Ellington Financial Inc (EFC) 2014 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by, and welcome to the Ellington Financial fourth quarter 2014 financial results conference call. Today's call is being recorded.

(Operator Instructions)

It is now my pleasure to turn the floor over to Lindsay Tragler, Investor Relations. You may begin.

Before we start, I would like to remind everyone that certain statements made during this conference call may constitute forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical in nature, and they are based on Management's beliefs, assumptions and expectations. As described under Item 1-A of our annual report filed on Form 10-K on March 14, 2014, forward-looking statements are subject to a variety of risks and uncertainties that could cause the Company's actual results to differ from its beliefs, expectations, estimates and projections.

Consequently, you should not rely on these forward-looking statements as predictions of future events. Statements made during this conference call are made as of the date of this call, and the Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. I have with me on the call today Larry Penn, our Chief Executive Officer of Ellington Financial; Mark Tecotzky, our Co-Chief Investment Officer; and Lisa Mumford, our Chief Financial Officer. With that, I'll now turn the call over to Larry.

Thanks, Lindsay. Once again, it's our pleasure to speak with our shareholders this morning, as we release our fourth-quarter results. As always, we appreciate your taking the time to participate on the call today. First, some highlights. It was a challenging quarter for Ellington Financial. We did make money; our net income was $0.08 per share. And both our agency and non-agency strategies made positive contributions to our net income. However, losses from our interest rate hedges and credit hedges substantially offset those positive contributions.

We tend to be more hedged than our peers, and we believe that is the best strategy over the long-term. Nevertheless, we were disappointed with the relative performance of our assets and hedges. And not surprisingly, we are now are expecting something of a reversal there. We continue to see many attractive investment opportunities, particularly with our continued diversification. Keep in mind that we are just beginning to scale several of our newer strategies, where we see high growth potential, such as consumer loans and others. And we are getting closer to acquiring our first assets under our non-QM mortgage initiative, which has the potential to be a very large strategy for us.

These newer strategies didn't have a significant impact on our fourth-quarter results, but we expect them to contribute meaningfully to our earnings in the coming quarters. Finally, we resized our dividend to the opportunities that we are seeing over the medium term, especially in the sectors where we are actively ramping up. We will follow the same format as we have on previous calls. First, Lisa will run through our financial results. Then, Mark will discuss how the MBS market performed over the course of the quarter, how we positioned our portfolio, and what our market outlook is. I will follow with some closing remarks, before opening the floor for questions.

As a reminder, we have posted a fourth-quarter earnings conference call presentation to our website, www.ellingtonfinancial.com. You can find it in three different places. The home page of the website, the For Our Shareholders page, or the presentations page. Lisa and Mark's prepared remarks will track the presentation. So if you have this presentation in front of you, please turn to page 4 to follow on. I'm going to turn it over to Lisa now.

Thank you, Larry, and good morning, everyone. As you can see on our earnings attribution table on page 4 of the presentation, our fourth-quarter net income was $2.6 million, or $0.08 per share. For the full year, we earned $59.2 million, or $2.09 per share. In the fourth quarter, our non-agency strategy generated gross income of $7.7 million, or $0.23 per share, while income from our agency strategy was approximately $350,000. Within our non-agency strategy, our legacy RMBS assets, net of the associated interest rate and credit hedges, generated approximately $2.5 million, or $0.07 per share, of our non-agency income for the quarter.

However, income from our RMBS assets was significantly offset by our interest rate and credit hedges, as interest rates fell and high-yield credit rallied in the early part of the quarter. This created a meaningful drag on our fourth-quarter earnings. Related interest, rate and credit hedges resulted in net losses for the quarter of approximately $7 million, or $0.20 per share. Our CMBS strategy, also net of hedges, contributed approximately $3.4 million, or $0.10 per share, to our non-agency income for the quarter. Although our CMBS portfolio constitutes a relatively small part of our non-agency portfolio, our CMBS investments, most notably our investments in big pieces of new issued CMBS, have continued to perform well.

Our newest strategies, including small balance commercial loans, CLOs, European MBS and ABS, residential -- sorry, residential NPL, consumer ABS and loans, investments in mortgage-related entities, and distressed corporate debt generated the remainder of our non-agency income for the quarter, of approximately $1.8 million, or $0.05 per share. Within this group, small balance commercial loans have done especially well over the course of the year and quarter, as many of these stressed loans have been successfully resolved, often through refinancing. During the quarter, these loans generated gross income of $2.6 million, or $0.08 per share.

Our total commercial mortgage strategy, including CMBS and small balance commercial loans, generated a return on allocated capital of over 20% during 2014. As our other investment strategies continue to ramp up, we expect the relative contributions to net income to increase. As I mentioned, and as you can see on the attribution table, income from our agency strategy was small but positive for the quarter, while our Long Portfolio, which is predominantly comprised of fixed rate specified pools, performed well, its performance was countered by losses on our interest rate swaps and short TBAs, as interest rates declined and prepayment fees remained relatively muted.

