Ellington Financial Inc

NYSE:EFC

Earnings Call Transcript 2023-Q2

[Operator]

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial Second Quarter 2023 Earnings Conference Call. Today's call is being recorded. At this time all participants have been placed in listen-only mode and the floor will be opened for your following the presentation. [Operator Instructions]

It is now my pleasure to turn the call over to Tara Byrne [ph]. You may begin.

[Unidentified Company Representative]

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 Part 1, Item 1A of our annual report on Form 10-K and Part 2, Item 1A of our quarterly report on Form 10-Q for the quarter ended March 31, 2023. 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 Tecotzky, Co-Chief Investment Officer of EFC; and JR Herlihy, Chief Financial Officer of EFC. As described in our earnings press release, our second 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 the presentation are qualified in their entirety by the end notes at the backs of the presentation.

With that, I will now turn the call over to Larry.

[Larry Penn, Chief Executive Officer]

Thank you, Tara, and good morning, everyone. As always, thank you for your time and interest in Ellington Financial. I'll begin on Slide 3 of the presentation. For the second quarter, we reported net income of $0.04 per share and adjusted distributable earnings of $0.38 per share. Steady performance from our non-QM, residential transition loan and commercial mortgage bridge loan portfolios, combined with notably strong performance from our credit risk transfer investments, offset net losses elsewhere in the portfolio, and Ellington Financial generated a modestly positive economic return overall.

You can see on Slide 3 that the Credit strategy was the primary driver of our quarterly results, contributing $0.40 per share of net income, while Agency generated $0.06 per share on a relatively small capital allocation, and Longbridge contributed a positive $0.04 per share, even as wider HECM yield spreads compressed gain on sale margins and weighed on results. The lower margins at Longbridge were also the primary driver of the sequential decline in EFC's overall adjusted distributable earnings. HECM margins recovered somewhat in July, however. And notably, shortly after quarter end, Longbridge was able to acquire a reverse mortgage servicing portfolio out of a bankruptcy proceeding at a distressed price, which we expect will be immediately accretive to EFC's earnings and adjusted attributable earnings going forward.

The net interest margins for both Credit and Agency also ticked up sequentially as higher book asset yields due to portfolio rotation exceeded higher borrowing costs. Higher NIMs should, of course, be supportive of ADE going forward as well. Also during the second quarter, we signed definitive agreements for strategic acquisitions of two public mortgage REITs: Arlington Asset Investment Corp and Great Ajax Corp. Each of these transactions will add assets that complement and further diversify Ellington Financial's existing investment strategies, aligned with our expertise and offer other strategic advantages.

With Arlington, we pick up a portfolio of low coupon mortgage servicing rights at scale. These MSRs benefit in a rising interest rate environment, and so they provide an earnings profile that should function as a natural hedge to many of Ellington Financial's existing investments. And with Great Ajax, we substantially grow our RPL/NPL strategy by adding a portfolio of over $1 billion of first lien residential loans, also at scale and with limited credit risk by virtue of their low LTVs. This RPL/NPL portfolio includes both loans owned directly on balance sheet and loans financed via securitizations.

These transactions also provide other important benefits to Ellington Financial. With Arlington, we will assume more than $100 million of term non-mark-to-market unsecured debt and perpetual preferred stock, both with attractive cost of capital. And with Great Ajax, we will acquire a strategic equity investment in Gregory Funding LLC; Great Ajax's highly respected affiliated mortgage loan servicer, which could unlock multiple synergies and operating efficiencies across Ellington Financial's existing investment portfolio. In addition to these benefits, the acquisition should provide additional capital, both upfront and over time, to deploy into Ellington Financial's existing investment strategies at the highly-attractive yield spreads available in the market. You can find additional information about these transactions in the Presentations section of the Ellington Financial website.

Moving back to Ellington Financial's portfolio. We took several other steps during the quarter that should position us to drive earnings while continuing to navigate market volatility. With Agency yield spreads still wide on a historical basis, we grew that portfolio by 8% in the second quarter after shrinking it significantly in prior quarters. We also took advantage of an attractive entry point to add credit risk transfer investments early in the quarter before the spread tightening in that sector in June and July, and continue to expand our portfolio of high-yielding residential transition loans and proprietary reverse mortgage loans.

Similar to the prior three quarters, the size of our commercial bridge loan portfolio again declined in the second quarter as payoffs and principal paydowns significantly exceeded new originations. In addition, loans on multifamily continued to represent the majority of our commercial bridge portfolio. In non-QM, the bid from whole loan buyers, particularly insurance companies, continues to be relatively strong. As a result, we were able, this past quarter, to get good execution on one of our non-QM pools via an outright whole loan sale, and we now regularly consider whole loan sales as an alternative to securitization.

