Ellington Financial Inc (EFC) 2011 Q1 法說會逐字稿

Good Morning, ladies and gentlemen, thank you for standing by. Welcome to the Ellington Financial first quarter 2011 financial results conference call. During today's presentation, all parties will be in a listen only mode. Following the presentation, the conference will be open for questions.

(Operators Instructions)

This conference is being recorded today, May 10th. And I would now like to turn the conference over to your host Ellington Financial Vice President, Neha Mathur. Please go ahead.

Thank you, operator. Good morning all and welcome to our first quarter of 2011 Ellington Financial Earnings Conference Call. I am Neha Mathur, Vice President of Ellington Financial. Before we start I would like to read the following cautionary statement.

Certain statements made during this conference call may constitute forward-looking statements within the meaning of the safe harbor positions of the private security litigations reform act of 1995. Forwarding-looking statements are not historical in nature and can be identified by words such as anticipate, estimate, may, will, should, expect, believe, intend, seek, plan, and similar expressions, or their negative forms, or by references to strategies, plans or intentions.

Forward-looking statements are subject to a variety of risks and uncertainties that could cause the company's actual results to differ from its belief, expectations, estimates and projections.

Consequently, you should not rely on these forward-looking statements as predictions of future events. Factors that could cause the company's actual results to differ from its beliefs, expectations, estimates, and projections include, among other things, the risks described under item 1A of our annual report on form 10-K, filed on March 16, 2011, which can be accessed through the company's website at www.ellingtonfinancial.com or the SEC's website at www.sec.gov.

Other risks, uncertainties, and factors that could cause actual results to differ materially from those projected may be described from time to time in reports the company files for the SEC including reports on form 10-Q, 10-K and 8-K.

We further caution you that the 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.

Okay, with me on the call today are, Larry Penn, Chief Executive Officer of Ellington Financial, Mark Tecotzky, our Co-Chief Investment Officer, and Lisa Mumford, our Chief Financial Officer.

First we would like to provide some prepared remarks highlighting the events of the quarter and then we will be happy to answer any questions that you may have. We issued an earnings release yesterday, which covers several relevant performance statistics for the quarter as well as some information on our portfolio.

To better follow this call it would be very helpful to have the earnings release with you. You can access the release on our website and we will be going over several details of that release on this call. With that I will turn it over to Larry Penn.

Thanks Neha. It is our pleasure to speak with shareholders again this morning, as we release our 2011 first quarter results. And we all appreciate you taking the time to participate on the call today.

Our net-asset-based total return for the first quarter was 2.64% and since our inception in August 2007, we have achieved a net-asset-based total return of 59%. We are pleased to deliver those returns to those investors, while offering something unique in this space - upside potential through experienced management and sophisticated analytics in a distressed asset class with compelling value, but combined with downside protection thanks to our flexible structure and focus on risk management.

During the first quarter we saw some very interesting developments in the non-Agency RMBS sector, which as you know, is where we deploy most of our capital. We actually saw some quite divergent returns among several RMBS sub sectors as some of the riskier 2006 and 2007 vintage distressed sectors--which we have tended to avoid in favor of more seasoned distressed sectors--underperformed significantly.

As you may have heard, another source of significant non-Agency RMBS supply has just started to hit the market since the first quarter ended, in that the Federal Reserve has begun selling its $31 billion Maiden Lane II portfolio of non-Agency RMBS that it inherited from AIG; to date, almost 20% of the total current face of this portfolio is traded. The ongoing supply from this portfolio is very exciting for us and presents tremendous opportunities in sectors of the mortgage market that we have previously avoided, by and large, but that we can now reconsider at much more attractive entry points.

But even without the Federal Reserve's planned selling, we are still seeing hundreds of millions of dollars worth of securities in for the bid per day on average, and opportunities remain plentiful.

We increased our leverage in the last quarter and you will see we increased it modestly again this quarter. Our debt-to-equity ratio went from 1.93 at December 31, 2010 to 2.29 at March 31, 2011. With the financial environment continuing to improve we expect to continue increased leverage in the near term. We have been disciplined in leaving dry powder to increase our asset base, and the new opportunities we are seeing should reward our patience.

On our last call, we announced the hiring of Leo Huang as Portfolio Manager for commercial real estate debt investments and Ellington has hired additional staff in Leo's area since then. This has had an immediate impact, as you will see on the Bond Portfolio table on page three of our earnings release, where our CMBS and commercial mortgage loan investments have increased to about 5% of our total long non-Agency MBS as of March 31, 2011.

