EARN - NYSE

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Credit Company Second Fiscal Quarter ended September 30, 2025 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 detailed in our 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; and Chris Smernoff, Chief Financial Officer. Our earnings call -- our earnings conference call presentation is available on our website, ellingtoncredit.com. Today's call will track that presentation and all statements and references to figures are qualified by the important notice and end notes at the back of the presentation. With that, I'll turn it over to Larry.

Thanks, Alaael-Deen, and good morning, everyone. We appreciate your time and interest in Ellington Credit Company, which we often refer to by its New York Stock Exchange ticker E-A-R-N or EARN for short. Please turn to Slide 3. The credit markets generally rallied during the third calendar quarter, supported by a dovish shift from the Federal Reserve, which delivered its first interest rate cut for the year in September. Most corporate credit and CLO spreads tightened overall, as shown here on Slide 3, and that was even despite some notable pockets of weak credit performance in the high-yield corporate bond and leveraged loan markets. Major equity index is also advanced on expectations of further monetary easing. Turning now to Slide 4. Ellington Credit delivered another strong quarter against this backdrop. Our CLO portfolio ramp-up continued at a steady pace, and our net investment income rose accordingly. Our results also benefited from several CLO note redemptions at par on discounted purchases as well as our robust trading activity with more than 90 distinct CLO trades executed during the quarter. Finally, I'm very pleased to announce that Ellington Credit Company achieved full dividend coverage from net investment income in September, underscoring the earnings power of our portfolio as we get closer to being fully invested. Active trading remains at the core of our investment approach. And we believe it enables us to capitalize on mispricing to manage risk more effectively and to continually reposition the portfolio for optimal relative value. This past quarter, we saw yield compression between the CLO debt tranche markets and the leveraged loan markets, and that led us to reposition our portfolio in 2 important ways: First, this yield compression led us to increase our portfolio allocation to mezzanine debt, gaining more attractive yields on a relative value basis, especially with the downside protection they offer. Second, the yield compression led us to reduce our exposure to new issue equity. Instead, we gained similar exposures, but at better pricing in secondary market acquisitions of longer duration equity. Another advantage of frequent trading is that it provides more accurate and more actionable information on real-time market conditions and it improves our valuation process, as Greg will discuss later. Our predisposition towards active trading also highlights an advantage of EARN's relatively modest size with $225 million of equity to invest rather than say, $1 billion or more, we can remain nimble, rotate the portfolio decisively and be highly selective in our investments without feeling compelled to own the market. Our portfolio maneuvers this past quarter echoed many of our moves from the prior quarter. Looking back over the last 2 quarters, so dating back to our April 1 conversion to a closed-end fund, approximately 70% of our net CLO purchases have been of mezzanine debt tranches, reflecting our deliberate move up in credit quality. We believe that mezzanine debt tranches currently offer a compelling combination of yield and downside protection, complementing the equity positions we hold. We've also leaned more heavily into the secondary market where relative value opportunities are often more compelling than a new issue. As I mentioned, we've been especially favoring secondary market acquisitions in the case of CLO equity. As shown on Slide 7, as of September 30, our $380 million CLO portfolio was almost evenly split between mezzanine debt and equity tranches with about 14% of total investments in Europe. With that, I'll hand it over to Chris to review our financial results in more detail. Chris?

