EARN - NYSE

Good morning, ladies and gentlemen. And thank you for standing by. Welcome to the Ellington Credit Company First Quarter 2025 Financial Results Conference Call. Today's call is being recorded [Operator Instructions]. It is now my pleasure to turn the floor over to Alaael-Deen Shilleh, Associate General Counsel. Sir, you may begin.

Thank you. Before we begin, I'd like to remind everyone that this conference call may include forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not historical in nature and involve risks and uncertainties that are detailed in our most recently filed annual report on Form 10-K and our filed but not yet effective registration statement on Form N-2. Actual results may differ materially from these statements, so they should not be considered to be predictions of future events. The company undertakes no obligation to update these forward-looking statements. Joining me today are Larry Penn, Chief Executive Officer of Ellington Credit Company; Greg Borenstein, Portfolio Manager; Mark Tecotzky, Executive Vice President; and Chris Smernoff, Chief Financial Officer. Our earnings call presentation is available on our Web site, ellingtoncredit.com. Today's call will track that presentation, and all statements and references to figures are qualified by the important notice and end notes at the back of the presentation. With that, I'll turn the call over to Larry.

Thanks, Alaael-Deen. And good morning, everyone. We appreciate your time and interest in Ellington Credit Company. I am very pleased to report that on April 1st, we successfully completed our conversion to a registered closed-end fund. As planned, within days of the conversion, we quickly and efficiently sold our remaining agency mortgage pools and covered our TBA short positions, all with minimal impact on our net asset value. In fact, even with all the market gyrations in early April, we estimate that these pool liquidations had only about a $0.01 per share effect on earns that net asset value. This $0.01 effect was exactly what we had estimated on our last earnings call and it was the precise and well timed hedging by Mark Tecotzky and his team that made this excellent result possible. As a byproduct of our conversion to a closed end fund, we also changed our fiscal calendar to begin on April 1st. Therefore, on today's earnings call, when we were referring to the quarter ended March 31, 2025, to avoid confusion, we'll refer to that quarter as calendar Q1. Okay. So now to our calendar Q1 results. During calendar Q1, in preparation for the conversion, we increased our CLO portfolio by 46% to $250 million, while we kept the size of our long agency mortgage portfolio stable in order to maintain our exemption from the 1940 Act right up to the point of conversion. Also, starting in January, we aggressively ramped up our TBA short mortgage hedges. And so when volatility began to spike in March, we had already completely neutralized our exposure to the mortgage basis, thus saving us from the losses that we would have incurred when spreads widened later in the quarter. This positioning also enabled our agency mortgage portfolio to significantly outperform during those volatile periods leading up to and through our final sales in early April. Turning to Slide 4. Let's take a look at the market backdrop for the quarter. A strong January and February gave way to turbulence in March as investor sentiment soured on fears of tariffs, slowing growth and inflation persistence. Interest rate and spread volatility surged in March, equity indices declined and credit spreads widened, including in the CLO market, where both mezzanine debt and equity tranches saw meaningful price declines. You can see in the middle of Slide 4 that spreads on high yield, investment grade and CLO debt tranches widened and therefore, prices declined across the board during the quarter, with most of that occurring in March. Importantly, the price declines we saw were a function of potential future credit concerns, especially for companies that will be impacted by skyrocketing tariffs and not the result of any current or near-term credit concerns. Let's now move past quarter end and into early April. After selling all our mortgage pools following the conversion, our liquidity and buying power increased significantly and we got to work ramping up our CLO portfolio. Our timing was fortunate as we were able to add very attractive assets during all the April market turmoil. More recently, significant tariff deescalations have led to credit spreads and prices reversing course in May, retracing a significant portion of the March and April move. It was great to be able to put fresh cash to work in CLOs while prices were lower. To sum up calendar Q1, while our Agency mortgage strategy delivered positive results for the quarter, declining prices on CLO mezzanine debt and equity drove an overall net loss. Nevertheless, our adjusted distributable earnings continued to cover our dividends for the quarter, and we've seen prices come back strong so far in calendar Q2. I'll turn it over to Chris now to walk through some more of the financial details. Chris?

