assets with a short average life. Last year, we faced the challenge of LIBOR being essentially at zero, which suppressed the coupons on our floating rate bridge loans. However, Jay Powell provided our coupons with a 50 basis point boost last Wednesday. Projections for the forward curve suggest LIBOR could exceed 3.5% in a year. Thus, a bridge loan with a floating rate spread of 550 basis points might yield over 9% in a year. Despite all the volatility, our commercial mortgage bridge loan portfolio managed to generate solid annualized returns this quarter, and we remain optimistic about this sector. On slide 9, you can observe our consistent preference for multifamily assets in our commercial loan portfolio. Much has been discussed regarding the shortage of affordable housing in America. Although valuations have soared, multifamily rent growth has been robust. Unlike office and retail sectors, multifamily is not as susceptible to major disruptions from individual lease turnovers. Our residential transition loan portfolio also performed strongly this quarter. These loans are even shorter in duration, so their price volatility did not compare to what we experienced with our non-QM loans, and they continue to pay off quickly. A similar situation occurred with our consumer loans. Though these loans are of very short duration, they carry fixed rates, albeit high ones, and we've hedged some of their interest rate risk. That portfolio also produced strong returns, as did our non-Agency RMBS and RPL strategies. This past quarter was quite challenging for levered agency portfolios, resulting in losses for our Agency MBS portfolio. Although interest rate hedges helped soften the impact, the substantial yield spread widening severely affected us, with that strategy down $0.34 per share. Nonetheless, the yield spread widening has enhanced the future opportunities in the agency sector. It’s important to remember that the quarter-over-quarter changes in our smaller agency portfolio don’t signify any major downsizing on our end, but primarily reflect the mark-to-market declines experienced in that portfolio. One noteworthy aspect of Q1 was the unexpected stability in funding spreads; the funding markets for all our assets, whether agency pools or loans, functioned reliably throughout the quarter. Usually, changes in funding availability lead to spread and price volatility, but that wasn’t the case this time. If anything, due to the higher absolute rates we will now be paying our lenders as short rates increase, we are seeing a rise in interest from various funding sources. As I mentioned earlier, the area that hurt our performance was primarily the Agency strategy and to a lesser degree the non-QM strategy. Most mortgage originators are navigating a tough landscape, faced with rapidly rising rates and declining volumes. This contrasts with last year, which was advantageous for originators, characterized by high volumes and elevated loan prices. Currently, it appears that non-QM origination volumes will decrease, though not nearly to the extent of agency originations, and the loan prices for new production are considerably lower than they were throughout much of 2021. On many occasions, you’ve highlighted the advantages of being both a loan buyer and an originator as the balance shifts between the two for profit opportunities. With many non-QM originator competitors struggling, I perceive prospects both as an originator and an investor in loans moving forward. Given the turmoil in the market, we believe we can acquire excellent non-QM packages from a broader range of originators, and we have already purchased a couple of pools. Numerous non-QM originators have been impacted by the significant market fluctuations, prompting them to seek quick sales to reliable buyers. There are numerous factors at play with many moving parts, but our diversification effectively helped this quarter. Several sectors where we allocated smaller capital had remarkable performance, including CMBS, CLOs, RPLs, and non-Agency RMBS, all of which contributed positively. When we consider everything, overall performance was down just 1%, which I find quite satisfactory. So, what does our outlook look like moving forward? Generally, substantial downward price movements and numerous losses rejuvenate the opportunity landscape. This certainly applies to Agency MBS and non-QM sectors. It’s crucial for us to manage our portfolio without preconceived notions about future developments. The forward curve certainly anticipates many rate hikes, yet several aspects driving inflation might only be marginally affected by these increases. Therefore, we need to contemplate a broad spectrum of potential outcomes and remain adaptable in our strategies. While funding markets are currently functioning effectively, liquidity has decreased significantly, necessitating that we operate with sufficient cash reserves. Being compelled to raise cash quickly in a weak market can lead to considerable value loss. However, the yields and spreads we are observing present the best opportunity set we’ve seen since the market rebounded from the depths of COVID. Now, back to Larry.
