Ellington Financial Inc (EFC) 2017 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial Fourth Quarter 2017 Earnings Conference Call. Today's call is being recorded. (Operator Instructions)

It is now my pleasure to turn the floor over to Maria Cozine, Vice President, Investor Relations. You may begin.

Thanks, Darla, and good morning, everyone. Before we start, I would like to remind everyone that certain statements made during this conference call may constitute forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical in nature.

As described under Item 1A of our annual report on Form 10-K filed on March 16, 2017, 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 on the call with me today Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, our Co-Chief Investment Officer; Lisa Mumford, our Chief Financial Officer; and JR Herlihy, who will be replacing Lisa Mumford as our Chief Financial Officer upon her retirement at the end of March.

As described in our earnings press release, our fourth quarter earnings conference call presentation is available on our website, ellingtonfinancial.com. Management's prepared remarks will track the presentation. Please turn to Slide 3 to follow along.

With that, I will now turn the call over to Larry.

Thanks, Maria, and welcome, everyone, to our fourth quarter 2017 earnings call. We appreciate you taking the time to listen to the call today.

As announced this past December, our Chief Financial Officer, Lisa Mumford, plans to retire around the end of next month. I'd like to start by thanking Lisa for her 9 years of dedicated service to Ellington Financial. Her leadership and talents have been key contributors to the success of Ellington Financial since its inception.

I would also like to congratulate JR Herlihy, currently Ellington Financial's Treasurer, on his pending promotion to CFO upon Lisa's retirement.

JR has been with Ellington for nearly 7 years, and during that time, he has served in various roles, both on the investment side and on the financial reporting side, including: first, as a commercial mortgage specialist; and then as Co-Chief Investment Officer and Chief Financial Officer of Ellington Housing, which was an Ellington-sponsored REIT that had focused on direct investments in single- and multifamily residential real estate investments in the wake of the financial crisis.

So JR brings considerable investment and capital markets expertise as well as experience overseeing financial reporting to his new role as Ellington Financial's CFO. And congratulations also to Chris Smernoff, Ellington Financial's Controller, who will be promoted to Chief Accounting Officer upon Lisa's retirement.

2017 was a year of remarkable calm in the markets. Volatility was historically low despite 3 Fed rate hikes, a new administration in Washington, several significant geopolitical headlines and the first pullback in quantitative easing in a decade. Interest rates were unusually steady throughout 2017, and the VIX hit an all-time record low in November.

Credit spreads grinded persistently tighter over the year, and equities reached all-time highs going into year-end. Of course, as we witnessed these past few weeks, 2018 is an entirely different story. Besides the violent swings in stocks, the 10-year treasury has broken out of its 2017 range, credit spreads have widened and the VIX even touched its second-highest level since 2009.

At Ellington Financial, we have patiently built a diversified portfolio of loans and securities based on fundamental analysis and proprietary sourcing. We were able to grow the size of our credit portfolio nicely in the fourth quarter, and so that's getting closer to where we think it needs to be to help cover our dividend. Specifically, our credit portfolio grew by $284 million, which was a 38% quarter-over-quarter increase.

Now these figures include a chunk of interim investments that we acquired that were somewhat lower yielding but more liquid than the higher-yielding long-term assets that we expect to continue to ramp over the next couple of quarters. So you certainly should not extrapolate that 38% growth in the credit portfolio. JR will elaborate more on all this later in the call.

Thanks in part to this continued growth in our credit portfolio, Ellington Financial had a solid fourth quarter, showing steady improvement from the third quarter and the second quarter. And 2018 is off to a very strong start. We announced last week that Ellington Financial's book value per share was up approximately 1.8% or a full $0.34 per share in January.

So we're optimistic that all the pieces are coming together nicely. And as we mentioned in our earnings release and similar to the guidance that we gave on the last earnings call, we are forecasting that our credit portfolio will be fully ramped by the middle part of this year.

During the fourth quarter, with our share price trading at a significant discount to book value, we saw an attractive opportunity to repurchase our shares aggressively. We bought back nearly $10 million worth of our stock or more than 2% of our shares outstanding, which was accretive to book value by $0.08 per share. Since quarter end, we have purchased an additional 1.5% of our shares outstanding. And last week, our Board of Directors reloaded our repurchase program with an additional 1.55 million shares or about 5% of our total shares outstanding.

