Ellington Financial Inc

NYSE:EFC

Earnings Call Transcript 2024-Q3

[Operator]

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial Third Quarter 2024 Earnings Conference Call. [Operator Instructions] It is now my pleasure 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 1A of our annual report on Form 10-K and Part 2, Item 1A of 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 statement, 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 third quarter earnings conference call presentation is available on our website, ellingtonfinancial.com. Management's prepared remarks will track this presentation. Please note that any references to figures in this presentation are qualified in their entirety by the notes at the back of the presentation. With that, I will now turn the call over to Larry.

[Laurence Penn, executive]

As always, thank you for your time and interest in Ellington Financial. I'll begin on Slide 3 of the presentation. Perhaps the highlight of the quarter was the increase in our adjusted distributable earnings to $0.40 per share, which was a $0.07 increase from the second quarter and which covered our $0.39 in dividends for the quarter. The main driver of this quarter's increase in ADE was the contribution from our proprietary reverse mortgage business in our Longbridge segment, which included our second prop reverse securitization of the year. Back in the first quarter of this year, ADE in our Longbridge segment was actually negative, but it has increased each quarter since then, and it registered $0.12 per share in the third quarter. Our Longbridge segment represents about 12% of our equity capital allocation. It's great to see ADE having steadily improved in that segment. I've been consistently highlighting our Longbridge segment as holding significant untapped potential for Ellington Financial. Even if Longbridge's ADE can stabilize around $0.09 per share per quarter, we should be in excellent shape from a dividend coverage standpoint.







In the third quarter, Ellington Financial's investment portfolio expanded as we utilized our strong balance sheet to continue growing our high-yielding loan portfolios. For the quarter, our non-QM, RTL, commercial mortgage bridge, HELOC and closed-end second lien loan portfolios increased by a combined 26%. That portfolio growth drove our overall leverage a bit higher to 1.8x from 1.6x, even as we continue to shrink our lower-yielding agency portfolio and maintain additional dry powder to invest. At quarter end, our agency portfolio had shrunk another 14% sequentially and cash plus unencumbered assets totaled $765 million, which was just under 50% of our total equity. Not surprisingly, much of the expansion of our loan portfolios has been a direct result of the loan origination businesses that we have cultivated across a variety of credit sectors and over a number of years. Our originator relationships, including the equity stakes we hold in many loan originators and our emphasis on striking forward flow agreements with a diversified roster of originators have enabled us to adjust the acquisition volume and the underwriting criteria of our loan investments. This has enabled our loan portfolios to become among our largest, highest yielding and best performing strategies.





Meanwhile, the profits generated from our originator equity stakes have been a nice boost to our earnings and book value while also enhancing the diversification of our earnings stream. This continued in the third quarter with strong profits at LendSure and American Heritage Lending, where continued robust demand for non-QM loans drove strong origination volumes and wider origination margins. Recently, our loan portfolio expansion has also included adding meaningful exposure to the HELOC and closed-end second lien sectors, where we have both bought loans with an eye toward securitization as well as participated as securitization cosponsor with a large mortgage originator. We currently see the retained tranches and call options from these securitizations as offering very attractive risk-adjusted returns. The mortgage securitization markets are in great shape. And in turn, that's been great for Ellington Financial. During the third quarter, we priced a non-QM securitization that achieved AAA yield spreads near their 2-year lows. And as I mentioned earlier, we also completed a proprietary reverse mortgage securitization backed by loans originated by Longbridge with incrementally stronger execution than our inaugural deal earlier this year.





Finally, even aside from these excellent securitization executions, we're also continuing to improve the rest of the liability side of our balance sheet. Recently, we've added new financing lines on non-QM loans, closed-end seconds and HELOCs and consumer loans. And before the end of the year, we expect to add several cost-effective lines for our reverse mortgage business as well as a new financing line on the forward MSRs that we acquired through the Arlington merger. We anticipate using some of the proceeds from these financing lines to replace some of our existing higher cost debt and floating rate preferred equity. For example, we announced yesterday that we are redeeming our Series E preferred stock that we inherited in the Arlington merger, which now carries a cost of funds of well over 10% following its fixed to floating rate conversion earlier this year. These types of refinancing should be immediately accretive to earnings since in the current environment, we see returns on equity on incremental asset acquisitions reaching well into the teens. Meanwhile, with our overall leverage still low, we have additional capacity to issue more long-term unsecured debt, and we look forward to doing so. With that, I'll turn the call over to JR to discuss the third quarter financial results in more detail.

