Ellington Financial Inc (EFC) 2011 Q3 法說會逐字稿

Good morning Ladies and Gentlemen, thank you for standing by. Welcome to the Ellington Financial third 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's Instructions)

This conference call is being recorded today, November 8th. I would now like to turn the conference call over to our host, Ellington Financial Vice President, Neha Mathur. Please go ahead.

Thank you, Operator. Good morning, all. Welcome to our third quarter 2011, Ellington Financial earnings 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 provision of the Privacy Security Litigation Reform Act of 1995.

Forward-looking statements are not historical in nature and can be identified by words such as anticipate, estimate, may, well, 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 10-K filed on March 16th of this year, 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 can cause actual results to differ materially from those projected may be described from time to time in reports the Company filed with the SEC, including reports on forms 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.

With me today on the call are Larry Penn, Chief Executive Officer of Ellington Financial, Mark Tecotzky, our 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 would be happy to answer any questions that you may have.

We issued an earnings release yesterday following the close, covering several relevant performance statistics for the quarter, as well as some information on our portfolio. However, we also posted to our website an Investor Presentation which contains more in-depth information on our portfolio than we have previously published. We hope and expect that this presentation will make it easier for investors and analysts to follow our Company's portfolio and performance over time.

In the presentation you will find a great deal of detail on both our Agency and non-Agency long portfolios and details on our hedging portfolios and exposure, as well as additional disclosure on our current use of capital across the different strategies within the Company, as well as leverage within each strategy.

To better follow this call it would be very helpful to have the earnings release and the Investor Presentation with you. You can access these on our website and we'll be going over several details of both items on this call. Thank you and with that, I will turn it over to Larry Penn.

Thanks, Neha. It is our pleasure to speak with our shareholders this morning as we release our 2011 third quarter results. We all appreciate you taking the time to participate on the call today. There was no shortage of volatility this past quarter, as the market reacted to events as far-reaching as the downgrade of US Government debt and a sovereign debt crisis in Europe that threatens the integrity of the Euro and the very solvency of the European banking system. The S&P 500 dropped almost 15% for the quarter and interest rates plunged, with 10-year Treasury dropping below 2% for the first time in history.

In the securities market, non-Agency RMBS continued their steep decline that started in the second quarter, as illustrated by the 14% decline in the ABX 06-2 AAA over the course of the quarter. Ellington Financial was once again able to avoid significant book value declines, as our NAV-based total return for the quarter was only a modest 31 basis point decline. During periods of extreme volatility, many MBS buy-side investors often stay on the sidelines, but in this case we saw many large dealers pull back from the market as well, perhaps in anticipation of the implementation of the Volcker Rule. With the large dealers reluctant to add risk, it has become much easier for us to capture investment opportunities.

Given the sharp downward re-pricing we have seen in many non-Agency RMBS sectors, we have been actively trading and rotating our non-Agency portfolio. In fact, as of the end of the third quarter, a full 42% of our non-Agency long portfolio had been acquired only in the second and third quarters of this year. This speaks both the amount of portfolio turnover we have had and how compelling we believe the opportunities are right now.

Since our long positions, which had been concentrated in the more seasoned pre-2005 vintages, have not declined in price nearly as much as the newer vintage non-Agency RMBS, we have been aggressively selling these more seasoned higher-priced securities - a typical sale might take place around 80 cents on the dollar - and replacing them with newer vintage lower-priced securities - a typical purchase might take place at 30 to 50 cents on the dollar.

We are excited about these new investments as we continue to rotate our portfolio into lower-dollar-price, higher-yielding securities. We project double-digit yields - before leverage - on the bulk of the securities we have been adding. You can see the evolving sector rotation visually on slide three of our Investor Presentation, at least through September 30th, and on slide four of the Investor Presentation you can see our estimates of the yields on the various sectors of our non-Agency portfolio as of September 30th.

Now, the significant drop in the newer vintage subprime RMBS prices has not only had a significant impact on the long side of the portfolio, where for the first time in a while we have been aggressively adding newer vintage securities, but it has also had a significant impact on the short side of the portfolio.

From a Profit and Loss standpoint, our short ABX and other short credit positions have been highly profitable for the company both this quarter and year-to-date, as can be seen by looking at page two of our earnings release on the Earnings Attribution table. In fact, in that table you will see that credit hedges completely insulated losses on the long non-Agency portfolio. However by quarter end, for the same reasons that we are adding newer vintage securities on the long side of the portfolio, we have decided that it was time to start cutting back our short positions in newer-vintage MBS, particularly those tied to the ABX indices.

