Ellington Financial Inc

NYSE:EFC

Earnings Call Analysis

Ellington Financial's Strong Q2 Performance

Ellington Financial achieved robust Q2 results with a 4.5% economic return and GAAP net income of $0.62 per share. Adjusted distributable earnings rose by $0.05 to $0.33 per share. The company capitalized on tight AAA yield spreads for non-QM loans, boosting origination and sale margins. Longbridge’s contributions were significant, driven by higher origination volumes and securitizations. The book value per share increased, and cash and unencumbered assets rose to $764 million. The quarter saw a reduction in leverage ratios and plans for further asset growth amid wider yield spreads.

Strong Financial Performance Drives Confidence

In the second quarter of 2024, Ellington Financial demonstrated solid financial results, reporting GAAP net income of $0.62 per share and adjusted distributable earnings (ADE) of $0.33 per share, a $0.05 increase from the prior quarter. This strong performance is attributed to broad-based contributions from their diversified credit and agency portfolios as well as their reverse mortgage platform, Longbridge. The company achieved an economic return of 4.5% non-annualized, growing its book value per share to $13.92, reflecting an upward trend and stability amid challenging market conditions.

Diverse Revenue Streams from Strategic Investments

Ellington Financial's success was largely driven by their credit strategy, which generated $0.80 per share in GAAP net income. This was powered by impressive net interest income and net gains from non-QM loans, as well as growth from their equity investments in affiliates like LendSure and American Heritage Lending. Moreover, Longbridge contributed positively, reflecting strong performance in proprietary reverse mortgage loans despite some compression in gain on sale margins caused by wider yield spreads.

Targeted Securitization and Portfolio Management

The company strategically completed its first non-QM securitization in 14 months, capitalizing on favorable market conditions. This initiative allowed them to enhance their portfolio with high-yielding investments while effectively managing risks through timely asset sales. The second quarter also saw a 2.5% decrease in their total loan credit portfolio, now totaling $2.73 billion, attributed to successful securitizations and net sales of lower-yielding assets, aligning with their strategic focus on higher-quality, higher-yield investments.

Operational Efficiency and Risk Management

Ellington Financial's vertically integrated platform has shown remarkable operational efficiency. By collaborating closely with their loan originators, they are utilizing data-driven insights to monitor credit quality and manage loan performance. This proactive approach is reflected in the overall improvement in delinquency percentages in their commercial mortgages, where delinquency rates ticked down. Additionally, they maintained a strong leverage ratio of 1.6:1, providing ample room for growth and indicating healthy capital management practices.

Future Outlook: Confidence Amid Market Volatility

Looking ahead, Ellington Financial expects continued growth in its ADE, particularly within its non-QM and reverse mortgage lending segments. The recent periods of market volatility also present new opportunities, with management expressing optimism about the potential for increased loan origination volumes. They have approximately $764 million in combined cash and unencumbered assets to drive future investment decisions, allowing flexibility in capital deployment as market conditions evolve.

Earnings Call Transcript 2024-Q2

[Operator]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Ellington Financial Second Quarter 2024 Earnings Conference Call. Today's call is being recorded. [Operator Instructions]



I'd now like to turn the call over to Alaael-Deen Shilleh.

[Alaael-Deen Shilleh, executive]

Before we start, I would like to remind everyone that certain statements made during this conference call may constitute forward-looking statements within the meaning of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.



Forward-looking statements are not historical in nature. As described under Item 1A of our annual report on Form 10-K and Part 2 Item 1A on our quarterly report on Form 10-Q, forward-looking statements are subject to a variety of risks and uncertainties that could cause the company's actual results to differ from its beliefs, expectations, estimates, and projections.



Consequently, you should not rely on these forward-looking statements as predictions of future events. 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, EFC; and JR Herlihy, Chief Financial Officer, 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 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.

[Laurence Penn, executive]

Thanks, Alaael-Deen, 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.



In the second quarter, broad-based contributions from our diversified Credit and Agency portfolios as well as from our reverse mortgage platform, Longbridge, drove strong results for Ellington Financial. For the quarter, we generated an economic return of 4.5% non-annualized. We grew our book value per share after paying dividends, and we increased adjusted distributable earnings per share by a full $0.05 to $0.33 per share, and we see momentum for our ADE to keep increasing from here. I am very pleased with these results.



I'll first highlight the strong performance of our non-QM loan business in the quarter. In April, we completed our first non-QM securitization in 14 months, taking advantage of the tightest AAA yield spreads we've seen in 2 years and booking a significant gain as a result. In the months leading up to that April deal, we've been taking advantage of strong whole loan bids in the marketplace by selling many of our non-QM loans rather than securitizing them.



While the whole loan bid for non-QM loans remain very strong, we saw AAA securitization spreads tightened back to early 2022 levels. And so in April, we decided to securitize some of our non-QM loans rather than selling. That securitization transaction not only provided attractive economics, but it also provided us with high-yielding residual retained tranches to boot.



Following that April securitization, we proceeded to sell other non-QM loans into that strong whole loan bid. As you can imagine, given the recent risk [indiscernible] move in the financial markets, all this activity turned out to be extremely well-timed.



In addition, the continued strong demand for non-QM loans drove improved origination volumes and gain on sale margins industry-wide, which generated excellent results at our affiliate non-QM loan originators, LendSure and American Heritage Lending and less on mark-to-market gains on our equity investments in those affiliates.



