Ellington Residential Mortgage REIT

NYSE:EARN

Earnings Call Transcript 2023-Q2

[Operator]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2023 Second Quarter Financial Results Conference Call. Today's call is being recorded. [Operator Instructions]

It is now my pleasure to turn the floor over to Alaael-Deen Shilleh, Associate General Counsel. Sir, you may begin.

[Alaael-Deen Shilleh, Associate General Counsel]

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 and 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. We strongly encourage you to review this information -- review information that we have filed with the SEC, including the earnings release, the Form 10-K and the Form 10-Q for more information regarding these forward-looking statements and any risks related risks and uncertainties.

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 Residential; Mark Tecotzky, our Co-Chief Investment Officer; and Chris Smernoff, our Chief Financial Officer.

As described in our earnings press release, our first -- our second quarter earnings conference call presentation is available on our website earnreit.com. Our comments this morning will track to the presentation. Please note that any references to figures in this presentation are qualified in their entirety by the notes in the back of the presentation.

With that, please turn to Slide 4 of the presentation, I will now turn the call over to Larry.

[Larry Penn, Chief Executive Officer]

Thanks, Alaael-Deen, and good morning, everyone. We appreciate your time and interest in Ellington Residential.

Following the first quarter turmoil in the regional banking system, the second quarter began with investors bracing for the impact of FDIC directed sales of MBS. The Federal Reserve was no longer buying MBS and demand even from healthy banks seemed unlikely. As a result, early April saw Agency MBS yield spreads widening even further. However, when the FDIC directed sales finally got started later in April, the wider yield spreads attracted strong investor interest for money managers and the sales ended up being well absorbed by the market. With support levels established, the month of May saw even stronger demand for MBS, even while interest rate volatility remained elevated. While this rally was temporarily interrupted by the debt ceiling dispute, once that was resolved, volatility declined and MBS yield spreads tightened further all the way into quarter end.

Accordingly, we experienced moderate portfolio losses in April, but these were reversed in May and June. On balance, Ellington Residential generated net income of $0.09 per share and adjusted distributable earnings of $0.17 per share for the second quarter.

Over the course of the quarter, we maintained a relatively stable overall portfolio composition in size. We continue to hold mostly discount specified pools, and we continue to believe in the value of our portfolio going forward. In recent quarters, we have highlighted how our research and asset selection efforts have focused on finding pools with the lowest payoffs that will get the fastest prepayments. Indeed, as you can see on Slide 4, prepayment rates on our portfolio increased nicely quarter-over-quarter from 4.3 CPR to 7.4 CPR.

If you now flip to Slide 8, you can see that we continue to be underweighted, low coupon MBS in the second quarter. Keep in mind that over half of the universe of conventional MBS pools have pass-through rates of 2.5% or less. This low coupon cohort comprised a big portion of the holdings of the failed regional banks. And so not surprisingly, this cohort severely underperformed in the first quarter due to the anticipation of FDIC asset sales. Since we've been underweighted in this cohort, our results benefited in the first quarter from that position. As I mentioned, the FDIC asset sales ended up being well absorbed by the market, which caused this cohort to outperform in the second quarter. So EARN did not benefit from that outperformance in the second quarter.

Nevertheless, we continue to strongly favor the middle of the coupon stack. Avoiding high coupons shields us from some of the technical pressures of new production, especially with the Fed no longer a buyer. This also reduces our negative convexity and this reduces our delta hedging costs in what have recently been very volatile periods. And with rates this low, we don't think the extra call protection compensates you enough for the lower yield spreads in the low coupons. By contrast, we continue to see both meaningfully higher yield spreads and better technicals in the middle of the coupon stack, namely MBS with pass-through rates between 3% and 5%.

Elsewhere, our non-Agency and IO portfolios again contributed nicely to our quarterly results, driven by net gains and strong net interest income. Although the total size of our overall non-Agency portfolio was roughly unchanged quarter-over-quarter, we did rotate some capital into credit risk transfer assets at some very wide spreads before the spread tightening in that sector in June and July.