Thanks, Larry. And good morning, everyone. Please turn to Slide 5. For calendar Q1, we reported a net loss of $0.23 per share and adjusted distributable earnings of $0.26 per share. Our overall net interest margin increased by 20 basis points to 5.27%, supported by our growing capital allocation to CLOs. On Slide 6, you can see portfolio P&L by strategy, which was negative $0.24 per share from CLOs and positive $0.08 from agency. In our CLO portfolio, mark-to-market losses exceeded net interest income and modest gains on our credit hedges. In our agency portfolio, net gains on agency RMBS exceeded net losses on interest rate hedges for the quarter. At March 31st, our book value per share was $6.08 and combined cash and unencumbered assets totaled $169 million or 74% of total shareholders' equity. Our economic return for the quarter was negative 3.2%. Our debt-to-equity ratio adjusted for unsettled trades declined to 2.2 times at March 31st, down from 2.9 times at December 31st. Over the same period, our net mortgage asset to equity ratio decreased to about zero from 2.6 times, driven by a net short TBA position that almost entirely offset our Agency RMBS holdings at quarter end. Slide 9 shows our CLO portfolio increasing by 46% to $250 million at March 31st and capital allocated to CLOs expanding to 81% from 72% at December 31st. At March 31st, CLO equity comprised 66% of our total CLO holdings, up from 58%. And European CLO investments constituted 14% of our total CLO holdings, roughly unchanged from the prior quarter. On Slide 10, we show that our Agency RMBS holdings decreased slightly to $504 million from $512 million at December 31st. As Larry mentioned, we disposed of all of our remaining mortgage positions shortly after April 1st. Slide 11 details our interest rate hedging portfolio where you can see that our rate hedges were entirely in short TBA positions as of March 31st. And Slide 12 illustrates our net RMBS exposure where you can see that our net short TBA position fully offset our long agency pools. We also maintained modest credit hedge and foreign currency hedge portfolios at quarter end related to our CLO investments. Slide 13 illustrates that nearly all of our loans underlying our CLO portfolio are floating rate and as such, have much lower interest rate duration than agency mortgages. In connection with the conversion, we also changed our fiscal year to end on March 31st the day prior to the conversion with our first full fiscal year following conversion to end on March 31, 2026. Therefore, the three month period ended March 31, 2025, during which time we operated as a taxable C corporation, will constitute its own short fiscal year. And next month, we will be filing a transition period 10-K for that short three month fiscal year. Then moving forward, as a closed end fund, we will be making 1940 Act filings such as N-CSRs, N-CEN and N-PORT rather than 10-Qs and 10-Ks. So we still plan to continue issuing earnings releases on a quarterly basis Finally, as a closed end fund, we will be reporting a net asset value per share moving forward, which is substantially the same metric as the book value per share we've reported previously. With that, I'll pass it over to Portfolio Manager, Greg Borenstein to discuss how the CLO market has performed, how we've positioned our CLO portfolio and our market outlook.