Larry Penn, CEO
Thanks Mark. I'm pleased with how we navigated the market volatility in the first quarter. We did what we've done so many times before. First, we relied on our disciplined hedging and liquidity management to protect book value, even building up excess liquidity to capitalize on the better investment opportunities. Second, we maintained a diversified relatively low leverage portfolio. Third, we dynamically rebalanced our hedges in response to the fast-changing market conditions. And fourth, we were opportunistic in our timing to raise capital, both through our common ATM program and through our senior unsecured note deal. I'm excited about how our portfolio is positioned today, as well as with all the dry powder we have on hand, in light of the rich investment opportunity set that we're seeing today. So far this year, we've been able to ratchet up, not only yields but also yield spreads in most of our loan origination businesses, while also adding some attractive loans and securities in the secondary market, including even some secondary purchases of discounted non-QM loan pools, as Mark mentioned. Ellington Financial's strong balance sheet and liquidity position have also provided valuable support to our loan originator affiliates. As both JR and Mark mentioned, rapidly rising interest rates and widening yield spreads have compressed gain on sale margins for loan originators. And many originators have been forced to scale back operations in the face of losses, especially those who did not properly hedge their locked loan pipelines or were under-capitalized or both. While we do expect loan origination volumes to moderate in the higher interest rate environment, we have also seen a number of competitors break their rate lock agreements. I think that this represents a golden opportunity for our affiliate lenders to add market share and enhance their visibility in the marketplace. Finally, since quarter end, interest rate volatility has continued to be elevated and we've seen further yield spread widening in many sectors. While that's another headwind on a mark-to-market basis, it's a great time to be putting all our dry powder to work. With that, we'll now open up the call to questions.
Operator, Operator
And we'll take our first question from Crispin Love with Piper Sandler. Please go ahead. Your line is open.
Crispin Love, Analyst
Thank you. Good morning. And you touched on this a little bit during the prepared remarks, but just hoping for a little bit more color. So, given the significant rate moves and spread widening we're seeing and have seen for a bit, how are you seeing the new reinvestment yields compared to the impact you would expect from the cost of funds side? Would you expect the NIM to widen from where we are right now given the rate backdrop? And then also just what are the ROEs you're seeing on new investments?
Larry Penn, CEO
Mark, do you want to handle that?
Mark Tecotzky, Co-Chief Investment Officer
Yes, I believe you will see the net interest margin widen primarily due to the increasing spreads. If yields rise, our financing costs will likely increase at a similar rate to the yields on our assets. In the first quarter, we not only experienced rising yields but also a significant increase in spreads. Therefore, I expect the net interest margins to grow. Additionally, I think I missed part of your question.
Crispin Love, Analyst
Yes. Just do you have any color on ROEs that you're seeing on your new investments?
Mark Tecotzky, Co-Chief Investment Officer
I believe we are diversified, so there is a variety of return on equities depending on the sector, but we are currently seeing many in the teens.
Larry Penn, CEO
Yes, definitely mid-teens. In terms of net interest margin and its future trajectory, it's important to distinguish between the credit portfolio and the agency portfolio rather than analyzing the overall net interest margin. In each portfolio, we anticipate an expansion in net interest margin. As Mark mentioned, the funding market remains robust, providing us with good momentum to maintain lower funding costs relative to our spreads. On the asset side, it's crucial to note that we're dealing with a bit of a peculiar moving average. If you examine the investments made in the fourth quarter and early in the first quarter, we experienced some spread compression in certain segments, such as small balance commercial and residential transition loans, leading to a slightly narrower net interest margin. However, we now have significant capital available, and the investment prospects in some markets like non-QM have improved considerably over the past few months. As we start deploying this new capital, we expect to see the net interest margin in credit widen considerably. Additionally, our leverage will likely increase due to the unsecured note deal, which offers us the opportunity to prudently enhance our leverage in credit.
Crispin Love, Analyst
Thank you for that information. I have one more question. Do you have an update on book value through April or any qualitative comments on that?
