Ellington Credit Company

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Ellington Credit Company 2024 second quarter financial results conference call. Today's call is being recorded, and 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 and 1 on your telephone keypad. At any time, if your question has been answered, you may remove yourself from the queue by pressing star and 2. Lastly, if you should require operator assistance, please press star and zero. It is now my pleasure to turn the floor over to Aladin Chalet, Associate General Counsel. Sir, you may begin.

Thank you. 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 and Part 2, Item 1A of our quarterly report on Form 10-Q, 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. Unless otherwise noted, 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 Credit Company, Mark Takotsky, our Co-Chief Investment Officer, and Chris Mernoff, our Chief Financial Officer. We are also joined by Greg Bornstein, Head of Corporate Credit at Ellington Management Group. Our second quarter earnings conference call presentation is available on our website, which we've recently changed to ellingtoncredit.com. Our comments this morning will follow that presentation. Please note that any references made on the call to figures in that presentation are qualified in their entirety by the notes at the back of the presentation. Furthermore, neither that presentation nor the call today should be construed as a solicitation of votes or proxies. Any such solicitation will only be made pursuant to a proxy statement or other appropriate proxy materials filed with the SEC and labeled as such. As a reminder, during this call, we'll sometimes refer to Ellington Credit Company by its NYSE ticker, E-A-R-N, or EARN for short. With that, I will now turn the call over to Larry.