Let me direct you for a moment to our earnings attribution table on page two of our earnings release, where you will see that in our non-Agency RMBS strategy we were again profitable in the quarter both on the investment side and on the derivative side, including both credit derivatives and interest rate hedges.

In our non-Agency RMBS strategy, realized and unrealized gains on these investments contributed $0.30 a share to earnings, while gains on interest rate hedges and credit derivatives contributed $0.10 a share combined. This was possible because the non-Agency RMBS market is still fundamentally a distressed and inefficient market and Ellington has the infrastructure and experience to capture relative value through trading across different asset classes, sectors, vintages and structures.

Now I would like to say a brief word about our dividend policy. As you know, our present intention is to pay a quarterly and special dividends so that at least approximately 100% of the company's net income each calendar year is distributed prior to April of the subsequent calendar year.

In March, we not only paid out our $0.81 of fourth quarter 2010 earnings per share, but we also paid out the remainder of our 2010 earnings that had remained undistributed going into the fourth quarter- that was a total dividend of $1.31 per share. Yesterday, our Board of Directors declared a first quarter 2011 dividend of $0.40 per common share, payable on June 15, 2011 to holders of record on June 1, 2011. This dividend reflects a level that management currently believes is conservative relative to the company's long-term earnings prospects. Management expects to continue to recommend dividends of $0.40 per share each quarter, together with any potential special dividends to be declared following the end of each fiscal year as may be necessary to meet the companies targeted 100% payout ratio.

We are hopeful that this incremental level of consistency in our dividends will be helpful to our shareholders going forward. And now I will turn it over to Lisa to discuss some of the financial highlights of the first quarter.

Thank you Larry and good morning everyone. As Larry mentioned for the first quarter we earned $11.1 million or $0.66 per diluted share. After adjusting for the impact of the $1.31 per share fourth quarter dividend that we paid in March 2011, our book value grew 3% to approximately $393 million. As a reminder, all of our operating results flow through our P&L including the mark-to-market on our investments and derivative holdings.

Our non-Agency portfolio, our primary strategy, contributed over 90% of our total non-Agency and Agency MBS income. You can see from our earnings attribution table on the second page of the earnings release, that from our non-Agency portfolio we had realized gains of just over $5 million compared to approximately $2.3 million for the fourth quarter of 2010.

Non-Agencies generally experience a run-up in prices during January and February. We thought this run-up was overdone and we were able to take advantage by selling some of our holdings at attractive prices, thus contributing to our returns.

We began investing in Agency IO's during the quarter. These instruments not only serve to provide protection against interest rate and prepayment risk in our Agency portfolio but also provide yield. We may, over the near term, increase modestly our holdings of Agency IO's.

The average yield on our non-Agency RMBS holdings declined this quarter as the sectors we have tended to favor have continued to perform well and as we continue to turn over the portfolio.

The average cost on our non-Agency RMBS increased about four points since the end of 2010 and we are seeing yields on new purchases of our typical seasoned subprime RMBS investments, averaging in the range of about 7% to 8%.

That being said, given the technicals that have developed in the more troubled sectors like 2006 and 2007 subprime--we expect that we will have opportunities to be able to increase our yield on the portfolio in the near future. On the Agency RMBS side of our portfolio, yields increased given the decline in prepayment speeds over the quarter. We continue to focus our Agency RMBS investments on 30-year fixed rate pass-throughs that we believe are better insulated against prepayment increases.

The climate for borrowing continues to improve as evidenced by the decline in our average cost of funds but the lengthening in average remaining term under our reverse repurchase agreements, relative to last quarter. Currently, our reverse repos covering our Agency portfolio are generally executed with original terms of 180 days, while our reverse repos financing our non-Agency portfolio are generally executed with 90 day original term. This compares favorably to just one year ago.

This improving climate for borrowing led us to modestly increase our use of leverage during the quarter as Larry mentioned. While our total leverage ratio is 2.3x to 1, that still puts the market value of our entire non-Agency RMBS portfolio-at around $372 million-below our roughly $400 million capital base, showing that we still have significant buying power in our most important asset class. With that I will turn the presentation over to Mark.

Thank you Lisa. This quarter, on the asset side, we maintained portfolio concentrations in many of the same asset classes we have liked in prior quarters. At the end of the first quarter we had a substantial long position in seasoned subprime RMBS, with the rest of our long portfolio spread mostly across manufactured housing, senior Alt-A/Jumbo MBS and smaller position in PrimeX than we have had in previous quarters.