Interest income on our agencies was augmented by training gains and unrealized gains. We turned over approximately 32% of the agency portfolio during the fourth quarter. At the end of the fourth quarter, our long non-agency portfolio had grown to $897 million, up from $732 million last quarter. And our agency portfolio increased to $1.2 billion, as compared to $1.1 billion as of the end of September. The growth in our portfolios was driven by deployment of the remaining proceeds from our September capital raise.

Within our non-agency portfolio, we increased our holdings of RMBS, CLOs, residential NPLs, and European non-dollar denominated assets, including MBS and CLOs. We also bought our first US consumer loans and distressed corporate loans, and made a strategic investment in a mortgage originator, our second investment in an originator. Our leverage ratio, excluding repo debt on US treasuries, increased to 1.96 to 1, which is in the range of where it has historically been for us.

Finally, our core operating expense ratio was in line with our expectations, at an annualized rate of 2.6%. Our repo costs held steady, and we increased our number of available counterparties. In addition, our weighted average remaining days to maturity on our repo borrowing increased significantly, especially for our non-agency borrowing for average days to maturity, at year end, stood at 295 days, up from 100 days just two quarters ago. This largely reflects the impact of the two-year non-mark-to-market facility we entered into during the third quarter. I will now turn the presentation over to Mark.

Thanks, Lisa. In the fourth quarter, there were two big stories in US debt markets. The first was the decline in interest rates, especially in the long end of the curve, where 10-year and 30-year yields dropped 34 and 46 basis points, respectively. Our long-held view is that forecasting interest rates is not the way to generate consistent annual return for investors. So since EFC's inception, we've made a conscious choice to hedge interest rate risk, rather than gamble on a rate move in our favor. While interest rate hedges cost us money in the quarter, if you think back to the taper tantrum in the middle of 2013, our rate hedges helped us to preserve book value through some very volatile quarters.

The second big story was the drop in oil prices, and what that will mean for the US consumer going forward. Over the long run, we believe that lower interest rates, and lower oil prices, will have a net positive effect on our consumer-centric, credit-sensitive portfolio. However, at quarter end, these forces were not yet strongly reflected in asset pricing. So profits in our non-agency portfolio were notably impacted by losses on our interest rate hedges. In financial markets, it often takes longer than the quarter for pricing to fully adjust to material but slow-moving fundamental changes. We expect that over the longer term, our portfolio will benefit from the shift that we identified.

Lower interest rates are highly supportive of home prices, and we expect that they will lead to more voluntary prepayments on our non-agency portfolio. On slide 11, you can see that as of quarter end, the average cost basis of our Jumbo Alt-A portfolio was 72, well below par. So any increase in prepayments would be a big boost to our yields. When interest rates drop, there is a several month lag before prepayments start to impact bond cash flows. It takes time for borrowers to complete the new financing process, and it takes time for services to collect loan payments, and to pass them onto bondholders.

There was also a seasonal effect of prepayments during the fourth quarter, with the end of the year traditionally being a slower time for re-financings and home sales. So for the quarter, we saw only marginally faster prepayments on our portfolio, but we expect prepays to accelerate if rates stay low. Prepayment speeds could also get an additional boost from the incremental loosening of mortgage credit standards that we have recently observed, particularly from the agencies. Lower mortgage rates support home prices, and our portfolio will also benefit home price depreciation accelerates.

Mortgage rates dropped about 35 basis points during the fourth quarter, which means that, by the end of the quarter, people can pay about 4% more for a home, and secure the same monthly payment. We probably won't see the effect of this move until the spring buying season, and we don't believe these benefits will reflect in the non-agency RMBS prices for the quarter. To elaborate a little more on the potential impacts of the second move that we identified, the decline in oil prices, for a consumer-focused credit portfolio like ours, it acts like an increase in wages.

That should also serve to lower default rates in most regions. And just like lower interest rates, the benefit to housing comes gradually over time, so it wasn't immediately reflected in asset prices by quarter end. In the case of interest rates, if they stay low, we believe that we will earn back the majority of our hedge losses, in the form of lower expected credit losses, faster prepays, and higher asset prices over time. If interest rates go back up, we will recoup our hedge losses on that reversal.

The larger point that I'm driving to is that hedge losses or gains are recognized immediately. But many times, the risks that you are trying to hedge manifest over time. At the end of the quarter, we sit with a large portfolio of consumer debt, mostly secured by houses, and borrowers that are now much better positioned to pay off those debts than they were just a quarter earlier. On slide 11, you can see the size of our credit portfolio grew substantially, as we invested an additional $165 million over the quarter, as we continued to deploy the proceeds of our September capital raise.

On a percentage basis, we increased our allocation to some of our newer strategies, European MBS, residential loans, investments in mortgage-related entities, consumer ABS loans, and distressed corporate loans. However, despite the levels of volatility in broader market, the few episodes of price weakness in mortgage credit were modest, compared to the volatility that we saw in high-yield corporate debt. We were busy, and we've successfully put a lot of money to work. We believe that many of the strategies we've been ramping up weren't putting a material amount of capital to work, which should help us to both increase and diversify returns going forward.

Taking a step back and looking at the larger picture over the past year, yields on basically everything with a CUSIP have come down. 100 plus basis point drop in 10-year yields, drops in corporate yields, drops in agency mortgage yields, et cetera. As a manager, you have choices to how you respond to a lower-yield environment. You take more credit risk by going down in credit quality. You take more interest rate risk, you increase leverage. The path we have chosen is to try to generate as much return as we can, without increasing the risk borne by our shareholders.

