Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2021 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 open for your questions following the 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 2021 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.

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.

Joining me on the call today are Larry Penn, Chief Executive Officer of Ellington Residential; Mark Tecotzky, our Co-Chief Investment Officer; and Chris Smernoff, our Chief Financial Officer. As described in earnings press release, our fourth quarter earnings conference call presentation is available on our website, earnreit.com.

Our comments this morning will track the presentation. Please note that any references to figures in this presentation are qualified in their entirety by the end notes at the back of the presentation. With that, I will now turn the call over to Larry..

Thanks, Jay, and good morning, everyone. We appreciate your time and interest in Ellington Residential. To begin, please turn to slide three. The fourth quarter was a challenging one for Agency RMBS. As an increasingly hawkish Federal Reserve, a flattening yield curve and elevated volatility weighed on the sector.

Prior to the fourth quarter, the Feds position on inflation was that high inflation would be transitory, but that view was challenged by consistently high inflation reports. As the bond market struggled with this inconsistency, actual and implied volatility rose, and the Fed finally acknowledged that higher inflation would likely not be transitory.

The Fed began tapering its asset purchases in November, but then accelerated the pace of that tapering schedule in December after revising its inflation outlook.

Rising inflation also increased expectations of EARN and more frequent Fed rate hikes in 2022, as well as an acceleration of Fed balance sheet runoff, and perhaps, even outright asset sales from the Fed. These shifts drove not only an increase in volatility, but also a sharp flattening of the yield curve, as you can see on slide three.

The yield on the two-year treasury increased by 46 basis points to 0.73%, which was its highest level since the beginning of the COVID-19 pandemic, while the yield on the 10-year treasury was essentially unchanged.

As a result, mortgage yield spreads wide and most Agency RMBs underperformed treasuries and interest rate swaps, higher coupon specified pools and other shorter duration RMBS underperformed in particular, in light of the flattening of the yield curve. Please turn to slide four. For the fourth quarter, Ellington Residential generated an economic loss.

But as with other periods of market volatility, our dynamic interest rate hedging and lower net leverage help limit that fourth quarter loss to a moderate $0.21 per share. We had net gains on our interest rate hedges, which included gains on our high coupon TBA short positions, as well as on our treasury hedges and interest rate swaps.

But these offset -- and these offset most of the net losses on our portfolio. We finished the year with a debt-to-equity ratio below 7 to 1, still well below our pre-COVID levels. We generated core earnings of $0.28 per share for the fourth quarter and we finished the year with a net interest margin of 1.81%.

While core earnings did decline quarter-over-quarter. That was mainly because our average holdings were smaller and we think that the prospects to expand our net interest margin and grow core earnings per share are currently quite strong, which is significantly higher reinvestment yields today. Turning now to 2022.

We’ve seen the market’s intense reaction, the hawkish pivot from the Fed, intensifying so far this year, just as other evolving macro and geopolitical factors have driven a general risk offset sentiment in the market, volatility has continued to surge, interest rates have continued to increase especially the front-end of the yield curve and the agency mortgage basis has widened substantially.

Agency MBS current coupon spreads are 30 basis points to 40 basis points wide or year-to-date. And pay-ups for prepayment protected specified pools have declined meaningfully. This weakness has not been limited to the agency markets either.

Fixed income yield spreads have widened across the Board, including investment grade corporates, high yield bonds and non-agency and non-QM CMOs. And of course, the major equity indices are also down considerably so far this year. We’ve definitely been taking advantage of opportunities by actively trading and repositioning our portfolio.

But we are also laser focused on risk management, so that we can maintain appropriate liquidity and leverage levels to guard against further volatility and yield spread widening and so that we can be in a position play office -- offense when the time is right.

These risk management measures have served us very well during previous times of stress, most recently during the COVID-related market volatility in 2020. In his remarks, Mark will elaborate further on how EARN’s position going forward. But first, I’ll pass it over to Chris to review our financial results for the fourth quarter in more detail.

Chris?.