Similarly, our originator affiliates, LendSure and American Heritage, have recently been selling more of their production to third-party whole loan buyers. Not surprisingly, given how high mortgage rates have been, new originations in the non-QM sector continue to be very low compared to last year. As a result, our non-QM home loan portfolio remains relatively small, finishing the quarter at $446 million, which is a more than 40% year-over-year decline. Of course, other segments of our loan portfolio, especially residential transition loans, have taken up the slack. And if spreads widen and our securitization spreads continue to tighten; our non-QM portfolio should have plenty of room to regrow.

Our loan portfolios continue to benefit from the short duration and strong overall credit performance. We continue to dynamically adjust our interest rate and credit hedges, and this past quarter, that also included establishing new hedges related to those pending public and REIT acquisitions. In fact, it was the addition of interest rate hedges related to those pending acquisitions that explains why our interest rate sensitivity table, which you'll find on Slide 14 of the presentation, all of a sudden shows a modest negative duration. Meanwhile, and as usual, we have maintained high levels of liquidity and additional borrowing capacity. We ended the quarter with a recourse debt-to-equity ratio of 2.1:1, which is still towards the lower end of our historical levels.

As you can see back on Slide 3, our cash and unencumbered asset levels reflect that we have substantial dry powder to invest. In particular, our commercial mortgage loan portfolio is as small as it's been in a while, and with the distress that we and others expect to hit the commercial real estate sector, I wouldn't be surprised if we ultimately deploy a lot of that dry powder in non-performing commercial mortgage loans. Finally, we look forward to closing the Arlington and Great Ajax acquisitions later this year, which will add meaningfully to our capital base.

With that, I'll turn it over to JR to discuss our second quarter financial results in more detail.

[JR Herlihy, Chief Financial Officer]

Thanks, Larry, and good morning, everyone. For the second quarter, we reported net income of $0.04 per share on a fully mark-to-market basis and adjusted distributable earnings of $0.38 per share. These results compared to net income of $0.58 per share and ADE of $0.45 per share for the prior quarter. On Slide 5, you can see the attribution of earnings between Credit, Agency and Longbridge. The Credit strategy generated $0.40 per share of net income driven by net interest income on our loan portfolios, net gains on our CRT portfolio and net gains on our interest rate hedges. A portion of these gains were offset by negative results in our investments in unconsolidated entities, including net losses on equity investments in loan originators and commercial mortgage loan-related entities, as well as net realized and unrealized losses on our consumer loans and credit hedges.

Finally, although we have seen uptick in delinquencies in these portfolios year-to-date, our residential and commercial mortgage loan portfolios continue to experience low levels of credit losses and strong overall credit performance. In fact, several classes of our non-QM securitizations were upgraded by Fitch in May. According to Bank of America research from June, among the 17 issuers with five or more deals outstanding, our EFMT non-QM shelf is tied for the lowest reported 30-plus day delinquencies. Since 2017, we've done 14 EFMT securitizations and currently have 11 deals outstanding, encompassing approximately 5,800 loans and $2.5 billion of UPB. And remarkably, despite the large size of that portfolio, those deals have experienced no cumulative losses like to date.

Meanwhile, our Agency portfolio generated net income of $0.06 per share for the second quarter. The quarter began with elevated interest rate volatility and widening Agency MBS yield spreads as the market prepared for sales by the FDIC of MBS from failed regional banks. Later in the quarter, with the FDIC sales well absorbed and with the debt ceiling dispute resolved, volatility declines and Agency MBS yield spreads tightened. Accordingly, we experienced moderate losses in April, but these were reversed in May and June. And on balance, we had positive net income for the quarter in the Agency strategy.

Finally, Longbridge contributed $0.04 per share of net income in the quarter. Longbridge's positive results were driven by net gains related to the resolutions of HECM buyout loans, net gains on proprietary reverse mortgage loans and net gains on interest rate hedges. These gains were partially offset by net losses on the HMBS MSR equivalent, which was driven by the combination of higher interest rates and wider yield spreads in the HECM market during the quarter, and a net loss in originations as reduced gain on sale margins on HECM loans more than offset an increase in overall origination volumes. EFC's net income for the second quarter also reflected expenses related to the Arlington and Great Ajax transactions, as well as net losses driven by higher interest rates on the interest rate swaps we use to hedge our preferred equity and unsecured long-term debt.