Thanks, Chris. It's a pleasure to speak with everyone today. Calendar Q1 presented a number of headwinds, particularly for CLO equity. While payment default rates remained low and fundamental strong in general, there were several challenging technicals. Continued loan coupon spread compression to start the quarter, coupled with loan price declines to end it weighed on CLO equity valuations. These phenomena were most pronounced in the US, while the impact on European positions was comparatively muted. In CLO mezz, while our US positions did experience mark-to-market declines as well, those declines were smaller than on equity, and mezz also outperformed most other corporate credit markets on a credit beta adjusted basis. Meanwhile, for our European mezzanine positions, strong carry and realized gains exceeded mark-to-market losses. We also had gains albeit at modest ones from our credit hedges. In CLO equity early in the quarter, loan coupon spread compression continued to be an issue with the majority of the loan market trading above par to start the year. This caused CLO net interest margins to contract, which weighed on equity interest payments. On the other hand, some deals were able to benefit from resets and refinancings. And at EARN, we had gains from deals that liquidated, offsetting some of the mark-to-market declines elsewhere in the portfolio. Loan coupon spread compression concerns have since receded as only 10% of the loan market traded both par by the end of March and just 4% by the end of April. However, with the May rallies, that percentage has begun to creep up again. Loan prices closed calendar Q1, down $0.82 based on the Morningstar/LSTA US Leveraged Loan Index, declining in sympathy with the sell-off across credit markets. CLO debt tranches, particularly AAAs, saw their credit spreads widen in the quarter. This weakness was driven by several factors, including weakness in investment grade and high yield corporate bonds, CLO ETF capital outflows, heavy primary CLO supply and elevated macro volatility. Wider credit spreads on CLO debt tranches resulted in CLO equity refinancing and reset options becoming less valuable, which also negatively pressured CLO equity prices. These effects were also more pronounced in the US than in Europe. And as a result, our European CLO equity investments outperformed their US counterparts in the quarter. Meanwhile, our Mezz portfolio, both in the US and Europe held in better. Higher quality BBs remain well supported by real money investors and hence had relatively limited price declines on the quarter. While our CLO portfolio had become more concentrated in CLO equity in prior months, we have more recently seen compelling value in mezzanine tranches once again. And we have been directing our excess interest cash flows and sale proceeds into some highly attractive BB investments accordingly. We believe these investments will help balance the portfolio and protect us from the potential of increased credit defaults, given continued uncertainty surrounding tariffs and their effect on the fundamental picture for credit moving forward. The outperformance of Europe versus US and of mezz versus equity during the quarter demonstrated the benefits of diversification in our portfolio. We intend to remain active in both the US and Europe and in both equity and mezz based on relative value. I believe the market volatility overall has been a big positive for EARN. As Larry mentioned earlier, we came into April with cash to deploy. While we experienced some mark-to-market losses in calendar Q1, most of the price declines were driven merely by credit spread widening as opposed to by accelerating realized credit losses. We were able to be opportunistic with our deployment and take advantage of these wider spreads. And indeed, much of the credit widening has retraced so far in May. Looking ahead, we will continue to prioritize portfolio liquidity and agility as the current trading environment may demand great flexibility in response to an uncertain credit backdrop. Now back to Larry.

Thanks, Greg. I commend Mark Tecotzky and his team for doing an incredible job rotating out of our agency mortgage positions with minimal impact on net asset value in what was an extremely challenging market around the tariff announcements. We sold our last mortgage pool on April 7th. And as a final tally, our Agency mortgage strategy generated positive portfolio income for 2025 of about $2.55 million. In contrast, over the same time frame, the Bloomberg US Agency MBS Index generated a significantly negative return versus treasuries. With the conversion now behind us, I am excited to have dry powder for our portfolio managers to deploy in such a compelling market. Since the April 1st conversion, we've bought an additional $51 million of CLO investments through yesterday. And we've also sold some positions at profits that we thought had become too fully valued. With the mortgage pools gone, our debt leverage now stands at less than half a turn. We started April with a net asset value of $6.08 per share. While additional credit spread widening in April did drive further CLO price declines, the effect on our portfolio was contained and we ended the month of April with an estimated net asset value in the range of $5.85 per share to $5.91 per share. I am pleased to announce that similar to what most other CLO focused closed end funds do, we have started posting on our Web site a brief tearsheet, where you can find updates of many of our portfolio metrics as of month end. We plan to continue posting these tearsheets on a monthly basis going forward. You can find our monthly tearsheet right on our home page, www.ellingtoncredit.com by clicking on the link labeled monthly NAV and portfolio update. I'll give you a few moments now to open up the tearsheet. As you can see, there's a lot of information assembled on this page, but I'd like to highlight a few things in particular. Near the top in the common stock data section, you'll see our April 30th range of estimated NAV per share centered around $5.88 per share as well as our monthly dividend and dividend rate. Then to the right, in the CLO portfolio underlying loan data section, you'll see a bunch of statistics on the corporate loans underlying our CLO investments. Moving down the page in the portfolio overview section, you'll see the breakdown of our portfolio as of April 30th, including the fact that coming into May, a full 18.8% of our total portfolio or about $59 million was in cash and cash equivalents. So you can see that we have plenty of dry powder to deploy in the aftermath of the April market weakness. Finally, to the right, you'll see the total return performance of our stock in April versus a few relevant indices, whether measured on a stock price based total return basis or on an NAV based total economic return basis, I think you'll find that our April performance compared very favorably with that of other CLO focused closed end funds. Moving on to May. I'll just mention briefly that so far this month, we've seen a good amount of credit spread tightening, which of course, has been a tailwind for our NAV. As of last night, our total CLO portfolio stood at $284 million, up from $250 million at the time of our conversion. Amid the ongoing elevated market volatility, we continue to add investments selectively in both CLO mezz and CLO equity and we continue to actively trade the portfolio to take advantage of relative value opportunities between subsectors, all while drawing on the disciplined risk management that we're known for. Even as we've been putting capital to work, we have also been maintaining high levels of liquidity so we can still play offense should we see further market dislocations. This kind of dynamic market environment is where I believe our active management approach will shine. As we continue to ramp up our CLO portfolio, I believe we are in excellent position to drive strong earnings and unlock value for shareholders moving forward. We will also look to add corporate debt to our liability structure later this year, which should be accretive to net investment income. Now let's open up the floor to Q&A. Operator, please proceed.