The loans back in the 2019 and 2020 CRT issues that we bought recently had both significant home price appreciation and fast prepayment speeds until mid-last year, both of which have helped to substantially derisk these bonds. Additionally, these borrowers have locked in 30 years of very low fixed rate payments and now rate change are driving their debt-to-income ratios even lower. Combined this with the bond tendering programs this year by Fannie and Freddie, and you have a combination of great fundamentals and great technicals driving strong total returns. This is a good example of how the breadth of Ellington's platform, combined with the flexibility of EARN's mandate helps drive EARN's total return.

Moving to the liability side of the balance sheet, both our debt-to-equity and net mortgage assets to equity ratios were roughly unchanged quarter-over-quarter. I will note, however, that the second metric, which reflects our net mortgage exposure, did fluctuate a lot intraquarter. With markets choppy and spreads wider in May, we covered the majority of our net TBA short position. And then with the market rally in June, we put most of that net short TBA position back on. Similar to last quarter, we ended the second quarter still well below the high end of where we're comfortable adding leverage or net mortgage exposure.

Finally, we continue to turn over our lower-yielding MBS with the aim to improve our net interest margin and adjusted distributable earnings.

I'll now pass it over to Chris to review our financial results for the second quarter in more detail. Chris?

[Chris Smernoff, Chief Financial Officer]

Thank you, Larry, and good morning, everyone. Please turn back to Slide 5 for a summary of Ellington Residential's second quarter financial results.

For the quarter ended June 30, we reported net income of $0.09 per share and adjusted distributable earnings of $0.17 per share. These results compare to net income of $0.17 per share and ADE of $0.21 per share in the first quarter. ADE excludes the catch-up premium amortization adjustment, which was negative $376,000 in the second quarter as compared to a negative $299,000 in the prior quarter. As Larry mentioned, positive results in May and June exceeded net losses in April and Ellington Residential finished with positive net income overall for the second quarter as net gains on our interest rate hedges exceeded net losses on our Agency RMBS and negative net interest income, which was the result of sharply higher financing costs.

Our asset yields also increased during the quarter, but by a lesser amount than our borrowing rates. As a result, our net interest margin decreased to 0.93% from 1.16%. Additionally, we continue to benefit from positive carry on our interest rate swap hedges where we receive an overall higher floating rate and pay a lower fixed rate. Our lower NIM, combined with slightly lower average holdings on our Agency RMBS portfolio, drove the sequential decrease in ADE.

Meanwhile, pay-ups on our specified pools decreased to 0.98% at June 30 from 1.09% at March 31 for two reasons. First, average sales on our existing specified pools decreased quarter-over-quarter with higher interest rates; and second, the pools that we sold during the quarter had higher payoffs than the health population.

Please turn now to our balance sheet on Slide 6. Book value per share was $8.12 at June 30 as compared to $8.31 at March 31. Including the $0.24 per share in dividends in the quarter, our economic return was 60 basis points. We ended the quarter with cash and cash equivalents of $43.7 million which was up from $36.7 million at March 31.

Next, please turn to Slide 7 for a summary of our portfolio holdings. Our Agency RMBS holdings were essentially unchanged at $889 million at June 30th as net purchases were roughly offset by principal paydowns and net losses. Similarly, our aggregate holdings of non-Agency RMBS and interest-only securities decreased only slightly over the same period. Our Agency RMBS portfolio turnover was 19% for the quarter.

Our leverage ratios were roughly unchanged quarter-over-quarter. Our debt-to-equity ratio adjusted for unsettled purchases and sales was 7.6x as of June 30 as compared to 7.5x as of March 31, while our net mortgage assets to equity ratio was 7x as compared to 6.9x as of March 31.

Finally, on Slide 9, you can see the details of our interest rate hedging portfolio. During the quarter, we continued to hedge interest rate risk through the use of interest rate swaps and short positions in TBAs, U.S. Treasury securities and futures. We again ended the quarter with a net short TBA position.

I will now turn the presentation over to Mark.

[Mark Tecotzky, Co-Chief Investment Officer]

Thank you, Chris.

After a strong first quarter, EARN had a modest positive return for the second quarter and yet another period of significant volatility. And that volatility was across the board, not just in yields. Yields were on a rollercoaster ride during the quarter, with the high and low points for the two-year note, a jaw dropping 112 basis points apart. In addition, the slope of the yield curve oscillated drastically during the quarter with the spread between two-year and 10-year treasury trading in a 68 basis point range.