On Slide 6, you can see a breakout of the ADE among the investment portfolio, Longbridge and corporate overhead. Next, please flip to Slide 7. In the second quarter, our total long credit portfolio increased by 1% sequentially to $2.45 billion as of June 30th. The slight increase was driven by moderately larger non-QM and RTL loan portfolios quarter-over-quarter and by net purchases of CRT investments, which occurred primarily in May. A portion of the increase was offset by a smaller commercial bridge loan portfolio, where loan paydowns significantly exceeded new originations. For the RTL, commercial bridge and consumer loan portfolios in total, we received principal paydowns of $349 million during the second quarter, which represented 22% of the combined fair value of those portfolios coming into the quarter.

On the next slide, Slide 8, you can see that our total long Agency RMBS portfolio increased by 8% quarter-over-quarter to $918 million as we opportunistically added specified pools during the quarter. On Slide 9, you can see that our Longbridge portfolio decreased by 3% to $430 million as of June 30. The decrease was driven primarily by the success Longbridge had during the quarter resolving HECM buyout loans, most of which were acquired – which – most of which were acquired in the transaction that closed in March. This decline was partially offset by originations of proprietary reverse mortgage loans. In the second quarter, Longbridge originated $297 million across HECM and prop, which was up 27% quarter-over-quarter. The share of originations through Longbridge's wholesale and correspondent channels increased incrementally to 79% from 77%, while retail declined to 21% from 23%.

Next, please turn to Slide 10 for a summary of our borrowings. The top of this slide now shows the costs related to our recourse borrowings only. On our recourse borrowings, the weighted average borrowing rate increased by 29 basis points to 6.67% as of June 30th, driven by the increase in short-term interest rates. Book asset yields for both our Credit and Agency strategies also increased during the quarter, thanks to portfolio turnover, and we continue to benefit from positive carry on our interest rate swap hedges, where we overall receive a higher floating rate and pay a lower fixed rate. As a result, net interest margins in both our Credit and Agency strategies expanded sequentially.

Our recourse debt-to-equity ratio adjusted for unsettled purchases and sales remained low at 2.1:1 as of June 30th compared to 2:1 as of March 31st. Our overall debt-to-equity ratio, again, adjusted for unsettled purchases and sales, increased incrementally to 9.2:1 as of June 30th as compared to 8.9:1 as of March 31st. Finally, at June 30th, our combined cash and unencumbered assets totaled approximately $538 million, and our book value per common share was $14.70, down from $15.10 in the prior quarter. Including the $0.45 per share of common dividends that we declared during the quarter, our total economic return was 30 basis points for the second quarter.

Now over to Mark.

[Mark Tecotzky, Co-Chief Investment Officer]

Thanks, JR. EFC had a slightly positive return in a very volatile quarter. There was volatility in both the absolute level of rates as the five-year note moved on an 86 basis point range and in the slope of the yield curve, as the slope of the two-year versus 10-year moved in a 65 basis point range. That is a huge range and reflects the market as living between fear of more bank failures and fear of persistent inflation. Credit spreads also saw a lot of volatility with the on-the-run investment-grade index moving in the 17 basis point range.

While it wasn’t a memorable quarter for returns, we were busy at Ellington Financial with two announced public mREIT acquisitions and some new opportunities materializing that can help to drive future returns. Despite growing market consensus that the Federal Reserve is either at or very near the end of its tightening cycle, the heightened levels of interest rate volatility that characterized the market in 2022 have persisted in 2023, including into the third quarter. Larry mentioned that we kept our interest rate hedging discipline across all portfolios, and I think that is very important to preserve book value.

As you can see from Slide 7, the credit portfolio was remarkably stable in size. Most categories did not move much, although we did opportunistically add CRT at some very wide spreads, by late last year, we identified some specific sectors within CRT as potentially offering above-market returns. The 2020 and 2021 vintage Fannie Freddie production that backed these bonds have had both tremendous HPA as well as very fast prepayment speeds until mid last year, both of which have helped to substantially derisk the bonds.

Additionally, unlike floating rate borrowers that are being strained by increasing debt service costs, these borrowers have locked in 30 years of very low fixed rate payments and now, wage gains are driving their debt-to-income ratios even lower. Combine this with a large GSE bond tendering program this year, and you have a combination of great fundamentals and great technicals, which has driven strong total returns. This is a good example of the breadth of Ellington’s investment expertise and the flexibility of our mandate helping to drive EFC’s total return.

On Slide 8, you can see the larger agency portfolio as discussed.

And on Slide 9, you can see that through Longbridge, we added private label reverse, which we view as an exciting and growing part of the reverse mortgage market.

On Slide 19, you can see that our credit hedges grew substantially in the quarter. We added protection as index spreads tightened both for those pending public acquisitions and as a spread hedge for non-QM agency. In terms of portfolio performance in the quarter, our RTL portfolio continues to chug along, generating substantial net interest income.