Meanwhile, Longbridge also contributed robust earnings for the quarter, led by both strong origination volumes and strong performance of proprietary reverse mortgage loans. Similar to the boost in industry non-QM volumes, HECM origination volumes were also up significantly for the quarter, including for Longbridge. But unlike non-QM, we saw wider yield spreads in the HMBS securitization markets.



As a result, gain on sale margins for Longbridge's HECM business actually compressed in the quarter, which mostly offset the benefit of their higher origination volumes. Finally, following quarter end, but prior to the recent market volatility, we successfully completed our second securitization of proprietary reverse mortgage loans originated by Longbridge, achieving incrementally stronger execution than our inaugural deal that we executed in the first quarter.



This securitization converted another slug of short-term repo financing into long-term locked-in non-mark-to-market financing. Again, given the risk-off move we've seen in August, this was another well-timed transaction. That transaction also provided us with high-yielding residual retained tranches.



On last quarter's earnings call, we predicted a second quarter turnaround at Longbridge, and Longbridge did a great job and delivered both on a GAAP basis and ADE basis. Longbridge is an important part of that ADE momentum I mentioned earlier.



Also in the second quarter, Ellington Financial's results benefited significantly from the very solid performance of our residential transition and commercial mortgage loan strategies as well as non-Agency RMBS.



Both for the second quarter and continuing into the third, we have added attractive high-yielding investments over a wide array of our credit strategies, especially HELOCs and closed-end seconds, prop reverse, commercial mortgage loans, residential RPL/NPL, CMBS, and CLOs.



The growth of the commercial mortgage portfolio has included both new originations as well as the purchase of 2 additional nonperforming commercial mortgage loans. At the same time, we have continued to call securities in lower-yielding sectors, including agency and non-agency RMBS. Since we generally utilize higher amounts of leverage in our MBS portfolios, especially our Agency MBS portfolio, these MBS sales, coupled with the non-QM securitization, drove down our leverage ratios overall in the second quarter despite the increased capital deployment in our credit strategies.



Moving forward, we have plenty of cash and borrowing capacity to drive portfolio and earnings growth with significant unencumbered assets plus other lightly leveraged assets. That d[ rive pattern ] is particularly valuable given recent spread widening.



And with that, I'll turn the call over to JR to discuss the second quarter financial results in more detail.

[JR Herlihy, executive]

Thanks, Larry, and good morning, everyone. For the second quarter, we are reporting GAAP net income of $0.62 per share on a fully mark-to-market basis. and adjusted distributable earnings of $0.33 per share. On slide 5, you can see the attribution of net income between Credit, Agency, and Longbridge.



The credit strategy generated a robust $0.80 per share of GAAP net income in the quarter driven by strong net interest income and net gains from non-QM loans, retained non-QM RMBS, non-Agency RMBS, and commercial mortgage loans. We also benefited from mark-to-market gains on our equity investments in LendSure and American Heritage Lending, which reflected strong performance from increased origination volumes and strong gain on sale margins for those originators.



Similar to the prior quarter, we received another sizable cash dividend from LendSure in the second quarter. In addition, with interest rates slightly higher quarter-over-quarter, we had net gains on our interest rate hedges. Offsetting a portion of all these gains was a modest net loss in residential RPL/NPL.



Meanwhile, the Longbridge segment generated GAAP net income of $0.05 per share for the second quarter, driven by net interest income and net gains on proprietary reverse mortgage loans, along with positive results from servicing. In HECM originations, higher volumes were mostly offset by a decline in gain on sale margins driven by wider yield spreads on newly originated HMBS.



In servicing, tighter yield spreads on more seasoned HMBS led to improved execution on tail securitizations, which contributed to the positive results from servicing. Notably, Longbridge also contributed $0.06 per share to our ADE in contrast to its negative $0.01 per share contribution last quarter.



Finally, in what was a down quarter for the agency mortgage basis overall, our agency strategy nevertheless generated positive net income of $0.01 per share for the second quarter as net gains on our interest rate hedges along with net interest income, slightly exceeded net losses on Agency MBS.



Our results for the quarter also reflect a net gain driven by the increase in interest rates on our senior notes. This gain was partially offset by a net loss also driven by the increase in interest rates on the fixed receiver interest rate swaps that we used to hedge the fixed payments on both our unsecured long-term debt and our preferred equity.



Turning to slide 6. You can see the breakout of ADE by segment. Here's where you can see that solid $0.06 per share contribution from Longbridge, which drove the overall increase in EFC's ADE, which rose $0.05 per share sequentially to $0.33. Turning next to loan performance. In our residential mortgage loan portfolio, after excluding the impacts of our purchase of one nonperforming loan portfolio and our consolidation of another nonperforming loan portfolio, the percentage of delinquent loans increased only slightly quarter-over-quarter. Meanwhile, in our commercial mortgage loan portfolio, including loans accounted for as equity method investments, the delinquency percentage also ticked down sequentially.



We also had a significant mark-to-market gain on one of our nonperforming commercial mortgage loans based on progress on the resolution process. That said, we continue to work through those 2 nonperforming multifamily bridge loans that we referenced last quarter. While not meaningfully higher quarter-over-quarter, loans in nonaccrual status and REO expenses continue to weigh on the ADE in the second quarter.



Next, please turn to slide 7. In the second quarter, our total loan credit portfolio decreased by 2.5% to $2.73 billion as of June 30. The decline was driven by the cumulative impact of the non-QM securitization completed during the second quarter and net sales of Non-Agency RMBS, retained non-QM RMBS, and non-QM loans, which more than offset net purchases of commercial mortgage bridge loans, HELOCs, closed-end second lien loans, residential RPL/NPL, CMBS, and CLOs.