Larry Penn, CEO
I'm going to stick to what we said, which is that you should expect a mark-to-market decline since the end of the quarter. We have a schedule we adhere to, typically releasing our book value estimates around the middle of the month, and we will continue with that. Looking at the market, it's important to note that this is not solely an agency portfolio. There are many factors at play, and I would prefer not to provide a specific number at this time.
Crispin Love, Analyst
Understood. Thanks for taking my questions.
Larry Penn, CEO
Thank you Crispin.
Operator, Operator
We'll take our next question from Eric Hagen with BTIG. Please go ahead. Your line is open.
Eric Hagen, Analyst
Hi, thanks. Good morning. I think I just have one. I think you alluded to it in your prepared remarks; a lot of what has been securitized in non-QM this year is really you can say a backlog of collateral on the balance sheets of investors with lower coupons. Do you have any perspective on how spreads could respond or evolve as newer collateral gets securitized in non-QM, and what you think that means for the returns to the levered investor holding on to the residual risk? Thank you.
Larry Penn, CEO
Do you mean spreads on the tranches, the liabilities? Is that what you mean?
Eric Hagen, Analyst
Right.
Mark Tecotzky, Co-Chief Investment Officer
That's a great question. Yes, thanks, Eric. I believe this is partly why spreads on non-QM tranches widened significantly in the first quarter. The market largely maintained a pricing speed convention of 25 CPR, regardless of the note rate on the underlying collateral and loans, and how that relates to what a non-QM borrower would expect for the current note rate. In a deal we priced on April 14th, we adjusted our pricing speed slightly to consider these factors, but that hasn't been typical. I think when we start to see higher note rate non-QM loans being securitized—specifically those around 6.25% note rate and above—spreads will likely tighten. Investors will probably see the 25% CPR pricing speed as a more accurate estimate and perceive less extension risk on those tranches. This should provide some support for the retained yields on newer securitizations. However, if the economy enters a recession and short rates and mortgage rates decrease, then those holding retained pieces may face the possibility of faster prepayment rates and quicker deal pricing speed. I think you make a good point, and I expect we'll see tighter securitization spreads as the current loans in the non-QM market are brought to securitization.
Eric Hagen, Analyst
That's helpful color. I appreciate it.
Operator, Operator
And we'll take our next question from Doug Harter with Credit Suisse. Please go ahead. Your line is open.
Doug Harter, Analyst
Thanks. Can you talk about, what size the amount of kind of excess liquidity or excess capacity you have to kind of take advantage of the wider spreads, kind of keeping in mind I know you said that you probably hold excess liquidity in the current environment?
J.R. Herlihy, CFO
Sure. There are a few ways to answer that question. First, I would highlight our cash and cash equivalents along with unencumbered assets at the end of the quarter, which together amounted to about $1 billion. Approximately one-third of that total was $360 million in cash and $630 million in unencumbered assets. While we might not encumber all those assets, it indicates our additional borrowing capacity. Moreover, the cash figure was notably high because we finalized a $210 million transaction on the last day of the quarter. Overall, these figures suggest we have around $1 billion in cash and borrowing capacity available. Our liquidity levels have generally been higher in the post-COVID period compared to pre-COVID, allowing us to maintain excess liquidity and lower leverage. As of the quarter's end, we certainly have more than enough resources to allocate.
Doug Harter, Analyst
Got it. Can you discuss how you believe the mix between agency and credit may evolve based on the opportunities you perceive each day?
J.R. Herlihy, CFO
Sure. So I mean, historically agency has been at the low-end 15% of the capital allocation at the high-end 22%, 23%, which really we hit for a brief amount of time a few years ago kind of 2019. So we're currently 85-15, so 15% being the low-end of the agency range. I think the part of the capital allocated agency there will always be an Agency strategy. It helps us comply with three tests and 40 Act tests and the like. It also provides liquidity and diversification. So we talked a lot about the benefits of having that Agency strategy which we also operate on a more risk-adjusted basis with the TBA short. And it's pretty heavily hedged. So I think there will always be an allocation to agency. This 85-15 is probably a good split to think about going forward though, because credit has been growing even before this quarter. Over the last 18, 24 months, credit has been growing relative to agency as we grow our origination businesses. And I would kind of expect that to continue on the margin. Larry you'd like to add anything?