One area of focus for us is working through our second quarter 2022 vintage loans, which were originated at the top of the housing market. Some of these loans have extended their maturity because it has taken longer for the borrower to sell the property than they expected. But we ultimately expect credit performance to be strong for these loans, given the LTVs that we underwrote to. For newer vintages, including loans originated in Q4 2022 and Q1 2023, we are seeing strong, albeit still early performance. Despite affordability challenges, home prices stabilized earlier this year and have been hedging higher. Meanwhile, our commercial bridge loan portfolio continued to pay down, and we’re starting to see some more interesting opportunities in that sector.

A lot has been written about the pullback of regional banks from lending, and the recent Fed Commissioned SLOOS report confirms that’s happening in real time. This is all great for Ellington Financial. We’re seeing some high-quality deals come to us that historically would have gone to regional banks. Also, the substantial cash flow stress in part of the commercial mortgage market is presenting us with more distressed NPL opportunities. Those are exactly the kind of investments that were the bread and butter of our commercial mortgage strategy that started over a decade ago.

Sheridan Capital, our commercial mortgage loan originator and servicing partner, has been a great relationship for us so far and I expect them to be highly strategic for EFC going forward. Not only are they generating operating profits now, but their expertise in construction, renovation and property management further broadens EFC’s own capabilities and expands the net in terms of what types of opportunities we can pursue.

Our portfolio of non-QM loans retained tranches also performed well in the quarter. As Larry mentioned, that sector has attracted strong demand from insurance companies, which has helped solidify spreads, both for whole loan sales and securitizations. Loan sales and securitizations are now both viable and profitable exit strategies and provide some healthy competition for each other. That’s true for both EFC portfolio loans as well as production from our originator affiliates. For EFC, our non-QM portfolio has shrunk substantially since the second half of last year when prices were quite depressed. Now, with securitization spreads tighter and liquidity improved, we see a substantial opportunity to grow the portfolio again moving forward.

Our non-Agency RMBS portfolio also had a strong quarter, led by CRT. We tend to increase allocation to non-Agency RMBS when securities [indiscernible] loans, and we have seen this dynamic a few times in the past nine months. We constantly think about the relative value merits of loans versus securities, and pivoting some incremental capital between these two sectors is a great way to add excess return.

For our loan originator affiliates, it looks like the worst may be behind us. Loan prices are creeping up, and while the volume is still well below 2021 levels, it has been stable, in some cases, growing.

In Agency MBS, we are modestly profitable for the quarter. There were some moments of very wide spreads in the quarter, which we used to grow that portfolio. It’s almost unimaginable how the opportunity set in that space has been recharged. Fannie 6s closed in July at a lower price than where Fannie 2s traded just two years earlier. The forward curve is telling us that the Fed is probably nearing the end of its tightening cycle so some of the tailwinds probably taken out of the market, but rate volatility is yet to subside.

Looking ahead, many sectors in our portfolio have very high unlevered asset yields, including RTL, commercial mortgage bridge and non-QM loans, which gives strong support to our ADE and our dividend. These yields are a tailwind to be sure, but there are headwinds too. Origination volumes are low and competition in many asset classes, especially from insurance companies, is fierce. We have a lot of work ahead to complete the Arlington and Great Ajax acquisitions, but when we do, the incremental capital and strategic investments should only enhance our ability to take advantage of a broad range of investment strategies.

Now back to Larry.

[Larry Penn, Chief Executive Officer]

Thanks Mark. I am pleased with Ellington Financial’s performance so far this year in what continues to be a fluid market. Despite the interest rate volatility, our regional banking crisis and a difficult origination environment, EFC generated an annualized economic return of 7.4% through the first six months of 2023. I think we’re in a good position to grow adjusted distributable earnings going forward with wider net interest margins, both in Credit and in Agency, and at Longbridge as well, with improving HECM gain on sale margins and that recent distressed MSR purchase. And as Mark highlighted, we’re benefiting from reduced competition from banks in our lending businesses, which could be another catalyst for strong, long-term risk-adjusted returns.

Of course, the pending acquisitions of Arlington and Great Ajax represent important milestones for Ellington Financial. Each of these transactions will add strategic assets that complement and further diversify Ellington Financial’s existing investment strategies and align with our expertise. And by significantly increasing our scale and bringing us a substantial additional group of shareholders, these transactions should enhance liquidity of our common stock, while lowering our operating expense ratios to boot. We project that each of these transactions will be accretive to our earnings within the coming year. We expect to close both these transactions before the end of 2023, at which time EFC’s equity base should exceed $1.7 billion. That would be around double our equity base at the end of 2019, right before COVID, no less.