For our RPL, commercial mortgage, and consumer loan portfolios, we received total principal paydowns of $381 million during the second quarter, which represented 21% of the combined fair value of those portfolios coming into the quarter as those short-duration portfolios continued to return capital steadily. That steady stream of principal payments should provide lots of dry powder to take advantage of opportunities, especially if we are entering a risk-off environment.



On slide 8, you can see that our total long Agency RMBS portfolio declined by another 31% in the quarter to $458 million. We continue to shrink the size of that portfolio and rotate the capital into higher-yielding opportunities.



Slide 9 illustrates that our Longbridge portfolio increased by 18% sequentially to $521 million, driven primarily by proprietary reverse mortgage loan originations. In the second quarter, Longbridge originated $305 million across HECM and prop, which was a nearly 50% increase from the previous quarter.



As Larry mentioned, shortly after quarter end in July, we completed our second securitization of prop reverse loans from Longbridge, which locked in term non-mark-to-market financing at an attractive cost of funds.



Please turn next to slide 10 for a summary of our borrowings. On our recourse borrowings, the total weighted average borrowing rate increased by 11 basis points to 6.98% at June 30. 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.



The net interest margin on our credit portfolio declined modestly quarter-over-quarter while the NIM on agency assets increased. Our recourse debt-to-equity ratio decreased to 1.6:1 at June 30, down from 1.8:1 as of March 31, driven by the non-QM securitization in April and a decline in borrowings on our smaller but more highly levered Agency RMBS portfolio.



Our overall debt-to-equity ratio ticked down as well to 8.2:1 from 8.3:1. At June 30, our combined cash and unencumbered assets totaled approximately $764 million, up from $732 million at March 31. Our book value per common share was $13.92 at the quarter end, up nicely from 139 at March 31. And our total economic return was 4.5% nonannualized for the second quarter.



Now over to Mark.

[Mark Tecotzky, executive]

Thanks, JR. This is a very solid quarter for EFC. Not only did we have a strong economic return, which drove book value higher per share, but we also had a sequential improvement in our ADE, which I expect to continue. Our earnings this quarter showed the value of EFC's vertically integrated platform.



It's been a challenging couple of years for the mortgage origination business with mortgage rates so high, housing affordability is so bad, and existing home sales so low. But LendSure and American Heritage Lending have persevered and have both posted solid earnings in Q2, driven by a higher gain on sale margins and increased origination volumes, which led to an increased valuation for our equity stakes in them.



Longbridge also contributed strongly to the ADE this quarter, driven by profits in their proprietary reverse business. But at EFC, we don't just own the originators. We also buy their loans, collaborate with them on credit decisions, maximize proceeds via securitizations when the arb is attractive, and retain what we expect to be high-yielding assets from those securitizations for our portfolio. All that helped this quarter, the power of vertical integration was on full display for us.



We did another securitization of Longbridge's Prop reverse mortgages in July, and we expect Longbridge's loan origination volumes as well as their securitization volume to continue to grow in that sector. In the second quarter, we also completed a non-term securitization and opportunistically sold more of those loans as well.



Credit spreads were relatively tight in Q2, so we took some gains in a few different parts of the portfolio. Now we are well positioned for some wider spread opportunities that we are seeing this week with the recent volatility. We had another strong quarter from our commercial mortgage platform as well. Our affiliate originator servicer, Sheridan Capital, has a like-minded approach to commercial mortgage credit risk.



They have been fantastic at not only sourcing opportunities but also working with our EFC commercial team to help manage our few delinquent loans. Sheridan Capital has deep property management expertise to closely monitor construction progress, CapEx expenditures, and renovation quality control. This expands EFC's capabilities to manage nonperforming loans in REO when necessary to maximize proceeds.



While Q2 was a quarter of tight spreads and strong demand for structured products, this past week should serve as a reminder that market consensus can change on a dime, often leading to violent repricings in a matter of days.



Look at Slide 19. We've kept many of our credit hedges in place. In Q2, they provided insurance we didn't end up meeting, but they are once again showing their value in August. Hedges provide multiple benefits to us. We use them to minimize the risk of spread widening for upcoming securitizations. We use them to stabilize our NAV in times of volatility, and we use them to potentially help offset some of the impact of increasing corporate and consumer stress if the economy weakens.



We've been adding to our portfolio of high-quality closed-end seconds and HELOCs and even picked up an attractive pool late last week amid the sell-off. As opposed to our nonterm loan portfolio, where we lend to borrowers who aren't served by the GSEs, these second lien HELOC generally are offered to borrowers with low note rate Fannie, Freddie, Ginnie Mae loans and provide a way for high-quality, low LTV borrowers to extract equity from their homes when having a low note rate, first lien, which makes a cash-out refi inefficient.



We think this is a large and exciting opportunity for us, and we have invested the time and resources to build out prepayment and credit models and have developed our sourcing capabilities. With their higher note rates, this sector adds a lot of ADE for Ellington Financial.



As to the rate and spread volatility in the past week, while I wouldn't be surprised if it led to mark-to-market losses in some parts of the portfolio, we also see this volatility as recharging the opportunity set with wider spreads and some price dislocations to capitalize on. Furthermore, if the lower interest rates we're seeing, if they stick, should lead to increased loan origination volumes in both non-QM and at Longbridge.



Given that all these platforms have excess lending capacity, greater volume should be supportive of bottom-line economics. EFC is in a good position to add assets here, and we're really excited about the current opportunity.



