Larry Penn - Chief Executive Officer Mark Tecotzky - Co-Chief Investment Officer JR Herlihy - Chief Financial Officer Jason Frank - Deputy General Counsel & Secretary.

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the Ellington Financial, Fourth Quarter 2020 Earnings Conference Call. Today's call is being recorded. At this time all participants have been placed in a listen-only mode. The floor will be open for your questions following the presentation. [Operator Instructions].

It is now my pleasure to turn the call over to Jason Frank, Deputy General Counsel and Secretary. Sir, you may begin..

Thank you. 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.

As described under item 1A of our Annual Report on Form 10-K filed on March 13, 2020, and under Part 2 item 1A of our Quarterly Report on Form 10-Q as amended for the three months period ended March 31, 2020, 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 statement, whether as a result of new information, future events or otherwise.

I am joined on the call today by Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, Co-Chief Investment Officer of EFC; and JR Herlihy, Chief Financial Officer of EFC. As described in our earnings press release, our fourth quarter earnings conference call presentation is available on our website, ellingtonfinancial.com.

Management's prepared remarks 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, please turn to slide three, and I will now turn the call over to Larry..

Thanks, Jay, and good morning everyone. As always, thank you for your time and interest in Ellington Financial. Ellington Financial was again firing on all cylinders in the fourth quarter, as we delivered strong results in all of our diversified credit and agency strategies.

As you can see on slide three, we generated net income of $1.44 per share, which translated into a non-annualized economic return of 8.7% for the quarter and we generated core earnings of $0.37 per share.

I am pleased to report that with our strong fourth quarter results, we more than made back the losses from earlier in the year, and have positive net income and a positive economic return for the full year 2020. Given the extreme volatility of last March and April, I think that this is a remarkable accomplishment for a hybrid mortgage REIT.

And 2021 is off to a great start, our economic return in January with more than 3% and our estimated January 31 book value per common share was $18.05, which is now within just $0.22 of where it was last February, prior to the COVID related volatility. And that's before giving credit to the $1.06 of dividends on our common stock since last February.

Now getting back to the fourth quarter results. Our loan origination businesses again led the way. In the reverse mortgage space, Longbridge concluded an outstanding year, in fact a record year for both origination and volume and net income.

In the non-QM business, LendSure had a record quarter for origination volumes and earnings, and in October we completed our second non-QM securitization of the year, which drove strong performance on the portfolio side of that business.

Meanwhile, we had strong credit performance from our short duration loan portfolios, particularly residential transition mortgage loans, small balance commercial mortgage loans and our consumer loan portfolios. Notably, for most of these investments, we either originated the loans directly ourselves or through our origination partners.

In November we securitized a pool of unsecured consumer loans purchased through one of our loan flow agreements. Finally, I'll also add that post quarter end, in fact just earlier this week we priced yet another very successful non-QM securitization which Mark will discuss in more detail later.

As we've highlighted before, we believe that the loan origination platforms that we are building in Ellington Financial are crucial to ensuring us a continued steady flow of high quality investments. These origination platforms also provide significant franchise value to Ellington Financial.

In fact, I believe that this franchise value already represents tremendous underappreciated upside for EFC stock price, especially given the sizeable premiums which many public loan origination companies currently trade. I believe that these platforms will continue to differentiate EFCs business model moving forward.

In addition to our loan strategies’ performing well, our credit security is also performing very well in the quarter. Most notably, CLOs, CMBS, non-agency RMBS and European RMBS as prices continue to recover from the March selloff.

Finally, our Agency portfolio delivered another quarter of excellent results, driven by tightening yield spreads, attractive dollar rolls, hedging gains and attractive financing rates. During the quarter, we were able to further extend and improve our sources of financing.

In addition to the loan securitizations I mentioned, we also extended the term of one of our loan financing facilities and also added another such loan financing facility, which closed shortly after your-end.

Okay, many may not view details about asset financing facilities, that’s the most exciting news, but I'm mentioning it in part to remind everyone that in no small part it's not just our lower leverage, but it's also our disciplined approach to managing our financings that enabled us to whether the COVID liquidity crunch last year as well as we did.

Finally, I'll point out that we were again able to deliver strong results this past quarter even while maintaining leverage below our historical averages. We finished the year with a recourse debt to equity ratio of 1.6:1 down from 1.7:1 last quarter and significantly lower than the average of 2.7:1 in 2019.

With this low leverage and ample cash on the balance sheet, we have plenty of dry powder to add assets and grow earnings from here and that's exactly what we plan to do. And with that, I'll pass it to JR to discuss our fourth quarter financial results in more detail..

Thanks, Larry, and good morning everyone. I’ll also start with slide three, which shows a summary of our fourth quarter results. For the quarter ended December 31, Ellington Financial reported net income of $1.44 per common share and core earnings of $0.37 per share.

These results compare to net income of $1.06 per share and core earnings of $0.41 per share for the third quarter. With net income and core earnings comfortably exceeding our dividends, the board increase our monthly dividend rate by 11% in November, our second dividend increase since the reduction last April.

For the full year 2020 we reported net income of $17.2 million or $0.39 per share. Next, please turn to slide six for the attribution of earnings between our credit and agency strategies.