It is clearly a time of consolidation in the mortgage REIT space, and Ellington Financial’s strong balance sheet and track record of steady returns have enabled us to be an attractive partner in these two transactions. When you consider the accretive impact to earnings that we are expecting from these M&A transactions, the benefits of increased scale and the dry powder we have available for the attractive opportunity set in front of us, it is definitely an exciting time for Ellington Financial.

Finally, I’d like to close by addressing existing Arlington and Great Ajax shareholders. We hope you agree that these pending transactions should be highly attractive and accretive for you as well. We look forward to introducing ourselves and our company to you, and we sincerely hope that your ownership continues.

With that, we’ll now open the call up to questions. Operator?

[Operator]

[Operator Instructions] Our first question comes from Bose George with KBW. Please go ahead.

[Bose George, KBW]

Hey everyone, good morning.

[Larry Penn, Chief Executive Officer]

Good morning.

[Bose George, KBW]

Trying to figure out the impact of the pending acquisition. So there was, I guess, it was like that $3.6 million of expenses related to the acquisition. And how much was the financial impact of the hedges that were in place ahead of the deal closing?

[Larry Penn, Chief Executive Officer]

Sorry, you mean that the deals haven’t closed? You mean had at quarter end, I guess, maybe?

[Bose George, KBW]

Yes. I think the comment that you made that you had some interest rate hedging on, I guess, in anticipation of the deal’s closing. Is that right that these hedges…

[Larry Penn, Chief Executive Officer]

Yes. That’s right.

[Bose George, KBW]

So just curious what the impact was there a financial impact related to that that was also running through earnings this quarter?

[Larry Penn, Chief Executive Officer]

Yes. For Q2, the impact of those hedges were not material, were very small. And you got the $3.6 million, and the $3.6 million is the right number of expenses that we put through related to the transactions in the second quarter.

[Bose George, KBW]

Okay. And then for the second half of the year or just before the deal – until the deal closes, is there much in terms of transaction expenses? Or is this kind of the bulk of it?

[Larry Penn, Chief Executive Officer]

There are. The banker fees are success based, right? So that’s right. And then otherwise, the expenses are taken as incurred, so we still have more legal work to do between now and then. So, it’s – I think those are the big – the primary components.

[Bose George, KBW]

Okay. And then just on the MSR, the distressed reverse MSR you acquired, how much capital did that entail?

[Larry Penn, Chief Executive Officer]

Negligible.

[Bose George, KBW]

It was pretty small. Okay. And then just one on excess capital. How would you characterize your sort of your dry powder? And are you keeping some excess also ahead of the acquisitions?

[Larry Penn, Chief Executive Officer]

Sure. So we had cash of $195 million, which is about 15% of our NAV. So we keep 10% to 15% typically, other encumbered assets of $340 million and leverage on agency was about 6x. So, between those two categories, we could probably add. In 2022, we were a range of 2.3 times to 2.7 times recourse debt to equity. In 2019, we are 2.6 times to 2.9 times. 2019 granted a larger allocation of capital to agency. But from our 2.1 times today, we could, I think, pretty comfortably get into the 2 times, 2.5 times area just based on what’s unencumbered and additional borrowing capacity on assets that are finance.

[Bose George, KBW]

Okay, great. Thank you.

[Larry Penn, Chief Executive Officer]

Thank you.

[Mark Tecotzky, Co-Chief Investment Officer]

Thanks.

[Operator]

Thank you. We’ll take our next question from Crispin Love with Piper Sandler.

[Crispin Love, Piper Sandler]

Thanks. I appreciate you taking my questions. In the release and on the call, you mentioned credit strength and low levels of losses but a pickup in delinquencies. I’m just curious if you could expand on that a little bit? What levels of delinquencies are you seeing? And are they primarily in the commercial portfolios and RTL? Or are there any other areas worth calling out?

[Larry Penn, Chief Executive Officer]

Sure. So it’s really the RTL and commercial bridge where we’re seeing upticks. And I don’t know, Mark, if you want to speak qualitative to those? I mean there’s still, I think, small in the scheme of things and certainly, the credit losses are small. The Q tomorrow will flush out those precise numbers.

But I don’t know, Mark, if you want to talk about the trends especially that we’re seeing in RTL, which I think you got into a bit in your prepared remarks? And maybe expand on that theme?