Now back to Larry.

[Laurence Penn, executive]

Thanks, Mark. I was very pleased with our performance in the second quarter, where we saw strong results across our credit portfolios and took advantage of tight spreads to monetize gains. In particular, it's great to see the strength in our non-QM and reverse mortgage loan platforms, which drove the sequential growth in our book value per share and ADE.



At Longbridge, we have more work to do to grow origination volumes further, but the positive developments in the proper versus securitization markets and a strong July in originations should bode well to Longbridge going forward. Lower long-term interest rates could also provide a big boost to Longbridge's origination business. Since the size of the loans that borrowers are able to take out generally increases as long-term interest rates decline.



It is loan size, more than loan interest rate that is the key driver of origination volumes in the reverse mortgage market, both for purchases and for refinancing. Meanwhile, both during calmer times and more volatile times, we continue to rebalance our portfolio and direct capital to where we see the best opportunities.



So far in the third quarter, we've added scale in non-QM, RTL, Crop Reverse, Commercial Mortgage Bridge, and closed-end second and HELOCs, growing each of those portfolios meaningfully. At this point, we are still trimming in some lower-yielding sectors, but I expect the pace of that trimming to slow going forward.



We are also working on adding to our financing lines, specifically for our forward MSR portfolio, and I see that getting done around the end of Q3. As we've been detailing today, our investment pipeline across our diversified proprietary loan origination channels is strong. And the loan originators in which we have invested are not only providing healthy flow into that pipeline but generating operating income themselves.



Because we have equity investments in those same originators, this, in turn, also helps drive our results. We continue to actively pursue making small but strategic investments in other non-QM and RTL originators. And in fact, we closed on another one following quarter end, helping lock in another strategic sourcing channel.



In light of the recent market volatility, I'm particularly happy to have executed on our recent asset sales and securitizations in different parts of the portfolio ahead of that sell-off. These moves locked in gains when spreads were tighter, and they also freed up additional borrowing capacity and capital to redeploy. We have ample dry powder and just in the past few days, we've been putting that dry powder to good use.



I believe Ellington Financial is well-positioned for continued portfolio and earnings growth over the remainder of the year. With that, we'll now open the call up to questions. Operator, please go ahead.

[Operator]

[Operator Instructions] We'll go first to Bose George with KBW.

[Bose George, analyst]

The first question was just about capital deployment, how would you characterize your -- the level of capital deployment? Is there still -- you mentioned some dry powder, but just how much upside to ADE just from fully optimizing the balance sheet?

[Mark Tecotzky, executive]

So I think that the first answer -- first of all, I'd approach the question would be to look at the unencumbered and cash on balance sheet. So we had $565 million of unencumbered and close to $200 million of cash. And typically, we'll keep cost 10% of equity in cash. So that's maybe $150 million.



If we add -- so the recourse leverage on credit was 1.5x. If we took that to 2x, that takes our overall recourse debt equity back to 2x and adds a few hundred million more of borrowings or $600 million more, I guess, in that example. So I would say in this quarter, we -- that there are a few moving pieces in the portfolio, but we continue to trim and call lower-yielding assets.



So that's been offsetting. We went through the laundry list of credit portfolios that we grew in Q2 and into Q3. But then we also sold Agency and non-Agency MBS. So those are kind of working in opposite directions. But suffice to say, a 1.6 in overall leverage. We have lots of room, both from excess cash on the balance sheet, those unencumbered assets to add leverage and then other assets like our forward MSRs that are levered but lightly levered.



So you can draw several hundred million of additional buying capacity just from those different numbers that would still take us just to 2x recourse debt to equity.

[Laurence Penn, executive]

Yes. And as we -- this is Larry. As we trim that agency portfolio and more is focused just in the credit sectors, you could think of that 2:1 leverage ratio, I think, is kind of a fully invested as being fully invested. So probably, again, as we trim agency, probably not going to get all the way to 2:1 in terms of being fully invested, but at 1.6, we have hundreds of millions of [indiscernible] of room to add even before we get close to that.

[Mark Tecotzky, executive]

Yes. And then that's -- and we're really focused on secured financing. Longer term, we have several tranches of unsecured debt at Ellington Financial and pricing for recent deals has been wider than it had been in prior years. But I think it's fair to say over the longer term, we see adding more unsecured debt to liability structure is another step that we would consider. So that would also take up the recourse debt to equity ratio, but again, over a, I'd say, a longer-term period.

[Bose George, analyst]

And then while you hedge your portfolio very closely, can you just talk about how the portfolio potentially benefits from a steeper yield curve, if the forward curve is right and the Fed is cutting quite a bit over the next year.

[Mark Tecotzky, executive]

So yes, in terms of interest rate hedging, we've tried to hedge out across the curve. So we don't really express an opinion on what the future shape of the yield curve is going to be through our interest rate hedges. So just mathematically or on paper, just the first-order effect of a steeper yield curve or a flatter yield curve, we neutralize that with hedges.



Now I think there's a couple of other things going on. Whenever you have -- when the notional balance of your repo, it exceeds the notional size of your swaps, then a drop in financing costs is going to be beneficial, right? Like if you have the -- if the swaps exactly equal the size of the repo and the market is predicting now, I think the base case is a 50-basis point cut in September, the Fed cuts 50 basis points, okay, our repo costs go down 50 basis points, but the floating leg we receive on swaps goes down 50 basis points, too. So if you repo exactly equal your swaps, then it kind of washes out.