We have set out to accomplish this by diversifying our sources of returns, and using active trading to monetize market inefficiencies and trading opportunities are. Clearly, the fourth quarter wasn't our strongest, but we haven't increased leverage, we haven't exposed the portfolio to more interest rate or credit risk. You see the more diversified source to return reflected in the portfolio composition chart. You don't see big changes quarter to quarter, but if you were to go back and compare it to a year ago, as we do on slide 12, you do see bigger changes.

We think we're building the right portfolio to respond to both the challenges and opportunities that lie ahead. In addition, the markets may well have to navigate a Fed rate hike later in the year. This would be the first one in a long time. Markets might have to contend with the Greek exit from the euro. The fact that the US rates are subject to potentially strong opposing forces, much lower European interest rates are pulling them down, while potential Fed Reserve tightening is pulling them up, has potential to drive the continuation of high levels of volatility we have seen since the start of the year.

Given this backdrop, we don't think it's the right time to reach for yield, and volatility may present a system of very compelling opportunities in the coming months. As you can see on page 12, the agency portfolio also grew, as we deployed capital from the raise. Our preference for lower loan balance taper didn't do much help our fourth-quarter returns, despite the drop in rates. But those assets have become more valuable since quarter end, as the refinancing index started to move up. On the hedging side, our hedges grew roughly in line with the long portfolio.

Within the fourth quarter, there was some volatility between different tranches and different series in the high-yield indices, which allowed us to opportunistically reposition some of our CBS hedges. As I discussed before, lower mortgage rates and lower oil prices should significantly boost the performance of our long credit portfolio over time. With that, I'll turn the call back to Larry.

Thanks, Mark. As you can see, we are ramping up nicely in our newer strategies. Now, we are still seeing excellent value in many non-agency RMBS sectors. So I expect that non-agency RMBS will continue to represent the largest sector allocation in our portfolio for some time. That said, on slide 12, you can see the clear trend toward more diversified returns, and a larger opportunity set, over the past year, with non-agency RMBS representing only 59% of our non-agency portfolio at the end of 2014, down from almost 80% of the portfolio at the end of 2013.

Meanwhile, our CMBS strategies continue to shine, as we continue to trade that portfolio extremely actively, and where, in 2014, we achieved our highest returns on equity of any of our strategies. The areas we are expanding into, such as consumer ABS loans, non-QM mortgages, and European MBS and ABS, are all sectors where we believe we can leverage our expertise and analytical capabilities, to achieve compelling risk-adjusted returns. We are casting a wider net, but we're still in our wheelhouse, and within our core competencies.

There is also a definite theme to our expansion. We are naturally gravitating to areas of the market that are now underserved by banks, because the new regulatory and market environment limits banks' ability to participate in them. Faced with the supplementary leverage ratio, banks just can't earn an adequate return on equity, in many previously lucrative sectors and business lines. Banks that underwrite conduit CMBS deals can no longer retain the riskier tranches, and try to sell them over time.

Faced with a [vocal rule], banks are severely limited in their ability to hold illiquid spread product and inventory. And faced with explicit regulatory constraints and implicit regulatory pressures, they can no longer participate in many of the lending activities in which they dominated before the financial crisis. While we are pleased with our diversification effort so far, we have further to go. We look forward to launching our non-QM loan acquisition business in the near future, and that has the potential to create a steady pipeline of attractive opportunities for us, for a long time to come.

Although the P&L impact of some of our newer initiatives has been relatively small to date, we are now looking forward to scaling up further, and we expect them to contribute more meaningfully to our financial results in the coming quarters. As an example of a sector we have entered more recently and are scaling up, in the latter half of 2014, we started purchasing consumer ABS and loans. We like the relatively short duration of these assets, and we believe they offer an excellent risk/reward profile. We have focused our investment activity on originators that have long track records, and can provide us with extensive loan-level performance data for us to analyze.

In fact, we are able to apply loan level data analytics, techniques and models similar to those that we utilize in our RMBS strategies. We've also made progress on our initiative to invest in mortgage origination platforms, which we expect to lead to a pipeline of newly originated non-QM mortgages. During the fourth quarter, we announced a strategic investment in Skyline Financial, a multi-channel mortgage lender led by an experienced and highly regarded management team. We are seeing numerous opportunities for these types of investments and relationships.

And we believe that we are sought after not only as a capital partner, but also as a strategic partner, as we are willing and able to share our technology, capital markets expertise, and loan analytics, to help our partners improve everything from the efficacy of their hedging programs to their loan performance. Another natural area for us to expand into, with the right origination partners, is mortgage servicing rights, or MSR's. However, with interest-only securities trading too tight in our opinion, we aren't actively looking at MSR's right now. With interest rates so low, a shakeup in the [IO] market could change that pretty quickly, though.