Thank you, Larry, and good morning, everyone. Please turn to slide five, where you can see a summary of EARN’s fourth quarter financial results. For the quarter ended December 31st, we reported a net loss of $2.8 million or $0.21 per share and core earnings of $3.7 million or $0.28 cents per share.

These results compared to net income of $860,000 or $0.07 per share and core earnings of $4 million or $0.31 per share in the third quarter. Core earnings exclude the ketchup premium amortization adjustments, which was positive $169,000 in the fourth quarter, compared to negative $1.2 million in the prior quarter.

During the fourth quarter, as Larry noted, most Agency RMBS underperformed U.S. Treasuries and interest rate swaps, with higher coupon specified pools and other shorter duration RMBS particularly underperforming in light of the flattening of the yield curve.

Ellington Residential had a net loss for the quarter as net realized and unrealized losses on our Agency RMBS exceeded net interest income and net gains on our interest rate hedges due to higher interest rates, Our net interest margin decreased quarter-over-quarter to 1.81% from 1.88%, as you can see on slide five, driven by higher cost of funds.

We also had a smaller average portfolio quarter-over-quarter, which combined with the decrease in NIM attributed to the decrease in core earnings. Pay-ups on our existing specified pools declined modestly during the quarter as well, while new purchases during the quarter consisted of pools with lower pay-offs.

As a result, the average pay-ups on our specified pools declined to 1.07% from 1.44% sequentially. Please turn next to our balance sheet on slide six. Book value per share was $11.76 at December 31st, compared to $12.20 at September 30th. Including the $0.30 of fourth quarter dividends, our economic return was a negative 1.8% for the quarter.

As I mentioned, our average portfolio size over the entire quarter was smaller, but our portfolio was actually larger on December 31st, compared to September 30th, and thus our debt-to-equity ratio increased to 6.9 times as of year-end, as compared to 6.7 times as of September 30th.

Our net mortgage assets-to-equity ratio also increased to 7.1 times from 6.4 times over the same period. Despite this modest increase in leverage, we continue to maintain higher liquidity and lower leverage at year-end compared to periods prior to the COVID-19 pandemic. Next, please turn to slide seven, which shows a summary of our portfolio holdings.

In the fourth quarter, our Agency RMBS holdings increased by 8% to $1.29 billion as of December 31st, while our non-Agency RMBS holdings were roughly unchanged. In light of the higher volatility, we traded actively during the fourth quarter as our Agency RMBS turnover was 49%, as compared to 23% in the prior quarter.

Please turn now to slide eight for details on our interest rate hedging portfolio. During the quarter we continue to hedge interest rate risk through the use of interest rate swaps and short positions in TBAs, U.S. Treasury securities and Futures.

Similar to recent quarters, we ended the fourth quarter with a net short overall TBA position on a notional basis, but a net long overall TBA position as measured by 10-year equivalents. We continue to concentrate our long TBAs held for investment in lower coupons and our short TBA positions in higher coupons.

I will now turn the presentation over to Mark..

Thank you, Chris. Today’s market environment is very different than what prevailed over much of the fourth quarter of last year and it’s also very different than how things looked at the end of the year.

So in addition to reviewing our activity and performance in Q4, I want to also give an update on 2022 performance, our outlook going forward and are positioning.

The fourth quarter was pivotal, because the Feds thinking and messaging about inflation underwent a dramatic pivot and once the Fed changed its view of inflation, by extension that has implications for the pace of tapering both the start and magnitude of the hiking cycle and the timing and pace of balance sheet reduction, faced with higher and more persistent inflation numbers during the fourth quarter, the Fed guided towards a faster taper, an earlier and more aggressive hiking cycle and opened the door for significantly sooner and faster balance sheet runoff.

These were all red flags for Agency MBS. The yield curve bear flattened and the March Fed hike became the market expectation. Over the last year and a half we have been terming out our repo with some six months and 12 months repo and now that is starting to pay off, given the sharp rise in short-term rates.

The Fed pivot was obviously bad for Agency MBS and as a result MBS not only declined in price, but also underperformed hedging instruments. This led to Ellington Residential’s modest loss for the quarter.

