Ania Pritchard - IR Larry Penn - CEO Mark Tecotzky - Co-CIO Lisa Mumford - CFO.

Steven DeLaney - JMP Securities Doug Harter - Credit Suisse Mike Widner - KBW Lee Cooperman - Omega Advisors.

Presentation:.

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial Third Quarter 2015 Financial Results Conference Call. Today's call is being recorded. At this time, all participants have been placed in listen-only mode and the floor will be opened for your questions following the presentation. [Operator Instructions].

It is now my pleasure to turn the floor over to Ania Pritchard, Investor Relations. You may begin..

Thanks, Jackie. Before we start, I would like to remind everyone that certain statements made during this conference call may constitute forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are not historical in nature and they are based on management's beliefs, assumptions, and expectations.

As described under Item 1A of our Annual Report on Form 10-K filed March 13, 2015, forward-looking statements are subject to a variety of risks and uncertainties that could cause the Company's actual results to differ from its beliefs, expectations, estimates, and projections.

Consequently, you should not rely on these forward-looking statements as predictions of future events. Statements made during this conference call are made as of the date of this call and the Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

I have with me today on the call Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, our Co-Chief Investment Officer; and Lisa Mumford, our Chief Financial Officer. With that, I will now turn the call over to Larry..

Thanks, Ania. Once again it's our pleasure to speak with our shareholders this morning as we release our third quarter results. As always, we appreciate your taking the time to participate on the call today.

First some highlights, despite difficult dynamics, where global market volatility caused interest rates to fall, and credit spreads to widen significantly across the Board, Ellington Financial was still able to generate a small profit for the quarter. Our credit hedges inflated us from some of the impact of widening spread.

And we also benefited from the fact that many of the asset classes that we have been opportunistically rotating into as part of our portfolio realignment, like short duration commercial loans, and distressed small balance commercial mortgage loans, are generally less sensitive to movements in interest rates.

2015 has certainly been a challenging year so far, with a very high level of volatility. But we're excited about the investment pipeline we are building and the opportunities we are seeing. Things are cheaper now, and there's less competition.

As announced in our earnings release, we refined our capital management strategy, including a new dividend level, and an accelerated pace of share repurchases. I will elaborate fully on that later in the call. We will follow the same format as we have in previous calls. First, Lisa, will run through our financial results.

Then, Mark, will discuss how the MBS market performed over the course of the quarter, how we positioned our portfolio, and what our market outlook is. I will follow with some closing remarks before opening the floor for questions.

As a reminder, we posted our third quarter earnings conference call presentation right on the Home page of our website, www.ellingtonfinancial.com. Lisa and Mark's prepared remarks will track the presentation. So if you have this presentation in front of you, please turn to Page 4 to follow along. I'm going to turn it over to Lisa now..

Thank you, Larry, and good morning everyone. As you can see in our earnings attribution table on Page 4 of the presentation, during the third quarter, we earned net income of $3.9 million or $0.12 per share.

Our credit strategy generated gross income of $10.6 million or $0.31 per share, our Agency strategy had a gross loss of $1.8 million or $0.05 per share, and we had expenses of $4.9 million or $0.14 per share. Our return on equity for the quarter was 0.5% and on a year-to-date basis was 4.7% or 6.3% annualized.

In both our credit and Agency RMBS strategies, during the third quarter, the significant tightening in swap spreads negatively impacted our results, leading to losses on our interest rate hedges. In both strategies, we hedge against the risk of rising interest rates.

Both strategies were also impacted by yield spread widening that affected most sectors of the fixed income market during the third quarter. However, in our credit strategy, our credit hedges offset some of the impact of the widening, and on our Agency strategy, our pay-up increased during the period.

Within our credit portfolio, it's important to note that while the spread widening that took place during the quarter dampened our results; its impact was in the form of unrealized losses. We were not in any way forced to sell asset and realize actual losses.