Market expectation is strong between fear that the wave of bank failures would force the Fed to be more accommodative and fears that inflation would be resistant to higher interest rates. Ultimately, by the end of June, inflation fears had worn out. The curve reinverted to levels seen just prior to the collapse of Silicon Valley Bank and interest rates rose, most dramatically for five-year notes and shorter maturities.

How MBS performed in the quarter depends a lot on what coupons you're talking about. Now with 90% of the FDIC MBS pool selling behind us, the MBS sector has weathered the supply wave and fared better than many had feared, and the supply was absorbed in a much shorter timeframe than originally anticipated. When demand materialized for $1 billion block of season discount MBS, the FDIC accelerated their pace of sales. The process is now largely over, well ahead of early expectations.

Money managers showed up in size for the opportunity to get invested in coupons and loan attributes that have been difficult to source. As a result, low coupon MBS performed quite well for the quarter after that early April spoon. For intermediate coupons between 3% and 5%, performance was not nearly as strong, relatively little of this intermediate coupon cohort was included in the FDIC sales. Concerns of a deeper yield curve inversion combined with less investor focus caused performance of the intermediate coupons to trail that of 2.5% and below.

On balance, EARN had a modest net gain for the quarter, constrained primarily by limited exposure to low coupons as well as delta hedging costs related to the elevated volatility. We did not make any major changes to our positioning and think we are well positioned for the current market opportunities and risks.

We believe that the current environment is very favorable for Agency MBS. Market expectations are that the Fed hiking cycle is largely behind us. We've gotten encouraging inflation data for a few months in a row now. Fears of an ongoing deluge of Agency MBS supply from waves of bank failures did not materialize, and we've now just passed the peak seasonal supply months of mortgage origination. Money managers have been big buyers of MBS this year and are no longer underweight MBS, but we think that some bank buying may materialize before year-end, given new capital requirements, which would be a further tailwind to the sector.

For EARN, as you can see on Slide 15, we did raise our weighted average coupon slightly in the quarter by about 15 basis points incrementally to nearly 4%, which is still well below new production. That positioning should shield us from the current coupon production with giant average loan sizes and lots of negative convexity, but still provide us with a hefty yield and potential for strong price appreciation if the forward curve is right and we have a recession.

Repo rates have stopped marching higher so as we turn over our portfolio and increase our asset yields that should support our NIM in ADE. In addition, our lower dollar price holdings continued to deliver consistent paydowns well above TBA expectations. Ellington has had ongoing data studies to analyze out-of-the-money prepayments as a function of loan attributes. There is currently a 22-point price range for liquid mortgage coupons spanning 2 through 6 NAVs and also a myriad of different issue years and loan attributes as well. So there is a really rich opportunity set now to take advantage of that research.

Mortgages remain at widespreads, the market has just absorbed almost all of the FDIC supply and peak summer origination volumes are now passed. So far, in the third quarter, realized volatility has remained high although the full trading range has been noticeably tighter than what we saw in the second quarter. At the same time, Agency MBS have substantially underperformed investment-grade corporates and high-yield bonds so we think they had ample room to catch up. And in the widely discussed scenario where we get a mild recession, we think Agency MBS will offer very good relative value versus corporates.

Now back to Larry.

[Larry Penn, Chief Executive Officer]

Thanks, Mark.

In what continues to be a highly volatile market, I am pleased with Ellington Residential's ability to preserve value -- preserve book value over the first half of the year and generate $0.26 in earnings per share. Looking ahead, our outlook for Agency MBS is positive as both nominal yield spreads and option-adjusted spreads are still wide. Realized volatility has declined and higher interest rates are helping to bring inflation down. The Fed may be nearing the end of its tightening cycle and FDIC sales have been well digested by the market with around 90% of pool positions and 60% of CMO positions already reported as having been liquidated. Longer term, the return of bank demand for MBS should help stabilize spreads as well.

As we look forward to the second half of the year, we have maintained excess liquidity and additional borrowing capacity to capitalize on attractive investment opportunities as they arise and to manage volatility if it spikes again. We will continue to be opportunistic about adding leverage, allocating capital between agency and credit and rotating the portfolio to drive NIM and ADE. As always, we will also rely on our dynamic hedging strategy and active management to protect book value.

With that, we'll now open the call to questions. Operator, please go ahead.

