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spk01: 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. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If at any time your question has been answered, you may remove yourself from the queue by pressing the pound key. Lastly, if you should require operator assistance, please press star zero. It is now my pleasure to turn the call over to Jason Frank, Deputy General Counsel and Secretary. Sir, you may begin.
spk11: 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-month 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 statements, 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 Takotsky, Co-Chief Investment Officer of EFC, and J.R. 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.
spk08: 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 37 cents 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 was more than 3%, and our estimated January 31st book value per common share was $18.05, which is now within just 22 cents 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 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 have highlighted before, we believe that the loan origination platforms that we are building at 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 sizable premiums at which many public loan origination companies currently trade. I believe that these platforms will continue to differentiate EFC's business model moving forward. In addition to our loan strategies performing well, our credit securities also performed 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 year end. Okay, many may not view details about asset financing facilities as 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 weather 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 to 1, down from 1.7 to 1 last quarter. and significantly lower than the average of 2.7 to 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.
spk07: 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 31st, Ellington Financial reported net income of $1.44 per common share and core earnings of 37 cents per share. These results compare to net income of $1.06 per share and core earnings of 41 cents per share for the third quarter. With net income and core earnings comfortably exceeding our dividends, the Board increased 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 39 cents 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 13 cents 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 sell-off earlier in 2020. We also had another quarter of strong performance from our equity investments and 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-unrealized 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 remained 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 leverage 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 to one from 1.7 to one at the end of the third quarter, while our overall debt-to-equity ratio decreased to 2.6 to 1 from 2.7 to 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 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 15 cents, down slightly from 16 cents in the prior quarter. Other investment-related expenses increased quarter-over-quarter to 12 cents per share from 8 cents, 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 31st 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 31st estimated book value per share stood at 1805. Now, over to Mark.
spk06: Thank you, JR. Q4 was a strong quarter for EFC. Today, I'll review performance for the quarter in the full year, how the portfolio evolved in the quarter, and our outlook for the coming months. In the fourth quarter, EFC had significant contributions from each of our three core credit strategies. 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 mentioned 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 meant 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 are certainly a few individual loans where the underlying property cash flow is 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 markets and to 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 EFC shone 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 were 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 policies. 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's 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 and securitize new non-QM loans at highly attractive levels, which helped drive profits and 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 forced seller at the end of March turned on just an incremental extra turn or two of 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, but if spreads and liquidity turn against you, Being over-levered 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 of leverage on our credit assets, our returns would have been marginally higher. But 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 of our 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 through LendSure and manufacturing our end product investments directly by issuing securitizations. We like the model better than just buying those securities in the secondary market. Here's a good illustration why. We priced a 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 our AAA financing costs. Of course, there's a lot more to the equation here. The loans are originated at a premium. We take prepayment risk and credit risk, and we have to absorb deal fees. So I don't want to oversimplify 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 gain 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. Owning originators can be a bumpy road in the short term. Gain on sale margins and origination volumes can ebb and flow, and in addition to that, our investments in the originators don't directly generate core income for EFC, so they can be underappreciated by the market at 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 upside is theoretically not capped. Another advantage for us is that originator earnings are sometimes inversely correlated with securities yields. So these investments can be countercyclical 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 charts on slide 7, 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 MBS, 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 yields 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-focused strategies through 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.
spk08: 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 33 cents per share in 2020. I'm extremely proud that we were able to limit our realized losses for the year in our credit portfolio to just 33 cents per share. But that's 33 cents per share. We're not getting back. But look one row lower. Our unrealized losses in our credit portfolio in 2020 We're $1 per share, much of it COVID-related mark-to-market losses. That's a dollar per share that we can get back. And so far in 2021, we've already made great headway getting that back, and it's our goal and expectation that we're going to get most of that back in 2021. That would represent a huge tailwind in 2021 for our earnings and our book value per share. And we're off to a great start there. With our estimated $18.05 book value per share as of the end of January, we're already very close to our pre-COVID book value per share, and that's before giving credit to the $0.06 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 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 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 it 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 have posted 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. With that, we will now open the call to questions. Operator?