During the fourth quarter the credit strategy generated a total gross profit of $1.69 per share, while the agency strategy generated a total gross profit of $1 – excuse me, of $0.13 per share. These compare to $1.17 per share in the credit strategy and $0.17 per share in the agency strategy in the prior quarter.

Our credit investments generated excellent results for the quarter driven by strong net interest income and significant mark-to-market gains across the portfolio. We benefited from excellent performance in all of our credit strategies, as prices and liquidity continued to improve following the substantial market selloff earlier in 2020.

We also had another quarter of strong performance from our equity investments in mortgage originators. Finally, with credit spreads tightening across most asset classes, our credit hedges were the only negative contributor to results during the quarter.

Our agency strategy also had another strong quarter as agency RMBS yield spreads tightened quite significantly.

We benefited from strong net interest income, net realized and unrealized gains on our holdings of long TBAs driven by Federal Reserve purchasing activity and net realized and un-realized gains on our interest rate hedges as long term interest rates rose.

A portion of this income was offset by net realized-unrealized losses on our agency RMBS investments driven largely by elevated prepayment activity. Turning next to slide seven, you can see that our total long credit portfolio increased by approximately 2% in the fourth quarter.

The quarter-over-quarter increase was driven by larger non-QM and residential transition loan acquisitions, which more than offset significant payoffs on our small balance commercial mortgage loan and consumer loan portfolios, as well as the completion of two loan securitizations during the quarter.

Removing the impact of the two securitizations, the long credit portfolio grew by nearly 15%. Turning next to slide eight, you can see that our long agency RMBS portfolio increased by 4% quarter-over-quarter, but remains significantly smaller than it was pre-COVID.

Recall that earlier in 2020, in response to the COVID related market volatility, we strategically reduced the size of our agency portfolio in order to lower leverage and enhance our liquidity position. We continue to keep this portfolio relatively small throughout 2020 which has kept our levers low.

Turning to slide nine, you can see that our recourse debt to equity ratio adjusted for unsettled purchase and sales decreased during the quarter to 1.6:1 from 1.7:1 at the end of the third quarter while overall debt to equity ratio decreased to 2.6:1 from 2.7:1 over the same period.

Our weighted average cost of funds decreased in the fourth quarter as well to 2.03% from 2.2% in the third quarter. As our older, higher cost repo borrowings mature, we continue to replace them with repo borrowings priced based on current lower cost - lower cost borrowing rates.

At year end we had cash and cash equivalents of approximately $112 million along with other unencumbered assets of approximately $442 million. As Larry mentioned, we have plenty of dry powder to add assets from here. For the fourth quarter, total G&A expenses per share were $0.15, down slightly from $0.16 in the prior quarter.

Other investment related expenses increased quarter-over-quarter to $0.12 per share from $0.08, mainly due to non-QM securitization issuance costs that we incurred in the fourth quarter, but not in the third quarter.

For the fourth quarter we accrued income tax expenses of $7.9 million, primarily due to an increase in deferred tax liabilities related to unrealized gains on investments held in a domestic TRS.

Finally, our book value per common share at December 31 was $17.59, up 6.9% from $16.45 at the end of the third quarter and after a strong start to 2021 our January 31 estimated book value per share stood at $18.05. Now, over to Mark. .

residential mortgages, commercial mortgages and consumer loans. Overall we achieved an 8.7% total return with only modest leverage and for the entire year EFC had a positive economic return of 2%.

Our simultaneous focus on both protecting against downside shocks and seizing opportunities guided our decisions every moment of what was probably the most volatile year ever for structured product assets.

One reason I mention that our 8.7% return in Q4 was achieved with modest leverage, is because having modest leverage coming into the crisis last March was one of the primary reasons that EFC was able to weather the storm without selling credit sensitive assets at deeply distressed prices.

Too much leverage in March that you had to sell assets at the lows, and then you didn't have assets remaining to drive future performance or any cash to invest. Our performance for the year demonstrates our disciplined approach to underwriting credit risk. We have remarkably few headaches in the portfolio today.

There is certainly a few individual loans where the underlying property cash flow was challenged, but by and large we believe that our loan investments are well covered by the value of the underlying assets and I feel highly confident that we’ll continue to see favorable resolutions on these loans.

You can't really judge a company's underwriting standards until the market hits a speed bump. Before the speed bump, it always looks better to have chased higher note rates, higher LTVs, lower FICOs, because everything performs the same and you'd rather have the extra yield. But given the disruption to the capital market into the U.S.

economy in 2020 and the substantial problems in many sectors of the credit markets, underwriting practices were really put to the test and the EFCs shown across three of its areas of focus, residential, commercial and consumer.

Our strong underwriting was reflected in our performance and it allowed us to play offense in the spring when assets were really distressed and new lending opportunities are so attractive. Non-QM is a great example.

Yes we had some delinquencies, yes our servicer worked closely with borrowers that have a COVID related loss of income, but the challenges were manageable and we believe that our position as a lender was secure, because we had faith in our origination process, including our underwriting and appraisal policy.

Because of that confidence, our origination partner LendSure was one of the first to restart its non-QM lending program following the crisis and that has really paid off for EFC in two significant ways.

First, it immediately increased LendSure prominence in market share and the broker community responded by rewarding LendSure with increasing volumes; and second, with less competition, we were able to buy any securitize new non-QM loans at highly attractive levels, which helped drive profits in core earnings at EFC.