[Operator]

[Operator Instructions] And our first question comes from Doug Harter with Credit Suisse.

[Doug Harter, Credit Suisse]

Thanks. Hoping you could talk a little bit more about the potential to add more mortgage leverage, and what would kind of be the catalyst that would cause you to increase that leverage.

[Larry Penn, Chief Executive Officer]

Hey, Doug, thanks for the question. So, to me, I think the catalyst will be some kind of reduction in interest rate volatility, and you've seen it a little bit, right? So, yesterday was volatile, last Friday was volatile. We're not making as big a range. I mentioned this in my prepared remarks, like the difference in the highs and the lows in this quarter is a lot less than what it was in the second quarter, the second quarter was pretty extraordinary. But you're still seeing a lot of elevated volatility. So I think reduction of volatility is important because the delta hedging costs when things really move around can be significant. So that's one thing.

I think the other thing is to see other pools of capital come in and start supporting the mortgage market. So what you saw in the second quarter is money managers that had a lot of them have been sort of underweight mortgages relative to Bloomberg Agg or Barclays Agg allocation mix, bought a lot from the FDIC, and they covered their underweights, right? But you haven't seen bank participation yet, I mentioned again in the prepared remarks, we think that's something that you could materialize in Q4.

But I think that's important that you need to see other large pools of capital. I mean a lot of people recognize mortgage spreads are wide, but what you need to see is actually demand. And so you saw the money manager demand in Q2 that absorbed sort of simplicity, but like that absorbed to a large extent the selling from the FDIC portfolios, but you need to see other pools of capital who want to get invested in mortgages because you may see money managers sort of not nearly as aggressive in mortgage additions going forward, given that they're not nearly -- that do not underweight the sector as the way they had been.

[Doug Harter, Credit Suisse]

Got it. And how do you think about the demand by coupon depending on kind of where that -- those other pools of capital come from? How do you think about which coupons are most likely to be interested in?

[Mark Tecotzky, Co-Chief Investment Officer]

So it's an interesting question, right, because I think historically, bank buying was typically around current coupon. I think now, though, with contemplated changes in capital charges, more scrutiny on interest rate risk. You might see them have a preference towards shorter duration mortgages than they historically have. But you haven't -- it's just really too early to say. But in my mind, just other investors, whether it be insurance companies or banks, coming and taking advantage of not only the very widespread of mortgage versus treasuries, but the widespreads on mortgages versus corporates, that I think I want to see a little bit of that for -- we would increase the exposure.

We kept the exposure relatively constant through the quarter. We still have room to grow it. It's a little bit -- if you look at sort of the mortgage exposure we've had over a long period of time, over five years, it's a little bit higher than what we've normally run. But mortgages are wide, but there's a lot of interest rate volatility. And you need to see, I think, other large pools of capital, be it foreign investors, insurance companies, banks or money managers continue to deploy. And you've seen -- you've definitely seen a slowdown of on the part of money managers, right? They covered a lot of their underweights in Q2. And they've been less sort of just all-in bonds than they were.

[Operator]

Our next question comes from Mikhail Goberman with JMP Securities.

[Mikhail Goberman, JMP Securities]

Just kind of a capital management question. How are you guys thinking about the trade-off of issuing a little more stock at the margin going forward as you see investment opportunities versus the use of share buybacks with the stock, I guess, sort of in the upper 80s of book value currently?

[Larry Penn, Chief Executive Officer]

I think we're sort of consistent with what we've done before. I think once we get into the around 80%, hopefully, we won't get there. But if we do, I think that's where we have historically repurchased. And -- so I think that's a good expectation, barring anything unforeseen. And then in terms of issuance, I think we're trying to keep our capital base pretty stable. Obviously, there's issues in terms of G&A expenses as if we get below, let's say, $100 million or something like that. So I think you'll continue to see some moderate issuance just to sort of keep our capital base roughly the same. And yes, so I hope that's helpful.

[Mikhail Goberman, JMP Securities]

Yes. And what kind of opportunities are you seeing at the margin in the non-Agency portfolio? I know it's very small, but you always mentioned you could always add a little bit at the margin. So just wondering what you're seeing there.

[Larry Penn, Chief Executive Officer]

Mark?