[JR Herlihy, executive]

For the third quarter, we are reporting GAAP net income of $0.19 per share on a fully mark-to-market basis and adjusted distributable earnings of $0.40 per share. On Slide 5, you can see the attribution of net income between Credit, Agency and Longbridge. The credit strategy generated $0.45 per share of net income in the quarter. Including associated financing costs and hedging gains losses, we had strong net interest income and net gains from non-QM loans and retained tranches, non-Agency RMBS, closed-end second lien loans and CMBS. We also benefited from mark-to-market gains on our equity investments in LendSure and American Heritage Lending, which reflected strong performance at those originators, driven by increased volumes and wider origination margins. Offsetting a portion of these gains were net losses on our consumer loan portfolio and a related equity investment in the consumer loan originator as well as negative operating income on certain nonperforming commercial mortgage loans in REO.



Finally, we had a net loss on the Great Ajax common shares repurchased in connection with last year's terminated merger. Meanwhile, despite strong results in originations, the Longbridge segment generated a GAAP net loss of $0.03 per share for the third quarter, but this net loss was driven by interest rate hedges as rates fell during the quarter. We had a mark-to-market gain on our HMBS MSR equivalent, but this gain was muted by wider HMBS yield spreads, so the gain didn't keep pace with the net losses on the interest rate hedges that we hold against this position. Wider HMBS yield spreads adversely affect the value of our HMBS MSR equivalent because they lower the component of projected servicing income that stems from the right to fund and securitize future borrower draws. In HECM originations, a decline in origination margins, also driven by wider HMBS yield spreads was partially offset by higher volumes, whereas in Prop Reverse originations, results were boosted by the securitization we completed in July, along with improved origination margins and higher volumes, and this led to strong profits in that product line. In total, origination volume at Longbridge increased 16.5% sequentially even as industry-wide volumes were down overall for the quarter. Notably, Longbridge contributed $0.12 per share of ADE in the third quarter, driven by the strong quarter from PropReverse. For the quarter, our Agency strategy generated net income of $0.06 per share with net gains on our Agency RMBS exceeding net losses on interest rate hedges.





In the quarter, interest rates fell, the yield curve steepened and Agency MBS yield spreads tightened as the market anticipated the beginning of the Federal Reserve's interest rate cutting cycle. Indeed, in September, the Fed reduced the target range for the Fed funds rate by 50 basis points and also released updated projections that implied another 50 basis points of interest rate cuts later in 2024, although that expectation is no longer shared by the market. Finally, our results for the quarter also reflect a net loss on our senior notes, driven by the decline in rates. This loss was partially offset by a net gain, also driven by the decrease 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 is where you can see the $0.12 per share contribution from Longbridge, which drove the overall increase in EFC's ADE to $0.40 per share for the quarter. Turning next to loan credit performance. In our residential mortgage loan portfolio, the percentage of delinquent loans decreased quarter-over-quarter. In our commercial mortgage loan portfolio, the percentage of delinquent loans increased with 4 small balance commercial mortgage loans moving to 90-plus day delinquency during the quarter. But I'll note that subsequent to quarter end, one of those loans paid off at par plus all past due interest, 2 others are expected to resolve favorably in the fourth quarter.





And for the fourth, we believe that the property value roughly approximates the UPB. We also continue to work through these 2 larger nonperforming multifamily bridge loans that we referenced last quarter. Moving into next year, we expect that resolutions of delinquent loans in REO, together with redeployment of resolution proceeds will be a tailwind to ADE. Next, please turn to Slide 7. In the third quarter, our total long credit portfolio increased by 19% to $3.25 billion as of September 30. The increase was primarily driven by net purchases of non-QM loans, closed-end seconds, HELOCs, commercial mortgage bridge loans and non-Agency RMBS. A portion of the increase was offset by smaller CLO and CMBS portfolios driven by net sales. For our RTL, commercial mortgage and consumer loan portfolios, we received total principal paydowns of $318 million during the third 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. On Slide 8, you can see that our total long Agency RMBS portfolio declined by another 14% in the quarter to $395 million. We continue to sell down that portfolio and rotate the capital into higher-yielding opportunities. Slide 9 illustrates that our Longbridge portfolio decreased by 5% sequentially to $494 million, driven primarily by the completion of our securitization of prop reverse mortgage loans, partially offset by new proprietary reverse mortgage loan originations during the quarter. Please turn next to Slide 10 for a summary of our borrowings.