When you have repo in excess of your swap notional amounts, then that's a beneficial thing to you. I think the things we're thinking more about is when you see a cutting cycle start, I do think you see investors express a preference for fixed-rate assets as opposed to floating-rate assets. So we've been adjusting some of our hedges internally to be more focused on loan indices as opposed to, say, a high-yield bond index.



That's kind of one second-order effect, I think, makes sense. And it's interesting. If you look at some of the recent fund flows, there's this $11 billion AAA, CLO, ETF, JAAA, that just came out of the blue this year. I think it's had its first outflow ever yesterday, right? So the expectation of the market that you're going to see lower short-term rates that is starting to be reflected in fund flows.



So we certainly think about how we position the portfolio. And I also do think when you see steeper yield curves, that does tend to be supportive of agency mortgages and non-QM mortgages. So I think there's some second-order effects for us, and we're positioning around it. But in terms of like a big move in ADE for the portfolio, I think you're only going to see that really significantly to the extent that the notional amount of our repo borrowings exceeds the notional amount of the swap hedges.

[Laurence Penn, executive]

And I'll just add one thing, right? So, I agree. Yes, I agree with everything Mark said. The -- if you look at the -- what's now a very large segment of the portfolio, which is residential transition loans. So we don't -- they're short. We don't really meaningfully hedge those from an interest rate perspective.



And I do think that as you see -- the rates tend to be a little stickier in that sector. I do think that if you see a drop in short-term rates, right, as everybody is predicting, I do think that you will actually have wider net interest margin on that portfolio because I think the -- our repo rates, they float though, absolutely ratchet down almost basis point with Fed cutting. But I think that the rates, the coupons that we'll be able to get on RTLs will be a little stickier.

[Mark Tecotzky, executive]

And that's the opposite that we saw when rates were right.

[Laurence Penn, executive]

Exactly, right. Yes, we've had some NIM compression in that sector versus where we were a few years ago when rates were -- short-term rates were a lot lower. So yes, so I think that's one good thing to look forward. And then those I think some of the things that I've seen you've written would echo this as well, which is that, let's say, we fast forward to a year and change from now, and we've got long-term rates and short-term rates with a free handle, right, that's going to be good for -- you're going to see mortgage rates go down across the board just on an absolute basis, and that should be really good for originators, right? Just you'll see a lot more refi activity, et cetera.

[Operator]

We'll go next to Crispin Love with Piper Sandler.

[Crispin Love, analyst]

First, just on HELOC and closed on second. Is this an area that you expect to see a lot of runway, just given home affordability, higher APA, higher rates with many mortgages in the 3% to 5% range, or if we do get a sizable rate rally to this opportunity diminish in coming quarters, but then you give the benefit from higher originations as you've been [ making ]. Just curious on your thoughts there.

[Mark Tecotzky, executive]

Yes. Crispin, it's Mark. If you just look at how many Fannie 2s and Fannie 2s and Fannie 3s that are out there in existence all the stuff that was created in 2020, 2021, first half of 2022, that is an enormous pile of Fannie-Freddie-Ginnie loans. And for the second liens in the [indiscernible], the originators are targeting borrowers with those really low note rate first liens.



So that -- if rates were just to stay where they are, that opportunity looks like it's pretty big. You're exactly right. If you saw a big rate rally and mortgage rates came down a lot, then all of a sudden, doing the cash-out refi is going to start to look to be comparable economics to people that are saying, I'm going to stay put with my fixed rate first lien mortgage.



And if I want to borrow a $70,000 to some home renovation or something, I'm going to take this closed-end second lien. So yes, there is a trade-off between -- we're first seeing mortgage rates and how big that opportunity set is. But you're exactly right. We've positioned ourselves to have a seat at the origination table, not in Fannie Freddie space, but in the non-QM space with our originators.



And so lower mortgage rates across the board, I think, would be definitely supportive to the origination volume. So -- this -- we don't think about it explicitly sort of hedge on origination volumes, but it certainly functions that way. We're attracted to it now because you get a real high note rate, it's very supportive of ADE.



We think we understand the prepayment function and the credit quality is really strong. So that's what's been driving us. It just looks like an attractive asset to add to the portfolio to complement already what we're doing in RPL and non-QM and the private label reverse.

[Laurence Penn, executive]

And if I could just add to that, Mark. I just want to add that I really -- based on what Mark said right about -- the rates would have to drop a lot for those -- all those low coupons that were originated pre-2022 especially, right, to become refinanceable. If mortgage rates are maybe they're getting close to 6% now, but your debt's still 200 basis points away, right?



So you're going to need quite a big drop, I think, before HELOCs and close in seconds are going to no longer make as much sense for people. The thing that I'm a little more on the radar screen about is what's going on with the agencies, right? So I'm not -- I don't think volume is necessarily going to be an issue for a very long time in terms of that market.



But the question is with this agency pilot program coming out and all that, that could obviously lead to some serious competition. I mean it's not a big pilot program, but if it becomes more than the pilot program, there could be some serious competition there. And we don't want to be competing with the agencies, but we're going to keep going. The assets that we're seeing now are looking great, as Mark said. And we'll see what happens.

[Crispin Love, analyst]

And then just one last question from me. Are you seeing single asset, single borrower security opportunities in the current landscape? Is this an area where you're adding? And would that fit well within EFC's credit portfolio on the commercial side? And just kind of curious what kind of returns do you think you might be able to get right there that you are interested.

[Laurence Penn, executive]

Yes. It's a great question. Do you want me to take it, JR? Or do you want to take it?