Even though we love the assets coming out of our loan pipelines, stock buybacks are just a compelling use of capital where our stock price has been recently. As I've mentioned in the past, we think that a discount of 20% or more to book value is a level where we should be buying aggressively, and we have been. At these levels, stock buybacks are providing substantial accretion to book value, which should ultimately lead to both significant accretion to earnings per share and a higher stock price.

With the passage of the Tax Cuts and Jobs Act in December and, in particular, the lowering of the maximum federal corporate income tax rate from 35% to 21%, many publicly traded partnerships, especially those in financial businesses, have been discussing the possibility of converting their tax status from partnership to corporation.

As alluded to in our earnings release, the management of Ellington Financial has been actively evaluating potential actions in response to the new tax laws, and that includes reassessing our structure as a publicly traded partnership. I will discuss this further in my closing remarks later in the call.

Today's call will follow a similar format to prior earnings calls. Lisa Mumford is here with us today on the call, but in the spirit of the ongoing transition of the CFO duties from Lisa to JR, JR will be delivering the rundown of our financial results. After JR, Mark will discuss market performance and our portfolio performance over the quarter and what our outlook is going forward for our markets and our portfolio. Finally, I will follow with closing remarks before opening the floor to questions.

And with that, I will turn the call over to JR.

Thank you, Larry, and good morning, everyone. I'm excited to take over as Ellington Financial's Chief Financial Officer upon Lisa's retirement.

Please refer to Slide 6 for details on the attribution of earnings between our credit and agency strategies. Our credit strategy contributed the entirety of our income for the fourth quarter. Credit assets generated gross income of $12.7 million or $0.39 per share while our agency strategy generated a slight loss of $58,000, which rounds to $0.00 per share. After expenses and other adjustments, we produced net income of $7.4 million or $0.23 per share. For comparison, in the third quarter, we had net income of $6.2 million or $0.19 per share.

The following is a brief overview of the drivers of our results. Let's begin with the credit strategy, which represented about 75% of EFC's allocated equity at year-end. Gross income increased by $4.7 million or $0.15 per share quarter-over-quarter. As Larry mentioned, we made significant purchases this quarter, and the incremental carry from these investments is reflected in higher quarter-over-quarter interest income. Our borrowings also increased with these purchases so interest expense is correspondingly higher.

Net unrealized gains were significant this quarter, driven by the completion of our first non-QM securitization and an increase in the value of Longbridge Financial, one of our mortgage originator strategic investments. Further tightening of credit spreads also led to mark-to-market gains on certain assets while contributing to the losses on our credit hedges and other activities for the quarter.

Additionally, other investment-related expenses were considerably higher than last quarter because we fully expensed the deal costs associated with the non-QM securitizations, which were $1.68 million or $0.05 per share rather than amortizing these expenses over the life of the deal. Finally, P&L impact from trading activity and interest rate hedges was limited for the quarter.

Again this quarter, interest income was the primary driver of earnings in our credit strategy. Over the course of 2017, we steadily increased the size of our credit portfolio, and our net interest income has increased in kind. As we look forward to 2018, we believe the high-quality interest income from our loan assets will be the key to generating a steady and predictable earnings stream.

In the fourth quarter, we added assets in the following strategies: small-balance commercial mortgage loans, non-QM loans, consumer loans and U.K. nonconforming RMBS. As Larry mentioned, we also acquired a substantial amount of more liquid, somewhat lower-yielding assets in the U.S. non-Agency RMBS and CLO note markets.

Although these investments have yields below our target for EFC, they are relatively liquid and provide the opportunity for solid, positive carry on the capital they are using, pending deployment of that capital into higher-yielding strategies.

Finally, the non-QM loans that we securitized remained on our balance sheet because we are deemed, for GAAP reporting purposes, to effectively control the securitization trust. As a result, we have consolidated the entire securitization on our balance sheet so the debt sold to third parties in conjunction with the securitization is included on our balance sheet under the caption other secured borrowings at fair value. In total, our credit portfolio increased to $1.02 billion at year-end, an increase of 38% from the previous quarter and 86% from the previous year-end.

Looking now at performance by strategy. We had quarter-over-quarter increases in gross income from the following loan-related strategies: consumer loans, small-balance commercial mortgage loans, non-QM loans, European nonperforming loans and investments in mortgage originators. Security strategies that posted higher growth income this quarter included CLOs and U.K. nonconforming RMBS.