[Mark Tecotzky, Co-Chief Investment Officer]

Yes. Hi, Crispin. So, I mentioned in my comments that the second quarter of 2022 for most areas represented the peak in home prices, and then they sort of drifted lower second half of last year. And now they’ve been gradually increasing, I believe, last three or four months, the most recent three or four months of this year. So what happens is the construction partners that we lend money to that bought homes in the second quarter of 2022, when they went to put the property – sell the properties, it was taking them a little bit longer to sell the properties than we have historically seen. So we have a model informed by historical data that looks at a lot of good features, how complex renovation is and geography and all that stuff. And we could see the second quarter 2022; the houses were on the market for a little bit longer. It also took them a little bit longer to finish their renovation.

So we’re working through that. It’s been a focus. Everything is going pretty well, and what you see now is home prices have sort of stabilized, now started to tick back up a little bit. That trend – we don’t see that trend anymore. So now, sort of the fourth quarter of 2022 and the first quarter of 2023, those resolutions are coming at sort of exactly the rate that we would have predicted.

I don’t think it’s really going to be a performance issue. I just think it’s going to be a little bit of a time line extension. And there are extension fees, and so there is sort of economics that accrue to a company when loans do extend. But I just wanted to mention it because – it was a trend that we have been focusing on for the last few months and something we’ve been working through.

[Crispin Love, Piper Sandler]

Thank Mark and JR; I appreciate all the color there. And just one last one from me. Mark, can you talk a little bit the distressed NPL opportunities you are seeing in the market? It sounds like you’ve begun to see some opportunities, so curious if you’ve bought any yet? And are there – what were the key areas in CRE where you expect the majority of these NPL opportunities over the next several quarters?

[Mark Tecotzky, Co-Chief Investment Officer]

So, yes. No, that’s a great question. They are coming in two flavors, right? So, the first flavor is you are seeing in the CMBS market, so commercial mortgage-backed securities, not loans. You are seeing in CMBS tranches that had been previously investment grade and came to market [indiscernible] investment grade and traded relatively tight spreads, so inside 150, 170 to the curve where they were priced when those markets came to market. Some of those prices now are down substantially, so sub-$50 price. Some of them are single asset, single borrower deals, some of them are more just conduit deals where the amount of delinquency is high relative to the enhancement levels, so the market is pricing in a recovery less than par. And I'd say in the past month or so, we've seen a pickup in that, so that's exciting for us.

Now the other area is going to be just delinquent mortgage loans, and that used to be pretty much the main thing we did in our commercial strategy going back 2010, 2011, then it – that opportunity dried up. There was a great opportunity in bridge origination, we pivoted. But now, we're seeing that opportunity. We think it's going to come back on non-performing commercial loans, and there's obviously been – some of these bank takeover by the FTC is going to add some volume. But away from that, we've seen some opportunities where you're buying loans at substantial discounts to par, right? By that, I would characterize below $0.75 on the dollar. And it's really more of a real estate play as opposed to just you're putting out capital to earn your coupon, right? And so that is early stages.

Look, we mentioned that SLOOS, that Senior Loan Officer Opinion Survey, right, that banks are probably going to be – depending on the size, is probably going to be in an environment where they're going to have more – they're going to have more capital requirements. They're probably going to have more regulatory scrutiny upon some of the commercial activities and delinquent loans. And so we think that there are going to be loans that come to maturity where the new loan is going to have to be smaller in size than the old loan, and that's sort of the catalyst for opportunity. Either a bank might want to sell loan at a discount or you're going to need a partner to come and inject some capital.

So it's early stages, but we think that that's going to be a big, persistent opportunity. And it's an opportunity set that requires a very specific set of expertise on a part of a manager, and we're – we have – we have a lot of resources that have a lot of experience in that area. We've done a bunch of it. And so I think that we are excited that that's going to be a place that we can deploy a lot of capital and have – and deploy in an area where we can have very high expected returns.

[Crispin Love, Piper Sandler]

Thanks. I appreciate the answers.

[Operator]

Thank you. We'll take our next question from Doug Harter with Credit Suisse.

[Doug Harter, Credit Suisse]

Thanks. Can you talk about how you're balancing diversification and the benefits of that across all the opportunities versus kind of the ability to have scale and kind of be larger in any of those opportunities?

[Mark Tecotzky, Co-Chief Investment Officer]

[Indiscernible] that I don't know. Sorry.

[Larry Penn, Chief Executive Officer]

No, you go ahead, Mark.

[Mark Tecotzky, Co-Chief Investment Officer]

Yes. Sure. I was just going to say, so it's a very interesting question. There are certain sectors that you have substantially better economics if you have scale. So I think non-QM is a great example, right? If you are – and we went through this back in 2017; when our origination volumes were $30 million a month from our origination partners, it was taking a year to ramp to a deal. So that means you've got to have loans on REPO for a year and you're hedging them for a year, and securitization market can change a lot. And so now, we have much greater volume, we can ramp to deal size much quicker. You have better economics on your transactions. We kind of have a virtuous cycle of being a repeat issuer that we get sort of tighter spreads than sort of new originators. So scale, no question there, its super helpful.