[Operator Instructions] We'll take our first question from Eric Hagen with BTIG.

Really great timing with the divestment of the Agency portfolio. I think you said $50 million of CLOs have been acquired since the conversion. I mean how does the yield on those assets compare to the, call it, $250 million that was in the back book? And then right now -- forgive me if I didn't hear you guys. But right now, do you guys have dry powder to deploy or are you fully deployed right now?

So as you can understand, the market has gone through been in a few different places since April 1st. I think that overall, the weighted average yield that we purchased, I would say, varied from slightly wider to some things were potentially hundreds of basis points back. I think what's important to note too is, it's not simply like we scaled up the portfolio pro rata. As we spoke about early on when we started buying CLOs, we were buying a lot of discounted mezzanine paper as we thought that was the best risk adjusted return. We started shifting more heavily into equity, in particular in new issue as the market dislocated a bit, new issue investments stopped. And I think that more of the additions were potentially shifting back balancing into mezzanine. And so simply looking at the overall return in some of these cases, the profile of some of the bonds we were purchasing changed based on investment thesis. So just caveating that it should be broken out by different types of sectors. But overall, it ranged from moderately wider to hundreds of basis points.

And then I think did you also ask about…

Dry powder…

So yes, we still have good dry powder. The other thing that's interesting about the way that -- I think the way that we manage our risk that impacts dry powder, is that we give ourselves, if you will, more dry powder. So we have cash reserves basically that we keep back. But as we add more credit hedges, we actually give ourselves in a way credit for having more dry powder, right? We can increase the asset side of the portfolio, the more credit hazards we have on. So given that spreads have tightened now, we tightened quite a bit. I think you're going to see us putting back on more credit hedges at some point soon, and that will also kind of give us the way we risk manage the portfolio more dry powder. So we still have lots of room to increase the size of the portfolio from that $284 million figure that I think I mentioned earlier.

I imagine you guys are following the headlines for the asset management industry making a push for 401(k) plans to have better access to the private equity industry. I'm just curious what your perspective's on this are? I mean does it mean a more efficient market and tighter spreads and that's a good thing or is the CLO market so big and growing so fast at this point that a huge influx of demand wouldn't necessarily disrupt this really high and attractive return that you're getting in the asset classes right now?

I think it will be a while until you see that filter down to the CLO asset class. But in terms of having an impact on spreads, Mark or Greg, do you have any thoughts on that?

I'd say that the first order effect of this can be seen not in the closed end fund space necessarily even though there's obviously a lot of retail demand. But you've seen in the ETF sector, looking at the growth of overall especially AAA ETFs, perhaps that's more an appropriate first step in terms of where that type of money would flow into here, maybe it filters down to this eventually. I think that their second order effects, we saw that CLO issuance was incredibly robust exiting 2024 into 2025 as that demand coming into AAAs through the AAA ETFs were tightening AAA levels to increase the attractiveness of securitization. So it's a bit of a double edge, it can couple of ways, I guess, where perhaps it compresses yields at some point if there's demand, but also perhaps that demand is coming into the liability side, which could just be creating an attractive arb for the equity further down. So there's several factors at play where we sort of have to wait to see how it shakes out in terms of what the true effect would be.