So I think 2020 demonstrated the efficacy of many of our core principles. The first core principle is ‘monitor your leverage closely.’ The difference between being an opportunistic buyer or a fore seller at the end of March turned on just an incremental extra turn to have leverage.

The extra turn of leverage that many managers reach for when spreads are tight is rarely rewarded over the long run. It can certainly work out with slightly higher core earnings for a quarter or two with spreads and liquidity turn against you, being over leveraged is the enemy of long term performance.

Obviously in a risk-on move like we saw this past quarter, if we had an extra turn a leverage on our credit assets, our return should have been marginally higher, but the balance sheets must be managed not just for the upside case, but also to be stable when asset prices are under attack like they were last March and the type of leverage matters a lot too.

The term non-mark-to-market structure of several law facilities added additional resilience and flexibility when the market sold off. The second core principle is when you’re a lender like we are, you try to get as close as you can to the ultimate borrower. Again, I think non-QM is a great example.

In this business we are originating loans to LendSure and manufacturing our product – our end product investment directly by issuing securitizations. We liked the model better than just buying the securities in the secondary market. Here's a good illustration why.

We priced the non-QM securitization deal yesterday, the AAA tranche, which is 75% of the deal, priced at a yield under 0.8%, but the average note rate on the underlying loan was about 5.7%. So that gives us an enormous spread over AAA financing cost. Of course there's a lot more to the equation here.

The loans originated a premium; we take prepayment risk and credit risk, and we have to absorb deal fees.

So I don't want to over simplify it, but by getting closer to the ultimate borrower, the homeowner and overseeing the entire process, I think we're able to manufacture much higher yielding and frankly much safer investments compared to just buying them after they've been originated, warehoused and securitized.

We gained a deeper understanding of the credit risk when we are closer to the borrower and are more involved with the initial underwriting of the credit. The third core principle is our belief that ownership stakes in origination businesses represent excellent alignment and are a great long term way to grow book value.

Only originators can be bumpy in the short - can be a bumpy road in the short term. Gain on sale margins in origination volumes can ebb and flow and in addition to that, our investment community originators don't directly generate core income for EFC so they can be underappreciated by the marketed times.

But over time, we think they can be material drivers of our book value and our franchise value, and because we own equity in the platforms, their upsides is theoretically not capped.

Another advantage for us is that originator earnings are sometimes inversely correlated with security yields, so these investments can be counter cyclical to some of the other investments in our portfolio and enhance our diversification.

For the quarter, we grew both our agency and credit portfolios, even while we had many loan resolutions and completed two securitizations. Our core earnings comfortably covered our dividend which we raised in November. Leverage is still low and has room to increase.

Looking at the pie chart on slide seven, the commercial strategy shrunk a little due to several successful loan resolutions. That's a portion of the portfolio that we're intending to grow substantially and we're currently seeing some attractive origination opportunities that should help us to do so.

We're also expecting some of our dry powder to be deployed in commercial NPLs given the inventory of defaulted loans that’s building up at banks and in CMBS deals. Consumer loans, where we have had very consistent performance throughout the year, shrunk this past quarter, but that was mainly the result of the securitization we did in November.

We expect growth in that portfolio. The residential mortgage loan portfolio grew from both non-QM and residential transition loans, even net of the loans we securitized. Our agency strategy also had another very strong quarter, finishing up the year more than 8% on allocated capital.

The agency portfolio again demonstrated its strategic value to the company in 2020. Over the years it has not only been a source of return, but it's also been a source of liquidity in times of stress such as last March and April.

Our strong fourth quarter earnings came from a combination of core earnings, as well as significant asset price appreciation, which means that the portfolio we bring into the start of the year isn't quite as high yielding as it was at the start of Q4.

For example, agency CMBS, in our way of looking at things was more expensive at the end of the quarter than the start, and that's also true for many of the credit securities we own. But it's less true for many of the loans we are targeting.

In some sectors we are seeing expected yield consistent with the second half of last year, plus the potential for some better financing terms. Our focus going forward is to continue to grow our real-estate and consumer focus strategies to both loan investments and securities. We have seen some attractive investment opportunities already this month.

A steepening yield curve and higher agency mortgage rates could drive incremental demand in non-prime and non-agency sectors in particular and as always, we are also focusing on improving and expanding our financing arrangements.

Finally, we are focused on supporting and providing resources to our origination businesses, so they can continue to grow and expand their footprint in what has been a very fertile market for originators. Now, back to Larry. .

Thanks Mark. Our strong fourth quarter brought our net income and economic return positive for 2020; a tremendous result for an unprecedented year. As to our core earnings and dividend, well throughout 2020 we consistently generated core earnings in excess of our dividend and our board has already acted twice to increase our dividend.

I see further upside to the dividend from here, given the earnings power of our current portfolio and given how much dry powder we have to continue to expand the portfolio, especially on the loan side. But, in addition to dividend upside, I also see a lot of book value upside from here. Please turn back to slide six.

As you can see towards the upper right area of this slide, realized losses in our credit portfolio were around $0.33 per share in 2020. I'm extremely proud that we were able to limit I realized losses for the year in our credit portfolio to just $0.33 per share, but that's $0.33 per share we're not getting back.

