Ellington Financial Inc (EFC) 2011 Q2 法說會逐字稿

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

(Operator Instructions)

This conference call is being recorded today, August 9. I would now like to turn the conference call over to your host, Ellington Financial's Vice President, Neha Mathur. Please go ahead.

Thank you operator. Good morning all, welcome to our second quarter 2011 Ellington Financial earnings call. I'm Neha Mathur, Vice President of Ellington Financial. Before we start, I'd like to read the following cautionary statements. Certain statements made during this conference call may constitute forward-looking statements within the meeting of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.

Forward-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 strategy, 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 beliefs, 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 10K filed on March 15, 2011, which can be accessed through the Company's Web site at www.ellingtonfiancial.com, or the SEC's Web site 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 with the SEC, including reports on forms 10Q, 10K and 8K.

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 obligations to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

Let's get started. With me today on the call are -- Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, our Co-Chief Investment Officer; Michael Vranos, our other Co-Chief Investment Officer; and Lisa Mumford, our Chief Financial Officer.

First, we'd like to provide some prepared remarks highlighting the events of the quarter, and then we'd be happy to answer any questions 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 the call, it'd be very helpful to have the earnings release with you. You can access the release on our Web site, and we'll be going over several details of that release on this call. Thank you. And with that, I'll turn it over to Larry Penn.

Thanks Neha. It's our pleasure to speak with our shareholders this morning as we release our 2011 second quarter results, and we all appreciate your taking the time to participate on the call today. The RMBS market has been as volatile as any market lately, and with volatility comes opportunity. We kept our leverage low and we've been extremely disciplined and patient in picking our spots.

As a result of all the uncertainty surrounding raising the Federal debt ceiling, the grave concerns about European sovereign debt and the solvency of the European banking system, fears of a double dip recession, and finally the downgrading of US treasury and the plunge in global equity prices, we are now in the midst of a mini financial panic.

Nevertheless, our net-asset-based-total-return for the quarter remained stable and was down 0.37%. Our free cash and liquidity remained high, and we're in a great position to take advantage of distressed selling. During the second quarter, the RMBS market tried -- unsuccessfully -- to absorb the full series of Maiden Lane II sales by the Federal Reserve, which led the Federal Reserve to discontinue those sales, at least for the time being.

There were other large financial institutions that continued their significant selling as well, most notably banks adapting to their more stringent regulatory capital requirements. To give you an idea of the kind of volatility we've seen in non-Agency RMBS, the ABX 2006-2 AAA, an index of 20 subprime securities, that we've often used as a hedge, started the quarter at the price of 58.5, dropped below 47 in June (to levels that we haven't seen since the first quarter of 2010) then traded back up to almost 55 in July, and has since traded below 45.

Keep in mind that this index reflects the prices of typical 2006-issued senior subprime securities, and that on a percentage basis, these moves reflect a high-to-low trading range for the quarter of over 20%. With prices down, we're seeing loss-adjusted yields on many non-Agency sectors in the 9% to 11% range, which is creating a great entry point for us to put capital to work.

With many non-Agency RMBS sectors down 10% to 20% or more in price, our portfolio of credit hedges served us well as we were able to protect against declines in our non-Agency RMBS portfolio, something that differentiates us from our REIT peers.

Our PTP structure, combined with very diligent security selection, made it possible for us to report stable and solid results for the quarter, a quarter where the asset class as a whole had extremely poor price performance.

There's a lot of pain out there in non-Agency RMBS, much of which may not be fully reflected in what's been publicly reported thus far. We haven't seen any truly distressed selling yet, but as we all know, sometimes market paralysis precedes distressed selling.

With our current liquidity position, we would view distressed selling as creating long-term opportunities. As we've been emphasizing recently, Ellington Financial has, for some time now, focused on non-Agency RMBS investments in securities with more seasoned, by that, pre-2006, 2007 collateral where borrowers have equity in their homes.

In the second quarter, we began a rotation into some 2006 and 2007 vintage distressed sectors, after seeing lower prices and improved credit performance. Mark will elaborate on this a bit later on the call.

Let me direct you for a moment to our earnings attribution table on page two of our earnings release, and specifically to the first section of the table covering non-Agency MBS and Mortgage Loans, which as you know, are the assets that are the primary drivers of the Company's earnings. I'd like to point out exactly how the credit hedges that we employ, together with a sizeable net interest margin on our non-agency MBS, insulated our portfolio from the kind of extreme market moves we've seen.