Specifically, we are shifting some of our ABX credit hedges to certain corporate instruments. We believe that these new corporate hedges, although perhaps less correlated to our long MBS assets and therefore apt to create some additional month-to-month volatility in our earnings, will nevertheless serve as valuable, long-term protection on our long MBS portfolio.

To be a bit more precise, we believe that some of the corporate instruments that we are short will see less price appreciation than ABX if overall credit spreads tighten and that is good on a short position, but we will see more price depreciation than ABX if overall credit spreads widen. Again, good for a short position.

With security prices as low as they are, and with our portfolio leverage still moderate and our liquidity levels high, we believe that we are currently very well positioned to take advantage of the current distressed state of the MBS market. While prices are not as distressed as they were in early 2009 the underlying mortgage loans are actually finally performing better on a fundamental basis.

If non-Agency RMBS prices recover quickly, as they did in the course of 2009, we would hope to see healthy gains on our portfolio and therefore strong short-term earnings. However, even if non-Agency RMBS prices don't recover quickly, we are building a non-Agency portfolio that we believe should generate solid double-digit yields, before leverage, for several years to come on a hold-to-maturity basis, and therefore be the foundation for strong long-term earnings.

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

The chart of slide 15 of the Investor Presentation should be helpful in analyzing the company's earnings and dividends paid through September 30, 2011. Now, I will turn it over to Lisa to discuss some of the financial highlights of the third quarter.

Thank you Larry, good morning everyone. As you can see on our earnings release for the quarter ended September 30, 2011, we reported a net loss in the amount of $1.2 million or $0.07 per share. This was an almost repeat of the second quarter and once again interest income and net realized and unrealized gains from our credit hedges combined to more than offset the impact of valuation declines on our non-Agency portfolio.

You will recall that our income statement includes the full impact of all of our mark-to-market adjustments on our investment and derivative portfolios. We ended the quarter with diluted book value of $22.32 per share, which is down $0.06 per share from the end of the second quarter, after adjusting for our second quarter dividend of $0.40 per share that was paid during the third quarter.

In spite of the continuing challenging market conditions, we continue to be successful in preserving book value. We are happy to provide for you our Investor Presentation, and included in that presentation on page ten you can see the relative stability of our book value as compared to the ABX 2006-2 AAA index since our inception back in August of 2007. In our Earnings Attribution table included on page two of the earnings release, you can see that our non-Agency strategy generated gains for the quarter of $2.8 million - this is both realized and unrealized gains.

Interest income and net realized and unrealized gains from our credit hedges offset the impact of net valuation declines in our non-Agency holdings and interest rate hedges. Average non-Agency valuation declines in our portfolio, based on assets held, were approximately 3% for the quarter and combined with valuation declines in the second quarter, equate to approximately a 7% decline in the last six months. Comparatively, the ABX 2006-2 AAA was down approximately 27% for the same period.

From the end of the second quarter, on a net basis after all purchases and sales, we increased our non-Agency portfolio approximately $57.1 million based on amortized cost. We did this in part by reallocating a portion of our available capital that previously was invested in unfinanced Agency whole pools. Our Agency strategy generated a small net loss for the quarter. The steep drop in interest rates adversely impacted the value of our hedges and offset the income generated on our pools. For the year, however, that strategy has generated a positive return.

At quarter end our leverage stood at 2.35-to-one as compared to 2.08-to-one at the end of June. We mentioned at that time that we would be likely increasing our utilization of leverage. On slide 13 of the Investor Presentation, we show how our capital has been allocated across our four strategies for the past four quarters. And you can see that since the second quarter we have allocated capital away from the liquidity management strategy and into our non-Agency RMBS and Agency strategies.

Don't be confused by the decrease in leverage within each strategy. Since we have shifted capital from the unleveraged liquidity strategy to the leveraged non-Agency and MBS strategies, overall leverage has increased. You can also see that even after having shifted our capital allocations we are still left with considerable capital in our liquidity strategy. This gives us a great deal of flexibility in these very volatile times.

Lastly, I would just like to mention our dividend policy. As you know, for the 2011 year beginning with the first quarter dividend that was paid in June we have been paying quarterly dividends of $0.40 per share. With the recent announcement of our third quarter dividend that will be paid next month, that brings our total dividend for the three quarters of 2011 to $1.20 per share, which compares to our nine month EPS of $0.51. You can see this pictorially on slide 15 of the Investor Presentation as Larry mentioned.

Our intention continues to be to pay out, in dividends, approximately 100% of our earnings, so if and to the extent our earnings for the year exceeds the sum of our quarterly dividends of $0.40 per share, and based on our September 30, 2011 numbers it does not, we would intend to pay a special dividend above the fourth quarter dividend to bring the total payout to be approximately equal to net income.