But look one row lower, our un-realized losses in our credit portfolio in 2020 were $1 per share, much of it COVID related mark-to-market losses. That's a $1 per share that we can get back. And so far in 2021, we've already made great headway getting that back and that's our goal and expectation that we're going to get most of that back in 2021.

That would represent a huge talent in 2021 for our earnings and our book value per share.

And we're off to a great start there, with our estimated at $18.05 book value per share as of the end of January, we are already very close to our pre-COVID book value per share, and that's before giving credit to the $1.06 of dividends on our common stock since last February.

Meanwhile, our traditional financing costs remain attractive and the securitization markets are providing even more attractive long term financing. We continue to focus on growing our proprietary loan origination businesses and continuing to grow our origination volumes at our originator affiliates.

This growth creates a virtuous cycle, driving increased earnings at the originator, which we participate in through our meaningful equity investment, while also driving portfolio growth for Ellington Financial.

Furthermore, we are actively on the lookout to leverage our strong track record as an origination partner by adding more strategic equity investments and low loan flow purchase agreements, so as to further expand, diversify and enhance our sources of investment product.

Finally, I'd like to close by highlighting how Ellington Financial has performed, not only in 2020, but over market cycles. Please turn to slide 23. This slide shows our net portfolio income on a fully mark-to-market basis for each of the 13 full years of our existence.

Whether was the financial crisis of 2008, the Taper Tantrum of 2013 or the COVID crunch of 2020, Ellington Financial has generated positive net portfolio income in each of these 13 incredibly varied years. EFC is one of the only publicly traded hybrid mortgage REITs to post a profit in 2020.

I am extremely proud of this result and of our entire history, which I believe reflect the strength of our team and our disciplined approach to investing, as well as the importance and effectiveness of our risk and liquidity management.

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 will now open the call to questions. Operator..

Thank you. [Operator Instructions]. Our first question comes from the line of Doug Harter of Credit Suisse..

Thanks. As far as you know kind of your sourcing allowance, you mentioned about getting us close to kind of the borrowers as possible as kind of the way to add value.

Can you just talk about your interests as kind of fully owning an originator versus kind of the equity ownership, and kind of how that, kind of how you think about the pros and cons of that?.

Well, this Larry, hey Doug! I think there is – yeah, there’s a few issues. The first one is that we certainly like having our – you know the principles at these companies, well LendSure in particular you know have a lot skin in the game there, a lot of ownership. I think consolidation is a small issue, it's not a big issue.

You know if we were to consolidate these companies on to our balance sheet then that would create some additional complexity I guess, in looking at our financials.

The – your know in the case of Longbridge, that's more of a, you know we own less that 50% there and we have a partner Stone Point, Homepoint Mortgage actually which just went public, which you know owns an equal share as us. So I don't think at this point certainly, there's no concept of majority there.

And you know we also have other stakes that we are exploring, we have one stake that we currently have where it's also minority interest. So I think for us, the important thing is the loan flow, right.

I mean we are – we have a big mouth to feed, right, in terms of the REIT’s needs, to generate investments that clearly are we think better from certainly on our return-on-equity standpoint and also just in terms of a repeatability stand point over time, just to keep that loan flow going. So that’s really super important.

So I don't think, obviously the franchise value indirectly through ownership of that is important and you're seeing that already in terms of the earnings flowing through the book values of these companies, which flows through the book value of our company, so that's all important, but you know I think it's really the loan flow is the key and the other is sort of the icing on the cake.

.

Got it. And then, you know I guess, are any of those equity interests, are they providing any cash flow through kind of dividend to the equity ownership or is kind of any of the kind of earnings being retained for growth within those businesses. .

Yeah, earnings is being retained for growth. .

Great! Thank you. .

Which is, and I just added, which is you know as Mark said, it’s not directly to core, right. If they were paying dividends, regular dividends, that could be core income, right, but they are not. I mean it’s – and it makes perfect sense for them.

We want them to grow their platforms and the multiplier effect on that growth is going to be much better than any dividends that they would pay out. .

Makes sense, thank you. .

Your next question comes from a line of Eric Hagen of BTIG..

Hey, good morning guys. Hope all is well? A couple of things here, first on the non-QM portfolio. Can you maybe go into some detail about how much you think LendSure can originate using your current outlook for interest rates and where do you plan to source the incremental capital to support the growth of that portfolio.

And then on the – how are you guys thinking about the consumer loan portfolio, just following up on your prepared remarks. Maybe I think I heard you say adding to it here. Any themes that you're picking up there, that kind of drive your outlook for credit performance, specifically at the non-QM portfolio and other direct lending strategies? Thanks..

Yeah, let me just take the first part on LendSure, which is, you know they are – I think we on a prior call talked about how they originated $80 million, over $80 million in October. So if you analyze that, that's just under $1 billion.

So we are certainly, I will just say our target which we think is an extremely realistic target is for them to exceed $1 billion this year and certainly hopeful that they can exceed it by a wide margin. But you know just to manage expectations I'd say, let's expect over $1 billion.

Mark, you want to talk about commercial loans? And by the way, we can also – I mean we're not – we don't have to exclusively purchase from LendSure of course. So we have looked at portfolios in the past and we’ll continue to look at purchasing non-QM from other providers as well, potentially even through flow agreements.