And while we are talking about prepayment risk, once again looming large, let's not forget about agency RMBS. We've been very patient over the past several years. And in that sector, we have largely avoided agency IO product, because we didn't feel that the risk/reward was right. But we are ready to increase our allocations to agency RMBS in general, and agency IOs in particular, should the opportunity arise. Given the current environment, we see potential catalyst for compelling opportunities in all of our markets. We are seeing global interest rates at all-time lows, we are seeing spikes in agency MBS prepayment activity, and Europe is still struggling.

If the Federal Reserve goes ahead with its plan to raise short-term interest rates later this year, we could be on our way to a flat yield curve, which tends to create lots of opportunities in the mortgage market. With the low leverage that we like to maintain, we feel that we're ready to capitalize on opportunities that may emerge suddenly, in many different markets in which we are now active. More generally, with a wide variety of asset classes to allocate among, we can be even more strategic and nimble in our asset allocation. We're active traders by nature.

So should one area, like agency IOs, all of a sudden present a great buying opportunity, we're always ready to sell other asset classes to make room for one that offers better relative value. I'd like to conclude by reminding everyone that with our focus on mark-to-market returns, as opposed to more stable metrics like core earnings, our reported earnings will tend to vary a lot from order to quarter. However, I think we've rewarded our investors with consistent performance over longer horizons.

Since our inception in 2007, we've achieved an average annual economic return of 12.7% with our worst year being just down to 0.41%, less than 0.5% down. And that was in 2008, no less. Keep in mind that this track record dates back to 2007, when many if not most of today's mortgage REITs didn't even exist yet. As we've said before, we won't necessarily be the highest flyer in our peer group in bull markets, but we believe that our approach will generate better risk-adjusted returns over market cycles. Our standout performance in 2013, when interest rates rose dramatically, is a fairly recent example of this.

With our successful diversification initiatives, and with the potential for high interest rate volatility in 2015, we believe our portfolio is well positioned for strong performance in the coming year. This concludes our prepared remarks, and we're now pleased to take your questions. Operator?

(Operator Instructions)

Trevor Cranston with JMP Securities.

Mark, thanks for the comments about some of the timing differences on your hedged positions versus the assets. To follow up on that a little bit, can you maybe comment on how much potential benefit you think there could be, in things like the FHA reducing insurance premiums? And just the drop-in rates potentially increasing the refinance ability of some borrowers? And talk about how many borrowers in your non-agency portfolio you think might still be in a position to benefit from that?

Sure. So, if you look at the conventional refi index, that's roughly doubled this year, from the end of the year. But if you look at the FHA time series, it's up a lot more than that. So that 50 basis point reduction in the FHA insurance premium, for the FHA borrowers, I think it's going to be a big deal. And it also is going to slow down some of the FHA to conventional refis that we've been saying. In terms of our own portfolio, one measure we look at is, we track what borrowers now, current mark-to-market below (inaudible) [EDLTV], above a certain vantage score or FICO threshold, and have been consistent on their mortgage payments. We think those are the ones that are most likely to take advantage of refi opportunities.

And it varies a lot by sector. So like in a sub-prime sector, you are not going to see a lot of that. When you get into the prime jumbo, you can see pools where 15%, 20% of the borrowers look as though they can take advantage of some of the lower interest rates. The other thing that we thought was significant about the FHA reduction is that we think you might see [mel watt] -- so FHFA -- do something also to ease credit a little bit.

So there's a lot of people speculating they could [a chain] see a low level price adjustments, that Fannie and Freddie charge, or these adverse market charges. So you might see a response from -- on the Fannie Freddie side, that might gradually loosen the credit box. So it has been incremental. But we have definitely seen credit loosening a little bit. And also, you're seeing some of the conduits that have been doing jumbo origination in the past year, now also look to get into all-day origination. So I think, for self-employed borrowers, borrowers that have a short sale in their past, there's getting to be a few more lending options for them.

Got it. That's helpful. You mentioned some people expanding into all-day originations, and obviously, you guys have talked about potentially accessing the non-QM market. Can you give some color on what you are currently seeing in that market, in terms of, if there are people out there who are getting a good, consistent flow of originations? And what you think the returns on those whole loans might be, versus the CUSIP market today?

We haven't seen securitizations yet. And I think people are just getting started with rolling out prices. So it's hard to say what volume they are getting. What we've seen in some of the higher note rate lending, and this is note rate, say, 8% to 9%, was a trickle of volume from a few originators. But I think there are people now, with lower pricing, they are looking for better credit borrowers, that are going to roll it out to more mainstream originators.

So I think, maybe by next quarter's call, you will have actually like seen something. And I think -- one of the originators we talked about might potentially having enough volume to do a Q4 securitization. I think Shell Point said something recently.

And then just in terms of the rates, I think we would be focusing more typically on, as opposed to the 8% to 9% that Mark mentioned, which is almost a hard money loan, we would be focusing more on stuff that we price maybe, say, call it 200 basis points above conventional rates, but with probably better convexity characteristics. So that's where I think it would probably -- again, we haven't started it yet, but I think that's probably where we see us heading.

Yes, probably like 5.50% to 7% type range. And I think, on those kind of loans, I think un-levered returns, through the un-levered yields, might be as much as, maybe, 100 wider than CUSIPs. But I think you have the potential to securitize them. And sell certain portions of the securitization at a lot tighter yields. So then to leave yourself with the remaining pieces that may be low double-digit yields.