Our intent is for our fourth quarter dividend, including any special dividend, to be paid in March 2012. Of course, the declaration and amount of future dividends remains in the discretion of the Board of Directors. With that I would like to 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 that we liked in prior quarters. At the end of the third quarter, we had a substantial long position, although smaller than in the previous quarter, in seasoned subprime RMBS, with much of the rest of our long portfolio spread across manufactured housing and senior Alt-A, Alt-B, and Jumbo MBS.

In direct contrast to our investment strategy at the start of the year, when we focused on very seasoned, very well credit enhanced securities, in the most recent quarter we have been spending our capital on 2005-2007 vintage subprime securities and Alt-B securities that often have no credit enhancement or very little credit enhancement relative to the delinquency pipeline. These securities are expected to take writedowns, but they trade at such low dollar prices, typically 30 to 50 cents on the dollar, that we believe that they offer very high expected returns. In fact, as of September 30, 2011, that sector of our non-Agency loan portfolio represents almost 25% of our total non-Agency long investments and you can see that on the breakout on page three of the Investor Presentation.

Much of the analysis for these sort of investments revolves around projecting liquidation values, liquidation timing and servicer behavior. We have favored investments where we believe we are buying pools of loans - some current, some delinquent - at a significant discount to the value of the underlying real estate. These investments expose our equity holders to some increased risks and potential rewards than what our other investments have exposed them to in the past. Specifically, our returns are now much more impacted by recovery values on delinquent homes.

By and large, these securities have projected yields of over 10%, assuming an additional 15% decline in home prices. These home price projections may prove to be over pessimistic, so we see a lot of potential yield upside in these securities.

I will also make a few comments on our Agency portfolio. This strategy has contributed to overall profits in most quarters. This particular quarter, the Agency strategy underperformed. Hand-in-hand with the weak environment for credit, this quarter we saw a substantial drop in interest rates and Agency mortgages widened relative to interest rate hedges.

However, after the close of third quarter and as you are probably aware, certain modifications were made to the government's HARP program. These changes are designed to help borrowers with high interest rate Agency mortgages and little or no equity in their homes, refinance into lower interest rate mortgage loans. So far, the proposed changes to HARP have been beneficial to the company's Agency mortgage strategy. Going into the announcement we had considerable holdings in high LTV, MHA pools that have increased in price significantly relative to our hedges since the announcement. MHA pools are newly issued pools where borrowers have participated in the Making Homes Affordable Program, and these new loans do not qualify for HARP, since they were issued after May 2009, the HARP cut-off date.

In choosing these types of prepayment protected pools, we believe we are well prepared to navigate the regulatory environment. You will see some additional detail on our Agency portfolio on slide seven and slide eight of the Investor Presentation.

So in summary, this was another quarter where our mandate really was to protect shareholder value. You may have seen many of our competitors take substantial hits to book value given how volatile the securities markets were. When making investments, we have what we believe are very conservative assumptions about home prices. Our "base case" scenario assumes home prices go down another 15% - if those assumptions prove to be overly conservative and home prices stay where they are or they go down less than our scenarios forecast, we could see yields on securities even higher than where we are buying them, according to our models.

On the short side of the portfolio, we were happy to see that our hedges have served us well and we successfully avoided considerable losses on the overall non-Agency strategy. Again, our expertise in selecting securities and in thoughtfully constructing the portfolio was critically important. Thank you, and with that I will turn it back over to Larry.

Thank you, Mark. Before we conclude our prepared remarks, I would like to mention two more matters, One industry-wide and one specific to Ellington Financial. First, in August, the SEC issued a concept release relating to the 3(c)5(C) exemption that many mortgage related companies, including most mortgage REITs as well as many non-REITs such as Ellington Financial, avail themselves of to avoid registering as an Investment Company under the Investment Company Act of 1940. In issuing its Concept Release, the SEC sought comments to help it better understand how and why companies use the 3(c)5(C) exemption, and whether any changes in the exemption were warranted.

While stock prices of companies in our industry that rely on the 3(c)5(C) exemption, including our own stock price, dropped considerably in response to the issuance of the Concept Release, we believe it is too early to speculate as to how-if at all-the SEC's actions might affect our company or the industry, and that it is way too early to change our strategy or take any preparatory action ourselves. The comment period for the Concept Release ended yesterday, and so far the industry and investor responses have been overwhelmingly supportive of maintaining and/or confirming the existing interpretation regarding the 3(c)5(C) exemption.