We also transitioned to an environment of lower prepayment expectations and the recent prepayment reports have been significantly slower than the blistering speeds of last summer.

As a result, pool pay-ups came down, but because we had maintained a preference for lower pool pay-ups coming into the quarter, EARN was able to avoid further book value declines. The spread widening of mortgages in the fourth quarter was orderly and the interest rate moves were quite manageable.

So that’s the kind of MBS underperformance that causes the book value decline, but results in wider spreads going forward, so the book value declined can be earned back over time from the wider spreads.

The big spike in realized value presents a different challenge, however, because Delta hedging costs generate realized losses that can’t be earned back over time.

For the quarter, we didn’t make any big changes in portfolio construction, but we did actively turn pools over both capture opportunities and take advantage of rapidly changing relative value between specified pool sectors. We maintained our short positions in higher coupon TBAs.

Now with much of the mortgage market at a discount, part of our research and trading focus is now on positioning the discount portions of the portfolio to capture higher turnover speed and to mitigate extension risk.

As I mentioned before, we had a relatively low pay-up portfolio coming into the quarter and now with the sharp decline in pay-ups during the fourth quarter and so far in 2022, certain loan balance subsectors, which we thought were too extensively priced for most 2021 and that’s starting to make sense for the portfolio For the fourth quarter and continuing into this year, the weight on mortgages wasn’t just a change in the Fed guidance on its balance sheet, there was also a big change in the shape of the yield curve.

The fourth quarter move in interest rates was a bear flattener, as the market reacted to the Feds new more hawkish stance towards inflation. Two-year swap rates are up more than 50 basis points over the quarter, while 10-year swap rates were up less than 10 basis points.

This change in the slope of the curve has some relative value implications for 15-year MBS versus 30-year MBs and higher coupons versus lower coupon that are informing portfolio construction. So far in 2022, Agency MBS underperformance is worsened.

But the recent underperformance is not mortgage specific, nor the result the Fed comments specifically directed to the pace of tapering. Geopolitical uncertainty has pushed spreads wider everywhere you look in fixed income, including investment grade corporates, high yield bonds, CRTs and CLOs, nothing has been spared.

One issue that has affected mortgages more specifically is the dramatic increase we’ve seen in both actual and realized volatility. That has meant widening nominal spreads have not been matched one for one with wider OAS.

So how have MBS held up so far this year and what are the opportunities and risks that lie ahead? Nominal yield spreads to treasuries for current coupon MBS are now 30 basis points to 40 basis points wider than they were coming into the year. That’s over a point of price under performance versus hedges.

And now that rates are higher, prepayment risk is lower and supply for mortgage banker should be lower. In fact, prepayments have already slowed down. That said, there are a few big questions hanging over the Agency MBS market.

First, once the Fed starts growing their portfolio, how long will it be before runoff starts? What will be the pace of that runoff? And will they exacerbate runoff without REITs sales? Another big question is whether higher mortgage rates, reduce mortgage supply and thereby mitigate the negative effects of Fed’s balance sheet reduction.

That happened in 2013 after the taper tantrum and many people forget that after their initial swoon that summer Agency MBS actually came roaring back later in the year.

However, in this environment, where home prices have run up so much, the possibility of reduced supply is still very much an open question, because many homeowners might continue to do cash out refinancing, mortgage bankers like Rocket are now focusing their efforts on the estimated $20 trillion in home equity that’s still untapped.

Nevertheless, even with all the uncertainty about the Fed, Agency MBS are a lot more attractive -- attractively priced now than they were at the start of the year. Spreads are wider, prepayment speeds are way down and pool pay-ups are much lower.

We have a much bigger range of coupons and prepay rates we can buy without exposing the portfolio to very high dollar prices and very high pool pay-ups. We’ve been actively replacing some of our lower coupon long TBA positions with some seasoned pools with attractive turnover characteristics.

And now that the price of higher coupons has come down, we’ve been adding to that segment of our portfolio as well. That said, we have not yet increased the overall size of our portfolio so far this year, as we expect short-term performance will be dominated by unpredictable exogenous factors.