spk01: Thank you. At this time, I would like to remind everyone, if you would like to ask a question, please press star, then the number one on your telephone keypad. If your question has been answered and you wish to remove yourself from the queue, press the pound key. Our first question comes from the line of Doug Harder of Credit Suisse.
spk03: Thanks. As far as your sourcing the loans, you mentioned about getting as close to the as possible as kind of the way to add value. Can you just talk about your interest as, you know, kind of fully owning an originator versus kind of the equity ownership and kind of how that, you know, kind of how you think about the pros and cons of that?
spk08: Well, this is Larry. Hey, Doug. I think there's a few issues. The first one is that we certainly like having the principles at these companies. Well, Lensure in particular have a lot of skin in the game there, a lot of ownership. I think consolidation is a small issue. It's not a big issue. If we were to consolidate these companies onto our balance sheet, then that would be create, you know, some additional complexity, I guess, in looking at our financials. The, you know, in the case of Longbridge, that's more of a, you know, as, you know, we own less than 50% there. And, you know, we have a partner, Stone Point, Home Point Mortgage, actually, which just went public, which is, you know, owns an equal share as us. So I don't think at this point, certainly, there's no concept of owning a majority there. We also have other stakes that we're exploring. We have one stake that we currently have where it's also minority interest. I think for us, the important thing is the loan flow. We have a big mouth to feed in terms of the REITs 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 standpoint over time, you know, 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, you know, 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.
spk03: Got it. And then, you know, I guess, are any of those equity interests, are they providing any cash flow through kind of dividends to the equity ownership or is kind of any of the kind of earnings being retained for growth within those businesses?
spk08: Yeah. Earnings is being retained for growth. Great. Thank you. Which is, and I just added, which is, you know, why, you know, as Mark said, it's not, it's not directly to core, right? If they were, they were paying dividends, you know, regular dividends, um, you know, that could be core income. Right. But, um, they're not, I mean, it's, and it makes perfect sense for them. We want them to grow. 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.
spk03: Makes sense.
spk08: Thank you.
spk01: Our next question comes from the line of Eric Hagen of BTIG.
spk05: Hey, good morning, guys. Hope all is well. A couple things here. First, on the non-QM portfolio, can you maybe go into some detail about how much you think LendShare can originate using your current outlook for interest rates and where 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 in the non-QM portfolio and other direct lending strategies? Thanks.
spk08: Yeah, let me – Eric, let me just take the first part on Lendsure, which is, I think we, on a prior call, talked about how they originated $80 million, over $80 million in October. So if you annualize that, that's just under a billion. So we are certainly, I will just say, our target, which we think is an extremely realistic target, is for them to exceed a billion this year. And and certainly hopeful that they can exceed it by a wide margin. But, you know, just to manage expectations, I'd say, you know, let's expect over a billion. Mark, do 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 Lensure, of course. So we have looked at portfolios in the past, and we'll continue to look at purchasing 9QM from other other providers as well, potentially even through flow agreements. I mean, that's something that is not out of the question.
spk06: Eric, were you asking about credit performance going forward in non-QM or more on the commercial bridge side?
spk05: Well, I was actually asking about what you're 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 direct lending strategies that you guys are pursuing, specifically around non-QM, of course?
spk06: Yeah, so we've had very consistent performance in that consumer loan portfolio throughout 2020. And, you know, right when COVID hit, that was definitely a portfolio that we – we're 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. You know, 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 portfolios 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 is starting to pick up, and we're certainly making 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 immune to changes in performance as a function of changes in the health of the U.S. economy, but we've been investing in that base for a long time now and we have sort of seen how it performs over cycles that um that sort of uh 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 which 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.
spk07: Right, and if I could just jump in for one minute. One additional point, Eric, on your question regarding origination volumes at Lensure. Larry mentioned that Lensure 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 additional update.
spk05: That's great. Thanks. That's helpful, Keller. Thanks, guys. Thank you.
spk01: Our next question comes from the line of Bose George of KBW.
spk12: Hey, guys. Good morning. Can you elaborate on where you're seeing the best returns? You mentioned, you know, like commercial MPLs. And also just what are your returns on the retained interest, you know, securitizations from the land shore loans? And then just on long breaks, do you retain anything or is that all just sold through the second programs?