Second, as you may have seen, on Friday we filed a universal shelf registration statement covering up to an aggregate of $750 million of common shares, preferred shares, rights, warrants or debt securities. As is typical for companies in our space, we filed the shelf registration the first time we were eligible to, approximately one year following our IPO. The shelf registration, which has not yet become effective, is designed to provide the Company flexibility over the next three years to launch registered offerings of equity and debt securities quickly, if and when the Company's circumstances and market conditions warrant.

This concludes our prepared remarks. Before we open the call up for Q&A, I would like to remind everyone that as usual we will be happy to respond to your questions to the extent that they are directed to matters related either specifically to Ellington Financial, or more generally to the mortgage and asset-backed marketplace in which it operates. We will not be responding to questions on Ellington's private funds or other activities.

Also as you probably saw yesterday afternoon, we released an estimate of our October month-end book value per share along with our third quarter earnings. While we are happy to discuss overall market events and trends, as usual we will not be answering any questions covering Ellington Financial's performance or portfolio composition beyond the period covered by yesterday's earnings release, namely, September 30, 2011.

Operator?

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

(Operator's Instructions)

And our first question comes from the line of Steve DeLaney with JMP Securities. Please go ahead.

Thank you, good morning everyone. Larry you touched on this in your comments. You referred to the ABX the 2006-2. We were all watching these mortgage CDS over the third quarter, CNBC got all over it. I think some consultant put out a piece on PrimeX, they certainly seem to sell off more than the cash bonds. We have seen that in some of the reports, as far as the book value declines, didn't reflect some of the magnitude, as we saw in the CDS. I guess, if you could, just generally, your thoughts about that market. Whether it is a liquidity issue or are people really buying protection or are they speculating?

The issue is I guess, when you saw those price declines of 15% to 25%, whatever index we are speaking to. Did you see that, within Ellington, as reflecting fundamental changes in credit or is this technical somehow or other tied to what is going on in Europe? I would just appreciate your thoughts on the derivatives versus the cash.

Sure, we have been very active in PrimeX for a long period of time. I am going to let Mark handle this.

Hello, Steve. The first thing I would say is, price changes in ABX-which is the 2006, 2007 subprime depending upon the index, and there are last cash flow bonds, there are bonds that are current pay-but those changes in ABX I think were largely reflected in changes in cash bonds that were similar vintage and similar quality.

So we saw 2006, 2007 last cash flow subprime bonds have about the same percentage price change as ABX.

Okay.

Now in PrimeX, there was that blog that gets picked up that was talking about how PrimeX was going to be the next ABX, and PrimeX trades at a much higher dollar price than ABX. Depending on whether it is ARM 1 or Fixed 1, a lot of PrimeX indices were a few points above par, within five or six points of par. What made ABX such a profitable short in 2008 was the fact that it started at a very high dollar price. Right? It went from $100 down to in the $30s for the AAA's.

Right.

So a lot of people were saying that well, maybe this PrimeX index is going to be analogous, right? But, what has been going on in housing for the last two years, really, has been a little bit boring. If you look at Case Shiller, home prices haven't moved much in the last couple of years. When we data mine the rate at which current borrowers are going delinquent, it has improved some over the last two years, and let's say for the last six or seven months, it has been static. So a lot of the price volatility, I think, is coming from exogenous factors. There is uncertainty about what is going on in Europe and that uncertainty translates into the risk appetite of investors in the US. There is also some uncertainty about whether European banks are going to aggressively de-lever and if they do aggressively de-lever, are they going to have large portfolios of mortgage holdings they want to sell.

You know, you did see Dexia go though that in the earlier part of the year, they sold their portfolio. So the price volatility we saw in PrimeX, that was not, that magnitude of volatility we didn't see in prime securities. But PrimeX is pretty thinly traded. The open interest is small and a $25 million PrimeX trade is a relatively large trade. So the Arm 1's which is an index which we had a substantial holding in a lot of last year, that index just went from par to about $95, and when it was $95 a lot of people said it was going to get down to $90. Right now it is back up, it is right around par now. So that has been a lot more volatile than the underlying cash bonds. And there was a lot of concern in the marketplace that some of these big macro funds that had profitably traded the ABX indices in 2007 and 2008 were going to set their targets on PrimeX, but it didn't really happen.

The other difference about PrimeX is it has a much, much higher coupon than ABX does. The coupon is over 400 basis points per annum. The ABX stuff is all under 50 basis points per annum.

Yes, that is part--if you want to be short this thing, there is a pretty high implied cost of carry. Right?