This can be seen by the fact that we actually generated realized gains of $12.1 million or $0.35 per share, the majority of which came from our non-Agency RMBS portfolio which we continued to sell down in favor of the other asset classes that we've been rotating into.

We also had a meaningful contribution to realized gains from our CLOs and non-performing residential and small balanced commercial mortgage loans. That said our legacy non-Agency RMBS still represents the largest component of our credit portfolio and therefore had still typically been generating most of our income.

However during the third quarter, the yield spread widening that occurred, and the resulting unrealized losses that we recorded, led to a reduction in its overall contribution to our earnings relative to our other asset classes.

Non-Agency RMBS contributed approximately $0.10 per share during the third quarter or approximately one-third of our total credit results. In comparison, last quarter, our non-Agency RMBS made up approximately 60% of our total credit results.

Within our credit portfolio those asset classes which are less sensitive to movements in interest rates and the global macroeconomic environment include our consumer loans, our non-performing residential loans, and our small balance commercial loans.

These three segments performed very well during the quarter and combined to generate income of approximately $4.4 million or $0.13 per share, an increase of approximately $1.1 million or $0.03 per share from the second quarter. They represent approximately 42% of our third quarter credit results.

The remaining 25% of our credit results came from income from our CMBS, CLOs including European credit investments, our relative value trading strategies as partially offset by losses of interest rate swaps and unrealized losses on distressed debt investments.

Over the third quarter, the size of our non-Agency RMBS portfolio declined by about $84 million, and it is now approximately 50% smaller than it was at the beginning of the year. As I mentioned earlier, our Agency RMBS strategy generated a gross loss of $1.8 million or $0.05 per share for the quarter.

On a year-to-date basis, however this strategy has generated positive income of $5.8 million or $0.16 per share, based on allocated capital of approximately 18% it has generated a nine month return on equity of about 4.2% or about 5.6% on an annualized basis.

This was achieved in spite of extremely volatile interest rates and widening yield spreads over the first nine months of 2015. Through active trading, we generated realized gains of $900,000 or $0.03 per share for the quarter, and $7.9 million or $0.23 per share for the nine months period.

At the end of the third quarter, our total long credit portfolio was approximately $655 million, down from approximately $753 million in the second quarter, while our Agency portfolio was up slightly to $1.2 billion from $1.1 billion.

Our debt to leverage ratio was up slightly relative to last quarter at 1.81 to 1 but remains lower than our historical norms as we have sold some of our legacy non-Agency RMBS holdings, our leverage ratio has declined.

However as we continue to put additional repo and financing lines in place in connection with some of our other credit assets, we expect that over time our leverage ratio will increase.

Our overall annualized net investment income, as a percentage of shareholders equity, was 9.2% for the quarter and we project that to continue to rise as we continue to realign our portfolio. Our expenses remain essentially on forecast and our annualized expense ratio for the quarter was 2.6%.

We ended the quarter with a diluted book value per share of $22.22, down just 2.3% from that of June 30. Our diluted book value at September 30 includes the modest accretive impact of our share repurchase activity which began during the third quarter. I will now turn the presentation over to Mark..

Thanks, Lisa. To begin, I will quickly go through the market backdrop for the quarter because at this point in the earnings cycle others has covered most of it already. During the third quarter, we got bad news about emerging economies, especially China, and what it previously been a fairly consensus view among market participants that the U.S.

economy was strong enough to shove off this global weakening with challenge in September, when the Fed decided not to raise the target Federal funds rate. This set the market with the feeling that things would worsen in the U.S. than previously thought.

It's more pessimistic view; was also reinforced by the weak September payroll report released in early October. Our portfolio was set up pretty well for all this. The real outperformers as to credit market widening were legacy structured products including non-Agency RMBS and legacy CLOs.

Price movements in these sectors are actually quite muted and housing market fundamentals remain strong, while legacy CLOs back the outperformed newer vintages. Every market drawdown the past year showed a lower and lower data of legacy structured products to high yield corporate bonds and equity.