Thinking ahead to the opportunity set for the remainder of 2022, with reduced Fed support for MBS, private capital will be able to demand a higher return on capital. Since March of 2020, when the Fed’s QE program started, and until just recently, private capital returns were held down by the Fed’s purchase program, which ignored relative value.

Even though yield spreads were tighter, there were plenty of silver linings for generating returns, including strong production coupon rolls and low spread volatility. However, in Q4, and so far in 2022, that has ended abruptly.

The taper obviously started sooner and is preceded faster than previously forecasts, and the timing and pace of QT is still an open question. So we’re currently in a market with much wider spreads and cheaper prepayment protection. But interest rate volatility right now was extremely elevated and it’s elevated because of factors no model can predict.

Our portfolio has a higher nominal net interest margin given the current yield spreads, but we have to deal with higher Delta hedging costs. So it’s a lower quality net interest margin. With both lower pool pay-ups and lower prices, we have a much bigger range of coupons and prepayment rates that we can buy, which we find interesting.

Once we get some interest rate stability, we will then expect our core earnings to increase pretty significantly. Not only our absolute yields much higher than they were at any point last year, but spreads to hedging instruments are also much higher.

But until we actually see that stability, we intend to manage the portfolio with conservative leverage. Now back to Larry..

Thanks, Mark. After two years of double- digit returns in 2019 and 2020, we generated a loss in 2021. But I was pleased that EARN was able to protect book value by limiting that loss. Fast forward to today and we’re clearly in an even more challenging market environment.

First, it’s become evident that the pandemic driven easy monetary policies will be ending faster and more abruptly than previously expected. So the market is finally being forced to reckon with the impact of quantitative tightening. The underperforming of agency mortgages, just like any yield product is a very logical reaction.

And on top of that, the geopolitical uncertainty of recent weeks has caused extreme interest rate volatility, which has further widened yield spreads and made it even more expensive to hedge MBS portfolio. in good markets.

We are relying on our interest rate hedging and discipline risk management to protect book value and put us in a position to play offense as compelling opportunities arise. Finally, our smaller size continued to give us an advantage moving in and out of positions response to rapidly changing market conditions.

With that, we’ll now open the call to questions.

Operator?.

And we will take our first question from Eric Hagen with BTIG. Your line is now open..

Thanks. Good morning, guys. Hope all is well..

Hi, Larry..

Maybe a few from me, can you say how much you currently have authorized to repurchase stock? The second question is, what would you say is sort of the bull case or the upside case for specified pools at this point? And then the third one is, if we look out a little bit and mortgage spreads at the long end of the curve are admittedly wider, but the Fed is aggressively hiking rates and funding costs are significantly higher.

How do you feel like you’d be hedging the portfolio in that sort of scenario? Thanks..

Okay. So we’ve got….

Yeah. Sure. So this is Chris. Remaining -- our remaining authorization is currently 7 -- roughly 766,000 shares as of right now..

Thanks..

Okay. And then your next question was, you wanted us to kind of speak to the bull….

Yeah. Just kind of….

Okay..

Yeah.

Just kind of figure out what the upside is for an investor and -- a levered investor in specified pool?.

Sure. I mean, so -- it’s Mark. So pay-ups come down lots. There lots of specified pools you can buy that are within a quarter point to TBA, right? So there’s not a lot of pay-up, you have to pay to get pools that have material -- materially better convexity then TBA. And so you’re looking at a market that has very wide spreads over hedging instruments.

So the levered yields on mortgages, if they’re 40 basis points wider and someone’s 7 times leverage, you are almost 300 basis points wider levered return. So, Larry mentioned, and I think, I mentioned it too that, you’ve had this extreme volatility. So you’ve had higher Delta hedging costs, which comes at the expense of some of that spread.

But I think the bull case is if you get some geopolitical stability, you have a much wider spread than hedging instruments and you don’t need to take prepayment risk to get there. So penny two and a half, penny threes, penny three and a half, none of those coupons are that far away from par.

So you don’t -- it -- you’re not so reliant on your prepayment model, getting everything exactly right. So, I think, to me, that’s the case. And like, when you look at the widening of seeming corporates and high yield and CLOs and CRT, those are all sectors that have a credit component.