spk08: Well, I'll start. Hey, Bose. So a reverse order. So with Longbridge, no, we don't purchase anything. We haven't purchased anything directly from Longbridge. 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 excess servicing rights. And that's certainly a very interesting and niche asset class, excess servicing rights on reverse mortgages. And that's something that we've definitely looked at before. Most of Longbridge's tangible value is in servicing rights. So that would be a possibility. And even though we do acquire HECMs ourselves and HECM derivatives like HECM IOS, things like that, Longbridge is not our source for that. They just sell mortgages. their production to dealers. So that's the Longbridge question. And sorry, the other two questions were?
spk12: Yeah, the returns on your retained interest from the venture loans.
spk08: Yeah, I don't think we, we don't disclose that, you know, because it's, I mean, there is, first of all, there is an arbitrage, as you're probably aware. um right which is that when you securitize you know there are expenses to do securitization but the value of what you take back um is uh which you know according to risk retention rules you know you have to actually you're you know compelled to actually keep that over time so it's not liquid uh that that retained asset but um you know i uh it's very high it's well into the double digits i'll just say okay um but it really depends on where you mark the asset. And like I said, it's a retained interest. So it's a little bit, it's odd, but certainly, you know, what we think is the range of fair values, as I said, it's well into the double digits, you know, so, but, but that's not something that I think we specifically disclose.
spk12: So, okay. No, that's helpful. Thanks. And then, Actually, just curious about your thoughts on asset prices, both on agencies and credit. Do you think spreads on things could continue to tighten, or how do you sort of see that? Mark?
spk06: 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 their 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's 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, you know, 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, and the prepayment side. Prepayment risk is substantial now in the agency market and on QM. Just understanding the risks on the assets, thinking about what their expected returns are, over a range of outcomes, you know, we have a new, you know, presidential administration, and then thinking how that drives earnings when we apply, you know, what we consider the appropriate amount of leverage. And viewing the opportunity set through that lens, I think there's a lot of opportunities we're going to have to put more capital to work.
spk12: Okay.
spk08: If I could just... Yeah, I just want to add a couple things to that. So the first is that... So for example, let's look at securities. Agencies had a great run in the fourth quarter, right? And now they're looking, I would say, a little on the tight side, not relative to other areas in fixed income, but relative to where they've been. So that's because we are active traders and we want to rotate, we want to go into the best areas where the opportunities are. So first of all, we can increase our TVA short positions. And then we have a trade on that we've talked about a lot that we really liked for the last few years, which is long specified pools and short TVAs, again, of the right flavor in each case. So an opportunity when spreads are tighter where we can still make money. But we want, 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. Small balance commercial is a great example. 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 here in the remainder of the first quarter and the second quarter of this year. But you can't just turn the faucet higher and immediately see higher flow, right? It takes time for that to come in. But if you look at the dry pattern 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, you know, 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, you know, 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, We see a lot of good, and the consumer loan portfolio we talked about as well. You know, we've got good flow arrangements there, and we certainly 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.
spk12: Okay. Yeah, that definitely makes sense. Just one more question. Just given the importance of mortgage banking, does it make sense to either include that in the way you sort of present core earnings or create like a new core plus category or something like that? Because I feel like now the core in consensus is, I feel like, not all that meaningful.
spk08: Well, perhaps. I mean, that's something that I guess we could explore. We think of core as being something that is more decentralized. interest dividend recurring like uh so that's not something that we thought about in terms of the our you know indirect um indirect ownership of the earnings of these affiliates you know as something that we could include in core but i mean i guess we could 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 um you know we you know that the um the earnings growth that we project that we see is something that is steady and, um, you know, is something that they can see as recurring, even if it's not in the form of interest or dividends.
spk12: That makes sense. So great. Well, thanks very much.
spk01: Our next question comes from the line of Trevor Cranston of JMP securities.
spk02: Hey, thanks. Um, I was curious, I think Mark mentioned in the prepared comments the pricing of the AAA on the non-QM securitization you guys just did. My recollection is that that was 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.