We believe that going forward structured credit will continue to outperform. We managed to avoid the real losers for the quarter, high yield distressed debt, and CLO 2.0s. CMBS also widened during the quarter but we did not have a lot of CUSIP exposure and like many others in this space we had CMBS hedges in place.

Many market participants are asking whether it's time to buy high yield aggressively but we are not convinced. The high yield market is becoming less and less liquid by the day and cash is decoupling from CDX. Our fear is that if redemption hit ETF or large distressed hedge funds price will drop further on supply.

In Europe, however our views are little different. UK non-conforming loans, whose performance looks good, did materially drop some price during the third quarter, unlike U.S. non-Agency RMBS. So we think there is real buying opportunity in this asset class. This quarter there were no changes in expected cash flows, instead there were just lower prices.

So expect that our going forward investments will have a higher yield or higher total return. Let's look at how the portfolio evolved in Slide 11. As you can see we are busy in the quarter. We shrunk the portfolio by almost $100 million, primarily signed CUSIP securities that performed well not only during the quarter but over a longer time horizon.

We sold season non-Agency RMBS as well as both U.S. and European CLOs. All these sectors are relatively unscathed by the credit volatility in the quarter. In addition, we deployed cash from these sales and higher yielding sectors like consumer loans and distressed commercial loans.

We have also been successful in securing some financing arrangements in some of these sectors. This is particularly important because it is precisely in these sectors where we are seeing an enormous spread between available asset yields and available financing cost. In some sectors, the yield gap between assets and funding can be 800 basis points.

This is important because it should allow us to generate net income with just small amounts of leverage which as you know is how we like to run our portfolio. As volatile spreads were in Q3, we still haven't seen how the market is going to act to a Fed hike during a time of weak liquidity. So operating with low leverage is vital.

Our plan was to raise cash by some sectors that trade spreads around approximately 300 over the yield curve and to try to reinvest the proceeds in sectors that we expect to provide double-digit yield. We also thought it would be prudent to sell assets in Q3 as opposed to trying to do so at the end of the year.

So now we've raised cash on these asset sales and can be opportunistic coming into year-end. In general, the newer investments we've added are yielding substantially more than what we've sold. And with a little bit of leverage the yield pickup could be tremendous. Slide 12 shows how far we have come since the end of 2013.

Our non-Agency RMBS portfolio is half what it used to be, and we now have a real presence in many higher yielding sectors, importantly our activities in consumer loans and commercial real estate are not easily replicated by others. So we believe that gives us the competitive advantage going forward.

If you turn to Slide 14, you can see our credit hedging. They have a dual purpose. First, they hedge against a weaker credit environment; and second, they partially hedge against asset spread widening. Our credit hedge has helped us this quarter, post quarter end the high yield indices have bounced back up without cash bonds failing seen.

We think there was a good reason to be concerned about high yield and leverage loans. There are lots of fundamental problems in the form of energy and commodity exposure and now that CLO issuance has slowed down there is supply issues as well. At new limit to CLOs had been the dominant source of demand for new leverage loans over the past few years.

So we like how we're positioned with credit exposure to the U.S. consumer, U.S. residential real estate, and U.S. commercial real estate hedges short positions in high yield. On the Agency side, it was a tough quarter. Agency mortgages substantially underperformed swap hedges. We lost a little $0.05 a share.

I think it's important to remember that when a loss is caused not by fundamental factors like a credit loss or faster realized prepayment it is a mark-to-market loss caused by an asset yield widening relative to its hedge those loss is going to reverse.

At quarter end, Agency CMBS was substantially cheaper than they were earlier in the year and has performed well since quarter end. With that, I'll turn the call back to Larry..

Thanks, Mark. During the third quarter, we purchased our first batch of non-QM loans from one of the flow agreements we have in place. This included settlements on commitments that we made in the late in the second quarter.