On our recourse borrowings, the total weighted average borrowing rate decreased by 21 basis points to 6.77% at September 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 increased to 1.8:1 at September 30, up from 1.6:1 at June 30, primarily driven by an increase in borrowings on our larger credit portfolio, partially offset by a decrease in borrowings on our smaller agency portfolio, the proprietary reverse mortgage securitization, which converted certain recourse borrowings to nonrecourse borrowings and an increase in shareholders' equity. Our overall debt-to-equity ratio ticked up as well to 8.3:1 from 8.2:1. Since mid-June, we've added 3 new loan financing facilities that have increased total borrowing capacity by $550 million. At September 30, our combined cash and unencumbered assets totaled approximately $765 million, roughly unchanged from June 30. Our book value per common share was $13.66 at quarter end, and our total economic return was 0.9% non-annualized for the third quarter. Now over to Mark.

[Mark Tecotzky, executive]

This was a strong quarter for EFC. We had a lot of portfolio growth in our core strategies. That portfolio growth, together with strong ADE at Longbridge, helped our ADE cover our dividend, which has been a primary goal of ours. We had solid contributions from our core strategies that should be repeatable. Our origination partners continue to grow their franchises and gain market share, which helped us acquire the loans we like at attractive valuations and at the volumes we've been targeting. The vertical integration of EFC was on full display this quarter. Our non-QM and RTL partners generally grew market share and increased profitability. These greater origination volumes allowed EFC to buy more loans with the credit profiles we seek. EFC's consistent loan pricing then allows our originators to offer more stable pricing to their broker and correspondent relationships, which makes them the counterparty of choice in many cases and helps them grow market share. With the securitization is as attractive as it's been this year, our securitization team takes over right after EFC approaches a critical mass of purchased loans.







For the quarter, non-agency mortgage bond spreads remained range bound and much tighter than much of last year. Our securitization team optimizes deal structure based on investor preferences and rating agency feedback. Including the deal that priced last week, we've now completed 3 securitizations since the end of July, 2 of non-QM loans and 1 of proper reverse loans. Securitizations serve 3 important objectives for EFC. Firstly, they allow us to replace short-dated repo with match-funded non-mark-to-market securitization financing. That both lowers the cost of financing and reduces the risk of funding hiccups and margin calls. Secondly, by leveraging loans with wide yield spreads with the investment-grade bonds that we sell at tighter yield spreads, we manufacture high-yielding retained tranches that are often more attractively priced than similar securities available in the secondary market, while also affording us with superior visibility and input on the credit profile. Thirdly, after a lockup period, these securitizations have call features, which provide us with significant economic benefits if interest rates drop and/or yield spreads tighten sufficiently. Another big trend for EFC this quarter is our growing presence in both the home equity line of credit market and the closed-end second lien market. To frame this opportunity, there's currently more than $30 trillion of home equity, much of which is controlled by homeowners with low fixed rate first lien mortgages.





In fact, 85% of Fannie, Freddie mortgages now have interest rates below current mortgage rates and nearly 70% of those mortgages are at least 2% below current mortgage rates. Over time, many of these borrowers will want to tap some of this home equity for a variety of reasons, like home renovation or debt consolidation without disturbing their first mortgage. Currently, the 2 dominant loan products to facilitate this equity extraction are fixed rate second lien loans and floating rate HELOCs. We have worked diligently to develop sourcing channels to acquire these products and have made a lot of progress in the past 6 months. Meanwhile, our research teams developed prepayment and loss models for these products as a natural extension of our long-standing agency and non-agency models. Based on these efforts, we concluded that these growing sectors represent another attractive high-yielding sector of the mortgage market for EFC's diversified credit portfolio. As you can see on Slide 7, we not only bought CUSIPs back by second lien loans in the third quarter, but we also added both HELOCs and second lien loans to the portfolio. That's the slice of the pie label D. And our buying in these sectors has continued at a brisk pace post quarter end. Both second liens and HELOCs fit seamlessly into EFC's portfolio as natural complements to our non-QM loan business. We have secured attractive financing terms so we can finance these loans in pocket of levered NIM.









In addition, much like non-QM, we can also securitize these loans, selling investment-grade bonds at terms we believe are more favorable to us than repo and retaining high-yielding tranches for our investment portfolio. Just like non-QM, these securitizations have valuable call features after a lockup period, which gives us the ability to refinance or sell the collateral down the road. Getting back to earnings, not only did our loan strategies have a good quarter, but we also had solid contributions from many of our CUSIP strategies such as CLOs, CMBS and other ABS. We also had meaningful contributions from our investments in loan originators. And while it continues to shrink, we also had a strong contribution from our Agency MBS portfolio. We did face some headwinds, however, we had some write-downs in our consumer portfolio and a write-down of our investment in the consumer loan originator, but these were one-off events that should be behind us. We continue to work out a few nonperforming assets. And while those should not be a continuing drag on GAAP earnings, they will continue to be a modest drag on ADE until we can resolve the assets and redeploy the proceeds. Financing terms continue to improve for virtually all our assets, and we continue to expand and broaden our financing relationships. The combination of our stable credit portfolio with consistent and well-received new issue securitization calendar has resulted in greater appetite among our repo lenders to provide us with repo financing and at more attractive terms.