Got it. Very helpful. And then the last thing. We saw, I think, last week, or maybe the week before, we heard that a few large money market funds had switched to a government-only mandate. So they wouldn't be buying non-agency repo anymore. Can you say if you think that might be a trend that's coming in that industry? Or if it has had any noticeable impact on the non-agency repo market so far?

Yes, so in the non-agency, no. I think that frankly, there are banks willing to lend on balance sheet. The agency repo is, I think, a business that's a little more challenging, actually, for some of the big banks now. Because with the SLRs, their return on equity is going to be probably fairly mediocre in that business. So I think, if anything, we've seen a shift from the bigger banks to the ones that have traditionally been in the non-agency market, which would be really the US banks.

We've seen no letup there at all. I think a lot of them, like I said, are just willing to balance sheet lend. As opposed to, say, run a match book. The agency market, I think, is a little more interesting. So you've got what you just mentioned, which is going to be a supporting force for agency repo. But then you have the other factor, which is from the bank's point of view.

So I think that there is, looking a little bit longer-term, I think there's probably going to end up being some dis-intermediation, some other players may be getting in the game, non-banks, et cetera, to basically bridge the gap. Because you've got this inefficient obstacle in the middle, which is [bank] capital requirements, but you've got a very willing lender in the money market funds, as you mentioned. And you've got a very willing borrower, in terms of everybody who, like the REITs that need mortgage REITs that need agency repo. So that's where I see that heading, longer-term.

Got it. Very helpful. Thanks, everybody.

Douglas Harter with Credit Suisse.

Was hoping you could just give a little more detail on the consumer loan, or consumer ABS strategy? And what's the underlying collateral there? And how are you -- where are you sourcing that?

We hired a specialist in 2014, and he's been using both his established relationships with various different originators. Some of it is in the installment loan space, staying away from payday loans, obviously. Some of it is in the auto space. Looking at other -- more off the run sectors, as well. So we're looking to basically get into business with borrowers that we think -- and we are doing extensive due diligence on the -- meet our criteria, in terms of being -- doing the business the right way.

And we don't want them to -- or us -- to be part of some of the consumer lending sector that's been tarred lately. So that's very important to us. But we are pretty open-minded. I think the banks -- once you get away from the -- the largest bank relationships, the ultra-high net worth customers, et cetera, it's just much tougher for people now to get credit. So we are looking at lots of different areas that we think could make sense. Right now, our greatest focus is in the consumer installment loan sector, and then secondarily in the auto sector. But we think that it's a pretty open playing field out there. And especially, we are going to go where the big banks are not going.

You had mentioned that the CMBS portion was one of the more attractive strategies. Looking forward, when risk retention rules go into effect, did that impact your willingness or interest in the B-pieces of new issue securitizations?

Yes, it is a confluence of factors. I would say that was part of it. And also, we've had limited competition. We like the fact that we can get involved to some extent, and in the -- dealers know what kind of collateral we like, and what kind we don't. So that helps a lot, as opposed to buying something in the secondary market that you're stuck with it. So I think that scenario, where -- so in terms of the B-pieces, that's certainly an area where I think will continue, because of some of the risk [retention] rules and others, to be a player.

But at the same time, it's been a great trading market, even just the tranches, the mezzanine tranches, et cetera. Because there are -- the calendar can be very lumpy, in terms of the issuance calendar. So you've got a lot of volatility and spreads. Our portfolio managers in this -- and in that area have a real trading mentality to them, which we love. And so I think they've timed the markets extremely well, in terms of when to get in and when to get out. As I mentioned, we really have actively traded that.

So that's an area that we would love to -- a balance between putting more capital to work, but also continuing to actively trade it. We make extensive use of the CMBX market to hedge, so that helps a lot. The -- as we've mentioned before, the ABX market and residentials is pretty dead at this point, so we don't have that tool the way that we do in the commercial market. So it all really helps. So I think that's a strategy that we would love to continue to increase our capital allocation.

Got it. And then last question from me. On the investments you are making with mortgage originators, do those investments give you -- do any of the current partners you've had there, do they originate non-agency product that could be -- that you guys could fund on your balance sheet?

Yes. We are working on that. So that is one of the goals, for sure. So that is -- whether we would -- by the way -- I think there are warehouse lines out that. I'm not sure that we want to be in the warehouse business. But -- because that's, again, unless you are a bank, probably doesn't make sense, from an ROE perspective. But in terms of being a takeout, right, as an end investor, they are -- that's really what we're interested in. In loans, non-agency loans, as you mentioned. And then should the IO market widen out, and MSR's widen in sympathy, the MSR market, potentially, as well.

Got it. Thank you.

Mike Widner with KBW.

I guess I just wanted to follow -- I had a few questions on the more consumer mortgage related stuff, and just following up. If I turn to page 13 in the presentation, I'm just -- I'm trying to figure out what these consumer ABS loans are. And I know you give a brief description, as installment loans, and maybe some auto. But I look at the numbers on there, and I realize it's a small amount, $24 million. But weighted average life of half a year, and a yield of basically 9%, and trading above par. I guess I'm just trying to figure out what that actually is.