I mean we are – you know that's something that is not out of the question. .

Sure, yeah Eric, were you asking about credit performance going forward in non-QM or more in the commercial bridge side?.

Well, I was actually asking about what are you seeing as far as credit performance in the consumer loan portfolio and whether any trends or themes that you're picking up there, have any influence on other directly ending strategies that you guys are pursuing, specifically around non-QM of course. .

Yeah, so we've had very consistent performance in that consumer loan portfolio throughout 2020, and you know right when we think it came through – right when COVID hit that was definitely a portfolio that we were watching very closely, because it certainly concerned us.

I think a lot of the consumers there have benefited, you know substantially from the various stimulus programs from the government, and you know there were forbearance programs there, they’ve by and large ended and borrowers have been able to perform, so we have had strong performance there.

I think that portfolio, more than the real-estate focused portfolio is where you have sort of that low LTV sort of protection around your investment. On the consumer side, you don't have that. So I think it's a little bit tethered more to the economy than those other portfolios.

I mean right now, just it seems as though, the economy started to pick up and we are certainly make no predictions, but hopeful about the vaccine's ability to open up the economy. So it's just one of those things where every month we review it, we watch it very closely.

We're not – you know we're not immune to changes in performance, as the function of change in the health of the U.S. economy. But we've been investing in that space for a long time now, and we have sort of seen how it performs over cycles.

That sort of linkage to the real economy, more so than the real-estate strategies is one of the reasons why that portfolio is also shorter duration rates.

So it’s typically shorter loans and so that allows you, if you take an economic downturn, to change your underwriting guidelines relatively quickly, relative to how long the assets stay on the books. .

Right, and if I could just jump in for one minute. One additional point Eric on your question regarding origination volumes at LendSure. Larry mentioned that LendSure originated $80 million plus in October. November was a little lower, but December hit a new record at $95 million.

So even a higher run rate, I just wanted to add that, that additional update. .

Alright, that's great, thanks. That's helpful color. Thanks guys. .

Thank you. .

Your next question comes from a line of Bose George of KBW. .

Hi guys, good morning. Can you elaborate on where you're seeing some of the best returns? You mentioned, like commercial NPLs and also just what are your returns on the retained interest, you know securitizations from the LendSure loans. And then just on Longbridge do you retain anything or is that all just solid though the second programs. .

Well, I'll start, hey Bose. So the reverse order. So with Longbridge, no we don’t - we don't purchase anything. We haven't purchased anything directly from Longbranch.

I think that one thing that we've talked about, but not done is that, as Longbridge grows it may make sense one day for them to sell extra servicing rights, and that's certainly a very interesting and niche asset classic, extra servicing rights on reverse mortgages and that's something that we've definitely looked at before.

Most of our Longbridge’s tangible book value is in servicing rights. So that would be a possibility, but - and even though we do acquire, it happens to ourselves and [inaudible] derivatives, like [inaudible] and things like that. We are not, Longbridge is not our source for that.

They just sell their production to dealers, so that's the Longbridge question.

And sorry, the other two questions were?.

The returns on your retained interest from the LendSure loans. .

Yeah, I don't think we – we don't disclose that, because it's – I mean there is – and first of all there is an arbitrage as you know you're probably aware, right, which is that when you securitize their expenses to do securitization.

But the value of what you take back is which you know according to risk retention rules you know you have to – actually you're compelled to actually keep that over time. So it's not liquid, that retained asset, but you know I – it's very high up.

It’s well into the double digits I’ll just say, but it really depends on where you mark the asset and like I said, it’s to retain interest, so it's a little bit, it’s hard, but certainly you know where we think is the range of fair values is like that it's well into double digits, so – but that's not something that I think we specifically disclose. .

Okay, that's helpful, thanks. And then actually just curious about your thoughts on asset prices, you know both on agency and credit.

I mean do you think you know the spreads on things could continue to tighten or how do you sort of see that?.

Mark?.

You know, I don't know, that's always hard to predict and I’d say much more of our focus is on looking at the assets that we can buy, either loan or security form, thinking about how different exogenous factors can change your cash flow, and then thinking about what levered total return they generate for the shareholders with our financing arrangements.

I would just say that the pace at which new issue deals are being gobbled up, while still there is very strong, still very strong demand for new issue, it's not quite as ravenous as what it was you know during I'd say you know the fourth quarter and end of the third quarter of 2020. So a lot of money has been put to work.

I mean spreads are relatively tight now, but you know they could go tighter. But I just think, I think the biggest part of the move is certainly behind us if I had to guess. But I would say that you know that's hard to predict and what more of our focus is just understanding the risks, both on the credit side, you know on the prepayment side.

Prepayment risk is substantial now in the agency market and non-QM, just understanding the risks on the assets, thinking about what their expected returns are over a range of outcomes, you know with the new presidential administration and then thinking how that drives earnings when we apply what we consider the appropriate amount of leverage and viewing the opportunity set through that lens.

I think there is a lot of opportunities and we're going to have to put more capital to work. .

Okay. You know that makes sense… [Cross Talk].

If I could just, yeah, I just want to add a couple of things to that. So the first is that, like so for example, let's look at securities. Agencies had a great run in the fourth quarter, right and now they're looking you know I would say a little on the tight side.