And EFC has got to have enough capital and these acquisitions are going to help us with that. We've got to have enough capital to have scale in all the major businesses, right? So [indiscernible] scale matters. I think in RTL, it matters, too. You've got to be a meaningful takeout for your partners. You got to have meaningful loan balances to get the best levels from your REPO counterparties. Commercial bridge, same thing, we have a lot of repeat customers. People that have borrowed from us in the past had a good experience, they come back. You need to have capital to be available when some of your partners have another property they want to buy and you are like-minded with them on the value proposition.

I don't – I think we have enough, right? I think we have enough. I'm excited. Larry mentioned it, but 1 thing with Arlington is we're getting into servicing, right? And servicing has been an interesting sector. It's a sector where our core competence in understanding prepayments is a function of interest rates and loan attributes. It's going to matter a lot in being able to value and hedge those investments appropriately. And so with Arlington, we're getting scale in that sector, and that's another sector where you need to have scale to be meaningful.

So I think like you hadn't seen this venture to something like that a couple of years ago, and maybe part of the reason was just it was hard to get to scale. Do you have enough capital? So that having the bigger capital base is going to be really important because it lets you be scaled at a range of things to help you diversify. And the servicing is potentially a huge diversification, because that's a negative duration asset. Pretty much everything else we have is kind of floating rate, so zero duration or positive duration assets. So that can really help. Servicing is an [indiscernible] play, and now with distress in the agency market and non-agency market; we have a lot of discount security. So it's a good question. It's something we think about, and I think we have enough scale for all the things that are most of interest to us right now.

[Larry Penn, Chief Executive Officer]

And I would just add, thanks Mark. I would just add that diversification for a long time for Ellington Financial has been really important. I mean there's – we recognize that a lot of our peers are more focused in particular sectors, right, in the mortgage REIT space. I mean, you have, obviously, commercial versus residential. You've got agency versus non-agency, securities versus loans, but it's really important to us that we can rotate and be affirmative in terms of how we allocate capital to where we see the best opportunities at each point in time.

Now to do that obviously, you need to have dry powder, you need to be able to take advantage of liquidity in our portfolio and have sometimes a trading mentality. I think we have all those things. But when you think about how opportunities go in and out and dangers go in and out of all these different sectors, it's been really important to us to be able to kind of dial up and down as we've been doing with non-QM, and as we've been doing recently with our commercial mortgage bridge where we're – we've been letting that portfolio run down a bit and then because we see the opportunity in the horizon coming.

And again, it all helps the fact that we've got a short duration portfolio that's spitting out a lot of cash often in terms of – in the form of principal repayments. That can help us maintain that dry pattern and can help us allocate capital differently in relatively short periods of time compared to what other companies can do. So I think that's been really important to our success, and I think it's going to continue to be really important going forward.

[Douglas Harter]

I appreciate that answer.

And then just you guys have been focused on kind of shorter-duration assets. Any change to that? Kind of given where returns are today, would you be willing to kind of take more longer-duration assets? Or do you still like that shorter-duration asset?

[Larry Penn, Chief Executive Officer]

Well, I mean, I think if you look at – it's interesting, right? There's some longer-duration assets like non-QM, that's not a short duration asset. And reverse mortgage loans are not a short-duration assets, but they're securitizable and now we've been talking about whole loan sales, I think there are some very interesting opportunities to get good profits and realize those profits in different ways.

So yes, but in general, I think we intend or inclined to keep duration short, especially seeing how there are opportunities that are pretty visible now that could be coming around the corner like in commercial mortgage bridge, in distress. And distressed opportunities in the reverse mortgage space that Longbridge has been able to take advantage of starting at the end of last year, when – and beginning of this year when it acquired some of those buyout loans that look like are going to be very profitable. And that distressed acquisition of mortgage servicing rights that we happened in early July that we think we'll see more opportunities there as well. So it's a sector that's – where there's not a lot of competition, as I'm sure you know.

[Douglas Harter]

Great. Appreciate it. Thank you.

[Operator]

Thank you. We'll take our next question from Mikhail Goberman with JMP Securities.

[Mikhail Goberman, JMP Securities]

Hey guys. Good morning. Most of my questions have already been answered. If I could just squeeze in one more; if you guys are seeing any M&A-type opportunities outside of the REIT space at the moment? Or are you kind of taking a step back and digesting the two that you've just completed? Thanks.