Thanks, Larry, and good morning, everyone. Please turn back to Slide 4. For calendar Q3, we reported GAAP net income of $0.11 per share and net investment income of $0.23 per share. The weighted average GAAP yield for the quarter on our CLO portfolio was 15.5%. On Slide 6, you can see a breakout of our portfolio net income by CLO subsector, $0.13 from U.S. CLO debt, $0.03 from European CLO debt $0.08 from U.S. CLO equity and a slight net loss from European CLO equity. Strong net investment income across subsectors was complemented by net realized and unrealized gains on CLO debt and partially offset by net realized and unrealized losses on CLO equity and credit hedges. In the U.S. leveraged loan market, overall index prices were broadly unchanged, but performance diverged sharply by credit quality. Lower triple -- sorry, lower quality, CCC-rated loans felt several points amid isolated default concerns, while B-rated loans advanced on sustained CLO demand, further highlighting the theme of credit dispersion. Callable higher-quality loans continue to be repriced at lower rates with price premiums on those loans giving way to new issuance at par with tighter spreads. In Europe, leveraged loan prices lagged the U.S., largely due to more extensive repricing activity. Despite the mixed loan backdrop, U.S. and European CLO debt spreads generally tightened, supported by steady capital inflows and limited new CLO issuance. Seasoned mezzanine debt outperformed as loan prepayment and repricing activity remained elevated. CLO equity also benefited from tightening debt spreads, enabling equity investors to refinance or reset liabilities and lower coupons, though this was partially offset in both the U.S. and Europe by continued loan repricing and isolated default concerns. Slide 7 provides detail on our CLO portfolio, highlighting the continued sequential growth. In total, the CLO portfolio increased by 20% to $380 million. During the quarter, we made new purchases totaling $160 million, 62% of that in CLO debt and 38% in CLO equity and sold $29 million of CLOs, consistent with our active trading approach. At September 30, CLO equity represented 51% of total CLO holdings, down from 53% coming into the quarter, while European CLO investments accounted for 14%, roughly unchanged quarter-over-quarter. Slide 8 provides an overview of the corporate loans underlying our CLO investments. The collateral remains predominantly first lien floating rate leverage loans, representing roughly 95% of the underlying assets. Industry exposure is well diversified, led by tech, financial services and health care with no single sector exceeding 11%. Maturities are spread over several years with the largest concentrations in 2028 and 2031 and limited near-term maturities, producing a weighted average loan maturity of 4.2 years. Facility sizes skewed towards lower borrowers with 42% in facilities over $1.5 billion with a weighted average size of $1.6 billion supporting liquidity. Slide 9 provides further detail on our underlying loan collateral. Slide 10 presents a snapshot of our credit hedges as of September 30. During the quarter, we increased our corporate credit hedges alongside the growth of our loan portfolio. At quarter end, we also maintained a foreign currency hedge portfolio to manage exposure associated with our European CLO investments. Turning to Slide 11. At September 30, our NAV was $5.99 per share and cash and cash equivalents totaled $20.1 million. Our NAV-based total return for the quarter was 9.6% annualized. With that, I'll pass it over to Greg to discuss how the portfolio market has performed, how we positioned our CLO portfolio and our market outlook.

Thanks, Chris. It's a pleasure to speak with everyone today. Calendar Q3 played out almost as a mirror image of Q2. We began with robust performance in July, but momentum faded as the quarter went on. Growing concerns about idiosyncratic credit issues, coupled with continued loan coupon spread compression weighed on CLO equity and even pressured some of the more credit-sensitive mezzanine tranches. Even against this backdrop, both our mezzanine and equity positions contributed positively to performance. As we've mentioned before, we have been concerned throughout the year about the widening gap between strong and weak credits in both the CLO and broader corporate credit markets. Whether it is the prolonged impact of elevated interest rates on floating rate borrowers or the volatility around winners and losers created by AI, tariffs and changing trade dynamics, we've been deliberate and cautious about owning first loss credit risk. CLO equity has continued to experience muted return, not only due to default and distressed exchanges and some weaker credits, but also due to prepayments and stronger credits, reducing returns at both ends of the underlying loan portfolios. For CLO equity, the combination of these 2 factors has more than offset the positive impact of tightening liability costs and deals. On the margin, we generally continue to favor CLO mezzanine tranches as a more attractive balance of risk and return in the portfolio. The subordination and structural protections they offer help insulate us from the dispersion and idiosyncratic concerns mentioned earlier. That said, almost any investment becomes attractive at the right price, and we are continuing to see opportunities in both parts of the capital structure when they're offered at the right level. We are continuing to find the secondary markets far more compelling than primary markets, as has been the case for most of the year. We only participated in on new issues equity transaction in calendar Q3. Meanwhile, we saw an uptick in CLO trades for EARN from 79 in Q2 to 92 in Q3, emphasizing our trading-focused flexible approach. In our view, this is something that very much differentiates us from our competitors and should be a source of comfort for investors. Credit issues such as First Brands have roiled the credit markets, and that has led to selling pressure on the stock of CLO closed ends funds including EARN. Similar to what we've seen with BDC stock prices, I believe this is often due to investor uncertainty about the true condition of the underlying portfolio, including the portfolio marks. By trading our portfolio so actively, we possess a great deal of confidence in our underlying portfolio marks. Not only do we have a strong sense of where the market transacts, but it has been relatively straightforward to value our positions because many of them trade frequently, which makes us highly confident in the accuracy of our reported NAV. While we continue to favor mezzanine tranches, EARN has been able to take advantage of some interesting opportunities in the CLO equity market. We expect to continue to see compelling special situations, especially in the secondary market, where we find that our strong relationships and reputation as an active trading counterparty often give us early and differentiated access. While some CLO managers and dealers are willing to offer incentives to entice investors to commit to funding new issue CLO equity investments. We think it's critical to evaluate those incentives in the context of the manager's quality, the deal structure and the underlying collateral and only commit capital when the overall opportunity clears our risk/reward bar. Now back to Larry.