Being able to negotiate better financing terms from our repo lenders drops directly to the bottom line, GAAP earnings and ADE. Q3 brought us the first Fed cut in 4 years. Even with the post-election surge in interest rates, the market is still pricing in a few more cuts, which should be a bit of a tailwind for ADE and spread products going forward. Spread products typically do quite well in an easing cycle, and we still haven't really seen much of incremental bank demand for structured products, so there is certainly still room for spread tightening. At the same time, let's not forget that the rate cuts are in part a response to a slowing employment picture. We can't be complacent, and we need to remain very focused on credit performance. We noted in our earnings release that our residential delinquency rate dropped in the third quarter. As the job market cools, we need to continue watching these metrics closely and tighten underwriting guidelines as necessary. We have already seen how higher debt costs, insurance costs and property taxes have been a challenge for some multifamily properties. We've been moving up in FICO on our residential loan portfolios and are making good progress managing and stabilizing our few commercial assets that are under stress. I'm happy about our portfolio growth and the resulting ADE growth in the third quarter. I believe in time, resources and effort we have put into our loan origination platforms can continue to deliver strong returns going forward. Now back to Larry.

[Laurence Penn, executive]

It's great to see the growth of our adjusted distributable earnings during the third quarter, hand-in-hand with the continued expansion of our integrated loan origination businesses. Which now effectively drive the returns of our investment portfolio. I believe that we've established genuine franchise value in our securitization businesses, where our EFMT shelf has now added 2 successful proprietary reverse securitizations to the 16 total non-QM securitizations that we have completed since 2017. Performance of our non-QM EFMT securitizations continues to be very strong, and we have rightfully earned a long roster of repeat investors in the tranches that we issue. We've also helped our loan originator partners to build significant franchise value themselves as we provide them with capital, help them secure favorable warehouse financing, collaborate with them on credit decisions and work together with them on strategic initiatives. Ellington Financial benefits not only from high-quality loan flow, but in many cases, from our pro rata share of both of their profits as well as the increase in the value of their platforms. Ellington Financial's fourth quarter has started off with a good October.





Our credit portfolio grew further during the month in what was a broad-based expansion across sectors. It performed well from both the credit performance and total return perspective, and it benefited from yet another strong execution in the non-QM securitization market. Meanwhile, in our Longbridge segment, prop reverse origination volumes, origination margins and loan performance were again all strong in October. As is our typical practice, later this month, we will be putting out our estimated October month-end book value per share. Finally, I should also add that we were positioned conservatively going into election day from a leverage, liquidity and interest rate exposure perspective. The post-election volatility in interest rates has not materially affected us. With that, we'll now open the call up to questions.

[Operator]

[Operator Instructions] We will take our first question from Trevor Cranston with Citizens JMP.

[Trevor Cranston, analyst]

There's obviously been some significant moves in interest rates and agency spreads in particular, so far in the fourth quarter. Can you guys maybe just give us an update on kind of how you're thinking about relative value between agencies and credit opportunities as things stand today?

[Mark Tecotzky, executive]

Yes, you had pretty aggressive spread widening sort of middle October toward the end of the month. And in the last 4 or 5 days, you've had pretty aggressive spread tightening. The reduction in the size of the agency portfolio in EFC, I don't think you should interpret it as a comment on relative value of agencies versus non-agencies. It's more a process we've started a while ago where we want to devote most of the capital to non-agency origination securitization businesses, RTL, our commercial bridge. And so that's been behind the capital rotation. There are certainly times when you get this bounce of spread widening in the agency market that it offers compelling relative value. But for EFC, I think what you should expect is a continued decline in the amount of capital allocated to the agency portfolio. It's already very small. And the pace of that decline, I don't think is going to be too impacted by sort of relative value. And that portfolio is small right now, and we see growing capital needs in some of our loan businesses where we think we can create sort of better longer-term franchise value.

[Laurence Penn, executive]

And if I could just add one more thing. One thing on the mortgage basis that you don't really see, but it goes on behind the scenes is that we can be opportunistic and we can vary the extent to which we hedge our non-QM portfolio as we're accumulating non-QM loans for securitization, for example, or just to hold them. We often, but not always hedge them with TBA mortgages because they have a lot of the same convexity characteristics in terms of they prepay faster when rates go down, they prepay slower when rates go up. That's something that depending upon our view on the mortgage business, we can dial up the extent to which we're hedging our non-QM with TBAs versus more vanilla instruments like interest rate swaps.