[Mark Tecotzky, Co-Chief Investment Officer]

Yes. So we've liked CRT. We mentioned that in prepared remarks. That's a sector that we weren't buying in 2019, in 2020, we didn't really like it. What's happened to that market is you've had a huge amount of home price appreciation. So you have extremely low LTVs. Like some of these deals are LTVs in the 50 now. And the other thing you've had is the deals that were in existence during 2020 and 2021 and the beginning of '22, went through periods of time of fast prepayments. So that deleverages the structure. So it sort of builds up on a current basis, the amount of credit enhancement below these tranches.

That's important to us because we see sometimes the biggest risk in some of these sectors isn't a home price decline and high defaults like what you saw in '08, but it can be more weather-related events or sort of idiosyncratic, things like that. So building up that cushion, credit enhancement sort of, for us, sort of raises the credit enhancement levels above sort of the noise you can get from some of the weather-related stress.

So we'd like CRT. That sector has performed well in the second quarter, so spreads have come in. We've also historically liked some legacy in agency. That sector over time isn't as liquid as it used to be as it's paid down. So sort of our return threshold of that relative to CRT has changed a little bit as CRT remains very liquid.

Those have been the two primary things, but you could also see us add some mortgage 2.0. Volumes in that sector are lower than what they've been, but you do get opportunities from time to time very wide spreads, and that would be mostly investment-grade securities.

[Operator]

And our next question comes from Crispin Love with Piper Sandler.

[Crispin Love, Piper Sandler]

Mark, your comments a little bit earlier in the Q&A may seem like on spreads made it seem like they will stay stable kind of wide as they are right now, just given the need for more demand. So I'm just curious how you're thinking about the near term. And for EARN, if you would have a preference for tighter spreads or a preference for stability in spreads and just what those scenarios can mean for EARN?

[Mark Tecotzky, Co-Chief Investment Officer]

That's a great question. So right now, spreads are so wide and you make a lot of money on your shorts like all the SOFR swaps, you're paying a rate that is significantly lower than the rate you receive, right? So as opposed to 2020, 2021, wherever hedge you had, cost you money, right? You're paying a lot more than what you're receiving. This is the exact opposite, right? So spreads are wide enough now that if you just see stability, you've got -- you can put together a very strong quarter.

In terms of widening or tightening, what would I rather see I think when you get tightening, what you get is sort of short-term book value gains that come a little bit at the expense of longer-term ADE. But I guess, probably my preference is a little bit towards tighter spreads because I think that would come with the market where it would probably imply to me that you've seen some reduced volatility. You have the market expectation that the Fed is going to sort of not do very much for the next few meetings, probably came to fruition. And you've seen enough demand for mortgages to offset just new origination supply or sort of demand kind of exceed that to drive them tighter.

So I think I'd like to see that because you went through 2022, which was a really challenging year. And this year, it's sort of been ups and downs, but there's been a lot of volatility. So, I think the sector as a whole benefits from stability. And I think that would be a nice thing to deliver to investors to sort of like not only ADE, but also some book value gains.

[Larry Penn, Chief Executive Officer]

I would just add. So yes, I think less interest rate volatility certainly would be better given how we're positioned. But I think spread fluctuation is a positive for us, because we do have dry powder from a -- in terms of our net mortgage exposure and our leverage and as we said in the prepared remarks, we took advantage of that in the second quarter, covering a lot of our TBA shorts when spreads were wider and then we're putting them back on. So I think a fluctuating spread market is actually a good market for us, in particular, since we do dial up and down our exposure with aggressively sometimes.

[Crispin Love, Piper Sandler]

That's all helpful color. And then in the prepared remarks, I wanted to make sure I caught this right, but you made some comments that made it seem like banks could come back and be buyers of Agency MBS, I think, a little earlier than some expected. So can you just flush that out a little bit? And is this demand that you might expect later in the year or early 2024? Just curious what you think there. And if I heard you right.

[Mark Tecotzky, Co-Chief Investment Officer]

Yes. So I think if you go back prior to 2022, you had two giant pools of capital that were really sort of the cornerstones for anchoring mortgage spreads with the Fed obviously and banks, right? You had so much COVID-related stimulus. You had this explosion deposit growth on the banks. And a bit like mortgages, they bought a lot of mortgages. It was a time where they're paying almost nothing on their deposit costs. So they grew the mortgage portfolios a lot.