Not relative to other areas in fixed income, but you know relative to where they've been. So that’s because we are active traders and we want to rotate and we want to go into the best areas where the opportunities are.

So first of all, we can increase our TBA short positions and then we have a trade-on that we talked about a lot, that we really liked for the last few years, which is you know long specified pools and you know short TBA’s, again off the right flavor in each case, right. So an opportunity when spreads are tighter where we can still make money.

But we want – you know there's no question that we think the most consistent return on equity opportunities that we're seeing right now are in the loan spaces. You know small balance commercial is a great example. We can't – we have a certain amount of flow there.

I think we're seeing actually much greater flow recently, so I'm really optimistic about increasing that portfolio you know here in the remainder of the first quarter and the second quarter of this year, but you know you can't just turn the faucet higher to immediately see higher flow, right, it takes time for that to come in.

But if you look at the dry powder we have, we're definitely reserving space you know for that flow, which we think is you know really going to set up core earnings for the second half of the year, non-QM. I mean that's a very predictable flow, right, that we have, we talked about that.

So we're certainly keeping space up there and you know last year we did two securitizations and obviously we probably could have done another but for COVID, but this year you know we're certainly looking to do three securitizations at a minimum. So you know we see a lot of good in the consumer loan portfolio we talked about as well you know.

We've got good flow arrangements there and we surely would hope to see our normal flows there as well. So residential transition loans has been a small part of our portfolio, but ramping up there. So we really want to keep dry powder for you know as we see that flow coming in and that's really where the best opportunities are.

You know the securities markets are tight now, there's no question about it. So you know you've seen lower yields quarter-over-quarter, but that's okay.

You know as Mark said, there's just no reason to be adding on another turn of leverage and securities that might be on the tight side of the cycle when you know we've got that flow coming in on what we think is just a very reliable and much higher return on equity frankly. .

Okay, yeah, that definitely makes sense.

Just one more question; you know just given the importance of mortgage banking, does it make sense to you know either include that in your – the way you sort of present core earnings or create like the new core plus category or something like that, because I feel like now the core in consensus is actually like not all that meaningful. .

Well, perhaps. I mean that's something that I guess we could explore.

You know we think of core as being something that is more interest dividend recurring like, so that's not something that we thought about in terms of the – our indirect ownership of the earnings of these affiliates, you know as something that we can include in core, but I mean I guess we could take a closer look, but we don't have any plans to do that.

I mean our hope is that the market will recognize that you know we – you know that the earnings growth that we project and that we see, is something that is steady and you know it’s something that they can you know see as recurring even if it's not in the form of interest or dividends..

Yeah, yeah. No, that makes sense. So great, thanks very much. .

Your next question comes from the line of Trevor Cranston of JMP Securities..

Hey, thanks. I was curious, I think Mark mentioned in the prepared comments you know the pricing of the AAA on the non-QM securitization you guys just did. My recollection was that there was you know a decent amount lower than where the last deal you guys priced in the fourth quarter was.

So I was wondering if you could just elaborate a little bit on kind of how execution of deals have evolved over the course of the last few months. Thanks. .

Sure. Hi Trevor! Yeah, spreads are tighter, but sort of the velocity of tightening has slowed down. So there’s a really, really, violent tightening move, sort of you know second half of 2020 and I would characterize this year's spreads of sort of like grinding tighter, but at a much slower pace.

So in terms of the overall liability costs on securitizations, we consider that very attractive and certainly attractive relative to repo. But you know it's a competitive market, so that better deal execution is also leading to sort of higher loan prices and we think it will ultimately lead to lower note rates at the consumer.

So we're able to capture a portion of it, but you know the market sort of moves a little bit to sort of typically have some level of efficiency to it. .

Got it, okay, that helps. And then on the transition loans, you know a couple of questions..

Let me just add one thing. It looks like that the, you know just for reference, the deal that we priced last October, priced at swaps plus 90, right, and here you know you've got the coupons below 80 basis points, so….

Right, yeah, okay. So on the transition loans, a couple of things..

A - Larry Penn:.

Right, yeah, I got it. So on the transition loans a couple of things. One, can you give us what the actual balance of the transition loans in the portfolio was at December 31.

And then second, you know since you mentioned that that's a growing asset, can you remind us what kind of financing you have in place for those and what the sort of overall financing strategy is for the transition loans in particular?.

Sure. So to the first point, the balance to include the transition loan in non-QM in the same bucket in our presentation, the portion of transition loan, the residential transition loans was a little over $70 million, $70 million at year end. .

Okay, and can you talk about the financing you guys are using for those?.

Well, we're using you know lines that we have from banks from – and they are often – JR, do you want to elaborate on that a little bit? I mean these are, you know these facilities that we have, I don't think we want a quote specific spreads, but its similar right, similar to where we finance non-QM, yeah?.

Yeah, that's exactly right, and we don't talk about specific spreads on the line, but yeah, it's similar in terms of structure advance and spread and even counterparty in some cases to how we’re financing non-QM, and so that the unlevered yields on our shelves have held up pretty well.

I mean they are coming in with everything else, but they're still kind of firmly in the mid-upper single digits, so the spread to financing is still quite attractive on the deals that we are doing.