As opposed to some of the ABX indices we use as credit hedges in our portfolio, we've liked PrimeX as a long investment and provider of carry. We reduced much of the PrimeX position during the quarter as PrimeX increased substantially in price and we begun to see greater value in other sectors of the market.

During the quarter, we made money again on our non-Agency portfolio derivative positions. Our portfolio of non-Agency securities performed extremely well relative to the broader markets during the quarter. Our senior Alt-A and subprime bonds in our portfolio were strong performers again as was our seasoned manufactured housing.

The Fed's selling of the Maiden Lane II portfolio, inherited from AIG, which started during the first week of April, has lowered prices in many of the 2006 and 2007 weaker Alt-A and subprime securities.

At the end of the first quarter there was very little overlap between the sectors of the non-Agency market in the EFC portfolio and what the Fed is selling. The supply from the Fed is welcome news for us. It is pushing down prices in a sector where we don't have much exposure, thereby creating new opportunities for us without hurting our book value.

As Larry mentioned, we have seen yields come down a bit in the portfolio. Yield on a typical non-Agency bond in our portfolio is now about 8.8%. In response to very favorable financing terms and our constructive view on future long-term price levels for our holdings, we have modestly increased our leverage, which has helped to offset some of the yield drop. Going forward we are very hopeful that some of this new supply from the Fed will trade at prices that help augment our yield.

We are very excited right now about the opportunities for EFC in the non-Agency space as the result of the Fed selling the Maiden Lane portfolio. We have participated in the lists and there are two more lists this week. But we are still only in about the third inning of the Maiden Lane liquidation. The first few lists traded extremely well and many of the investment banks were initially very anxious to participate in this very high profile piece of business.

It has been a different story on the last few lists. Prices have come down and in some cases, securities have traded in the 60's in the third and fourth quarter of last year are now down 8 to 10 points in price. That is a 10% to 15% decline, and that is in the face of better delinquency data. That bulk of the securities up for sale, as Larry mentioned, are different from what we have previously focused on. We have tended to buy seasoned RMBS where borrowers have equity in their homes and have performed on their mortgages consistently over time.

The sectors we owned performed very well in the quarter but now we are starting to find some value in more of the delinquent securities coming out of Maiden Lane, either on an outright basis or on a relative value basis versus the ABX indices. We continue to focus closely on these sales as it presents a tremendous opportunity for us right now and we are excited to put some of our capital to work here.

And it is not just the Fed selling. As we discussed on previous calls, we have seen opportunities come from the impact of Basel III. We have seen banks taking action in the non-Agency RMBS market in an effort to improve their capital ratios. Many banks may want to sell non-Agency RMBS securities or buy protection on them as they continue to adjust to Basel III, and because our structure allows us to trade actively and make use of credit hedges opportunistically, this creates an opportunity for EFC.

One of the side effects of the Maiden Lane selling and the very public declaration from the Fed about the size of their portfolio and their intention to liquidate it, has been to cause other large holders of similar securities to also sell, perhaps trying to get in front of the Fed. So the supply and demand technicals for certain sectors in the non-Agency market have moved squarely in favor of the buyers. The fundaments are less clear though.

Housing prices have resumed their decline, a scenario we had considered likely, but the rate at which current borrowers are going delinquent has shown tremendous improvement. These mixed signals make our large research effort very important and it makes the ability to layer on hedges opportunistically important as well.

On the Agency side, it was a similar story, as the biggest seller was the government. The Treasury announced in March that they will be selling their $142 billion Agency pass-through portfolio over time at a rate of about $10 billion per month, contributing even more supply to the already-in-progress GSE portfolio liquidations.

Just since the first quarter of last year, the GSE and Fed Agency pass-through portfolios have shrunk by over $280 billion in MBS. This additional supply will help us to be extremely selective in our purchases of Agency RMBS. Thank you and with that I will turn it back over to Larry.

Thanks Mark. This concludes our prepared remarks. Before we open the call up for q-and-a, I would like to remind everyone that as usual, we will be happy to respond to your questions to the extent they are directed to matters related specifically to Ellington Financial or more generally to the mortgage and asset-backed market place in which it operates. We will not be responding to questions on Ellington private funds and other activity.

Also as you may have just seen, we released an estimate of our April month-end book value per share. While we are happy to discuss overall market events and trends, as usual we will not be answering any questions concerning Ellington's financial performance or portfolio composition beyond the period covered by yesterday's earning release, namely March 31, 2011. Operator?

(Operators Instructions)

Our first question comes from the line of Michael Diana with Cantor Fitzgerald. Please go ahead.