We'll take our next question from Crispin Love with Piper Sandler.

Following up on the dry powder question, where I believe you said you're at $284 million today in CLOs. First, what is fully deployed look like? And when would you expect to be fully deployed? And were you more aggressive putting capital to work in early to mid-April, given the price moves relative to your initial expectations for redeployment?

Greg, do you want to answer the second part and then I'll come back to the first part…

And I'm even happy. I mean, it might encompass a little bit more there. So I think overall, we were targeting just based around the conversion that we'd be putting money to work. And we actually saw things cheapening up very much into the end of March. In fact, I think as many market participants would agree, similar bonds trading by the time you got to April month end, and now we were rallying pretty aggressively through April. And so April -- the end of April versus early May, it's hard to tell exactly but things were actually better by the end of April than maybe the end of March in some cases. But we did put our foot on the gas more since it was opportunistic. I think we initially were expecting a little bit longer to ramp in. Overall, in terms of the pace and the dry powder available some of this, as Larry alluded to earlier, depends upon how much leverage we want to use. And just to come back to that a bit, the point, if we were to use credit hedges isn't necessarily to put on a local linear credit hedge that's going to weigh down against the dividend. The point of the credit hedges in these vehicles is if we want to use financing on, let's say, a really attractive piece of mezzanine paper, and you could potentially use on equity too, although we're very mindful of that. If we want to use any financing, this will affect how we think about liquidity in the vehicle. It's imperative that in any sort of shock or drawdown that this vehicle stay liquid. And so therefore, the direct objective of many of the credit hedges is to be able to make sure that we have liquidity in these types of market shocks. And so I think overall, if we see a lot of opportunity and if the math works out where adding some financing to a portion of the market that we want to invest in, including the cost to protect it from a downside perspective makes sense, I think you'll see us grow some more and potentially be able to leg into even more dry powder. I think right now, we sold off, we've rallied back, we're not back to tights, but we've seen a fair amount of recovery. And so I don't think we are being as aggressive as we otherwise could in terms of making sure that every last cent is at work right now, given our feelings on the market.

I'll just add that with -- right, if you take the midpoint of $5.88 per share as our NAV coming into May, times the latest share count that we disclosed, that's about $220 million of equity. And as Greg alluded to, it really depends a lot on mix between mezz and equity in the portfolio. And as I mentioned, we've sort of been actively trading and looking at different subsectors from a rotational standpoint. But I think we could easily be at half a turn of leverage. So that would put us over the $300 million mark, right, in terms of CLOs in the portfolio. But again, a lot of it is really almost more dependent upon the way that we risk manage the portfolio, that's really where more of the limits come into play. The other thing that I haven't mentioned yet on this call but I think I mentioned on the last call was that we are a full derivative user. And what that means is, it means we have to comply and to all sorts of different tests, but -- which is a little more work on our part, but not a problem. But the ratification of that is that we actually can use a repo and accounted as a derivative as opposed to as the type of senior security, it's called our debt, let's just call it, that would otherwise be -- have more severe restrictions in terms of containing our leverage as a closed end fund. So the bottom line is that, again, it's going to be more a function of the way we risk manage the portfolio and a portfolio composition than it is any of sort of maybe the normal types of leverage restrictions you might see. So we could easily get well over the $300 million market, even just with our current equity base. And then the last thing I wanted to say was that if we -- and I said, we're going to look to issue unsecured debt later this year and then, of course, that will also from a risk perspective, again, because a lot of it's by risk management from a risk perspective than that takes a lot of the risk off the table in terms of the short term nature of repo, you've got longer term unsecured debt. So that enables us, again, from a risk management perspective to have more assets for each dollar of equity.

And then last question from me. Can you share your latest thoughts on the ADE trajectory? Last quarter, you talked about likely not covering the dividend in the calendar second quarter, just given the MBS sales and elevated cash prior to full redeployment and then coverage resuming in the calendar third quarter. Do you have any updates there or any finer details?

I think we're still on plan there. So exactly, we might be a little short this quarter, but I think on track for the third quarter.