[Mark Tecotzky, executive]

Yes, it's a great point. When we saw that big spread widening, third week of October, we did reduce the TBA hedge on the non-QM and moved it more into swaps. Look, you're at a point in the agency market that if rates stay where they are, origination volumes are going to be pretty low, and you're going to have a very large treasury calendar. There's reasons to be constructive on the mortgage basis here for sure.

[Trevor Cranston, analyst]

And then on Longbridge, you guys highlighted in the prepared comments, the improvement in earnings there, which has been a nice tailwind. And Larry, you kind of mentioned the $0.09 number is a level that would give you decent dividend coverage. Is that kind of a level that's a good baseline to think about if we see more stability in rates and spreads from here? Or any sort of color you can give around kind of what you think about as a baseline contribution from them would be helpful.

[Laurence Penn, executive]

I have mentioned before that Longbridge's business being in the reverse mortgage business it's definitely rate sensitive. As rates go up, borrowers can -- just because of the way the math works, borrowers can borrow less against their houses. And vice versa, as rates go down, they can borrow more. Just big picture, they tend to see -- I mean, there's seasonal factors, other factors, too, but the market share, obviously, is going to factor into it. But they tend to see more origination volume when rates are lower. We actually have a hedge at Longbridge, which makes us money when rates go up to sort of buffer against the fact that we expect to see lower volumes and therefore, lower profits as rates go up. You will see volatility there from an ADE perspective because that hedge it's an interest rate hedge, so it doesn't contribute to ADE if it's profitable, it's more of a gain or loss, like a capital gain or loss. Yes, I think the $0.09 number is something that was just -- we obviously beat it by $0.03 or not obviously, but that's what we reported. That segment beat it by $0.03 this quarter. I'm really just trying to make the point that, A, it's achievable; and B, that's kind of a number where we think ADE will cover dividend.







In terms of a target, it's not an unreasonable target, but you will see volatility with rates. And we did beat it in this quarter. And I think the other thing that I mentioned was that our ability to do securitizations, we've done 2 so far. That's going to really help that number, too. That was a nice boost. I can't quantify it, but that was a nice boost as well to the ADE, because it sort of improves technically not a sale for accounting purposes, but you could sort of think of it as improves your gain on sale margins in that business. I think from a modeling perspective, I'm not uncomfortable with that as a long-term sort of stabilized value. And of course, over time, Longbridge getting into other businesses, prop reverse was not a big business for it, call it, a year ago or 18 months ago. There's lots of ways that Longbridge can add ADE in the future even away from its existing business lines.

[Operator]

And we will take our next question from Bose George with KBW.

[Bose George, analyst]

I just want to start, can you discuss the competition you're seeing within the non-QM market? And also, how has the more active participation from insurance companies impacted that market?

[Mark Tecotzky, executive]

Ellington, like most people in the non-QM space, has seen aggressive consistent buying of non-QM loans from a lot of insurance companies, a lot of them that are fixed annuity sellers. Really, I'd say, for the last 2.25, 2.5 years. That has been a fixture of the market for a while. I think it's done a couple of things. One is it has stabilized loan prices. You used to see a lot of volatility in non-QM loan prices. I really think about early in the sell-off in 2022, it was a market that had a lot more price volatility than the agency market. And I think the presence of consistent buying from insurance companies has taken out some of that volatility. For our originators, I think it's been welcome because they sell to Ellington, but they sell to other buyers as well. It creates competition. The insurance companies have different yield bogeys, a different liability structure than an Ellington Financial or an Annaly that is really funding on repo and then doing securitization.





There can be times where the competition from insurance companies can be serious and it really can push levels around to places where it doesn't look as attractive as it does at other times. But I'd say for now, it's been sort of a consistent presence that has stabilized the market. It's been a welcome diversifier for our originators. And you also see insurance companies buying the securitization. I feel like in some ways, they're competitors. In some ways, they're also clients. There's been enough volume to go around, but it's definitely created a different dynamic than what we had, I'd say, pre-COVID when it was not a market where you saw a lot of active insurance company participation.

[Bose George, analyst]

Then just to move to operating expenses. They were roughly up 18% over the quarter. Can you just discuss what drove that increase? And can we expect to see higher OpEx going forward?

[Laurence Penn, executive]

Part of that is we redeemed, I guess, you could say, options at the Longbridge level. That's one of the largest drivers which is a onetime thing. Employee held options. That's a nonrecurring that we would not see next quarter in Q4. That's probably the biggest driver.