I mean it is a small part of the portfolio, so we've probably kept it smaller and held the line on yield and underwriting, so that's helped our NIM in that strategy as well, but it's been very accretive certainly for core earnings and for earnings and the turnover has been very good in terms of we've been getting payoffs, even though COVID we were getting payoffs at par, so that's been a very good performing strategy for us.

.

Okay, that helps. Then one last thing on the non-QM side. You know you guys mentioned the benefits of you know LendSure being one of your earliest to kind of get back into the non-QM market after March, and you also mentioned you know the possibility at some point of adding potentially another full seller.

Have you guys seen many of the other lenders who were doing non-QM pre-March come back to the market already or is that something you more so expect to continue to evolve as sort of the agency REFI business starts to burn out a little bit over the course of this year. .

Mark, I would say I think most lenders have come back. I think we were definitely a first mover in restarting our lending operation, but you know I think since then a lot of the other lenders that you know we sought out in the market place pre-COVID, I think most of them are back originating. .

Okay. I appreciate the comments. Thank you, guys..

Your next question comes from the line of Crispin Love of Piper Sandler..

Thank you.

With LendSure or any of the other originators, are you worried at all about hold back in originations in 2021 following the record that we saw in 2020, and its potential impact on loan flow in 2021? I heard your comment a little bit earlier about the potential for $1 billion in originations from LendSure, but is there any reason to think that might be too aggressive considering the 2020 strength you might not repeat our I guess just asked another way, what gives you the confidence of that we could see continuing at the October or the December levels that you mentioned?.

This is Larry, hey Crispin. I think it's not – I suppose the agencies where I think you've got real questions about repeatability, especially as rates creep up, you know this is not nearly as rate driven as what's going on at agencies, so we're actually not worried about that. I would say that's not a concern.

It's the market that is still very under tapped, right. In fact you know we get a lot of – you know LendSure gets a lot of leads you can call it or loans from brokers, right, and if anything, it's harder to get brokers attention when there is so much REFI opportunity in conforming.

So when – you know that as rates start to creep up, if – you know if you see it getting tougher for brokers to do just REFI’S, which is obviously very easy and a profitable business right now, if anything I think you might see a greater focus from the brokers on non-QM, so we're not worried about that at all. .

Okay, thanks. And Mark, you mentioned that if you had taken the portfolio today, can you compare that to the last few quarters and what has changed recently and performed better than what you might have otherwise expected.

And then also if there are any other areas of the portfolio that you want to point out that are distressed currently?.

You know, we review in a fairly regular basis, any loans that are in a stage of delinquency, and I guess what I said is more anecdotal, but you know those meetings, those review meetings have gotten a little bit shorter over time.

So you know just when we look at the loans, say on the commercial side where a borrower has struggled, you know when we look at the valuation of the properties and we look at contact with the borrower and what their plans are, we're confident that in most cases you know our loans are well secured. So it wasn't so much sector specific.

You know words like the problems there are well known, right, lodging, retail, student housing. It was more just a comment that when we reviewed those loans in the portfolio, just – it's not as though we're seeing things where we're really concerned that the valuation is below what the loan amount is and JR mentioned it.

You know the pace of resolutions we've got has picked up and so I think that's another sort of barometer of surf to help with these markets and how capital is flowing.

There's – you know there's a lot of people interested in real estate right now and so it's also evidenced by the fact that the securitization market opened up so quickly after March, relative to what happened after the financial crisis and I think you know the fed activity helped a lot, but having active securities markets open, really is – it’s like a lubricant for transactions and I think that's been a beneficial to not only our portfolio, but a lot of portfolios.

.

Yes, so when – you know when we obviously – you're not going to have no headaches, right, coming out of COVID and you know some of the headaches that you have are as simple as well, you can't get into court to start a foreclosure on a small balance commercial loan for example, so that's a headache.

But it's not something that ultimately is, if you've underwritten that property right and you have the right loan to value, that’s you know going to impact your resolution.

If you could turn to page 11 in the deck, you know you can see how diversified by type we are and how when it comes to seniority, everything's first lien and if you, you know if you think about where the headaches are that are that are out there, it’s people that have taken second liens or third liens.

People have had too much concentration in malls or hotels or things like that, are – do we have some hotel properties, yes, but for example our biggest one we had, I think it was a 20% pay down on that loan, just – I think it was, I don't remember exactly when, but I think it was in the basically in the middle of last year, so which tells you a lot, right.

That the borrowers – you know that we were able to get that loan paid down to that extent, and the LTV still looks extremely solid there. So that loan is marked at par and we feel very confident about it for example. So yeah, there are a little headaches here and there, a lot around timing.

They are going to be somewhere, maybe there's a small shortfall, but nothing, you know really nothing material in the context of everything going on.

So I think we're really looking back, where we are really proud that the, the theory behind the underwriting actually turned into reality in terms of, we did have good appraisals, we did have good diversification. We did have good legal documents placed, all that stuff that you're concerned about.

So and in the other portfolios as well, like in – on secured consumer right. Again good, the performance there, we have the theory of all of our underwriting and all the data science that we, put into play, but you know and then there's the reality.

So I think we just feel very good about continuing to apply the same standards that we applied not to reach for yield, when it's inappropriate and I think we’re - so I think we are, feeling really good about our lack of headaches frankly. .