The ramp up business slowed than we had hoped but we are launching a bunch of new products and basically still just getting started. Some of the slow start was also just making sure that all the origination systems were integrated properly.

And now that those were in place, our primary non-QM source and originator on which we are significant strategic investor, had significantly ramped up their non-QM sales force just in the past 30 days. So we expect to really see things get going in November and December. Our consumer loan portfolio is a key growth area for us.

We continue to add to our portfolio under our flow agreements with originators. Our portfolio currently includes unsecured loans as well as auto loans. We have flow agreements in place with multiple originators and we're seeing lots of new opportunities in this area.

We're very selective as to who we'll buy product from, what product we'll buy including underwriting guidelines and of course at what price. So we end up turning down lots of opportunities but at the same time, we've been able slowly but steadily to increase our roster of originators that are providing us consumer loan throughout.

We have also arranged financing on many of our consumer loan and we expect to continue to expand our funding sources which would encompass most of our consumer loan flow going forward.

So with yields on this product that are already high on an unleveraged basis, as you can see on page 13 of the presentation, on a leverage basis the yields are extremely attractive. Shifting gears, we've added two new slides this quarter to the presentation.

Slides 29 and 30, coming after Slide 28, which shows our dividend and book value since our inception back in 2007 as a private company.

Over the years, we've often talked about many of a factors that we believe make Ellington Financial's returns higher quality returns and about how as we achieve these returns, we try not to take too much risk in our overall portfolio management.

The slides cover the entire period from Q1 2011 Ellington Financial's first full quarter as a public company. The end of the second quarter of 2015 which was the latest available data we had for the hybrid mortgage REITs.

Specifically, we've often talked about how less leveraged Ellington Financial is than the mortgage REITs generally, how careful we are in our cash and liquidity management, how we can and do use substantial amounts of credit hedges to reduce risk, how we make such liberal use of TBA short position to manage basis and interest rate risk in our agency portfolio.

And let's also not forget 2007and 2008 when as a 144A company, Ellington Financial broke even through the most difficult markets ever for structured credit while many mREITs at the time were crushed or even went bankrupt. Many of the mREITs around today weren't even in business back then. We're much more time tested in those companies to be sure.

Well, Slides 29 and 30, speak to Ellington Financial's relative risk profile as it has impacted book value and economic return two key metrics in this space. Let's start with Slide 29. This slide shows the stability of our book value per share in relation to the hybrid mortgage REITs.

Now obviously this doesn't include dividend which are as important a factor in economic return as book value and for economic return we're going to get there on the next slide, Slide 30. This Slide 29 speaks only to book value per share.

Why is stability of book value per share important? It certainly reflects that your portfolio isn't experiencing wild swings in value from period to period. It shows that you're being good stewards of your shareholders capital by avoiding serious stock issuances at heavily dilutive levels.

It also shows that over time your dividend is approximating your economic earnings. Now since every company sizes their shares differently, we have to normalize the graph to put every company on the same footing.

So for Ellington Financial and the 14 hybrid mortgage REITs, we computed the average book value per share over the entire period for each company and then graphed for each company the deviation of each of its book values from its average book value.

As you can see, Ellington Financial, the blue line popping out from all the grey lines representing the 14 hybrid mREITs clearly states the closest to the base line. And the statistics bare it out. As you can see on the table to the right of the graph, EFC has the lowest standard deviation of the entire group. Let's move on to slide 30.

This slide shows the same 15 companies over the same time period. But this time we're graphing the cumulative compounded economic return that includes both dividends and changing book value or compounded of course.

There is a twist however and it involves computing the Sharpe ratio which is why we consider the goal standard of performance evaluation in the investment industry. This will get a little tactical now, so I apologize.

Instead of just using the raw quarterly economic returns for each company, in computing the Sharpe ratio, you scale up or down each company's quarterly return by the calculated risk of that return as measured by the standard deviation of all the quarterly returns over the period.