[Operator]

And we will take our next question from Matthew Erdner with JonesTrading.

[Matthew Erdner, analyst]

Could you talk about your expectation for pace of securitizations? And then could you speak a little to the execution and how that's been on the reverse deals?

[Laurence Penn, executive]

Well, on the reverse deals, we're happy with the executions. I'm not sure exactly how you'd like me to elaborate further on that. It's not as uniform in that space in terms of the structures that people use in the reverse mortgage space are different and there's not a lot of issuance there and different issuers use slightly different structures in terms of how the debt is structured. But we've been very pleased. We've got repeat buyers, and we are accumulating for another deal. And we think that really helps us having that securitization outlet and that long-term locked-in financing on what's a very long-term product, obviously, is something that gives us a lot of confidence to continue to ramp up that origination at Longbridge.

[Mark Tecotzky, executive]

Yes, pace of non-QM securitizations next year. I think 4 to 6 deals is sort of a cadence I would expect us to do. It's going to depend on origination volumes and deal structures and there were times where we perceived repo financing is a better way to go. But if the market looks broadly similar to how it is now, I think 4% to 6% is where we should be.

[Laurence Penn, executive]

One thing that we've really tried to build here and have succeeded now is we not only have a diversified portfolio, but we have a really diversified and robust sourcing of all these different loan products, whether it's non-QM RTL, we have many sellers. We're buying a lot of loans each month. And we can dial up or down small balance commercial bridge lending. We're seeing also now increased volume there. We can dial up and down where it's like a faucet. And you turn the faucet a little higher and you get a little more flow, but then you can turn one faucet down and you can turn the other faucet up in the different products that we buy. I think we're in a great place to take advantage of where we see opportunities. We mentioned before that if at some point, the insurance bid in a particular month, let's just say, is so strong that we'd rather turn the faucet down in our non-QM buying, well, we can pick it up RTL or small balance commercial bridge or just CUSIPs. I really feel good about the diversity of our sources of growing the portfolio.

[Matthew Erdner, analyst]

And that kind of led into my second question about where are you guys seeing opportunities right now? I know in the past, you talked about commercial. You just touched on the bridge lending there, but is it just kind of a factor of what the market is thrown at you? And then could you expand a little more on what you guys are seeing and plan on doing in the HELOC and second lien space?

[Mark Tecotzky, executive]

Yes, I would say in terms of opportunity, buying the loans we like, getting to critical mass for securitization, executing the deals and keeping retained tranches that we expect they're going to have very high yield and the ability via the call options to get loans back in the future, that's a good opportunity for us right now, and we're pursuing that, and it's been that way the last 6 months for sure. And I expect that to be the case. We've also seen very good opportunity in CUSIP. I mentioned in my prepared remarks, we had great contributions in some of our non-agency stuff, CRT. We've done well in CMBS, CLO, we mentioned that we shrunk it a little bit because we took gains. We have a broad platform at Ellington and really I think a phenomenal suite of PMs. And so we have a lot of different sort of arrows in the quiver. I like having some CUSIPs as well as some loans. It's sort of a different return stream, and it's nice to sort of get the alpha that you can get from CUSIP.



Then the second part of your question, second liens and HELOCs. Again, in the prepared remarks, to us, we think we engage with that product the same way we do with non-QM. It's a high-yielding asset. It has a big spread versus our financing. Just having it on portfolio on a levered basis with an interest rate hedge on the closed-end seconds, you don't need one on the HELOCs because they're floating off of prime. Prime has kind of been locked to SOFR. With an appropriate interest rate hedge from time to time a credit hedge, that gives a nice levered return, but there's also securitization opportunities there. I would expect us to do a securitization relatively soon on one or both of those products and follow the same playbook we have for non-QM, retaining some high-yielding assets, keeping our call rights in place and replacing repo financing with selling investment-grade bonds that we think have a lower yield than the yield on the repo. And we talked about in the prepared remarks, it's match funding, you reduce margin calls. That's our plan for that product. Anything we can do in non-QM, we can do that in the HELOCs and then the closed-end seconds. That whole skill set we have and the whole playbook there, it's really transferable.

[Operator]

And we will take our next question from Eric Hagen with BTIG.

[Eric Hagen, analyst]

As you retire the preferred and make a move toward more unsecured, is that going to change the optics of your leverage? And is there maybe like a change in philosophy around how you manage with the secured leverage and the repo and where that leverage gets applied to certain assets as you retire the pref?