Thank you for all that color. .

Yeah, I just wanted to – this is JR. I just wanted to clarify one of the answers I gave a minute ago about the financing on RTL. So it's true that there are similar structures, and with similar, many of the same counterparties. The economics are not quite the same.

So the spread are little wider and advances a little lower on RTLs versus non-QM which is probably what everyone would expect given the liquidity and kind of securitizations happening in non-QM that are, where we have securitizations. It’s the other product, but not quite as expensive, so just wanted to add that clarification. .

Your next question comes from the line of Brock Vandervliet of UBS. .

Hey guys, I think most of its been covered by this point, but wanted to just circle up on the agency portfolio and how have you repositioned your hedges in the quarter.

I saw the basic disclosure in the back on the hedge positioning, but didn't get a sense in the time series, how that might have changed?.

I don’t think there was – I’d want to look back and answer with more precession, so we can follow up. But Q4, was quarter of pretty low rate volatility on the agency side, and we didn't have, big changes in that portfolio. So in terms of positioning on the yield curve, there wasn't any significant changes. .

Yeah, the other thing I would add is that, we liked the mortgage basis coming into the third quarter.

We liked the mortgage basis coming into the fourth quarter and those were good calls and so when you look at our TBA shorts, which as I mentioned before, we can really dial those up and down, depending upon what we think of the mortgage basis, the agency mortgage basis.

Those were fairly consistent, between in the third quarter and the fourth quarter. Now we mentioned that spreads are tighter, so I don't want to talk about what's going on in the first quarter of 2021, but don't be surprised if things look a little different when - as of March 31.

But we were pretty consistently constructive on the mortgage basis and we were right and that caused us to keep that hedging portfolio pretty similar in terms of its construction. That’s in contrast to you know – many, many periods in the past we got as high as I think maybe even 50% or more TBA shorts versus our longs.

So you know being closer to zero frankly, tells you what we felt about the mortgage basis at the time. .

Got it, okay. And just kind of a modeling housekeeping note, the tax rate bounced up this quarter, I think with the revs in the TRS.

Is that likely to continue or no?.

When you say tax rate, yeah, do you mean the actual rate or do you mean just our deferred taxes that you see flow through the income statement. .

Sorry, I guess I mean the latter. .

Yeah, because the rate. You know there’s talk obviously of copper rates going up, which could affect that. But the rate has remained constant that we apply. But it’s really a function of how much income we're generating in the TRS, and the income doesn't have to be taxable income, it can also be unrealized gains as well.

JR, you want to elaborate on that a little bit?.

Yeah, exactly. So the income tax provision increased this quarter because of activity in the domestic TRS and that includes one of our steaks in the mortgage originator. As Larry mentioned, as it increases even an under unrealized gain would trigger the increase of a deferred tax provision. So that's one of the drivers as well.

It’s just taxable income that we have generating in that [inaudible] from activity that occurs within our domestic TRS. So it’s not that the has change, but that just more income is driven to higher income tax provision. .

Right, and we of course limit our activities in the TRS, right, to things that we have to put in the TRS and we're going to – you know knowing that those are going to be taxable, as you can imagine, by and large those are very high ROE strategies right. We're not going to put a strategy that is a low ROE strategy in a taxable TRS right.

So we've got some very high ROE strategies in there. Certainly our investments in mortgage originators is one that we think is extremely high growth rate in terms of those investments.

And you know so when – if at some point in the future, we do, our TRS actually pays the REIT parent dividends, then those should be qualified dividends which would be a lower tax rate as well. It’s sort of another benefit for our investors as well. .

Got it. Okay thanks for color. .

Your next question comes from the line of Derek Hewett of Bank of America. .

Good afternoon, everyone. Most of my questions were already addressed, but could you provide some additional color in terms of what caused the book value increase in January.

Was it that further credit spread tightening based on that dollar of unrealized losses referenced on, I think it was slide six, whether its maybe stronger evaluations from the equity investments, in the loan originators given positive trends, maybe from the agency portfolio, or whether other factors involved. .

Yeah, I'm going to go – Mark and JR feel free to elaborate. It was not the originator investments. It was mostly spread tightening as certainly with the lion’s share. Mark or JR you want to add to that. And we by the way, spread tightening which we take advantage, both in unrealized, but also realized, right.

I mean we are definitely – when we are seeing security now that we think are you know potentially maxed out on – you know we are close to it, where the risk reward for us starts to shift, then we are actively selling. When we think that's appropriate. So yes, a combination of realized and unrealized driven by spread tightening.

Any color you want to add to that JR or Mark. .

Yeah, I’ll just add one thing. So the following – because there was a progression of asset recovery kind of following March and April of last year.

So agencies seem to come back quickly and then different credit assets kind of fell and followed in order and we talked about certain sectors are recovered faster than others, maybe non-agency and non-QM, whereas CLO and CMBS may have lagged and those last couple of strategies have really caught up as the year progressed and were some of the drivers of earnings in Q4 that we talked about.

I would say year-to-date 2021, we’ve seen spread tightening in those sectors continue. .

Okay. Thank you. That’s all from me. .

Thanks..

That was our final question for today. We thank you for participating in Ellington Financial, fourth quarter 2020 earnings conference call. You may disconnect your lines at this time and have a wonderful day..