Yes, there is a very high implied cost of carry. Just if you look at how PrimeX has been performing, the prepayments, the loss severities, the CDR's coming out of it. It hasn't been that volatile, right? So, if it is going to go back to fundamentals, you need to believe there is some catalyst that is really going to make the fundamentals change a lot. That expectation really isn't out there in the marketplace. But it could still move a lot, right? Some of these funds want to short it aggressively and they are not that price sensitive. It is thinly traded, as I mentioned before, primary dealers' risk appetite is way down.

With your portfolio flexibility, being a PTP, is that the type thing on relative value-looking at ARM 2 going down in the low $80s to mid $90s-is that the type of thing, when you see it selling off like that that you guys can step in actually go long?

Yes, we used to be long in a lot of PrimeX. We got out of it when it was well above par. On some of these dips, we did initiate small holdings of PrimeX. We recovered, we sold some of those holdings, we hung on to some. The fact that dealers' risk appetite is way down, it is double-edged sword for us. It makes liquidity worse but it makes valuation swings way more extreme, which I think is good for us.

You know the statistic Larry had about how much this portfolio turned over in the last couple quarters, we were able to do that because dealers really didn't get in the way in terms of positioning some of the bonds we thought offered really good value.

All right. Appreciate that color and just one final thing. I guess this is big picture. When you look at the market today, the sell-off we have had since June and speaking of the cash bonds, of course, on sort of the long side with your focus on the non-Agency more credit sensitive bonds. If you look at price levels, if you look at funding availability on repo, generally how do you view the opportunity you have right now versus the opportunity in the post-Lehman world in early 2009?

Funding is much, much better and much more reliable. With the shock we have been through, we haven't seen any material hiccups in funding, so funding is much better. The expected yields on the securities is, I think for most sectors, is lower than post Lehman, but the tail risk is much less. So, the environment, post Lehman all the shocks that we were worried about, most of them were coming from the mortgage market. You had Countrywide go under, Lehman go under, Fannie and Freddie were put into conservatorship, Bear went under. So the mortgage market was sort of the epicenter of the storm. Right now the shocks that concern us are much more exogenous, they are outside of the US. They are not focused on housing.

What we have seen out of housing is, generally speaking, all the policy initiatives we have seen take place out of Washington, or things they are contemplating, especially renting out REO as opposed to selling it - we think these sort of give us a positive return skew. So I think that yields are down a little bit post-Lehman, but there is a lot less uncertainty, there is a lot less tail risk and the funding is much more secure. So we are much more comfortable adding some leverage here.

As I said in the earnings release this is as attractive an entry point as we have seen. When you balance what you know and what we actually-obviously, we have a lot of history now and we have seen a lot of how borrowers and servicers have behaved. A lot of the stuff is baked in the cake, we just think that this is a very attractive entry point on balance, relative to and including early 2009.

Well, I appreciate that guys and thank you very much for the color.

Thank you and our next question comes from the line of Stephen Laws of Deutsche Bank. Please go ahead.

Hello guys, good morning. You have already touched on a couple things. I guess two quick questions. Can you talk about what unlevered yields are for the non-Agency RMBS you target today, versus say third quarter and even second quarter levels given your comments in the prepared remarks of 32% of that bucket being acquired at Q2 and Q3?

And then secondly, I know a few months ago you authorized the $10 million repurchase program. It looks like you were a little bit active in there but didn't repurchase a lot of stock. Can you talk a little bit about what is driving the repurchase decisions? Is it valuation driven, is it simply value, even given the discount to NAV it is not attractive as investment opportunities to take the investment portfolio? What would it take to make you more active in pushing that buy-back program?

Right, so two things. First of all, in terms of the yields we are seeing. By the way, I think I had mentioned it was 42%.

Oh, I am sorry, 42%.

Yes, not 32% in the last couple of quarters. So, as you can see on a blended basis, we believe our non-Agency portfolio, to look at page four of our presentation, now we are into double-digit yields and that is with--what we use as a standard. What we have been using as a standard, to evaluate securities, is assuming down 15% shock to home prices, but you can see that it is obviously enhanced quite a bit if home prices just stay where they are long-term.

But if you look at the bucket, the newer vintage bucket, most of that has been acquired recently. So, you can see there you are talking about either low double-digit 10%, 11% yield in that sort of standard case we run. And a good 200 to 300 basis points higher - depending upon the security. It can be even much higher than that, if there is leverage, in our flat scenario.

So, those are the types of opportunities we are seeing. We think that it is incredibly attractive. We think it is a great entry point. We think we have been patient throughout the year, keeping our leverage low and our powder dry and we think that, obviously, there are always risks. But we think that this is a great time to jump in and establish a position and I'm happy to say that is what we have been doing.