[Mark Tecotzky, executive]

I guess, first off, retiring that preferred, which is now that it's floating is well over 10% cost of funds. Like that seems like a no-brainer to us. And it's small. It's $24 million, $25 million. We have a few different channels to add financing to the balance sheet, secured and unsecured. On the unsecured side, Larry mentioned that we have, I would say, an appetite to do more. Of course, we need to balance what the pricing is going to look like relative to secured financing and other options. When we did our current $210 million deal a couple of years ago, it was at a spread of 322. And now recent deals in the mortgage REIT sector have been much wider spreads perhaps that are coming in. The cost of financing on unsecured is an important consideration. But big picture, we want to do more. In terms of secured financing, so I mentioned in my prepared remarks that since June, we've added 3 new facilities, secured facilities for loans. That's added $550 million of capacity. We've utilize some, but not all of that.





We have more to draw on new lines. We're expecting to add a new line for the MSRs that we got from Arlington. I think Larry mentioned that as well. The spreads on those are attractive. And between those 2 sources, we're talking about a few hundred million of additional financing compared to where we were at September 30. A few other things to think about. We have unencumbered assets on balance sheet of $550 million at quarter end. The bulk of that are agency and resi loans. And if you do 2:1 leverage on that, you're talking about another couple of hundred million of secured financing available on existing lines. And then we have cash. We had $220 million of cash at quarter end and at least some of that I would consider to be surplus that we've been working on deploying in October. And Larry mentioned that the credit portfolio is bigger in October. We have a lot of different pieces, but hopefully, that it gets your question. Yes. And then I'd just add that from a leverage perspective, with unsecured financing, we're more comfortable increasing the leverage. I do think that if we can do one or more unsecured deals, then you'll see our leverage tick up. And then we'd love to replace just over time. Now this is really more of a longer-term goal. But if we can replace a lot of our short-term repo financing with longer-term financing, that obviously just a better company, frankly. That's a longer-term aspirational goal. If you look at the mortgage REITs, on the residential mortgage REITs, they don't really haven't been able to pull that off as well, frankly.





But that's something that we definitely would have an eye toward long term. But short term, we're just looking at, as JR said, some of the floating rate preferred that now we can replace. And yes, and that decreases our equity and increases our debt. Yes, that's going to definitely at least show up as as an increase in leverage. We try to manage the portfolio very conservatively from a liquidity management perspective. We'll keep a close eye on that. And there's various steps, we are 1.8x debt to equity at September 30. All those different pieces maybe get us into the low 2s here in the next quarter or 2. And that's probably recourse.

[Operator]

And we will take our next question from Matthew Howlett with B. Riley.

[Matthew Howlett, analyst]

Just a follow-up on the preferred. I mean you could replace that preferred, right, with some of your other series, the ATMs and if you wanted to at lower cost? Or is there a ratio you want to take down?

[Mark Tecotzky, executive]

I think the new issuance on preferred has been pretty low in our sector in the past couple of years. We do have ATM facilities on different common and preferred, as you point out. Volumes have been pretty low on preferred. At least it's not exactly what you asked, but a new issue preferred doesn't seem to be there as much as bonds and other types of unsecured. I think that we try to be opportunistic on the capital structure, and that's another potential tool, but the volumes in preferred are pretty low, and it seems like investor appetite for unsecured is a lot greater than for new issue preferred. And if you look at where those are trading, it would still be expensive. The one that hasn't, the one that's still fixed, is trading at a a pretty big discount. We can't replace that coupon at par. I think debt is a better which we don't want to do, if we really want to reduce our -- I call it cost of funds, it's not technically debt. But from the commons perspective, it is. If we really want to reduce the load the cost of funds on the common, I think we're going to have to look to replace preferred with some form of debt, whether it's secured or unsecured.

[Matthew Howlett, analyst]

You're always the market leader on low-cost preferred. That's why I asked the question. But if it does open up, I'm sure you'll be back involved. Second question on the duration of the credit book, you guys have always been sort of short duration, high yield short durations. You've always pulled this off time and time again. As you start to invest more in retained tranches, non-QM, I mean, do you want to take a little more duration on the credit book given where we are in the rate cycle? Or do you foresee still being in that short and intermediate term?

[Laurence Penn, executive]

Yes. I think non-QM retained tranches, there are BP subordinated tranches that we retain that are long, but there's also excess IO that's quite short in duration. Then as you mentioned, the other products are shorter duration products with turnover fast, a lot of principal repayments, whether it's RTL, bridge loans, et cetera. I think all those things being equal, I think we like to stay shorter in duration. But we're not afraid like, look, in the reverse mortgage space, that's really long duration. Our retained tranche is there. I think it depends.