spk06: Sure. Hi, Trevor. Yeah, spreads are tighter, but sort of the velocity of tightening has slowed down. So it was a really, really violent tightening move, sort of, you know, second half of 2020. And I would characterize this year as 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 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 to 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.
spk02: Got it. OK, that helps. And then on the transition loans, you know, a couple of questions.
spk08: Let me just add one thing. It looks like it looks like that the you know, just for reference, the deal is that we priced last October, priced at swaps plus 90, right? And here, you know, you've got the coupon, you know, below 80 basis points, so. Right.
spk02: Yep, okay. So on the transition loans, a couple of things. The AAA. 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, 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?
spk07: Sure, so the first part, the balance, so we include the transition loan and non-QM in the same bucket in our presentation. The portion of transition loan, the residential transition loans, was a little over $70 million at year end.
spk02: Okay, and can you talk about the financing you guys are using for those?
spk08: Well, we're using... you know, lines that we have from, you know, banks from, and they're, you know, 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 to quote specific spreads, but it's similar. right, similar to where we finance non-QM, yeah?
spk07: 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 the unlevered yields on RTLs have held up pretty well. I mean, they're 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 for certainly for core earnings and for earnings. And the turnover has been very good in terms of we've been getting payoffs. Even through COVID, we were getting payoffs at par. So that's been a very good performing strategy for us.
spk02: Okay, that helps. Then one last thing on the non-QM side. You know, you guys mentioned the benefits of, you know, LendShare being one of the 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 flow 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?
spk06: This is 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 know i think since then a lot of the other lenders that um you know we saw out in the marketplace pre-covered i think most of them are back originating okay appreciate the comments thank you guys your next question comes from the line of crispin love of piper sandler thank you um
spk10: With Lendsure or any of the other originators, are you worried at all about a pullback 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 a billion in originations from Lendsure. But is there any reason to think that might be too aggressive considering the 2020 strength might not repeat or I guess just ask another way? what gives you the confidence that we could see continuing at the October or the December levels that you mentioned?
spk08: Well, Larry, hey, Crispin. I think it's not, as opposed to agencies where I think you've got real questions about repeatability, especially as rates creep up, this is not nearly as rate-driven as what's going on in agencies. So we're actually not worried about that. I would say that's not a concern. It's a market that is still very undertapped, right? In fact, you know, we get a lot of, you know, Lensure 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's so much refi opportunity in conforming. So when, you know, that as rates start to creep up, if you see it getting tougher for brokers to do just refis, which is obviously very easy and 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.
spk10: Okay, thanks. And Mark, you mentioned that you have a few headaches in 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 stressed currently.
spk06: You know, we review on 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, you know, 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, you know, contact with the borrower and what their plans are, you know, we're confident that in most cases, you know, our loans are well secured. So it wasn't so much sector specific, you know, whereas like the problems there are well known, right? Lodging, retail, student housing. It was more just a comment that when we review the 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 J.R. mentioned it. The pace of resolutions we've got has picked up. And so I think that's another sort of barometer of the health of 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, you know, the securitization markets 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.
spk08: Yeah. So when, when, you know, when we obviously there, 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, you know, small balance commercial loan, for example. So that's a headache, but again, It's not something that ultimately is, if you've underwritten the property right and you have the right loan to value, that's going to impact your resolution. If you could turn to page 11 in the deck, you can see how diversified by type we are and how, when it comes to seniority, everything's first lien. And if you think about where the headaches 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. 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. I think it was, I don't remember exactly when, but I think it was 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 we're, you know, that loan is marked at par and we feel very confident about it, for example. So, yeah, so there are little headaches there and there, a lot of around timing. There are going to be some where maybe there's a small shortfall, but nothing, you know, really nothing material there. in the context of everything going on. So I think we're really, looking back, we're really proud that the theory behind our 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. And in the other portfolios as well, like in unsecured consumer, right? Um, again, good, you know, uh, the performance there, we, you know, we have the theory of all of our underwriting and all the data science that we, that we, uh, put into play, but, you know, and then there's the reality. So I think we, um, just feel, you know, 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, you know, so, so I think we're, uh, feeling really good about our lack of headaches, frankly.