In terms of your second question, which was the share buy-backs. First of all, I can't get into too many details, but share buy-backs are going to be-we only started, obviously, mid-way into the third quarter and these things can take a while to get in place. There are restrictions in terms of blackout periods and what not, when the Company feels that it is basically more conservative not to be in the market. And there are other restrictions under 10b-18 in terms of buying restrictions. So there are a variety of reasons, but I think you hit it on the head. Given where security prices are-if we see, and I think you can see the average price that we bought shares back at, it was at --

$17.62.

Yes so, obviously, the stock price has recovered somewhat. Asset prices haven't, so these are all factors that we take into account. So, we will take it one day at a time, we can't really forecast where we are going but you are right that given that asset prices continue their decline throughout the quarter, we are very happy putting money to work at these low dollar prices.

Great, well thanks a lot for taking my questions.

Thank you and our next question comes from the line of Jim Roumell of Roumell Asset Management. Please go ahead.

Thanks, hello guys. I want to understand a little bit about leverage on the non-Agency side, slide 13. Am I reading correctly that on the non-Agency, the leverage at the end of the third quarter was just slightly, was 7%?

Sorry 7%?

Well, in other words, you a have 1.07. If I understand correctly....?

1.07.

No, that means that we had roughly as much debt as we had equity, debt to equity was about equal. Not that different from 1.00.

Put it in the context that if, historically you have always said that you would take non-Agency leverage up to a maximum of 1.50, where are you at in relation to that 1.50 on the non-Agency?

That is a great question. So yes, if you look at the--I would look at the left bottom on slide 13, just so you know we want to show both, but if you would look at the left hand chart Assets to Capital. What we have said in the past is that as a rough guideline, we think that 1.50-to-1.0 leverage overall, and I will explain what I mean by that in a second, on the non-Agency portfolio, we think is enough and a prudent amount of leverage.

Now, we have said that if we thought the opportunity was really compelling that we might on a shorter term basis maybe go above that and obviously it is going to be term financing, like that, that can change the mix as well. So you are right, in one sense you look at the chart on the left and you say you are 1.9-to-1.0 and you said that, generally speaking you are going to stick at 1.5-to-1.0.

So to explain that I would point you to the chart from the upper right which shows the Capital Usage-and sorry to have buried it in the footnote-but if you look at the second to last sentence of the foot note, I am just going to read it right now.

What it says is, and you can see if you look at the chart in the upper right, you can see we have this liquidity management strategy and that is just basically cash and unfinanced whole pools, so it is stuff that is cash or can be turned into cash in an instant and there is no leverage on that. So that is our liquidity.

And the way we manage risk is that we make sure, when we go to a dealer to get financing and we get a haircut, that haircut is typically, just say a 25% haircut on a non-Agency RMBS, right? So now in theory, if that were the only investment we had in the portfolio and we had financed it with a 25% haircut that would mean that portfolio would be at 4.0-to-1.0 leverage by this measure. But, what we would do at the same time is we would keep cash aside so that on a blended basis between the cash that we are keeping aside against that non-Agency RMBS and the non-Agency RMBS itself, with the repo bearing on it, we would then get to that 1.5-to-1.0.

So you can see how fat that liquidity management strategy is and I will read the footnote - A substantial portion of the capital used by liquidity management strategy includes capital set aside for the companies leverage strategies to enable the company to better withstand adverse changes in market conditions and financing availability.

So you have to look at a portion of the liquidity management strategy that is basically in reserve against the non-Agency RMBS leverage that we had. On a blended basis, when you take that portion you combine it with the non-Agency RMBS, we are well within the 1.5.

So Larry, why wouldn't that be reflected in the leverage by strategy? Why wouldn't you bake that in to show what you are describing as truer to economic reality?

You know what, we had an internal debate how to do it. You can do it either way. This is, I think, a little easier to tie back to our financials. And that is one of the reasons we did it. Because if you look at our financials, it ties back to how many non-Agency RMBS which is in the financials, how many borrowings we have. So from that you can see sort of the capital and the leverage and the borrowings that are all there and then you can see in terms of the liquidity management strategy and how big it is and the fact that our overall leverage on the portfolio is lower. And when you look at how much of a portfolio we have and how much capital we have, we have close to $400 million in equity capital. And when you look at how much non-Agency RMBS we have, it is roughly the same order of magnitude. So you can see portfolio-wide we are actually not that leveraged.

Okay, so let me then go to a more trending question, which is you have been saying and you noted that opportunities have been rising on the non-Agency given spread widening and what has been going on. It is basically more or less flat lined from the end of 2010 to today. 1.92 to 1.96. It looks like at 6/30 you were at 2.15, so it looks like you have been, I don't know if this is the transition from moving from the 2004 vintage that you feel kind of matured, so to speak, and replacing that into lower priced, newer vintage securities. But, I guess I am trying to understand the exposure line of non-Agency in the context of your narrative that opportunities in non-Agency have risen?

