Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2020 Fourth Quarter Financial Results Conference Call. Today's call is being recorded.

At this time, all participants have been placed on a listen-only mode and the floor will be opened for your presentation It is now my pleasure to turn the floor over to Jason Frank, Deputy General Counsel and Secretary. Sir, you may begin..

Thank you. And welcome to Ellington Residential's fourth quarter 2020 earnings conference call. Before we begin, 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..

Thanks, Jay, and good morning, everyone. We appreciate your time and interest in Ellington Residential. During the fourth quarter, the Federal Reserve purchasing activity remained elevated, dollar rolls continue to be strong and yield spreads on Agency RMBS tightened very significantly.

In addition, as you can see on Slide 3, long-term interest rates started to increase with a 10-year treasury rising 23 basis points during the quarter, while the US Treasury yield curve steepened with the two-year tenure spread increasing to 79 basis points. It's been over three years since we've been in a yield curve environment that's this deep.

Despite these movements actual and implied interest rate volatility remained low and Agency RMBS outperform dramatically. As you can see here on this slide even with the sizable increase in long-term interest rates, the price of Fannie Mae 2 have increased by more than 0.5 point, which equates to a spread tightening of nearly 30 basis points.

So far in 2021, we have seen long-term interest rates continue to rise and the yield curve continue to steepen as the market is anticipating a significant stimulus package from Congress and a modest increase in inflation expectations..

Thank you, Larry, and good morning everyone. Please turn to Slide 7, where you can see a summary of EARN's financial results. For the quarter ended December 31, we reported net income of $7.4 million or $0.60 per share and core earnings of $4.2 million or $0.34 per share.

These results compared to net income of $8.1 million or $0.66 per share and core earnings of $4.8 million or $0.39 per share for the third quarter. Core earning excludes the catch-up premium amortization adjustment, which was negative $559,000 in the fourth quarter compared to positive 405,000 in the prior quarter.

As you can see on Slide 7, our fourth quarter results were driven by strong net interest income on our Agency RMBS investments, net realized and unrealized gains on our long TBA holdings and net realized and unrealized gains on our interest rate hedges and other activities.

A portion of this income was offset by net realized and unrealized losses on our Agency RMBS investments driven largely by elevated prepayment activity..

Thank you, Chris. Our first update how EARN performed for both the quarter and the full year now closed with our forward outlook, now we are positioning the company to drive future returns. 2020 was quite a year, I have been active in the mortgage markets for a long time and I don't think I've ever seen a roller coaster ride like 2020.

The lows were lower and the high were higher, you had to expect the unexpected. During the screens in March and talking to our most important counterparties then I literally saw and heard things I had trouble believing but we have always managed EARN with two primary and simultaneous objectives.

These objectives helped us persevered through the turmoil. First protect book value against downside moves and second the opportunistic and capture upside when it presents itself. That philosophy is what drove our 2020 performance. Market shocks are almost always caused by something that is not in people's radar and COVID-19 was no exception.

The balance sheet shock that the pandemic caused in the second half of March was sudden an enormous and demonstrated have thoughtfully we manage our liquidity. If we were able to meet all margin calls, avoid forced asset sales and build up a liquidity cushion during this period.

And the subsequent opportunity that followed massive Fed intervention was also sudden and equally enormous. We we're able to capitalize on it. For the year EARN did great, stock delivered a best-in-class total return of over 30% and our total return on book value was an impressive over 13% for the year. We got there with a disciplined team approach.

As the pandemic cause panic and balance sheet shortages in March we had ample liquidity and we we're appropriately levered and our repo maturities we're well staggered with the diversified set of lenders. We we're able to weather the storm with modest controlled asset sales that did a minimal book value damage.

Throughout our history we've generally favored lower leverage in much of the peer group. The reason for that is the couple of extra turns of leverage that company's reach for when NIMs are tight and earnings are hard to generate. I mean the difference between being a forced seller or an opportunistic buyer during times of distress.

Instead of extra leverage we tried to make additional returns with more active trading and a deeper dive into prepayment..

Thanks, Mark. EARN's strong fourth quarter concluded what has been a remarkable year of outperformance for us. Please turn back to Slide Five.

During an unpredictable and unprecedented 2020, EARN generated an economic return of 13.1%, a total return on its stock of 36% and net income and core earnings that significantly exceeded dividends, dividends that we kept constant throughout the crisis and throughout the year.