spk07: Thank you for all that, Collar. I just wanted to clarify one of the answers I gave a minute ago about the financing on RTLs. It's true that there are similar structures and with many of the same counterparties. The economics are not quite the same. The spreads are a 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 we have securitizations of the other product but not quite as extensive. So I just wanted to add that clarification.
spk01: Your next question comes from the line of Brock Vandervliet of UBS.
spk04: Hey, guys. I think most of it's been covered by this point. But wanted to just circle up on the agency portfolio. 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.
spk06: I don't think there was – I'd want to look back and answer with more precision so we can follow up. But Q4 was a 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.
spk08: 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 TVA 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. Uh, you know, now we've mentioned that spreads are tighter, so, you know, I don't want to talk about what's going on in the first quarter of 2021, but you know, don't be surprised if things look a little different. Um, when, you know, at the, as of March 31st, but, um, but you know, we were pretty consistently constructive on the mortgage basis and we were right. And, uh, that, you know, caused us to, to keep that hedging portfolio, you know, pretty similar in terms of, uh, its construction. So that's in contrast to, you know, at many, many periods in the past, we got as high as I think maybe even 50 percent 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.
spk04: Got it. Got it. Okay. And just kind of a modeling housekeeping note, the tax rate bounced up this quarter, I think, with REVS and the TRS. Is that likely to continue or no?
spk08: Well, 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 statements? um sorry i guess i mean the uh i guess i mean the latter yeah because the the rate you know i mean there's talk obviously of corporate rates going up which could affect that but the rate you know has remained constant that we um you know apply but it's it's really a function of uh how much income we're generating in the trs and income doesn't have to be taxable income it can also be unrealized um gains as well jr you want to elaborate that on that a little bit um yeah exactly um so the
spk07: The income tax provision increased this quarter because of activity in the domestic TRS, and that includes one of our stakes in the mortgage originator. As Larry mentioned, if it increases, even an unrealized gain would trigger the increase of a deferred tax provision. So that's one of the drivers as well as just taxable income that we have generating in that blocker from activity that occurs within our domestic TRS. So it's not that the rate has changed, but just more income is driven to higher income tax provision.
spk08: Right. And we, and we, you know, we of course limit our activities in the TRS, right. To things that, uh, you know, 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, um, you know, 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, um, So we've got some very high ROE strategies in there. You know, certainly our investments in mortgage originators is one that we think is an extremely high growth rate in terms of those investments. And, you know, so when, if at some point in the future we do, you know, our TRS actually pays the reparent dividends, then those should be qualified dividends. you know, which would be a lower tax rate as well as sort of another benefit for investors as well.
spk04: Got it. Okay. Thanks for the color.
spk01: Our next question comes from the line of Derek Hewitt of Bank of America.
spk09: 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. Was it maybe stronger valuations from the equity investments and the loan originators given positive trends, maybe from the agency portfolio, or were there other factors involved?
spk08: Yeah, I'm going to, Mark and JR, you know, feel free to elaborate. It was not the... you know, not the originator investments. It was mostly spread tightening is, you know, certainly, uh, you know, would, would be the lion's share. Uh, Mark or JR, you want to add to that? And, and re by the way, spread tightening, which we take advantage both in unrealized, but also realized, right? I mean, we're definitely, when we seeing securities now that we think are potentially maxed out, um, on, um, know we're close to it you know where the risk reward for us starts to shift um then you know we're actively selling when we think that's appropriate so yeah so a combination of realized unrealized driven by spread tightening is any any color you want to add to that jr mark yeah i'll just add one thing so you're following um because there's a progression of asset recovery kind of following
spk07: March and April of last year. And so agencies seem to come back most quickly and then different credit assets kind of fell and followed in order. And we've talked about certain sectors recovered faster than others, maybe non-agency and non-QM, whereas CLOs and CMBS may have lagged. And those last couple 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 and those sectors continue.
spk09: Okay, thank you. That's all for me. Thanks.
spk01: That was our final question for today. We thank you for participating in Ellington Financial's fourth quarter 2020 earnings conference call. You may disconnect your lines at this time and have a wonderful day.
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