Larry Penn, CEO
Yeah. I'd just add. I think if agencies recover on a spread basis as we think, they will then you might see that 85-15 even tick a little bit lower in terms of agencies. Right now, the agency opportunity looks very good, but you could even see us tick below 15%, once we get the recovery that we're expecting in spreads on agencies. And the upcoming Longbridge closing, I mean, that's going to be credit, right? So that will also affect the split to credit.
Operator, Operator
We'll take our next question from Brock Vandervliet with UBS. Please go ahead. Your line is open.
Brock Vandervliet, Analyst
Thanks. Good morning, everybody. On LendSure, if you could just talk through the lower earnings guide for the year? Obviously, tons of cross currents around non-QM. But just wondering if you give more color there?
Larry Penn, CEO
Mark?
Mark Tecotzky, Co-Chief Investment Officer
Sure. Hi, Brock I think it – look last year and I sort of mentioned this in my prepared remarks you had a combination of very high volumes because the housing market was on fire very high volumes and very high loan prices right because you had relatively tight securitization spreads from the yield curve was at low levels, which is where you price a lot of the non-QM bonds off of. So last year was really a good market backdrop for non-QM originators. And so you have this year is you have mortgage rates a lot higher. So there are going to be some borrowers that would have qualified for mortgage at the rates they could have gotten a year ago that now when you figure out their debt-to-income calculations at the current rates their payments are higher and they might not qualify. So I think you're going to see – I think it's logical to see lower volumes. And the other thing I think is that because of all the volatility and the spread widening loan prices are lower. So even when you get to sort of current coupon non-QM loans now they're trading at lower prices than where they traded last year. And really total dollar of profits for these originators is pretty much the product of volume times gain on sale over their expenses. And I just think you have – you have some amount of lower volume across the board, presumably some amount of lower gain on sale. And I think it makes sense that that sort of translates into lower earnings. So I think their projections are sort of just a realistic assessment of market – what the market conditions are now versus when they did this exercise previously. Now the thing I'm optimistic about or I think there is also an opportunity to grow market share, right? And I mentioned it in my comments I think is that you've seen some real pain out there among originators and it's been an issue of honoring rate locks and things like that. So I feel like LendSure has really gone out of their way and they always do to comport themselves in a way that has a lot of sensitivity to their clients right mortgage brokers and the ultimate home purchasers that they serve, right? So I think that we have a good opportunity to grow market share. So I think the overall pie is shrinking a little bit but I think it's completely realistic and it's our hope we're going to – they're going to work really hard to achieve this is that we can get a little bit slice bigger slice of the pie.
Larry Penn, CEO
And if I could just add, we still think they're going to be LendSure is still projecting a nice profit not nearly what it was last year but a nice profit for 2022 still a very decent return on equity in terms of our investment in LendSure. The important thing, I think that we're doing for LendSure, which we kind of alluded to earlier was that we're trying to buy as much from them on a forward basis to kind of remove the hedging complexities and other kind of pipeline, potential pitfalls sort of move them over to Ellington Financial where I think it's sort of a more logical place for us to be hedging and taking that risk on the pipeline and letting LendSure just do what it does well, which is to originate products. And as Mark said, you're going to see lower gains on sale. And I don't think that's going to change until the backlog of non-QM product by some of these weaker hands, some of the lower coupon stuff, which is still overhanging the market. Until that's cleared up, I think you'll definitely continue to see lower gains on sale in non-QM even for current production. But it's still profitable and we still think they're going to deliver a nice return on equity for us in 2022.
Brock Vandervliet, Analyst
Got it. And just similarly on the resi transition, which seems to have been a sector gold mine. Just thinking of that as a bit of an operator or borrower I'd probably be more concerned about home price appreciation. I've got to worry more about that exit when I sell the home. I'm more worried about the cost of renovation, given wage and product price escalation. Doesn't that market slow too? Does it even matter for Ellington given your size and how do you think about that?