Thanks, Greg. I'm very pleased with EARN's results this quarter. The steady growth of our net investment income enabled us to achieve full dividend coverage in September, which is an important milestone that reflects the earnings power of our portfolio. While our net investment income can fluctuate month-to-month, as deals are called, distributions are reinvested or profits are taken through trading, we feel confident about our ability to maintain dividend coverage over the long term. Taking a step back, volatility and credit dispersion have remained defining features of the corporate credit markets in general this year and the CLO market, in particular. Uneven impacts from AI and tariffs have definitely factored greatly into the volatility and credit dispersion, but the recent Tricolor and First Brands bankruptcies first brands being a widely held CLO credit, by the way, underscores that the corporate credit markets are also vulnerable to idiosyncratic volatility and credit dispersion. Given that corporate credit spreads overall remained relatively tight during the quarter, we continued to expand our credit hedging portfolio as we ramped our investment portfolio. As shown on Slide 10, we increased our credit hedge portfolio to roughly $90 million of high-yield CDX bond equivalents by the end of the quarter. To put that in perspective, that $90 million equates to about 40% of our NAV as of September 30. So it's a very significant position. And following quarter end, we've continued to increase our credit hedges. This synthetic short position reached more than $150 million in high-yield equivalent as of October 31, as detailed in our October tear sheet that we released last night. While these hedges, like most hedge, can be expensive to maintain, the downside protection they provide is well worth the cost in our view, especially given where overall corporate credit spreads currently stand. If credit spreads widen, these corporate credit hedges should generate substantial gains to help offset any declines in our long CLO portfolio. Finally, I'll note that while high-profile defaults like First Brands tend to grab a lot of headlines, they also give you a real-world look at how CLO structures are designed to work and how our approach is meant to protect investors. In EARN, the impact from First Brands on our portfolio was quite modest. Our mezzanine debt tranches were largely protected by their equity buffers. And while some of our equity positions were affected, the overall fundamental effects for us was quite limited and was felt more in shorter-dated deals as opposed to the longer reinvestment period CLOs, where most of our equity exposure sits. And that's really the point of the diversification that the CLO market offers investors. You avoid taking outsized exposure to any one borrower. That principle, combined with our recent focus on CLO debt tranches served us well through the third calendar quarter. As we move forward, if corporate defaults were to become more widespread, our credit hedges will become even more important as another layer of downside protection. Looking ahead, with a balanced mix of mezzanine debt and equity tranches and robust credit hedging, I believe we're well positioned for both upside and resilience as market conditions evolve. We expect elevated repricing activity and ongoing credit dispersion to continue to create opportunities for outperformance through active portfolio management, further reinforcing our confidence in delivering strong total returns for shareholders. And since we're now close to being fully invested, our likely next step is to raise long-term unsecured notes, which we hope to complete in the coming weeks, market conditions permitting. We expect this additional capital to be accretive to both net investment income and GAAP earnings. Now let's open the floor to Q&A. Operator, please proceed.