[Larry Penn, Chief Executive Officer]

Right. Well, we're not looking at any controlling interest. We are – we always have our antenna out there and are pursuing with various levels of intensity, taking stakes – modest stakes, usually in smaller originators. So we still have some, I wouldn't even call it necessarily deals in the pipeline there, but certainly deals that we're exploring, but nothing tremendously material at this point, and nothing that would be controlling at this point.

[Mikhail Goberman, JMP Securities]

All right. Thanks guys. Good luck, best of luck going forward.

[Larry Penn, Chief Executive Officer]

Thank you, too.

[Operator]

Thank you. We'll take our next question from Eric Hagen with BTIG.

[Eric Hagen, BTIG]

Thanks. How are you guys. Looking at the – following up on the MSR here. I'm just curious how big you guys think you can get in that strategy? How much capital you can devote there? We've seen other companies run the paired MSR and MBS strategy, just wondering how you might run that strategy any differently than the stocks do now? Have you guys even managed that strategy historically at Ellington? Given more broadly and any performance results you can share from being an MSR investor in the past? Thank you.

[Larry Penn, Chief Executive Officer]

Sure. So – okay, so let's take that one at a time. So in terms of whether we've acquired MSRs in the past, I think – let's not talk about Longbridge for now. When we acquired that that was obviously acquiring as well an MSR business. But the answer is no. This is the first time that – when we closed the Arlington transaction, that will be the first time that we have such an interest in mortgage servicing rights – residential mortgage servicing rights of any substantial size. But as Mark mentioned, this is right up our alley in terms of the prepayment characteristics, which are, of course, the main driver of returns in that. And we'll work with third-party master servicers probably to start with, and I think that could grow pretty, pretty big. The portfolio that we're acquiring is kind of a – it's at scale, and one nice thing in that market is that you can bolt on small-sized packages at a lot of times much lower prices. Sometimes the bigger packages trade at higher prices than the smaller packages.

But yes, so I think we do plan to have a little bit of a roll-up strategy there, certainly in the beginning. But I see no reason. As long as, frankly, financing is there, continues to be there at attractive levels to be able to finance the MSRs, that's going to be key. But the yields that they're trading at given the risk profile and given the financing costs that are available currently, make it an attractive strategy. It's not a trading strategy, right? So I think, just consistent with what I was saying before, it's not going to be, I don't think a huge part of our portfolio anytime soon. But it's something that I think continues to – that we'll continue to add to and diversify returns and can achieve well into mid-teens returns, or not higher on a leverage basis.

[Mark Tecotzky, Co-Chief Investment Officer]

Yes. I just want to add one thing. I think how we're going to think about it relative to our peer group. We're probably going to take more of a relative value view. So like, I don't exactly replicate servicing. There's late fees and recapture and float. But like they are kissing cousins, right? So I think we'll be more focused on relative value. If the IO market gets cheap to servicing, you'll see us put capital there. If servicing gets cheap to IO, then the pendulum swings towards servicing. So I think that's one thing we'll do that others don't do.

What's interesting about the opportunity set now is just the way our – the way we think about prepayment and the way a lot of our models work is we tend to believe in technology and efficiencies that can make prepayments very fast on larger loans when they get in the money, right? So if you look at like buying servicing in 2021, right? You were buying new production stuff, larger loans, a lot of non-bank, Rocket, UWM, efficient servicers and so we kind of saw S-Curve on those kind of loans that can get very fast into getting the money, and that turned out to be the case, right?

What you have now, though, you have a giant pool of loans that are well over 200 basis points out of money. So it's more of a turnover play. It's more of a seasonal play and I think that we just see a little bit relative – better relative value in that market. So does that makes it more interesting now than maybe a few years ago?

And also, two, just the banks have pulled back. They're not nearly as big a force in Fannie, Freddie origination as they used to be. And those were the banks. It was Wells Fargo, it was JPMorgan, it was Bank of America that from time to time had really lofty servicing valuations because they had cross-selling and all those other stuff. Now is it's kind of a non-bank world in the agency space, valuations have come down. I think it's a good sector for us now. So it's sort of like – it's been this evolution in who's originating mortgages. It's this rate move that you have a big pool of way out of the money stuff, which we like. And just things lined up, and through Arlington we're able to get to scale pretty quickly.

[Eric Hagen, BTIG]

Yes. That's really helpful commentary. Thank you guys.

[Larry Penn, Chief Executive Officer]

Thank you.

[Operator]

Thank you. That was our final question for today. We thank you for participating in the Ellington Financial 2023 Earnings Conference Call. You may disconnect your line at this time, and have a wonderful day.