How did we do this? Through the extreme volatility of March and early April, our disciplined risk and liquidity management, protected book value, allowed us to avoid forced asset sales and preserve liquidity, enabling EARN to withstand the extreme market-wide volatility and liquidity crunch.

We emerge from the crisis with a strong liquidity position and that allowed us to take advantage of some extraordinary investment opportunities, while asset prices were still depressed. All the while we were able to navigate a mortgage refinancing wave, that saw Agency prepayment rates surge to their highest levels since 2012.

EARN's outstanding 2020 also filed a strong 2019 for EARN, when we generated an economic return of 14.6%. You can see the cumulative economic return for these two years on Slide six. Over this two-year period, EARN generated a cumulative economic return of nearly 30% which I believe, puts us at the top of the publicly traded Agency mortgage REITs.

Clearly, the operating and investment environment of 2019 and 2020 could not have been much more different.

Nevertheless, EARN was able to prosper in both periods and by doing so, I believe that we have without question demonstrated our ability to achieve our objective, which is to deliver strong and steady returns to our shareholders in a diversity of market environments across market cycles. Now, turning to the opportunities that lie ahead in 2021.

Short-term interest rates are likely to remain near zero for another year. And it seems unlikely that the Fed will start tapering asset purchases this year. There is no question these dynamics have been beneficial for Agency RMBS investors and our high net interest margin is certainly a nice tailwind for 2021.

But as we saw last year, market dynamics can change quickly, fiscal stimulus can be a boon to asset prices, but the fear of large fiscal deficits can recap it on MBS prices.

Meanwhile, as Mark discussed, technology continues to evolve at a blistering pace and we're expecting even more private non-bank mortgage originators to go public in 2021, bringing even more capital, attention, and technology to the sector.

In this environment, Agency MBS portfolio managers need to find the right balance between, on the one hand, constructing a portfolio that can hold up in today's high prepayment environment, and on the other hand, constructing a portfolio that is not overly exposed to extension risk and spread widening risk should interest rates continue to rise.

Finding this balance allows a disciplined portfolio manager to play offense during times of stress, something that differentiated EARN from the peer group in 2020.

Whatever path the residential mortgage market takes from here, changes in the prepayment landscape should favor our core strengths of prepayment modeling, asset selection, and dynamic interest rate hedging, and with our relatively low leverage and disciplined hedging, EARN should be well-positioned to capitalize both on the opportunities that we see right now and on those that are bound to emerge when things inevitably change.

It bears repeating that our success at EARN does not necessarily depend on the absolute level of interest rates, on the shape of the yield curve, or where net interest margins happened to be, and that's because of our portfolio management strategy.

We trade actively, we shipped our capital to where we think the best opportunities are, and we hedge along the entire yield curve, often using significant TBA short positions. Finally, please now turn to Slide 15 for our 2021 objectives. As we look ahead, our investment principles remain unchanged.

Capitalizing on investment opportunities presented by market volatility and uncertainty, diligently hedging and managing liquidity to protect book value, dialing up and down our MBS exposure opportunistically, and rotating our portfolio based on where we see the best value at each moment in time.

We look forward to meeting the opportunities and challenges to come in the year ahead. Before we open the floor to questions, I would like to thank the entire Ellington team for their hard work in 2020 and for all those listening on the call today, we wish you the best for 2021. And with that, we'll now open the call to questions.

Operator, please go ahead..

And your first question will come from Doug Harter with Credit Suisse. Please go ahead..

Thanks and good morning.

Hoping you could talk a little bit more about the type of environment that might allow you to dial-up the risk, and after living through last March, if you could talk about where the upper end of the range might be if the environment presented itself?.

Hey, Doug, it's Mark. So, when we wrote the script, it was a few days ago, and I think yesterday is a good example of some of the market volatility that we were starting to expect, as you see a lot more focus and what we've been written about inflation. So yesterday, for example, was a day of a pretty substantial mortgage underperformance.

So I think that we'll use opportunities like that to increase our mortgage exposure, either in pool form for in TBA form. People realize that you have a giant buyer out there in the Fed that's not driven by economics.

So there is going to be times where they're going to cause the pricing structure, the market that doesn't leave lot of the room for attractive NIM, but what they do is, they also create pricing distortion, so is going to be lots of well-to-value opportunities, as well..

Great. Thanks, Mark.

And then, just on how you might think about the range of where your net MBS exposure net leverage could get to, if the environment presented itself?.