The Agency MBS is still the sector that doesn’t have credit risk to it. It has challenges evolve. But it doesn’t have a credit component to it..

Yeah.

So, and the 30 basis points to 40 basis points widening, that’s just the current coupo6n, right, when you’re looking at specified pools now, with favorable turnover characteristics, so you’re not going to see as much extension, should rates continue to rise, payment protection pools that are going to, with volatility where it is, that means that there’s a significant risk of rates going down too.

So, the specified pool story is much more attractive now than it was previously..

Great. Yeah. I stopped on all my questions. I apologize for that.

But if we look out a little bit, mortgage spreads are a little wider at the long end of the curve, but the Fed is raising rates, how do you feel like the hedging in the portfolio evolves as that takes place?.

Yeah. I think the suite of hedging instruments we have Treasuries, Treasury futures, swaps, TBAs. We can target them at different points on the yield curve that matched where our partial duration exposure is. And if you go back to, we started EARN 2013.

We went through taper tantrum, we went through the end of 2018, which is very volatile, we went through COVID, right, like a Fed hiking cycle is something that the hedging instruments can inflate book value from.

And so what you’re seeing now is just underperformance, primarily underperformance in mortgages, relative to hedging instruments and that -- so it’s not about -- so we look at book value declines. We’ll see this -- so far this year, it’s not so much that the hedging instruments are don’t give you enough flexibility.

It’s just that the asset classes underperformed hedging instruments..

Yeah. All right. Thank you..

Sure..

And we will take our next question from Mikhail Goberman with JMP Securities. Your line is now open..

Hi. Good morning, guys. I’m assuming that, you said book value is about 10.45 to 10.50 at the end of February.

I’m assuming has been a bit more pressure in the week or so in March?.

Yes. I mean, it’s been volatile, but -- and that book value too that takes into account the dividends that have been paid as well. So it’s been….

Okay..

… every day is volatile. You’ve had some days, the end of February, where mortgages did extremely well and you’ll have certain days where there’s some underperformance. So it’s like, I think you’re kind of seeing that pattern across a lot of fixed income. Liquidity isn’t very good right now. So it tends to exacerbate daily moves..

Got you. Thank you for that. And just wanted to get your sense of how you’re thinking about the dividend right now.

I know you switched to a monthly dividend recently and reiterated the $0.10 yesterday, given I guess, core earnings dipped a little bit below the monthly run rate, how are you sort of thinking about the dividend going forward?.

Yeah. Look, core earnings per share is, at this point, I think, it’s clear that if we, once we sort of stabilize, I mean, and given our current yield spreads are, I’m not worried about $0.10 per share per month.

So -- and plus this portfolio, as we’ve always said, is about as liquid, as you can get, looking at the mortgage REIT peer group, for example, but it’s a -- almost predominantly by any measure, agency mortgage portfolio. So, not worried about core earnings per share, not worried about liquidity. So, yeah, I think, that’s the best way to address that.

We -- I think that this was a temporary dip, right, in core earnings per share and we want to be conservative here in terms of getting through this difficult volatile period, but on the other end, you’ll have a combination of lighter yield spreads.

And don’t underestimate also the support from just higher absolute yields, right? So, once you’ve got short rates and if you look at the forward curve and you’ll see that short rates are projected to go up, probably, look today, but close to 2% a year out. That’s a huge tailwind to core earnings per share, huge..

And if I can squeeze in one more, you guys have done really good work getting your operating expenses down last fall since I guess the height of the COVID panic. I guess my calculation about 335 basis points operating expenses.

Is there more good work that can be squeezed out here? Are we kind of -- is this kind of level we are at?.

No. I think mid-3s is sort of the level where we’re at..

Okay. Thanks a lot guys and best of luck in a tough environment..

Thank you..

Thanks..

Thank you..

That was our final question for today. Thank you for participating in the Ellington Residential fourth quarter and full year 2021 earnings conference call. You may disconnect your lines at this time and have a wonderful day..