Right, well as we mentioned before, the portfolio has increased from June 30 to September 30 and I think if you hear what we are saying you can infer that we are buyers in the market, so...

But why were you? If I am reading this correctly you were sellers going from 2.15 to 1.96, you were sellers, correct?

No, okay-so that is-you have to-- Just to show you, so we went from, let's look at going from 1.92 to 1.91 from 12/31/2010 to 3/31/2011, you might say that it is not that big a change. Remember that doesn't take into account that we might have doubled the capital. I am not saying we did, we didn't, but we might have doubled the capital in that strategy. This shows just how much leverage, dollar per dollar of capital. It doesn't show how much capital we devoted to that strategy and we are using more and more capital as you can see in the upper right in the non-Agency strategy now.

I got it. I got it. Okay, Okay. Really the upper right from 6/30/2011 to 9/30/2011 you see the increase in exposure.

Right, so I would look at upper right and in general I would also look at the total size of the portfolio, for example, on page three and at that's elaborated on page four of the Investor Presentation. I would look at the non-Agency portfolio in relation to our equity base and I think that gives you a really good handle on sort of the extent to which we have added or reduced risk over time.

Okay, last question. Mark said that your base case on housing, if I understood correctly is a drop of 15%?

Yes, that is sort of a standard shock that we use. You can call it a base case, I don't want to call it a forecast, but lets call it a base case. Yes, we definitely want any security we buy to look good in that scenario, that's for sure.

Right, I understand. Okay, what is I guess a little bit difficult to square is if you really think that housing is sitting in front of a 15% drop, why would you also be aggressive on non-Agency. In other words, fundamentally, I recognize you can run stress tests on a package that says look a 15% shock we'll still get 10% or whatever, but you know as well as I do if housing really drops 15%, theses securities are going to drop in value. Spreads are going to widen more. So I am trying to square those two narratives. It doesn't quite make sense a 15% drop in housing is your "base case" that you would want to also increase exposure simultaneously in non-Agency?

Our outlook on housing has really tempered a bit but I would again, this 15% really is more of a threshold than a forecast. Mark do you want to elaborate on that?

Yes, I would say the down 15% is in deference to the 3 million to 4 million homes that are delinquent right now. We want to make sure that the securities that we buy offer high yields if home prices go down another 15%. But, our actual forecast is more nuanced than that in the sense that we will look at things by region. We spend a lot of time calibrating our severity model. Our severity model has been extremely accurate.

So, what we think really plays out in a lot of these markets is less than a 15% drop but we want to make sure that before we commit any of the Company's capital, and this is to Larry's point, we want to make sure that if home prices go down 15%, the security still looks good. I think the scenarios that are implied by the price of securities right now, I think you can definitely see securities be up in price a year from now with housing down a year from now because the price of securities. The stuff we are buying now, we are buying a lot of stuff that used to be in the $60's that is now in the low $40's without home prices really going down at all in the last six months.

We think home prices can dip lower and if investors add some risk, you can get less concerned about some of the issues that can happen out of Europe, we think security prices can go up with home prices coming down.

Got it. Well it sounds like, Mark, that it is really more a standard stress test, not really a base case housing outlook.

Yes, I think that is right. When you are committing capital I think you want your assumptions to be conservative, right? That is what we try to do and we are not, relative to our peer group of investors in this space. We have always been a little more pessimistic than the peer group. I think right now when we drill down into housing, we are starting to see some signs that will make us think that our down 15% forecast might just be overly pessimistic. So one thing that a lot of people didn't talk about that we have been doing, that is a focus of a lot of research here, is to what extent investors buying delinquent houses and then renting them out, to what extent that has offered sufficiently attractive returns that it can create enough demand to absorb some of this REO inventory.

I think that we think certain markets could definitely function as a buffer and some of the rhetoric out of FHA about programs they want to have to encourage that. Maybe they will offer some leverage on that program there, we are watching that very closely.

Right. Well I think you guys have done a fabulous job of managing book value and the strategy in distinguishing yourself from traditional mortgage REITs has certainly played out and I applaud you for that. It is really, to have gone through the summer and to have book so nominally changed I think underscores the strength of the strategy.

Thank you Jim.

(Operator's Instructions)

Thank you and our next question comes from the line of Dorsey Gardner with Kelso Management. Please go ahead.