Yes, I would say, if you look historically where we've been at, the upper end of that range, I think, which still serves as an upper bound for us, and I think were we came into, where we ended the year was probably close to a lower bound.

Mortgages had a very, very strong Q4, if you look at the prices where things end in Q4, relative to where they are now, big sectors of the market, repriced substantially lower down over a point..

And if I could just add to that, a couple of things we talked about earlier on the call, Doug. One was the fact that you've got obviously prepayments very, very high. But you also have rates very low and the possibility of extension risk, especially as more and more of the mortgage universe is refinancing lower and lower coupon.

If that -- all of a sudden, interest rates reversed, you're going to have some low coupon mortgages expanding tremendously.

So we're at this real balancing act right now, where it is very dangerous environment, but on the other hand, it's also an environment, where, for example, we talked about how we made money on our longs and our shorts in TBAs, right.

I mean, this is -- made money on our shorts, even though mortgages had just a tremendous quarter, so it just shows you that in this type of environment, yes, if things move a lot, it's dangerous, but as an active trader, and as a company that's not afraid to put these alpha generating trades on, I think that's just a much higher quality way for us to generate earnings, as opposed to dialing -- just mortgage exposure at all times are diving a leverage up to that maximum, whatever you want to call it, probably 7 to 1 on net mortgage exposure.

I don't know if we ever been much higher than that 9 to 1 on leverage; I mean, that's not the way that we think is the best way to make money for shareholders in an environment like this..

That makes sense. Thank you..

The next question is from Eric Hagen with BTIG. Please go ahead..

Hey, good morning, hope you're well.

Can you talk about what the bulk case is for our specified pools to hold their ground or even strengthened a bit further from here relative to TBA, if the backdrop is for higher rates and a steeper curve? And then on the TBA position, can you shed some more light around how your maybe feeling about being lower in the coupons stack on the long side and where you might be more active going forward here? Thanks..

Sure. Hi Eric, it's Mark. In terms of specified pools, if you are in the right ones, a lot of them still have substantial carry versus either TBA shorts or versus interest rate for treasury hedges, so even if you don't have pay-up expansion from here, a lot of them still have very good positive carry.

In terms of positioning along the coupon stack, you still do have -- I mean, yes, there was a big sell off, but it's still, by and large, a premium market, so I would say that what rate moves like yesterday mean is that some of your hedges need migrate from shorter parts of the curve to longer parts of the curve, as prepayment models will now pricing more prepayment slowdowns, so certain coupons -- even the move since start of this year, you've had about a 40 basis point move in 10-year swap rates.

That's enough to change where your cash flow risk is concentrated. Look at the mortgage market. Outside of Fannie 1.5, everything else is still a premium, 102 on up to, say, 110.

So the moves this year have lowered some prices, pre-payments are still going to affect things and I would say that the flexibility you have, interest rate hedges across the curve, it doesn't make us gun-shy about lower dollar price TBA's if that's their best value.

I think that we have enough tools to manage interest rate risk and potential extension risk..

Thanks for the response..

The next question is from Mikhail Goberman with JMP Securities. Please go ahead..

Hi, good morning gentlemen, congrats on another fine quarter. Most of my questions have been answered, but I was wondering if you could maybe talk about the non-Agency book? Of course, the last two quarters I've done very well in our monetizing the portfolio there in terms of earnings.

Do you see any potential for that kind of mini-wave to come forward again, or are you going to opportunistically look for the next in our excellent entry point on that?.

Yes, thanks for the questions, it‘s Mark. I think now investor sentiment in regards to housing is very strong. And that applies to expectations of credit losses in legacy non-Agency, which is what EARN owns, as well as non-QM, as well as on jumbo, as well as single family rental.

So right now, the set of assumptions that's embedded in the pricing of all those sectors is, I think, appropriately optimistic. So from where we are now, you'll probably see that portfolio continue to come down in size if prices dropped and yields go up.

Let's say, there is another shock to the system in some form that the mortgage is not anticipating and you see a pullback in prices and an uptick in yields, and those look like a good alternative, a good diversification to the Agency strategy. We can certainly add it. I don't know where that would come from, but that's the nature of the shocks.

But I think right now, where we look at the pricing there, we're probably going to see that portfolio continue to shrink..

Okay, great. Thank you very much. That's it from me. Thanks..

Thank you..

There are no further questions at this time. Ladies and gentlemen, thank you for participating in today's conference. You may all disconnect..