But even before that, even if you go back to, like, say, the '90s or the '80s, right, banks have been big, big buyers of the mortgage market, and they own a lot of it, right? Then you go through 2022, you have -- they all have tremendous losses on their portfolio. A lot of those bank portfolios -- you saw sort of Silicon Valley was an outlier, but other banks had a little bit of the same issue, but to a lesser extent, lots of Fannie 2s, lots of Fannie 2.5s. These are sectors that went down 18, 20 points in price far more than a lot of these banks thought could happen, they had big losses on available for sale, held-to-maturity portfolios. And now they're sort of underwater with their deposit cost versus the book yield on those assets, right? So it's been challenging for them.

And so some of them were doing relative little securities investments last year, and we're doing a lot more on the loan side to reduce mark-to-market volatility in their portfolios. Now in response to Silicon Valley Bank, you're seeing a new regime sort of like a bank regulation talking about different capital charges, especially different capital charges for banks to $100 billion to $250 billion in size. Different ways of thinking about CECL. So what loan loss reserves you're going to have to have on loans, referencing FICO.

And so it's all those things in aggregate, sort of, I think tilt the attractiveness from banks a little bit away from loans and back more towards securities. I think the issue so far this year is that there's just been -- the first and foremost concern has been about deposit stability because if you're not concerned about -- you don't believe you have a stable deposit base, then you don't want to buy anything, right? And so they bought very little.

I think that -- I think as Silicon Valley and Signature Bank, as those takeovers get further and further in the rearview mirror and you have some deposit stability even at a higher cost, you're going to start to see some banks that will say -- look at the investment landscape, want to make investments. And I think when they look at that investment landscape, they're going to find MBS as attractive relative to treasuries, may be attractive relative to parts of the commercial mortgage market. And so I think you can see the ones that are sort of in the best position to take advantage of that.

[Crispin Love, Piper Sandler]

Great. That makes sense. And then just one last quick one for me. Could you give any update or book value third quarter to date?

[Larry Penn, Chief Executive Officer]

No, we don't.

[Operator]

And our next question comes from Eric Hagen with BTIG.

[Eric Hagen, BTIG]

One follow-up on the spread environment, just the portfolio. I mean how do you -- do you have an idea for how much prepays could pick up in the portfolio if mortgage rates sort of rally from here to kind of different levels of rallying? And is there a realistic upper bound do you think you think about for the portfolio even in like a bigger rally for rates?

[Larry Penn, Chief Executive Officer]

Well, yes, I think there's -- obviously, there could be a lot of numbers to go over. I think we can -- happy to take that off-line, but -- and sort of go through maybe each coupon. The non-banks are such a big portion, especially as refi activity starts to pick up of production that I mean and loan balances are higher. I mean there's a lot -- if rates rally a lot, I think you could see some very, very fast prints, but I think it probably makes sense to maybe talk about that offline, sort of go through the market generic coupons and we can tell you kind of what we think.

[Eric Hagen, BTIG]

Sure. I mean I'm not trying to get too exact, just maybe more how you think about it in kind of just the sensitivity in the portfolio, just maybe at a high level...

[Larry Penn, Chief Executive Officer]

Well, right. So we've got good call protection for 100 basis point rally for sure, if you look at our portfolio, more than that, then obviously, then you start -- our pool start turning more negatively convex. But as Mark said, we kind of like the combination of the call protection that the intermediate coupons provide and the extra yield versus the low coupons. So we've got some -- we've got good call protection. Mark, anything you want to add to that?

[Mark Tecotzky, Co-Chief Investment Officer]

Yes. I guess what I would say is -- so we've believed in sort of this lock-in effect that borrowers that have 2.75%, 3% and 3.25% mortgage rates, that mortgage -- the value of that mortgage that mortgage that might be mark-to-market up 20 points is a significant deterrent to people moving. And that's been borne out, right? You look at existing home sales are generational lows. There's been some more like academic papers talking about the impact it has in the mobility of the workforce. So, we've kind of believed that the IOs have benefited from that. And then sort of within that broad brush, then you look for sort of okay, the market, like that's not new news. So the market kind of expects that. And then where can you look for incremental speeds above and beyond market expectations and discounts. So we sort of talked about that in the prepared remarks.