[JR Herlihy, executive]

So I think the first SASB question, yes, that's part of the market we've been focused on. In small size, and you see that the portfolio grew from $22 million to $42 million quarter-over-quarter in CMBS. So it's still a small percentage of the overall credit portfolio. But yes, certainly SASB is an area that we focused on.



I mean in past years, TPs have been a much larger percentage of our CMBS portfolio, now it's much, much smaller. So yes, on the margin SASB the deals we're looking at in terms of how those yields pencil, I don't know, Mark, you want to address that, we get the -- I'm just thinking about in our disclosures where we would give more detail.



There will be more detail on in the queue on that question. But I know anecdotally, Mark, do you want to talk about some of the SASB CMBS incremental yields you're seeing?

[Mark Tecotzky, executive]

Yes. It's been a wild sector, right? So for years, we had almost no SASB exposure. It was a market where BBB and above all traded in the tight spread range and everything came at par and just didn't look that interesting to us. And now as you have this tremendous divergence of outcomes in commercial space is a function of property type.



We've seen some really interesting opportunities. There have been bonds that are still investment-grade SASB that have been down dollar prices in the 30s and 40s. And then -- so there's that. That's been an interesting opportunity for us. And the other interesting thing is you're getting a lot of new issue SASB, and it's been a pretty big volume and it's pushed spreads a little wider.



So from a leverage spread basis, it certainly looks as attractive to us or maybe even slightly more attractive tests than some of the other sort of bread and butter sectors like CRT, your legacy non-agency on the CUSIP side. So yes, the -- what's been going on in SASB has really been a lot of the focus of our CMBS team, as JR mentioned, for years, we were very active in the BPs market.



And just that market with not a lot of conduit issuance, there's just not -- it doesn't have the same opportunity as it used to. But the SASB opportunity on either lower dollar-priced distressed SASB where you're really doing very, very detailed analysis of the properties. And then up the capital stack to some of the bigger SASB deals that we think are coming at very attractive spreads. I definitely think you can see more capital get allocated there.

[Operator]

We'll go now with Douglas Harter with UBS.

[Douglas Harter, analyst]

Given the market volatility, can you talk about your appetite for potentially looking at more liquid assets versus your recent strategy of more proprietarily created loans?

[Mark Tecotzky, executive]

Sure. I think it's both, right? Like I think we've been opportunistic about that, and you've followed us for years, right? You look at what we did in 2020, we added a lot of legacy non-Agency when a few months before that, we were adding a lot of non-QM loans. So we're constantly looking at the trade-off between securities and loans.



And we take into account the difference in financing levels, difference in liquidity. So I would say for this market volatility, what that means to me is that maybe you're looking for incrementally a bigger pickup in loans relative to CUSIPs than you might normally look for, and that's typically what happens when you see this volatility, that sort of liquidity basis tend to [ accordion ] out.



So you see it every way, less liquid shelves versus more liquid shelves, unrated seniors versus rated seniors. All those things have been going one way this year up until the last week or so, liquidity spreads have been coming in, we did some loan selling and loan monetizing to take advantage of that, and now you're seeing to start to go the other way. So that relative value trade-off is something we always look at.



And I think might sit down and we discuss things with the PMs, that means to us that the threshold for adding loans relative to securities is incrementally a little bit wider now than what it was a couple of weeks ago.

[Laurence Penn, executive]

Thanks, Mark. And the other thing I would add, this is Larry, is that it was -- we happen to be looking last week at a second lien portfolio. And we pulled the trigger on that in the face of this sell-off, which was great. Got a better price. But in general, when you have these big market moves, for example, we saw some mutual funds selling, right, or ETF selling.



CUSIPs tend to trade more, obviously, and to be a little more volatile, right, in terms of just what you're actually able to buy. So I think when stuff like that happens, the first opportunities that are going to arise are going to be in CUSIPs. And absolutely, if it looks like there's some fore-selling will gobble us up. It's a little harder to dial-up your proprietary pipelines immediately, right?



That's just something that is going to kick in longer. So as you have these big risk-off moves and now the last couple of days risk-off moves, you're going to see more activity just in CUSIPs and be able to pounce on those. But longer term, as Mark said, I think our expectation is that it's going to be on the private side of the portfolio, the non-CUSIPs where we're going to continue to see driving RAD.

[Operator]

We'll go now to Eric Hagen with BTIG.

[Eric Hagen, analyst]

I actually wanted to follow up right there and ask about non-agency securities repo and your outlook there for spreads over so far to stay stable, including just the general supply of capital that's coming from some of the big banks that typically supply that capital and maybe the appetite to continue to supply and funding there for the market perspective.

[Mark Tecotzky, executive]

Yes, we have seen -- we've seen the same thing you've seen. The big banks now are very interested in repo as a balance sheet asset, right? It doesn't have price volatility, it has a healthy spread. So it contributes to NIM. So it's not only traditional banks, but you also have some very large investment banks that converted to banking charters during the financial crisis.



So we have seen -- we've gotten a lot more inbound calls from people wanting to add repo not on the agency side or that's been stuck at like SOFR plus anywhere between 5% and 10%, but it's been on the loan side, right, not on the CUSIP side. So anything, I'd say, SOFR plus 125 to SOFR 2.25, those kind of asset classes.



There's been a lot of interest in lenders trying to get more borrowings on the balance sheet. And so we've seen -- but it's like what rate a lender is at is important, but it's not the only thing that matters on the repo side. It's how easy are they to work with? What's their eligibility like? There's a million other things, but we have been able to negotiate better financing terms on loans this year than what we had in place last year.



