Ellington Financial Inc. Common Stock

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2022 Second Quarter Financial Results Conference Call. Today's call is being recorded. At this time, all participants have been placed on a listen-only mode. 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 second 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 second 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. To begin, please turn to slide three. The Federal Reserve's aggressive response to high inflation continued to drive markets in the second quarter. The Fed twice increased its target rate for the federal funds rate, including a 75 basis point hike in June. That was its largest since 1994. And it also finally initiated the runoff of its Treasury and MBS balance sheet. Meanwhile, geopolitical unrest and fears of a recession also weighed heavily on markets. Interest rates continued to surge in the second quarter, and implied interest rate volatility spiked to levels not seen since the onset of the COVID liquidity crisis in early 2020, and before that, not seen since the global financial crisis in 2009. Liquidity dried up, yield spreads widened, and prices fell across most fixed income sectors, including agency RMVs. On this slide 3, you can see just how much interest rates moved, particularly at the very front end of the yield curve, as the market reacted to an increasingly hawkish Fed. The 2-year and 10-year Treasury yields were each up over 60 basis points during the quarter. Short-term benchmark rates, such as LIBOR and SOFR, were up over twice that amount. The yield curve flattened, with some parts inverting. As you can see on this slide, the 5- to 10-year segment of the Treasury yield curve was inverted at June 30th. And fast-forwarding to today, the two-year yield is now around 40 basis points higher than the 10-year. This slide also shows what's happened with agency MVS yield spreads and prices. LIBOR OAS on Fannie 2.5s, for example, widened by nearly 50 basis points over the first six months of the year. Combine that spread widening with the move higher in rates, and you can see that Fannie 2.5s dropped more than 12 points from year end to June 30th, from 102 and change all the way down below 90. As usual, mortgage rates surged in sympathy with agency MBS yields. The Freddie Mac 30-year survey rate ended the first half of the year at 5.7%, an increase of about 260 basis points since year end, and its highest level since 2008. And this recent sharp increase in mortgage rates suddenly eliminated the refinancing incentive for most borrowers. With mortgage rates much higher, housing affordability has been absolutely pummeled. and that's now impacting home sale volumes. So with low housing turnover and dramatically higher mortgage rates, it's no surprise that prepayments have ground to a halt in the past few months. As a result, extension risk became the primary focus in the MBS market during the second quarter, as Mark will elaborate on later. Please turn to slide four. For Ellington Residential, our specified pool portfolio is currently concentrated in what were recently considered current coupons, but of course with the jump in rates, these are now discount coupons. During the second quarter, losses on our specified pool portfolio exceeded net gains on interest rate hedges and net carry, and this was the primary driver of our overall net loss of 82 cents per share. Our interest rate hedging strategy, which included aggressive duration rebalancing throughout the quarter and a positive contribution from our short TBA positions, helped prevent further losses. Next, you'll see that we're reporting $0.28 per share of adjusted distributable earnings, or ADE for short. We previously referred to this non-GAAP metric as core earnings. Our ADE was down $0.02 quarter over quarter, but it was still above our dividend run rate. The wider MBS yield spreads have clearly been a drag on book value, but on the positive side, they've also been a tailwind for ADE. Our net interest margin, or NIM, held up relatively well during the quarter, despite the rising cost of funds. That said, we are seeing a few headwinds to ADE in the near term. First, with the sharp uptick in short-term rates, our liabilities are repricing higher very quickly. Of course, asset yields available in the market have also increased, but that only gets captured into our NIM as we rotate our portfolio. So, as a result, our NIM is compressing in the short term. Now, we could accelerate our portfolio turnover to achieve a higher portfolio asset yield more quickly, but we happen to still strongly favor the relative value of many of the lower coupon pools that we've been holding. We're essentially waiting for the right exit point to turn over much of our portfolio. And by doing so, we're choosing to protect and enhance book value per share as opposed to maximizing our ADE in the short term. By the way, this all underscores the limitations of focusing too much on ADE, which is a backward-looking measure, in market environments with large swings in interest rates and spreads such as we're seeing today. But I have to emphasize that once we complete the portfolio rotation, we project that our ADE will again comfortably cover our dividend. As always, the relative liquidity and smaller size for a portfolio should be an advantage in repositioning it. I'll now pass the call over to Chris to review our financial results for the second quarter in more detail.