Now I think what's interesting is that whatever the statistic is, 99% of the mortgage market is out of the money now. And if mortgage rates drop 50 basis points, 97% is out of the money. So it takes a big move to get things in the money. But I think what is interesting is that the question is how much the mortgage rate need to drop to get people to up their turnover, if they're a little bit out of the money. So if someone is 300 basis points out of the money right off the bat, that's a real deterrent. But I suppose they're 200 basis points out of the money, and they've been delaying a move for two or three years, then it's not as much as a deterrent.

So I think it's -- when we talk to a lot of the non-bank originators, initially, they were saying we're just -- they all with little bit different numbers, but I think initially sort of what the conversation was, we think 5% mortgage rates is the breakpoint. If you get to 5% mortgage rates, then that's you can start talking about, hey, you're not at the 2021 lows, but you're not nearly to 2022 highs, and they think it 5%, I guess, to do borrower service or whatever, they start to see more demand, more people willing to go up at 3% and go into a 5% if they want to move or get an extra bed and whatever. But now when you talk to them, that was maybe like 8 months ago. Now when you talk to them, they're saying, "Well, we think you get to a 5.5% mortgage rate." That's enough to get people to move.

So I think you've had a bunch of people staying in a house that they'd rather sort of sell and buy something else. There's one thing you kind of tough it out for six months. Now people have toughed it out for a year and six months. And so I think that, that rate it takes to get people to sort of have a little bit higher turnover, I think that rate differential between the current -- their existing mortgage rate and the current rate, I think that widens over time as people get a little bit more antsy.

And the other thing you see is that like it's no secret, housing is very unaffordable now relative to historical measures if you just look at like median income versus monthly mortgage payments if you buy a medium-priced home. But it's getting a little bit better, not so much from -- I mean, there's three ways to get it better, right? You can have mortgage rates drop, you can have home prices drop or you can have wage gains, right? And so you've seen a little bit with wage gains. So compare housing now to the peak of 2022, you've had a little bit of an annual decline, and you probably had 4% wage gains. So kind of that alone low as DTI.

So I think over time, if you see wage gains continue, then things are a little bit more affordable for people. It's another motivation to move. So I think it's a function of time, and it's a function of rate, I don't think we're there now. But six months from now, if mortgage rates come down a little bit according to the forward curve, you might start to see a little bit of that more discretionary moving going on.

[Eric Hagen, BTIG]

Yes. Really amazing context there. Lots of changes on balance sheets for banks like you guys talked about their capacity for lending and supplying repo financing more specifically to the street. How are you thinking about like to scale for a mortgage REIT and its access to the repo market, which has historically been supported by banks? And do you feel like there's enough stable financing supported by the kind of non-bank repo lenders out there?

[Mark Tecotzky, Co-Chief Investment Officer]

So I guess for us, and obviously, not the biggest borrowers in the space, right, it's been stable, but it's been banks and non-banks. We have not seen banks pulling back at all, right? And so we've seen a consistent mix between bank and non-bank and rates have been consistent relative to SOFR. So I think there's lots of capacity. I don't think that is the limitation right now for anyone. Definitely not.

[Operator]

And our next question comes from Matthew Erdner with JonesTrading.

[Matthew Erdner, JonesTrading]

I just got a quick one for you. You mentioned you took TBAs off and then put them back on. Could you just explain your thoughts around that, and how you're thinking about TBAs going forward?

[Mark Tecotzky, Co-Chief Investment Officer]

I guess, we've always had, I think, one thing we've done maybe differently than some of the peer group, if we have liked the use of being short TBAs, we've liked that positioning of long pools, short TBAs in certain coupons. There are a lot of benefits to that. You sort of control your negative convexity that way. We think sometimes there's very good relative value doing that, especially in times when mortgage spreads are relatively tight. And so we will use dialing up and dialing down that TBA shorts as an expression of our view on how attractive the mortgage basis is. So despite all the benefits of TBA shorts, I just mentioned, when TBAs get to levels that we think are very wide, and we think they're much more likely to tighten than widen, then we'll reduce that exposure and just live with the slightly higher delta hedging costs that come with it.

[Operator]

And that was our final question for today. We thank you for participating in the Ellington Residential Mortgage REIT second quarter 2023 earnings conference call. You may disconnect your line at this time, and have a wonderful day.