Thanks, Eladine, and good morning, everyone. We appreciate your time and interest in Ellington Credit Company. The format of our call today will be a little different from that of previous calls. I'll start by discussing highlights of the quarter, as I typically do, and then Chris will describe the quarterly financial results in more detail. But after that, Greg Borenstein, Ellington's head of corporate credit, will join the call to discuss Earns' CLO portfolio composition and the outlook for the CLO portfolio from here. Then our co-chief investment officer, Mark Takotsky, will provide a brief update on our rotation out of agency MBS. Finally, I'll wrap things up and open the floor to Q&A. Greg Borenstein has been running Ellington's investing activities in the corporate CLO sector since joining Ellington in 2012 across a wide variety of market conditions and for a wide array of Ellington's funds and accounts. We've included a short bio for Greg on slide three. Once Earn completes its conversion to a CLO-focused closed-end fund, Greg and Mike Reynolds, Ellington's founder and head of all portfolio management activities, will officially be designated as Earn's two portfolio managers. We are all very excited to have these two veteran credit investors leading Earns' investment strategy going forward. As you can also see on slide three, the rest of Earns' management team will remain intact. Please turn now to slide four of the presentation, and I'll begin with an update on Earns' strategic transformation into a CLO-focused closed-end fund. As a reminder, it was last September that we began rotating Earns Capital into CLOs. And since then, we've been steadily growing that portfolio as we approach our targeted conversion date later this year. Everything continues to go as planned, and in early July, we filed our preliminary proxy statement in anticipation of a shareholder vote at our annual meeting later this year. Subject to that shareholder vote, we will convert to a closed-end fund for SEC purposes and a regulated investment company, or RIC, for tax purposes, thus completing our transformation from an agency mortgage REIT to a CLO-focused closed-end fund. We remain on track to complete all of these steps prior to year-end. On slide five, we reiterate some of the anticipated benefits to shareholders of the transformation, which include better projected risk-adjusted returns over the long term and enhanced access to capital markets. On slide six, we summarize Ellington's longstanding experience investing in CLOs and chart the ramp up of Earn's CLO portfolio. Earn acquired its first CLOs towards the end of last September. By year end, the portfolio stood at $17 million. And by March 31st, it had grown to $45 million. In the second quarter of 2024, we nearly doubled that number to $85 million. And as you can see on this slide, Earned CLO portfolio is now up to about $108 million as of last Friday. At that size, CLOs now account for roughly half of Earned's total capital allocation. Meanwhile, and as planned, we've shrunk our agency MBS portfolio significantly from $791 million last September to $531 million at June 30th, and we continue to downsize that portfolio as we acquire CLOs. With that said, until we actually complete our conversion process, we must continue to hold a core portfolio of liquid agency MBS in order to maintain our exemption from the 1940 Act. Fortunately, since we've concentrated our agency investments in liquid sectors, the cost of liquidating our agency pools to free up capital for CLOs has been very modest so far. We expect that to continue to be the case. Mark will elaborate on that later on the call. Please turn now to slide seven of the earnings presentation for the market backdrop for the second quarter. Despite some periods of market volatility, the CLO market continued to benefit from strengthening fundamentals, robust demand for leveraged loans, and continued capital inflows. Corporate loan prepayment rates increased further, reaching their highest level on a trailing 12-month basis since February of 2022. That drove further deleveraging in seasoned CLOs, which has continued to benefit benefit earns holdings of discount dollar price CLO mezzanine tranches. However, as we illustrate towards the middle of this slide, the Morningstar LSTA Leverage Loan Index actually ticked down quarter over quarter following six consecutive quarters of increases. This was simply the result of those high corporate loan prepayment rates in the second quarter, since many premium-priced corporate loans prepaid at par. Meanwhile, high yield and IG credit indices tightened further. as depicted here as well. In the CLO market, you can see here that credit spreads on double B and single B CLO tranches tightened overall as well, but there was significant dispersion among deals, with higher quality tranches generally tightening and lower quality tranches widening. The European CLO market also saw spreads tighten, particularly in higher quality mezzanine tranches. For CLO equity, tightening new issue mezzanine debt spreads were a double-edged sword. On the one hand, deals with better performing portfolios and higher debt costs were able to capitalize on those tighter spreads by refinancing or resetting their debt at cheaper levels. This activity drove strong positive returns for CLO equity in those particular deals. But on the other hand, the high volume of premium price loan collateral refinancing at par and at lower coupon spreads led in many deals to overall declines in net asset values and compressions in excess interest. These effects triggered mark-to-market losses for CLO equity in many deals, as both the interest payments on CLO equity, due to lower excess interest in the CLO, and underlying asset values declined in tandem. These dynamics led to mark-to-market losses on some of earned CLO equity tranches during the second quarter. Meanwhile, in the agency MBS market, yield spreads were little changed quarter over quarter, and the U.S. agency MBS index generated a slightly negative excess return relative to U.S. Treasuries. But those minor changes belied the significant negative impact of intra-quarter interest rate volatility in generating delta hedging losses, which, for example, you've seen reflected in the weak overall performance of the agency mortgage REIT sector this past quarter. I'll turn now to EARN's quarterly results on slide eight, and I'll begin with GAAP earnings. We had continued strong performance from our CLO mezzanine debt investments, both U.S. and European, driven by both opportunistic sales and some of our discount positions being called at par. On the CLO equity side, our U.S. CLO equity investments had mark-to-market losses driven by that heightened loan refinancing activity that I mentioned earlier, but our European CLO equity investments actually performed quite well. Overall, CLOs contributed positively to our net income for the quarter. In contrast, our remaining MBS portfolio contributed a modest $0.05 per share net loss for the quarter, caused primarily by that intra-quarter interest rate volatility. This drove our slight overall net loss for the quarter. Our ongoing rotation from agency MBS into CLOs continued to drive our net interest margin wider, our leverage ratios lower, and our adjusted distributable earnings higher. You can see on slide eight that our net interest margin expanded to 4.24 percent overall, while our debt-to-equity ratio declined to 3.7 to 1 at quarter end. The growth of the CLO portfolio with those wide net interest margins drove the sequential growth of our adjusted distributable earnings for the quarter. Ellington credits ADE grew 9 cents per share sequentially to 36 cents per share. I'll note, however, that we expect our ADE to tick down in the near term as we continue to sell agency pools and as the associated interest rate swap hedges that we initiated in much lower interest rate environments are terminated or burn off. That said, we do anticipate that our ADE will continue to cover our dividend in the third quarter. With that, I'll now pass it over to Chris to review our financial results for the second quarter in more detail.