Mark Tecotzky, Co-Chief Investment Officer
I would say that we haven't observed a slowdown. The housing numbers since COVID have been unusual; they don't resemble any trends from the past 25 years. Over the last year and a half to two years, we've seen one pattern of housing numbers, while prior to that, there was a different pattern regarding warehouse sales and market listing times. For residential transition loan originators, the positive aspect of this market is that once they complete renovations and list the house, they can sell it very quickly. We track this closely and review it monthly in detail, comparing the selling prices of properties to our expectations for their value after repairs, which include renovation costs.
Brock Vandervliet, Analyst
Yeah. The performance, yes.
Mark Tecotzky, Co-Chief Investment Officer
Yes, exactly. I’m very interested in tracking monthly sales, which are going well. The time on the market in the areas where we are active is still relatively short, and we are monitoring that closely. One important point I've been discussing with our partners is the supply chain issues. They are now looking at what's available from suppliers like Lowe's and Home Depot in terms of windows and doors before they buy a house or finalize their renovation budgets. This is a change from a couple of years ago when supply chains weren't a concern. They are handling this differently now, which may limit the scope and complexity of renovations, but they are doing it to ensure they have all the necessary materials upon purchasing the house. This avoids situations where a house is nearly finished but waiting for essential items like windows. Overall, that market is performing well. However, after the recent surge in housing activity, it’s important to be cautious about the potential for a downturn. Currently, that market remains strong, but a negative aspect, which Larry touched on, is that we haven't been able to raise the note rates on our purchases as we have seen in other sectors. With our financing costs increasing by 50 basis points this week following the Fed meeting, our net interest margin is tightening a bit, but financing remains solid, and there is potential for improvement. We see a real opportunity to grow our market share by bringing in new partners.
Larry Penn, CEO
We're a small player in a significant market, which we believe has long-term potential, particularly in regions like Texas where we are active in fix-and-flip and RTL projects. The demographics in these areas are favorable. As Mark mentioned, these loans are typically short-term, under one year from start to finish, which alleviates concerns about the long-term value of the collateral. We remain optimistic about this market, as it has provided us with one of our highest net interest margins. While we anticipate some margin compression, the market is quite fragmented, allowing us to continue to expand our market share. We feel confident about the credit risks we're taking due to the short duration of the loans and our focus on specific regions.
Operator, Operator
And we'll take our next question from Bose George with KBW. Please go ahead. Your line is open.
Bose George, Analyst
Hey, guys. Good morning. In terms of investment opportunities, just given the fallout with mortgage originators, do you think there's opportunities there to acquire other companies or is the focus more on growing the existing companies taking share?
Larry Penn, CEO
There will likely be opportunities in the future, but we are not very far along in any discussions at this time. We are currently showcasing certain aspects of our business. If I had to make a prediction, I would say that our primary focus is on the companies we currently have. We are potentially looking to acquire some teams, personnel, or branch offices from companies that may be facing challenges.
Operator, Operator
Okay. That makes sense. Thanks. And then actually on the Longbridge MSR, did you guys say you took a negative mark? And I was wondering what drove that? Yes, just curious, what drove that?
Larry Penn, CEO
Yes. The negative mark on the Longbridge MSR was primarily driven by the continued widening in the HECM market. A portion of the MSR's value stems from a straightforward servicing strip. Ideally, you would expect that as prepayments slow, this aspect would grow in value with rising rates. However, a significant value comes from the tail, where the HECM servicer has the right to meet the borrower's draw requests on the undrawn portion of the HECM. The profit derived from these additional draw requests depends on the price at which you sell to Ginnie Mae in the open market. As Ginnie Mae has widened and certain prices have decreased, this has effectively reduced the gain on sale from these tail draws.
Bose George, Analyst
Okay.