You can see that, on this portfolio, we had around $8 million of interest income and another $8 million of credit hedging income. This, combined $16 million of income, almost exactly offset approximately $14 million of realized and unrealized asset losses and $2 million of interest rate hedging losses. Lisa will elaborate a bit later.

As you may have seen on our press release, our Board of Directors declared a second quarter 2011 dividend of $0.40 per common share payable on September 15 to holders of record on September 1. Management expects to continue to recommend dividend of $0.40 per share each quarter, together with any potential special dividend to be declared following the end of the fiscal year as maybe necessary to meet the Company's targeted 100% payout ratio.

Finally, I'd like to discuss our announcement of the commencement of a stock repurchase program. The decision to initiate this program was not taken lightly. We realize that the many benefits of increasing our capital base over time, while repurchasing stock, will decrease our capital base slightly.

The current investment opportunities to deploy the Company's ample cash reserves are, as I've discussed and as Mark will discuss later, as good as we've seen for over a year. Nevertheless, we believe that this is the right time to establish a share repurchase program.

We feel that as a company, we have shown ourselves to be extremely disciplined in our decisions to issue or repurchase stock in the past. Going forward, while we plan to continue to tap into our considerable free liquidity to take advantage of the exciting investment opportunities that are developing, we believe that the adoption of the share repurchase program is more than warranted so as to allow a modest portion of the Company's ample free cash to become available to repurchase shares at a significant discount to book value. And now, I'll turn it over to Lisa to discuss some of the financial highlights of the second quarter.

Thank you, Larry and good morning everyone. As you can see in our earnings release for the quarter ended June 30, 2011, we reported a net loss in the amount of $1.3 million or $0.08 per share. Our income statement includes the full impact of all of our mark-to-market adjustments on our investment and derivative portfolios.

Our book value on a diluted basis at the end of June was $22.78. At the end of March, our diluted book value was $23.26. Adjusted for the $0.40 per share first quarter dividend paid in June, March diluted book value was $22.86 meaning that the change in our book value related to operations, excluding this dividend, was a decrease of 0.37% quarter over quarter representing a small decline in an economic environment otherwise marked by significant volatility.

I'd like to give a bit more detail on the earnings attribution table that Larry referenced, included on page two of our earnings release. On the first section of the table covering non-Agency RMBS and Mortgage Loans, you can see that our non-Agency strategy recognized overall loss of about $900,000 or $0.05 per share, a level that we are pleased with, given the level of volatility this quarter.

As Larry mentioned, our net realized and unrealized losses for the quarter in non-Agency totaled $13.8 million or $0.82 per share. Breaking that $13.8 million figure down a bit more, we actually generated realized gains of $3.5 million or $0.20 per share on our non-Agency portfolio, but this was more than offset by recognition of $17.3 million of unrealized losses on this portfolio or $1.02 per share. As I also mentioned, non-Agency RMBS valuations were down as much as 20% or more in certain sectors of the market. However, as a result of our more conservative security selection, with a focus on seasoned securities, the $17.3 million of unrealized losses for the quarter represented an average unrealized loss of only 4.7% of our $370-odd million in average non-Agency holdings for the quarter, substantially better than the typical non-Agency asset.

Meanwhile, our credit derivatives buffered the impact of our non-Agency investment valuation losses by adding $8.2 million or $0.49 per share to our quarter results. Our credit derivatives are mainly comprised of purchased credit protection through credit default swaps on ABX indices, primarily vintage years 2006 and 2007, together with purchased credit protection through credit default swaps on single name ABS securities. The $3.5 million of realized gains on the non-Agency portfolio also shows the benefits of our active portfolio trading style.

Our Agency holdings performed well, with prices firming over the quarter. However, the drop in interest rates swaps caused declines in the value of our interest rate hedges.

From our holdings table on page three of the earnings release, we can see that we reduced our holdings of Agency RMBS. This reflects the superior opportunities that we are seeing in the non-Agency RMBS sector and the related reallocation from Agency RMBS to non-Agency RMBS.

The average yield on our portfolio, net of our cost of borrowings, was essentially unchanged quarter over quarter. In the non-Agency RMBS sector, as Larry mentioned, we are currently seeing very attractive yields on new purchases, higher than we've seen in some time.

In July, we've seen new purchase yields per senior (although still distressed securities) still as high as 11% on a loss-adjusted basis.