[Operator Instructions] We'll take our first question from Crispin Love with Piper Sandler.

My question is on the hedges and the recent moves. As you said, you had a pretty meaningful move in credit hedges from the end of September to end of October. Can you just discuss what you're seeing? What drove the increase versus the end of September? You think spreads are too tight today? And then, of course, we've been hearing some of the -- all the macro noise in credit, private credit. So just curious on your thoughts there and what you're seeing in your portfolio and just more broadly?

Sure. I'll take the first crack at that. Greg, if you don't mind. Just the increase in the size of the credit hedges was mostly a function of just the increase in the portfolio size and the increase in the leverage in terms of just on an absolute dollar basis in terms of how much debt we have through repo. So a major component of how we size our credit hedges is to make sure that in a severe market downturn, we'll have enough liquidity through the profits on our credit hedges to manage any liquidity issues arising from our repo. So that's really where most of it comes from. But -- and then in terms of timing the market, I'll pass that to Greg. We obviously do have the ability and we like to also adjust size of the credit hedge portfolio in terms of how tight credit spreads are on a historical basis. Greg?

Sure. To echo Larry's point, I think it's important to remember these hedges are here to really sort of protect against a drawdown. It's not a short position, we're necessarily taking. And so early on when we weren't financing our positions as much or if we were more heavy in CLO equity, which we're not necessarily financing the way we'll finance CLO mezzanine positions, they aren't as necessary as we've increased financing on CLO mezzanine position since we've tended to favor those, we've needed to add more protection in these drawdown scenarios from a liquidity point of view. Now that said, we're constantly trading these hedges around as positions come up and down. If we are selling out of something, we may adjust them down to be careful not to be running shorter than we would like either. But you're right, I think that as we see some of these sales have grown in areas of the corporate credit market, we still think that tail risk is attractively priced. And so entering into some of those hedges at these levels versus where we could enter into long investments with some financing, that equation, we think, works out well for EARN generally.

And I'll just add, we'll be filing our NCSR, shortly, which gives a detailed look at our entire portfolio, including our hedges. And you'll see, if you take a look at those when they come out that they're really mostly what we would call tail hedges, right, to protect against tail scenarios.

Okay. That all make sense. But Larry, I get your point on increasing the hedges with the size of the portfolio in the calendar third quarter. But just looking at October, definitely saw a big increase in hedges, but a decrease in the CLO portfolio, if I'm looking at that right. Was that a more cautious view on credit?

Greg, do you have a view on that? I actually -- I would have to take a closer look at that to answer that.

I would need to take a look. We've not looked to necessarily represent a shorter, more cautious view. I think, in general, you may have seen some rotation. And as I said, the hedges are really there when we're financing mezz physicians, just as we're adding leverage, the drawdown with the financing can be something that we pay more attention to. The other thing too is earlier on, our hedging options were more limited than they are today in terms of setting up agreements with banks in terms of what we're able to trade. We use a lot of different -- we enter into a lot of different types of markets for different types of tail hedges. And so it's possible from a notional standpoint, you may see some things that are just a lower beta or delta that maybe have a higher notional to that point. And so we'd have to look through in terms of notional sizing. But overall, it's not necessarily an uptick in what we think is the actual risk or equivalent risk of the hedges. It might just notionally look different as we've moved from one product to another.

Okay. And then just last question. Just any color -- I'm just looking at the tear sheet for October. Any color on the CLO portfolio decreased a bit to $371 million from $380 million as you're kind of getting to full deployment? Any reason for the decrease there?

Over the course of October?

Yes.

Well, October is a quarterly payment date, too. So the equity portfolio will have distributions and generally a bit of a markdown in prices. And so while that came out and was distributed, I think there was some of that. Also CLO equity did sell off a little bit in October. I think that's what we saw in the market. And so you saw the NAV move to adjust that a little bit.