And after doing that, you get the graph on the left of the slide and Ellington Financial, as represented again by the dark blue line, has the highest risk adjusted compounded returns.

The Sharpe ratios which are on the table on the right represent the annualized compounded economic return for each company divided by the annualized standard deviation of that company's quarterly economic returns.

So Ellington Financial have not had the highest absolute compounded economic return over the period, it has had by far the lowest volatility of its quarterly returns which helps Ellington Financial achieve the high Sharpe ratio basically the best returns per unit of risk. To conclude, I'd like to discuss our capital management strategy.

As announced, our Board has set a new dividend level of $0.50 per share which is $0.15 lower than its previous levels. This is not reflective of any less confidence on our earnings power.

In fact as we've discussed earlier throughout this call, thanks to all the better opportunities we're seeing in so many of the sectors where we've been adding and all the investment pipelines and sourcing capabilities we're building, we're as confident as ever about the earnings stream we're creating.

We set our new dividend at a level commensurate with where we see our leverage to asset yields trending as we continue to realign our portfolio.

We believe that once our portfolio realignment is complete, we will have established an earnings stream that will cover our new dividend level on a yield basis alone, even before taking into account our trading, that has historically enhanced our returns by hundreds of basis points.

Now since we do mark-to-market through our income statement and since we're active traders, our actual earnings will necessarily continue to fluctuate from quarter-to-quarter. However it is our expectation that over time and over market cycles, we will generate earnings in excess of our dividend level.

Down the road if our leveraged asset yields trend even higher and our mark-to-market earnings follow suit, we will consider raising the dividend level. Initially, we plan to use the entire difference from our prior distribution level that $0.15 per share per quarter or approximately $5 million per quarter to repurchase our shares.

With our stock trading at such a significant discount to our assets, the values of which we are extremely confident, these share repurchases will be immediately accretive to book value and will amplify the earning power of our assets for our shareholders.

And in addition to making discretionary repurchases during our open trading windows, we also plan to enter into a 10b5-1 plan to ensure that we have enough trading days to implement these repurchases.

Ultimately, should our price to book ratio recover or other significant additions change, we will consider using this extra capital for other purposes appropriate such time such as increasing our investments in our most compelling asset classes or perhaps paying special dividends to the extent that our realized earnings substantially exceed the new dividend level.

I hope you all agree that Slides 28, 29, and 30, demonstrate very clearly that over our history, we paid substantial dividends to shareholders, while at the same time maintaining stability of book value even through the most difficult of market environment. These remain core objectives for us.

In fact at $0.50 per share per quarter, our new dividend level is still attractive by almost any metric representing a 9% yield based on our $22.22 book value per share as of September 30, and representing slightly over 11% yield based on our November 4, closing price of $18.07.

That said while we recognize that some shareholders might prefer 100% payout ratio, we also believe that it's important for us to be more focused on long-term value creation and the use of our earnings, whether in repurchase of our shares, when they're trading at distressed levels of whether to build book value over time through retained earnings.

To succeed, we recognize that first and foremost, we must continue to manage our investment portfolio and enhance our sourcing abilities to take advantage of the best opportunities for high risk adjusted yields and the potential for growth in building a franchise value.

However we also believe that this refined capital management strategy is an important step in achieving our goal, which as always is to maximize long-term value for our shareholders. Please remember management owns over 10% of Ellington Financial. We are aligned with you and we want to create long-term value for you.

This concludes our prepared remarks. We're now pleased to take your questions..

[Operator Instructions]. Our first question comes from the line of Steve DeLaney with JMP Securities..

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Our next question comes from the line of Sam Choe with Credit Suisse..

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Our next question comes from the line of Lee Cooperman with Omega Advisors..

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And now I’d like to turn the call back over to management for any additional or closing remarks. Ladies and gentlemen, this concludes Ellington Financial's third quarter 2015 financial results conference call. Please disconnect your lines at this time and have a wonderful day..