In the second quarter, we continued to borrow under our repo lines at attractive rates and terms. In the aftermath of the debt ceiling crisis in Washington and the ongoing credit ratings review by each of the major credit rating agencies, which culminated in the reaffirmation of the US credit rating at AAA by Moody's and Fitch, but a downgrade by S&P, some market participants have expressed concern about the availability of repo lines and increases in the cost of repo borrowing.

So far, none of our repo lines have been negatively impacted in the wake of these events. In fact, we are in discussions to expand the number of repo counterparties with whom we transact. Lastly, our leverage ratio dropped at the end of June to [2.08] (corrected by company after the call) to 1 compared to 2.29 to 1 at the end of March. This drop is tied to our redeployment of capital to the non-Agency strategy. I will now turn the presentation over to Mark.

Thanks Lisa. This quarter on the asset side, we maintained portfolio concentrations in many of the same asset classes we've liked in prior quarters. At the end of the first quarter, we had a substantial long position of seasoned subprime and the rest of our long portfolio is spread across manufactured housing, seasoned Alt-A and jumbo RMBS.

As Larry mentioned briefly, we also allocated some capital to some of the newer vintage, more delinquent sectors of the non-Agency mortgage market during the second quarter. We liked the pricing in those sectors, as those securities declined substantially over the quarter, and we also saw recent credit performance improve.

Throughout the almost four-year life of Ellington Financial, first a private company and now as a public company, our role as a manager has often oscillated between focusing on downside protection and focusing on capturing investment opportunities. This past quarter was one in which downside risk was substantial and required considerable focus.

Increased non-Agency RMBS supply, a weak housing market, uncertainty about servicer advances, and uncertainty about the frequency and magnitude of loan modifications, all combined to cause extensive price declines across much of the non-Agency markets.

The pain was not distributed uniformly though. Certain sectors in the market saw price declines in excess of 20% and certain sectors were relatively unscathed. So, both security selection and portfolio construction were critically important. Going into the quarter, our seasoned non-Agency RMBS portfolio generally had modest price declines because the investors demanded a higher yield in the face of greater non-Agency mortgage supply. In contrast, our views is that 2006/2007 vintage subprime dropped in price for two reasons. First, the investors demanded a higher yield in the face of greater supply, but secondly, underlying assumptions related to potentially lower servicer advancements, loan modifications and liquidation values changed cashflow expectations. These changing cashflow expectations caused the bulk of the decline in that sector, although as I mentioned, the underlying borrowers are actually performing better.

We've emerged from a tumultuous quarter with our book value virtually unharmed. As Larry mentioned, we now see a much more fertile investment landscape than we did at the start of the quarter. With the re-pricing of newer vintage subprime and Alt-As, we are able to diversify the long side of our portfolio and become more active in other sectors in the non-Agency markets. Additionally, we think political uncertainty about future housing policy creates potential positive return skew for our portfolio and for prospective investments. The past several weeks have seen a noticeable increase in political chatter about housing stimulus. For example, the Boxer plan refinancing bill, the Dorchuck plan to sell delinquent loans out of non-Agency RMBS trusts, and plans to have Fannie and Freddie convert foreclosed homes into rental properties, as opposed to some selling them as REO.

All these proposals face challenges, and we don't expect any of them to be adopted in the current form, but housing stimulus is part of the political dialog again, and the proposals we had reviewed seemed likely to be supportive of non-Agency pricing.

Additionally, since most of the mortgage origination market is still controlled by the government, credit availability is unchanged by recent market events and borrowing cost have come down. This is in sharp contrast with the commercial market, which is mostly dependent on private capital for financing. Thank you. And with that, I'll turn it back over to Larry.

Thanks, Mark. This concludes our prepared remarks. Before we open the call up for Q&A, I'd 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 either 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 in Ellington's private funds or other activities.

Also, as you may have seen this past Friday, we released an estimate of our July month-end book value per share. While we're happy to discuss overall market events and trends, as usual, we won't be answering any questions concerning Ellington Financial's performance or portfolio composition beyond the period covered by yesterday's earnings release, namely June 30, 2011. Operator?

Thank you sir. We will now begin the question and answer session.

(Operator instructions)

There appear to be no questions at this time. I would like to turn the conference back to Larry Penn.

Thank you operator. And thanks everyone for joining us this morning. Enjoy the rest of the summer.

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