Crispin, I'll just add that the debt portfolio increased net month-over-month and the equity portfolio decreased mainly driven by what Greg mentioned, the distribution.

We'll go now to Doug Harter with UBS.

You mentioned potentially being in the market for unsecured debt. Can you talk about your appetite for leverage and how you think about where leverage would be kind of for the context of this conversation, we'll hold the asset composition the same just to take that piece of it out of the equation?

Sure. So as I said, we're really close to fully invested right now. I think at 300 -- between $370 million and $380 million, let's call it, we would have room definitely to go up to around $400 million, maybe a little bigger. We are constrained by all of the restrictions of the '40 Act. We're a fully compliant derivative user and that gives -- that does give us a little more flexibility. So a little less than 2:1 leverage. Again, that's also given our current 2:1 asset to equity leverage. That's given our current portfolio composition as well, right? So the more mezzanine debt that we have, the more we can leverage the more equity we have, the less generally. And if we were to do an unsecured deal, I think you could see, right? So let's just say for argument's sake that it was a $50 million deal, right? So that additional capital, I think just a good rule of thumb again would be something a little less than 2:1 assets to that additional debt capital.

We'll hear next from Eric Hagen with BTIG.

Do you have any perspectives or predictions on the amount of CLO supply we might see next year? And just how sensitive the market could be at higher levels of issuance and maybe just some of the conditions that you feel like will drive the spread environment next year?

Sure. To be honest, I don't have a lot of conviction there. I think some of it will depend on what we see with new issue loan supply. I think if you speak to a lot of market participants, everyone sort of admits that it's been a challenged ARB with loans being so tight. I think similar to this year, you'll see a lot of reset and refinancing activities of existing deals as opposed to proper new issue, just where the market is today. But that said, it's hard to tell what may happen on both the asset and liability side. Depending what happens with rates, that can force technicals within the loan market, potentially with on the liability side as well. And if you get a situation where some of the loans tend to sell off and maybe widen on spread while AAAs and maybe some of the up the stack tranches hold in better, this may present a good window for new issue -- true new issue to pick back up. But right now, it feels like we will continue in this environment where things are now, where people are getting creative with existing deals, trying to give them new life and extend them out versus newer -- cleaner new issue deals. That's where we see the demand at least today.

Okay. That's interesting. Do you have any general perspectives on the presence of AI-related credits, which show up in the CLO market, especially the middle market CLO zone? And if you think there's like a lot of indirect sensitivity with respect to like the AI narrative just more generally in the connectivity that it has to the flow of credit?

Sure. So addressing the first part of the question, it definitely will have an impact on the loan market. I think that as AI filters through a lot of different -- it isn't even necessarily all about tech. There's going to be a lot of companies where AI can benefit companies in terms of reducing costs. AI could potentially make some companies uncompetitive though. And so I think that when we speak to CLO managers and we take a look at our own on some of these credits, you will find that a portion of the market will be affected, sometimes good, sometimes bad, by what AI may ultimately end up bringing. This is another point on our concern around dispersion. If it strongly creates winners and losers, this isn't necessarily the best thing for CLO equity. If the winners prepay out at tighter levels and the losers have fundamental problems, that's not necessarily good for the overall weighted average spread of the portfolio or good for the default rate of the portfolio. And so this dispersion is one of the things we're concerned about. As far as it relates to the middle market space, I'm not sure I would specifically comment differently. There's been some information and articles recently about some of those areas maybe of sort of the private credit middle market space that have started to reveal some problems in some of the names. There may be some similarities with the same way AI can affect the broadly syndicated loan market. It will affect these areas of the credit markets as well. It may just take a second to come through as marks don't move as quickly as the underlying loans there are not as actively traded. And that's something that as much as we will go into those markets, we remain much smaller because given our very trading-focused background, it's not as easy for us to assess the day-to-day risk as things move when underlying portfolio -- or some of those portfolios are not reacting to up-to-date information. And so it does lead us to be cautious in some of those areas, to your point, around how quickly if AI leads to an adverse issue in those portfolios that we'll be able to see that information.