Right. It's tough. You can't. You've got a -- I'm going to let Mark answer -- but, you've got -- remember, that's ABS and loans. So the loans are much higher yielding, and the ABS are these very short duration things that are pulling down the weighted average life and the yield. So I will pass to Mark.

Yes, that's a mixture of things. So we did buy a few securities in that space that are very short. Now, maybe they are one-quarter of a year long, and that's bringing down the average life a little bit. On the loans side, our preference has been, typically, things less than two years to maturity. And we have not been going for the higher note rate stuff.

We're trying to align ourselves with borrowers that we think don't have traditional banking relationships, but are good credit risks. And so for those things, on an average life standpoint, will be about three-quarters of a year. So even if it was all loans, I think that portfolio we're building now is going to be less than a year on average life.

It is replenishing, though.

Yes. It will replenish, right. And then, as we get more into auto, there, you are probably looking at things that are more like two-odd year average life. So it will be relatively short, as Larry mentioned. We want to make sure that we are clearly far from the edge, as to -- in terms of note rate, we don't want to be anywhere near the highest in the space, but we think there are a lot of opportunities there.

As you -- see, in an economy that has not generated a lot of wage increases for the vast majority of people, and it's very typical for people to tap equity in their home. So people need, periodically, short-term loans, we think it's a good risk/reward for us, as long as we are really focused on partnering with the right lenders that are getting to the borrowers that really need the loan, and are in a position to responsibly handle the additional debt.

And in these -- under a year, and like you said, they are not the highest rates -- but 9% and above in -- for less than 1 year loan does sounds to me -- that's not the traditional -- (multiple speakers).

No, that's not the -- no, the loans are much higher yielding than that. So what I was saying before is that the -- so the loans are yielding -- the note rates are even higher, but the loans are yielding well into the teens, okay?

I'm just trying to get a better picture of -- debt consolidation loans, are these medical loans? Are these online -- is your source in online lender that's -- (multiple speakers).

We haven't gone down the online route. We're looking at it. Yes. So -- but, again, just to be clear -- the -- this -- what you're seeing in that one row has been dragged down, both in average life and in yield, by the fact that, almost as a cash management tool, we saw some -- what we thought were minimal risk, very short, high-yielding -- almost like money market instruments that are weighing that down. So I wouldn't -- and when we're looking to gather towards -- to the growth, I wouldn't focus on that. And it's just the quirk of what we bought first, which was some of the ABS tranches, as opposed to the loans, that making's this row look funny.

Yes, so I understand the funny part. I guess I'm just trying to reconcile. You said they are not hard money, but they would clearly appear to be sub-prime. You didn't give an average FICO score, but I have to imagine that anybody who is paying double digits --

Yes, absolutely. Yes, sub-prime, for sure. Yes.

Okay.

Yes, and yields to us of definitely in the teens. So that's our projection, of course. So --

Net of credit expense?

Net of credit losses, exactly.

Yes, okay. And any sense for how big -- I hate to make too big a deal out of it, because it's $24 million at the moment. But it's getting tougher in the mortgage market. We can come back to the non-QM in a minute, but --

Yes, this could be a 10% strategy for as, absolutely.

All right. That could be meaningful. So then I guess just -- you've answered a little bit. But similar question, trying to understand non-QM, and exactly what you are doing, and the timing and size and all that stuff. And I guess maybe, just to put a little finer detail on the questions that were already asked and answered. What kind of FICO scores are we talking about here? And is it going to be full dock, low dock. And at this juncture, do you think it's securitizable? And what kind of leverage and that sort of thing do you envision?

Yes, what we are looking to do is partner with a group that we think are very thoughtful about credit, and hopefully start with them, something de novo. Where we think is the biggest opportunity is probably for self-employed borrowers. Self-employed borrowers have been one sector of the market that, if you look at the early years of all day, say 2002, 2003, a lot of the things that RFC was doing, performance on those loans was incredible. Their typical guy was 700 FICO, self-employed, 70 LTB, they got very solid credit performance out of those borrowers. So that's the space that we think, right off the bat, looks to us like the most underserved, and potentially the most interesting, from a risk/reward.

Yes, so without a W-2, obviously, those are challenged borrowers for accessing mortgage credit right now. So we feel that we can do the right due diligence, get comfortable with their credit, their ability to repay everything else, and that's definitely an area that we see as one that could be very good for us.

Yes, that makes sense. That said, the 2001 vintage loans had a tremendous benefit from the home price appreciation that came. So, I don't know. It's -- and the reason I just push on a little is because we've been hearing about non-QM, and the different anecdotes about the great opportunities out there, for at least three years now. And we have yet to see any material -- as you have said, there is not a lot out there to look at, at the moment.

Yes, you don't need to stretch on LTV, by the way. You are talking about home price appreciation. But that's not something where, in this market, we don't feel -- and I don't anyone else either -- feels like that's where they want to stretch.

So the type of -- I don't know if this is just anecdotal, or this is what you think the opportunity for you guys is. But it sounds like you are describing not 100% LTV. I don't know if you are looking at 80% or 90% or whatever.