And I think that will keep going because I think what would stop that would be, if you saw SOFR really come down a lot, but it's 5 and 3 now, SOFR comes down 50, 100 basis points, I think that's still going to be attractive for the bank. So that's another way I think at the margin, we're going to grow some ADE is just by continuing to negotiate and take advantage and be opportunistic about the best financing levels we can get.



One thing that is sort of helping that is the securitization spreads. Larry mentioned [indiscernible] non-QM spreads this year. That is give the lenders a little bit more confidence to come down on their SOFR spreads. So that has been across the board better, whether it's CUSIPs or whether it's loans, but for the CUSIPs I'm talking about is like SASB that Chris was asking about or CRT or legacy non-Agency.



And the agency stuff, that's been fine for years. It didn't really widen in '22. It has a [indiscernible] so that stuck where it is. But anything else, we've gotten better financing terms. And I do think that that's going to continue.

[Laurence Penn, executive]

And I think, especially in repo on fixed income CUSIPs, I think it has further to come down given how much spreads have tightened. And just given how -- I mean, when was the last time you heard about a lender having a loss on fixed income CUSIP repo. I mean it's been a really long time. They're much better at managing that risk.



The [ haircuts ] are high, a lot higher even than in a lot of like warehouse loan repo on the loan side as opposed to CUSIP side. So I think that actually has room to come down more.

[Eric Hagen, analyst]

Can you share how much capital you have allocated to the credit hedges and how you think about maybe scaling that opportunity you rotate more capital into the credit portfolio?

[JR Herlihy, executive]

Yes. So on Slide 19, we give an overview of the credit hedges. And you can see on a -- it's not exactly the capital allocation, but a high yield equivalent $120 million notional is our CDS, which is where most of our corporate hedges are, we have a small amount in CMBX and then European related to currency risk for the most part.



So it's meaningful, and Mark went through the different uses and benefits that provides, but relative to the size of our several billion dollar credit and agency portfolios, it's small, but it does help on the margin in the way that he mentioned. We have taken -- the size of these credit hedges down over time as we move more towards loans and away from CUSIPs that don't always have hedging instruments available or the need to hedge with low spread duration, for example.

[Laurence Penn, executive]

Yes, they really take minimal capital to put on and maintain and they're, in fact, risk reducing. So in terms of -- when we think about -- they don't take any capital away certainly from our ability to add assets.

[Operator]

We'll go now to Matthew Erdner with JonesTrading.

[Matthew Erdner, analyst]

Could you talk about current expectations for credit performance? And then if recent economic data has made you shift asset allocation, but I do know you're going more so in the credit and away from the agency.

[Laurence Penn, executive]

Sure. Mark, why don't you take the first half of that, and you can go second if that works. So on the performance of our loan portfolios. We mentioned in our prepared remarks and earnings releases that in commercial, the delinquency percentage declined quarter-to-quarter. We do still have the 2 multis delinquent loans that we're working through.



But overall, the percentage of delinquencies relative to fair value declines between the 2 quarters. And then in [ resi ], it ticked up slightly by 10 basis points, call it, when you exclude NPLs that we bought during the quarter. So, yes, it's -- and credit realized losses continue to be small, but we do highlight those 2 nonperforming multifamily product properties that we're working through.

[Mark Tecotzky, executive]

Remember -- and also remember that we mark-to-market through our income statement, right? So we've marked those 2 nonperformers down. And so when those resolved, we do not expect to that affect our net income in any negative way. And in effect, what it will do is free up capital to redeploy so that we can continue to boost our ADE.



And the second half of your question about, I think, an economic slowdown and how that might change our perception of adding credit assets. Would you mind repeating that and market if you wouldn't mind tackling that, please?

[Matthew Erdner, analyst]

Yes. Just if we were to go into a recession, how you guys would think about asset allocation, and if it would change from your current stance?

[Mark Tecotzky, executive]

Yes. I guess the way I think about it is -- in the early days in non-QM, we had loss expectations on it and our originators would take loan loss reserves. And what we saw is that performance was so good, shockingly good that they built up a war chest loan loss reserves and -- because there weren't any losses, right?



And so to me, the aberration has been the really tailwind of home prices really strong default performance from, say, I mean we started LendSure 2014. 2014 up to middle of 2022, I think performance was aberrationally good. And I think now we're going into -- we're in a period of time where you're going to -- you see some delinquencies; you're going to see some losses.



But I think it's absolutely consistent with how we underwrite things. And the same thing is true for residential transition lending. You've seen the unemployment rate tick up. Jay Powell was talking about it a lot at the press conference. We make no predictions about the economy, but we watch things like a hawk, right? And so we slice and dice the data a million different ways.



We've certainly seen a lot has been written about it that there's been kind of FICO inflation that a 700 FICO today is probably more like a 680 FICO 4 years ago, right? So that observation or that belief has informed our credit eligibility criteria. So we've matriculated up in FICO. And I think as an originator, and this gets the point I want to make in the prepared remarks about how it's not just we own originator, and we're hands off.



We are collaborative, right? And so we give them access to our data scientists and our data and our research team to come up with best underwriting practices where you can be relevant to the brokers or the correspondent you're working with, but you're getting great quality loans. And so if we see performance deterioration in certain parts of the portfolio, then that serves the feedback loop being changed [indiscernible].



So that process, that iterative process of analyzing the data and then updating and adjusting guidelines on the reaction to it. That's -- I see that as a big part of our job. And as a big part of our job 10 years ago, but just 10 years ago, you didn't see a lot of delinquencies. You'd look at it, say delinquencies are fine, okay, let's go ahead.