Thanks for taking my call. Clearly the numbers that we are looking at are unaudited numbers and given the volatility in this end of the market, how much could you be off? Number one. Number two is the shelf registration will that be, will we be supplied with audited numbers. Audited numbers can be imperfect given the nature of the beast that you are dealing with but how much comfort do we have that the numbers are real, if you will, that there has been a third party that has taken a look at the valuations?

I would say that the process that we go through on a quarterly basis is no different than what we do on a year-end basis. Our numbers are reviewed, you are right, they are not audited on an interim basis but they are reviewed by our external auditors and I think our process, the important thing is that our process is no different.

We believe, we have been doing this at Ellington for 16 years now, we think that we have a very robust valuation process. And we've been widely recognized as such. We are comfortable with the numbers.

I mean, just to take the opposite point of view, everybody in this business thinks that they have the best valuation process and they often have been wrong, i.e. Bank of America, Countrywide, you name it. I guess what I am questioning is, given the down draft in RMBS and then the timing of doing a shelf registration of very, very large pile of securities here, it is possible that the book value generation could be generous, maybe quite generous, one doesn't know. And so people who are committing capital, let's say at this point in time or whenever it becomes effective. My understanding is that it hasn't been indeed effective. So there is the risk here that somewhere down the road that the valuations might be generous, let's say.

Well, I would say this. Let me say a couple of things, first of all. Don't take my word for it if you have contacts on the sell-side of the street. You can ask them what they think of our valuation process. You can see the kinds of bonds that we own and the amount to which we have marked them down. Again, I think the integrity of our numbers stands up next to anyone's.

Like I said, don't take my word for it, you are right, I could like any company say that our prices are robust, but I do, but I encourage you that if you have contacts, experts in this business, to ask the about how we value our securities. We are doing business all the time on the repo side, we are talking about valuations, we are turning over the portfolio a lot. In fact, we have a procedure internally where we are obviously kept in valuations against where we are selling bonds, we are repoing bonds. We have what we consider a very robust process. We get multiple, we just don't get one mark from one dealer we get multiple marks in general. So there is a lot that we do.

In terms of the shelf registration I don't really understand that. I hope I spoke to that before in terms of what that shelf registration is. I think you might have misinterpreted what I said so maybe we can take that off line. But I don't understand the tie in to the shelf registration. Maybe can talk about that separately?

Well I mean because if people are going to be buying securities in your Company going forward, it is partly based on what may or may not be a good job of hedging your positions. And if in fact, those book value valuations have some water, then securities will be sold that will essentially, it might be an attempt-putting it in the worst possible light-that those valuations are not that hard and fast. One way to paper over valuations that are, let's say generous, would be to issue more securities into the public market in order to dilute the discounts in the stated values that you have.

Sure, look, I agree with everything you say, I just think it is all very premature.

What is premature?

Tying it to the shelf. Whenever a company goes to raise capital I am sure that will always be a concern of investors. I think you should, I think you are putting too much emphasis on the-this is a shelf registration.

I guess the point I am making is that there is really, it is the nature of the beast, there are no third parties. It is very difficult to value these securities, they are highly illiquid and as we have seen, just in the last three months or six months, extremely volatile.

Look, point taken. I think we are honestly not communicating here because again, I think you are not understanding what a shelf registration is as opposed to maybe a take-down or something like that so I think we should take it off line.

Explain to me, then, the shelf registration.

No, let's take it off line sir.

Okay, and then another point is, the announcement that you would be buying in your own stock and then the total purchase was 17,000 shares, is that correct?

17,500 yes.

17,500, excuse me. You know it does look as if it is an attempt to, frankly, hold up the price of the stock. You made the statement it was such a commitment that you thought the stock was such value that you were putting more of your money where your mouth is, so you were going to repurchase the stock. Many companies make that statement, some carry through on it and buy their stock, some do not and whether it is window dressing or a way to prop up the stock, people have to make their own judgment, I say.

So, one moment you say that your stock is great value and the next moment you go into registration on $750 million of securities, some part of which is equity, preferred and what have you, which would indicate that you are diluting out this great value that you have in your stock that you thought was undervalued. So, there is this conflict, if you will, between your statements and your actions.

Yes, so first of all I am not going to repeat what I said about the shelf registration. I don't think you understand what a shelf registration is. I will explain...

I have been in the business 45 years so maybe you can explain it to me.

All right and on the second point, I think I explained before about 10b-18, black-out windows, things like that. I think if you look at the volume that our stock has traded at and look at the 10b-18 rules that might give you some color. All I will say is you should judge us over time on that.

I am going to have to conclude, we are over the time limit now so thanks everyone for participating this morning. Have a great day and we will see you on the next call.

Thank you Ladies and Gentlemen, this concludes the Ellington Financial third quarter 2011 financial results conference call. You may now disconnect.