No, not -- probably 80%, or -- 80% or less, absolutely. Yes, no need to push it. These are borrowers that have the cash. They just --

I think about it this way. You go to 2005, 2006. New issue sub-prime business was about a $600 billion a year securitized business. So we can be orders and orders of magnitude smaller than that, right? We can originate, in a year, 100 million loans, 200 million loans, that are good, solid credit. That's meaningful to us. So that allows us to be extremely choosy.

So, I don't think -- see, I don't -- and I think it's unclear to know how big the opportunity is, until you really get out there. But we can be so much smaller than how these markets used to be, and still have it be meaningful to us. That you're not talking about needing to get to some tremendously large number of borrowers for it to be a good program for us. So I think you'll see that reflected in our guidelines, right? That we are going to be extremely thoughtful about the credit risk we want to take. And for the size, how we want to start this thing, we can be very selective.

Yes, this -- the whole market could easily be $50 billion, maybe $100 billion, right? It's certainly possible. So for 1% of that, that's a lot. So -- and there's not that many people doing it right now. So there you go.

Not many at all. So -- and then just finally, on that topic. Would you envision -- probably in the short term, they sit on the balance sheet un-levered. But how would you think about generating -- what kind of ROEs could you generate? Because presumably, the bogey is going to be north of 10%, once you apply [levers]/

I think the first thing for us is not look to securitization. The first thing for us is to get an asset that -- where the credit is going to be solid. That we think is reasonably easy to hedge the (inaudible) risk. We'll probably be looking at seven ones, right, short of duration. And to get returns that with -- may be --

We think financing is probably out there in the plus 200 range, right? So Mark was talking before about 5.5% to 7%, in terms of the note rate, so you can do the math. You'll get a good return on equity with that. And I think that our philosophy in these areas is often, if the asset is a good asset, and from a risk/reward standpoint, taking into account credit and convexity and everything else, then it will -- it makes sense. And we can look at loan sales, we can look at securitization, we can look at buy and hold. There's just lot of different things, lot of options.

And while they're on the balance sheet, you build up a track record of performance, which I think is an important precursor to efficient securitization. So the main thing for us is, find borrowers that are good credits, that we think will have a note rate gets us to our ROE targets. Make sure we're thoughtful on our diligence, and build up a portfolio of solid performers. And then, once we are at that point, then we will see what the next steps are.

Okay. And just to put that all in context, you wouldn't envision any kind of securitization on that stuff, certainly this year. If you want to track record --

Maybe from some others. I would not expect it to see it from us.

Yes, sure. And then so -- and then to get to the ROEs that you are talking about, if I do the simple math, you're talking about two turns of leverage, that vicinity?

Yes, one and a half to two turns, something like that.

Yes, okay. Listen, thanks. And thanks for answering the long questions.

Lucy Webster with Compass Point.

It's Jason here. Hopefully, the last question on the consumer lending segment. But there was a large alternative asset manager that did a securitization of marketplace loans, I think in late January. Is that what we should think about the end goal being there?

Right now, we have assets that we are happy to fund on balance sheet. If we thought that we wanted to lever that position via securitization, we would -- for the size we are at now, we don't have critical mass for securitization. We don't even really have critical mass yet to do financing. So we haven't thought so much about that. I think as the portfolio grows, we will think about both options. Do you want to just finance them on balance sheet? Or do you want to access term financing in the securitization market? So we could go either way.

Yes, as it ramps up, I think, then we will -- there will be a fork in the road, where we will have to make a decision about how to finance that, and whether to finance that. The good news is, is that these loans, just on an un-leveraged basis, have are really nice return. So, into the double digits. So we're not going to be forced to do anything, for sure. But we will consider all options.

Given the leverage we run at, we are generally a lot less levered than most other people in this space. So right now, balance sheet is fine for us. And as we ramp up, we will consider all these different paths.

Right. It just seems like we have been talking about non-QM, and here we are sitting talking about, maybe this year, we get a securitization done. And consumers, seems like it's just accelerated that much faster. So --

Yes.

If you think about getting that to a 10% position versus non-QM, it seems like there's just much more of an opportunity there.

Yes. No, that make a lot of sense. We have the consumer on the balance sheet, yet we don't have the non-QM. So I think you are dead on.

Okay. Fair enough. And then on the RPL/MPL activity, it seems like, to us, we've seen a lot more supply come in 2015, yet we're seeing indications, at least, that pricing remains just as strong. Any thoughts there, on when or if that breaks and becomes a much more attractive market? Or is the demand simply that strong?

I'll tell you, we were frustrated with the pricing of the big packages, the HUD packages, the big bank packages in 2014. We did not participate, we didn't think it was good ROE. We didn't think it was good for the shareholders. So what we did towards the end of 2014, we got more active in buying some smaller packages, maybe in the $10 million to $40 million range. We thought the pricing was much more attractive. We think the returns are going to be far, far superior. So we've found things to do there.

Our sense of, I guess, some of the more recent larger trades is that it seems, to us, that there are fewer people really aggressively bidding. So I don't know if it's really translated into lower prices. My sense is, they are a little bit lower. But people that bought big packages, first half of 2014, are now starting to see whether those loans are performing according to their expectations. If they're not, they're probably either not going to participate, or adjust the level at which they choose to participate. So we think the market is going through that adjustment.