Larry Penn, CEO
Unfortunately, it's not a very hedgeable risk. There's no TBA market for HECMs. Longbridge and we are indirectly experiencing fluctuations over time, which have recently been down due to some widening in the HECM market.
Bose George, Analyst
That’s okay. No, that makes sense. And then just when the Longbridge deal after it closes, have you decided, how you're going to report that just given the consolidation of securitizations and I guess that inflates your balance sheet?
J.R. Herlihy, CFO
Yes. Sure. So it's a work in progress and the timing of the consolidation will depend on when the transaction closes. So if it closes prior to June 30, and the consolidation in the financial statements will start on Q2. And I think the tentative plan is we'll certainly be reporting detail on Longbridge itself and the continued EFC portfolio probably in a segment type format.
Bose George, Analyst
Okay. Its great. Thanks.
J.R. Herlihy, CFO
Yes. If you examine Long Bridge's balance sheet, you will notice there is one significant asset and one significant liability that correspond to the underlying loans issued by Ginnie Mae and Ginnie Mae itself on the liability side. Therefore, we encourage people to consider the net effect of those two when evaluating the consolidated entity, particularly regarding the MSR that is retained from those securitizations. The balance sheet will reflect this in terms of GAAP.
Operator, Operator
And we'll go next to Mikhail Goberman with JMP Securities. Please go ahead. Your line is open.
Mikhail Goberman, Analyst
Hey. Good morning, Guys.
Larry Penn, CEO
Good morning.
Mikhail Goberman, Analyst
Just a couple of questions from me. Where are you seeing loan rates on newly originated loans? And how much would you expect higher rates to impact non-QM volumes over the remainder of this year?
Mark Tecotzky, Co-Chief Investment Officer
Thank you for the question. Currently, most of the non-QM production is between 6.5% and 7%, depending on the type of loan and borrower credit attributes. It's challenging to predict how this will affect volume since we only have six to seven weeks of data reflecting the significantly higher rates. Volumes are holding up well, but it's tough to determine if this is indicative of the overall market or if we're gaining or losing market share. In this market, it seems likely we're gaining market share as we continue to service our clients effectively. It is expected that volume may decrease slightly since home prices have risen, and higher rates mean higher payments. Currently, we're seeing note rates in the 6.5% to 7% range. Additionally, there has been a noticeable tightening of securitization spreads since March. Despite these changes, the market is displaying a more positive tone, with larger buyer participation in securitizations. Many lower note rate loans that were locked in last year or earlier this year have had their risk distributed, and we are over halfway through that process. As a result, we might see tightened securitization spreads and a slight decrease in non-QM note rates without a corresponding change in treasury yields, which would be beneficial for volumes.
Larry Penn, CEO
Yes. And if I could just add, Mark. So first of all one big difference right between agency volumes and non-QM volumes is non-QM volumes were already that market is already primarily a purchase market right? So as opposed to the agency market, which until recently of course was a vast majority refi market. So the drop in volume that you're going to see is a lot less in non-QM. And the other thing I would say is, with the curve a lot flatter and given the certainly the short-term dynamics of what's going on in non-QM market I think that the you're going to see 7% note rates real soon. The market is always a little slow to react. It takes a little bit of time. But I think 7% note rates is given where yields are right now in the market treasuries etc. I think that's I think we're going to get there pretty soon.
Mikhail Goberman, Analyst
Great. And if I can just squeeze in one more. Would you expect additional unrealized losses on originator investments in the second quarter based on how rates have moved?
Larry Penn, CEO
Yes, in the case of LendSure, it's difficult to say definitively. However, with Longbridge and some weaknesses in the Hakam market, we might anticipate additional unrealized losses. We believe that long-term spreads will eventually stabilize. On a mark-to-market basis, I do think there could be losses related to the MSR, but the origination platform remains very strong.
Mikhail Goberman, Analyst
Great. Thanks a lot. Happy weekend.
Larry Penn, CEO
Thank you. too
Operator, Operator
And that was our final question for today. We thank you for participating in the Ellington Financial first quarter 2022, earnings conference call. You may disconnect your line at this time and have a wonderful day.