Ellington Credit Company

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2022 Third 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. If you would like to ask a question at that time, please press star 1 on your telephone keypad At any time, if your question has been answered, you may remove yourself from the queue by pressing star 2. Lastly, if you should require operator assistance, please press star 0. 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 third quarter 2022 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 Takotsky, our Co-Chief Investment Officer, and Chris Smirnoff, our Chief Financial Officer. As described in our earnings press release, our third quarter earnings conference call presentation is available on our website, earnbeat.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. After a challenging first half of the year, the third quarter started off on a constructive note. with interest rate declining and interest rate volatility subsiding in July. As has been the typical pattern this year, yield spreads followed the direction of interest rates, with both declining in July, and virtually all fixed income products benefited. Agency RMBS, investment-grade corporates, and high-yield corporates reversed most or all of their losses from the prior month and posted significant outperformance during July versus Treasuries and interest rate swaps. Ellington Residential itself generated a positive economic return of nearly 6 percent in July. The good news proved short-lived, however. Continued elevated inflation led the Fed not only to raise the Fed funds target range by 75 basis points in both July and September, but also to accelerate its balance sheet runoff. Central banks around the globe also continued tightening their monetary policies. Over the course of August and September, interest rates rose sharply, large segments of the yield curve inverted further, and volatility surged. The move index, which measures the yield volatility implied by short-term options on long-term treasury notes and bonds, reached its highest level since the COVID-related market volatility of March 2020. Market sentiment steadily weakened, and we saw widespread selling across asset classes, including forced selling by some asset managers to meet margin calls and redemptions. particularly toward the end of the quarter. Liquidity deteriorated, and yield spreads widened in virtually every fixed income sector, including agency RMBS, with many sectors hitting their widest levels of the year. Technical headwinds in the agency RMBS market included not only the Fed's acceleration of the reduction of its MBS portfolio, but also extremely weak bank demand. Turning to slide three, on the top half of the page, You can see just how large these yield curve moves were during the quarter. Then, on the bottom half of the page, you can see the impact these huge moves had on agency RMBS yield spreads and prices. Both nominal yield spreads and option-adjusted yield spreads widened significantly across the coupon stack, and the combination of wider spreads and higher rates led to sharp price declines. You can see on this slide that Fannie Five and a Half's which was still the current coupon at September 30th, dropped by more than four points quarter over quarter. As you can also see in this slide, that represented an absolutely massive 57 basis points of OAS widening on that coupon, according to JP Morgan's models. And meanwhile, for the longer duration Fannie 3 1⁄2s, which was and is a fairly representative coupon within the 30-year portion of Ellington Residential's agency portfolio, well, that coupon dropped by more than six points in price also representing substantial OAS widening. Since the primary mortgage market takes its lead from the secondary mortgage market, the mortgage rates that homeowners see surged in sympathy with agency RMBS yields. The Freddie Mac 30-year survey rate ended the quarter at 6.7%, which was its highest level in the past 15 years, and even touched 7.08% two weeks ago. That was its highest level in over 20 years. as expected following these recent mortgage rate increases. Pre-payments continue to grind to a halt, housing is much less affordable, home sale volumes are declining, and we're seeing the first clear evidence of declining home prices nationally. In summary, the market environment in August and September could hardly have been more difficult for agency RMBS. Ellington Residential experienced a significant net loss for the quarter, as net losses on our specified pools exceeded net gains in our interest rate hedges and net interest income from the portfolio, and as we incurred significant delta hedging costs as a result of all the volatility. Our net loss was significant on a mark-to-market basis, but our disciplined and dynamic hedging strategy, which included aggressive duration rebalancing throughout the quarter and positive contribution from our meaningful short TBA position, helped prevent even greater book value declines. Next, on slide four, you'll see that we're reporting 23 cents per share of adjusted distributable earnings for the quarter. As we mentioned on last quarter's call, our ADE faces near-term headwinds as the sharp rise in short-term rates is repricing our repo liabilities higher, and they're repricing higher very quickly at that. And while our asset yields are also increasing, that only gets captured in our NIM as we rotate our portfolio. We're being patient about turning over our deep discount pools given what we perceive as excellent relative value in that sector. As a result, our NIM is compressing in the short term, but we think it's important to prioritize maximizing total economic return over just trying to maximize short-term ADE. It bears repeating that this all underscores the limitations of focusing too much on ADE, which is a backward-looking measure, particularly in market environments with large swings in interest rates and spreads, such as we're seeing today. The disciplined approach that we're taking with the portfolio turnover, combined with our sequentially lower book value, also meant that our leverage ticked up this quarter. As always, we remain focused on liquidity and risk management, and we continue to follow the same guidelines that have helped us manage past financial shocks effectively. Of note, we continue to hold a strong liquidity position at quarter end, with cash and unencumbered assets representing 27% of our total equity at September 30th. Finally, I'd like to point out that a significant portion of Ellington Residential's losses for the third quarter, and indeed for the year, resulted from yield spread widening, and I believe that the prospects of recouping many of these losses are strong. I'll now pass it over to Chris to review our financial results for the third quarter in more detail. Chris?