Until they get out of the way, though, there's a few very large buyers that, just frankly, seem to have a much lower return on capital bogey, or are probably overestimating the return. So we'll see where that shakes out. But until those few buyers get out of the way, we are not going to be able to buy those bigger packages.

I'd say we were more active, last quarter of 2014, than we had been the first half of 2014, definitely.

Yes.

Okay. That's helpful. Thank you.

Brock Vandervliet with Nomura Securities.

Especially for those of us that are newer to the story, if you could just take a minute and scale through some of the products, or all the products, that you've mentioned, to the extent you can? Just give us a ladder of returns, highest to lowest, or vice versa? Just in terms of, given a finite amount of capital, where would you try and maximize returns? Thanks.

Right. Okay. One thing that's tough is that we -- not tough, but we are very total return oriented. So there are many securities that we will buy that have a mid-single-digit yield, for example, in the RMBS space, now, where we buy it because we think that there is a very high probability that will tighten, say, 100 basis points, over a relatively short period of time. And so you end up with a total return, in that case, that could be well into the double digits. So -- but if you turn to page 13 of the presentation, that's, I think, a good place to start.

And that's certainly -- the categories, it's the portfolio has been stratified in a way that we think is maybe the most logical. Now, as we were talking about that consumer ABS and loan row -- and some of the other rows are guilty of this, too -- sometimes you have some things that are lumped together, because we couldn't have -- we could go on for pages and pages, obviously, if we really got granular. Sometimes things are lumped together that are pretty different. So -- but I think if you look at sub-prime RMBS and jumbo Alt-A, can look at those yields, they are lower than they were a year or two ago. But we still think that they, in many sectors, have room to run.

And as Mark mentioned, some of these sectors have the possibility, especially, let's say, in the Alt-A sector, have the possibility where prices are still discounted, have the possibility of increased prepayment. So you can see yield boost there, as well. And looking down, you can see in CMBS, that's one of the highest yields there, 13%-odd. That's because of the B-pieces that we've been buying. In Europe, we've got, again, a wide variety. It's -- obviously, we've got all MBS in just on one row.

Some things that are shorter and safer, that we think that are going to have good total returns. Some things that are more buy-and-hold for a while, with higher yields. You've got -- we talked about, in the consumer ABS space, where you have got a barbell, right now, of very short, almost money market type securities, with lower yields, and loans that are in the double digits. And that's where, certainly, we're going to see some growth there.

And you've got non-QM, hopefully, waiting to come aboard. And we talked about how the un-leveraged asset might be in the 5.5% to 7% range. But then with a warehouse line of LIBOR plus 200, you can easily get double-digit returns there, as well. So it's a lot of different -- obviously, a lot of different strategies, a lot of different asset classes. But we are going to continue to be focused on total return in some of the more liquid sectors. And you might see some lower stated yields on this page there.

But still, we think, hopefully, can achieve a good return on equity through active trading, which is what we've done for years, and then higher yields on some of the newer sectors, as well. So happy to walk through things in more detail with you. Feel free to call us at any time.

Thanks very much. Just a follow-up on the non-QM strategy. Does the Skyline Financial relationship limit you to simply sourcing loans through them? Or are you free to source across the space?

Yes, we -- absolutely. That transaction does not limit us, in any way, in terms of who we deal with.

Got it. Okay. Thank you.

(multiple speakers) Last question.

Your final question comes Jim Young with West Family Investments.

Could you talk about your near-term and longer-term outlook? And opportunities that you see in the reverse mortgage sector? Thank you.

Sure. Hey, Jim, it's Mark. So in the reverse mortgage sector, we've been active there. We have liked the reverse mortgage pools, the government guaranteed pools. They have very stable cash flows. They have absolutely no credit risk. They are Ginnie Mae backed. And they are easy to finance. And we put a stake in --

Also IOs, we've had --

Yes, we've had reverse [mortgages]. And then we bought an equity stake in a very small reverse mortgage originator, because when we look at the demographics of the country, we think there's a potential for that product to become a very big mortgage product going forward. To date, it has not been marketed, we think, in the most efficient way.

Been a lot of infomercial stuff. But it's a product that makes a lot of sense as a retirement tool for people that have a lot of equity in their home, and want to do some estate planning. So this [long-range], investment, I think, gives us a lot of option value to partner with someone that we think can grow. So we've found interesting things to do there, both the pool side, the IO side, and then the stake in the originator.

And just like anything on the pool space, especially anything as liquid as Ginnie Mae, although these are less liquid, certainly, than your garden-variety MBS, things move around. So we trade that actively, we had accumulated, I think, what was considered a pretty large position amongst our peer group. I'm not -- there was maybe one other mortgage REIT that I think had a presence in that space.

But it's niche product, and we had taken a pretty big stake in it a little while ago, and things tightened a lot, we got out, and then things subsequently widened a little. We got back in. But not necessarily to as large extent before. So we absolutely can actively trade that, and it's a very specified pool space. Each pool is different, and we like it. It suits our -- it suits us.

There are no further questions at this time. Ladies and gentlemen, this concludes Ellington Financial's fourth quarter 2014 financial results conference call. Please disconnect your lines at this time, and have a wonderful day.