Now you're into sort of a much more normal regime, home price in more expensive, note rates are higher, people are signing up for bigger payments. And so there's going to be some delinquencies. And so we monitor it. We're pricing for it. And I think we're very well equipped to respond to it.

[Laurence Penn, executive]

And I want to add one thing. Just if you turn to Page 12 of the presentation, right, you can see the various segments of our loan origination business and those pipelines that we've been talking about. And you can see consumer loans, it's a very small segment, right, compared to the others, I mean, tiny.



And if you look at our portfolio generally, right, we are a residential-focused company in terms of the credit risk that we're taking. And let's include also multifamily in that, right, because that's most of our commercial mortgages are on multifamily properties. And you can see that on another slide in the presentation. But -- but as to your question, if we go into a recession, right, you'll see rates come down.



And even though there's definitely issues, right, on affordability of housing. There's also a lot of issues on supply, right? And you have those 2 things, you have very little supply versus the demand. But you've got an affordability problem, right? And so those 2 things are counteracting each other. But if we go into a recession, against your question, our rates go down and mortgage rates go down, which they would in that scenario.



Now all of a sudden, you're really helping the affordability issue because you're going to have mortgage rates lower. And on the multifamily side, you're going to really help the cap rate issue. And remember, we're these are bridge loans that in terms of the vast majority of our commercial mortgage loan portfolio. So you're really talking about valuations at the end of that 12 or 18-month term.



So with cap rates, they come down. So I really feel good about how our portfolio, again, being very residential-based and given the technicals of that market. And in addition, what would happen if long-term rates came down. I feel very good about how we would withstand that kind of a scenario.

[Operator]

Well your next from Lee Cooperman with Omega Family Office.

[Leon Cooperman, analyst]

So I have 3 questions. Most people own the stock for income, given everything you had to say, you think you restore your dividend before the end of the year to the $0.15 per month level?

[Laurence Penn, executive]

I feel great about maintaining the dividend where it is. I -- at this point, no, that's not something that I would expect to raise it. And -- but we've tended to keep our dividend stable for a long time. And so I wouldn't have that expectation of raising it.

[Leon Cooperman, analyst]

You would think the dividend is really sustained at the [ 13, 10 ] a month level?

[Laurence Penn, executive]

Yes, absolutely.

[Leon Cooperman, analyst]

The second question, you guys have been active in capital management. What is your attitude towards that presently?

[Laurence Penn, executive]

Yes. I think JR alluded to it earlier. I think our next big move on the capital management side is going to be unsecured debt. Rates have come down and those -- whether we look at baby bonds or other types of offerings, they tend to be a little sticky. So we're being patient and watching that market.



So I think adding unsecured debt to the portfolio, I think, is important. And it's also a little bit of a healthy cycle as you do that because ultimately, look, we're not rated by any of -- it's like S&P and Moody's, for example, right now, we have a great Egan Jones rating. But at some point, that's something we might want to look into is to get a rating from, let's say, S&P and Moody's and the like, and that will enable us to issue even more unsecured debt.



Of course, as we add things like baby bonds, which aren't rated, that also helps the capital structure and can help us get those other ratings. So -- but anyway, the next move, I think, significant move. Again, this is just a prediction, I can't predict where the capital market is going. They're not there yet for us, I think, would be some sort of an unsecured deal.

[Leon Cooperman, analyst]

And I need you to help me out since you guys are smarter in the credit markets than me. Everyone seems to think interest rates are too high. I actually think they're low. And the evidence I would use is the stock market is near a high. There's a lot of speculation in the market prior to a great financial crisis 2008, the 10-year buy yielded line with no GDP.



You have inflation of 2% to 3% and real growth of 2% to 3%. The 10-year would not be undervalued at a 4% or 6% yield. So I think interest rates are going to go up. And I read the Democratic platform, which is 80 pages long. I read the Republican platform, which is 22 pages long. Nobody seems to be cared by the debt that we're creating in the system.



So I think we're heading to some kind of financial crisis. And I don't know if it hits us in 5 years, 10 years or doesn't get us at all. What's your view of what's going on in the country fiscally?

[Laurence Penn, executive]

Yes. So again, as Mark said, I just want to reiterate, we try not to color. And this is just us, I understand that other companies and of course, you with your own portfolio, Lee, are going to take a different approach. But we try not to color our interest rate hedging.



We try to focus more on, okay, here's where long-term strips are, here's where short-term iterates are, what can we buy just given those realities as opposed to -- and then hedging appropriately. But I absolutely agree with you, not on short-term rates necessarily, but I do agree with you on the longer-term rates that given the increasing size of the debt, budget deficits, nobody is talking about really cutting in any meaningful way.



And not to mention that, it's not so clear that notwithstanding what we've seen or a port or 2 that wage inflation is really behind us. which is the thing that I look at most closely, I think, in terms of thinking about where all of this could go. I agree with you, I think long-term rates, I think it's going to be challenging for the Fed to get even not 2%, even 2.5%, whatever.



And so I think it's going to be challenging for long-term rates ultimately to get where at least maybe the forward curve the markets are predicting.

[JR Herlihy, executive]

I agree with you.

[Operator]

Thank you, everyone. That was our final question for today. We would like to thank everyone for participating in Ellington Financial's Second Quarter 2024 Earnings Conference Call. You may disconnect your lines at this time, and everyone, have a wonderful day.