[Matthew Howlett, analyst]

You're picking up great yields. Can you quantify what you could call securitization-wise next year? I mean, how much was the stuff issued? And I'm assuming if 2002, 2003, all the stuff issued back then could be called if rates move lower going forward.

[Laurence Penn, executive]

Yes. I don't have that at my fingertips, sorry. But you're right, there's going to be some deals that are going to past the lockup period at some point. I don't have that.

[Mark Tecotzky, executive]

And when we put out our Q early next week, it will have more information about the existing deals, and you can put the pieces together versus with what's outstanding and then what you can see from Bloomberg in terms of coupons on the remaining tranches.

[Laurence Penn, executive]

You did see Veris call a few deals a couple of weeks ago. Basically on the non-QM side, the rules are you can call it the earlier of 3 years or when the amount of loans in the deal by current face are less than 30% at deal closing. I think given the prepayment environment we've been in so far, what's going to come sooner is the 3-year date. Anything '22 and when we get to 2025, it's going to be anything '22 and earlier, you'll have the right to call them. Some of that activity.

[Matthew Howlett, analyst]

Some of those deals obviously had very low coupons on them.

[Laurence Penn, executive]

We have deals out there where the senior bond had a coupon below 1%. There are going to be some deals out there that got done with pretty high note rates that are going to get in the call window soon.

[Matthew Howlett, analyst]

It's upside. Clearly you guys have the option of doing it. If spreads remain tight, I'm assuming you'll look at a lot of these deals.

[Laurence Penn, executive]

To be fair, and when we do a deal, we know about the call. And depending on what the note rate is and what the forward curve is, we may ascribe some value to it. We discount that value at a really high discount rate. But so we take it into account. It's not like 100% found money, but we've called a bunch of deals in the past. And when we have, it's been certainly a profitable event.

[Matthew Howlett, analyst]

Last question is, I've covered Ellington for a long time. And the company, as it evolves, it's growing, these originators, these stakes and originators are all growing. And of course, you have Longbridge. Just to clarify, Longbridge it's consolidated on the balance sheet. There's no mark-to-market fair value on Longbridge versus Amerisure and the others.

[Mark Tecotzky, executive]

Yes, we mark-to-market the assets that are consolidated on the balance sheet. We fair value those loans like we fair value everything else. But yes, that's right. There's no equity value to the originator explicitly on the balance sheet.

[Matthew Howlett, analyst]

My question for the shareholders, I mean the book, I know you update the 1366 book. But I mean, when you start to think about the potential value of something like Longbridge or even your other originators and you look at these other originators, Rocket, Penny, trading way above reported book. And as these businesses grow, I'm assuming they're going to continue to grow here. I mean, what can you tell investors to EFC is sort of the 1366, we're different than the books we've given you over the last decade because we have embedded value in these stakes that might be worth a lot more in a public or private valuation setting. I just would love to hear your comments on how investors should look at something like Longbridge.

[Laurence Penn, executive]

I think if you look just even recently, like I mentioned earlier that Longbridge had negative ADE in the first quarter of this year. I think we need to put up some stability there. And like I said before, there's great signs that if we're not there yet, we're heading there soon. But you're absolutely right that it would be great. And I think once we can achieve that stability where you can say, ok, and this is really, frankly, more your expertise than ours and more your job than ours, but you would say, there's chunk of this company that should be trading at a multiple of earnings, not a percentage of book value. I think, what you're getting at. I agree with that 100%. And we said that right now, our capital allocation, I said earlier, our capital allocation longer is 12%. Even a high multiple on 12% of the company can have a meaningful impact in where you trade overall. But look, I think for now, it's about covering the dividend and our ADE covered the dividend in the third quarter. I feel good about it.

[Mark Tecotzky, executive]

I think underscoring the point, we talked about $0.09 as kind of a stabilized maybe run rate or target on numbers, that's a lot more than 12% of our dividend. 12% of capital. That's 23% of our $0.39 dividend.

[Matthew Howlett, analyst]

I'm assuming all entities are hiring and all originators are all hiring now. I'm assuming you guys are in growth mode for all these stakes you have.

[Laurence Penn, executive]

Yes. Everybody is trying to be more efficient. I don't know that we're necessarily at our originator, whether it's ones that we own stakes in or the ones that we don't or Longbridge, obviously, which is part of us. I don't know if you're going to see massive hiring at this point. I think everybody has been able to, over the past few years, just get a lot more efficient after the rates spiked in 2022. I don't think you're necessarily going to see a huge amount of hiring there. But you might see some, especially as product lines increase, things like that.

[Operator]

That was our final question for today. We thank you for participating in the Ellington Financial Third Quarter 2024 Earnings Conference Call. You may disconnect your line at this time, and have a wonderful day.