Hello, it sounds like, just to confirm, Maiden Lane you don't need to buy part of the Maiden Lane portfolio in order to benefit here because of the spill over effect that this is having on the whole market. And then secondly, what sort of loss-adjusted yields do you think you are looking at based on the Maiden Lane activity on those sectors?

Yes, this is Mark. You are exactly right. We have bought from Maiden Lane lists, we also have securities that look like what is in Maiden Lane but have come from other sellers. We have seen a big price drop in the kinds of sectors that are represented by Maiden Lane. The thing about Maiden Lane is that it is a very undiversified portfolio. It is mostly 2006, 2007 vintage subprime and newer vintage Alt-A and generally very weak-performing stuff.

So, the last purchase from Maiden Lane, I think loss-adjusted yields we are going to be getting are somewhere around 9% to 10%. That is a big-pick up in yields from where our models thought those securities were trading in the first quarter. As I mentioned before, we have seen some of the bonds coming out of Maiden Lane, coming out and trading at prices, you know, 7 points to 8 points below where they had traded the second half of last year.

Okay, great, thank you.

Thank you and our next question comes from the line of Steve Delaney of JMP Securities, go ahead.

Thank you, good morning everyone. I had a question about the new CMBS segment that you are moving into with hiring Leo. Could you talk a little bit about, I think you mentioned 5% current allocation, sort of where you see that going as, sort of a range as a percentage of the portfolio. Where in the capital stack that you are focused and with the unlevered and levered returns that you are looking for there?

Sure, I think that, as you mentioned, right now it is about 5% of the portfolio and less than 5% of our capital, since as Lisa mentioned the size of our non-Agency portfolio is below our capital base. So we will have dry powder. I think we are at 5% right now and looking to go potentially as high as 10%. One thing that is going on right now is that, just like in a lot of the other sectors, there has been a lot of movement in spreads and there has also been in contrast to the residential market, there has been some new issue activity as well. So one thing that we have done already is purchase some new issue securities and in some cases have been able to sell those at a substantial profit.

So this just gives us another tool to take advantage of all this volatility in spreads and inefficiencies that we are seeing in the market. When and if, and it will come back eventually, the residential securitization market comes back, that will create other opportunities for us as well there, although for now, it's all really secondary activity pretty much in residential.

So I can see us going up to 10% of the portfolio and it is going to move around a bit because we do actively trade and spreads are moving around a lot. And we are seeing yields, even though we are lower on the capital stack there, than we are on residentials. We are making what we believe are solid investments and we are seeing yields that are approaching double digits on those investments as well. Go ahead Mark.

Yes, I want to say that it is a different strategy than what we are doing in the non-Agency RMBS. In the non-Agency RMBS for the last couple of years by and large, we have thought the best value has been in buying the most senior class of the deals. We have generally bought the most senior bond of the deal-stuff that was originally AAA, but that's now trading at distressed prices. In CMBS, especially on the new issue side, where you are seeing lower LTVs, you are seeing very strict underwriting. We have found some value participating lower down on the capital structure. And we have also found some value in some of the legacy commercial real-estate CDOs.

Okay. Got it. So you are involved in the CMBS 2.0 but also looking at the legacy stuff as well.

Yes.

But the legacy stuff, I can tell from your dollar price of $0.84 you are not focused on super seniors really?

Yes, the A-4s where they trade now to get the sort of return that we want for this vehicle would require more leverage than we would be comfortable putting on in that sector.

Great and just one final thing, guys. We are hearing out there at the JMP conference this week on the Agency side, people are talking about doing repo rolls late last week for 30-days at 20 basis points. I was just wondering if on the non-Agency side, I know you don't do a lot of leverage there but have you seen signs where your borrowing costs are improving? Is there a spillover benefit to non-Agency funding from what we are seeing in Agency?

I think our non-Agency funding has improved a little bit. It seems as though every month counterparties are more willing to put securities on. They are willing to go out a little bit longer in term. The rate comes in a little bit. What happens in the Agency market with these assessment fees with, sort of like, literally overnight it causes almost like a step function drop in the repo rates. For treasuries, Agency securities came down like 5 basis points to 10 basis points overnight. So, you didn't see that dramatic over night drop on the non-Agency market but financing continues to get better and get more stable on the non-Agency side.

Okay, thanks a lot, appreciate the color.

(Operator Instructions)

There appear to be no more questions at this time, I would like to turn the floor back to Larry Penn for any closing comments.

All right, thanks operator and thanks everyone for joining us this morning and we will see you next quarter.

This concludes today's Ellington Financial first quarter 2011 financial results conference call. You may now disconnect.