We also had an excellent quarter on CMBS, although this strategy was slightly less profitable than in the third quarter. We had modest declines in quarter-over-quarter income from our legacy non-Agency RMBS and corporate credit relative value.

Our Agency RMBS strategy generated a slight loss of $58,000 for the fourth quarter, which rounds to $0.00 per share. Although current coupon 30-year Agency RMBS barely budged during the quarter, many of the shorter-duration assets that we held in EFC, such as higher-coupon pools and 15-year pools, had mark-to-market losses. These unrealized losses were offset by the net interest income on our investments plus the meaningful gains on our interest rate hedges, and we roughly broke even.

At December 31, 2017, we had Agency RMBS holdings of $872 million compared to $816 million as of September 30, 2017. Since year-end, much of the fourth quarter spread widening in higher-coupon pools and 15-year pools has reversed.

Combined, the credit and agency strategies had a debt-to-equity ratio of 2.38:1 at December 31, 2017, which is a significant increase over the previous quarter end when that ratio was 1.91:1. The increased leverage resulted from the significant growth of our investments, coupled with a reduced capital base due to repurchases and dividends. Leverage was also higher because we consolidated non-QM securitization for GAAP reporting purposes. If we weren't consolidating the non-QM securitization-related debt, our adjusted debt-to-equity ratio would have been 2.18:1.

During the fourth quarter, we repurchased 656,239 common shares, on average, at a 20% discount to diluted book value per share. As a result of these discounts, our share repurchases were accretive by $0.08 per share. For the quarter, our general operating expenses were $4.4 million, representing an annualized expense ratio of 2.8%, which was in line with the ratio for the full year 2017 as well. We ended the quarter with diluted book value per share of $18.85.

I will now turn the presentation over to Mark.

Thanks, JR. Q4 continued many of the themes established earlier in the year: a flatter yield curve, tighter spreads for most commoditized sectors such as high yield, limited interest rate volatility and limited credit spread volatility. All that seems like a distant memory now.

In Q4, credit markets were stable and strong, taking their cues from the steady march higher in stocks, and you felt like you were competing with many other investors to add assets to the balance sheet.

For EFC, it was a very busy quarter, and a lot of the portfolio steps we took not only helped the Q4 performance but are also helping in 2018. Q4 was also a realization for EFC of a lot of initiatives that we worked on throughout the year. First, we substantially grew our portfolio. We grew it in 2 ways: organically with proprietary investments; and also, in a more traditional way, by purchasing attractive assets in the open market.

There were 2 big accomplishments for our proprietary pipeline. Firstly, we securitized our non-QM portfolio with our inaugural deal which priced in November. EFMT 2017-1 is the ticker on Bloomberg. All of the mortgages in our deal were originated by LendSure Mortgage, our non-QM provider, in which we hold a strategic equity investment. Our deal was well received by both rating agencies and investors.

Rating agencies, attracted to our low LTV and disciplined underwriting guidelines, rewarded us with a capital structure that allowed us to generate gross financing proceeds of 98% of principal balance. As a result, the deal provides the company with long-term financing that not only isn't mark to market, but it is much more levered than repo and allows us to magnify the excess spread on the deal into the junior tranches that we retained.

We had a blue chip list of investors that bought our bonds and have additional investors that are interested in purchasing loans directly from LendSure in the future. We currently have over $50 million of unsecuritized long-term loans on balance sheet and are growing our portfolio every week.

The securitization also has the potential to add significant franchise value to EFC's equity stake in LendSure. The non-QM market has performed well and is increasingly competitive, so we are constantly focused on how to protect profit margins and grow LendSure's footprint.

The second significant organic growth milestone was the pricing of our second Ellington-managed CLO and retention by EFC of the equity and some of the debt. Now that we are no longer a first-time issuer, we benefit from both -- we benefited from both tighter debt spreads and a more advantageous capital structure. The deal was well received, and we are growing our name in this area. We plan to have EFC participate in further Ellington-managed CLOs.

We worked hard in Q4 improving our financing terms across the board. This included our financing lines for non-QM, consumer loans, small-balance commercial, mortgage loans, residential, NPLs and our retained CLO tranches. As LIBOR has been rising, we have been able to negotiate financing at lower LIBOR spreads, working to keep our all-in cost of funds as close to unchanged as possible.

Financing terms in the market are vastly improved from a year ago. And with its low-levered balance sheet, EFC is an attractive counterparty for lenders. Taking advantage of lender demand to finance EFC's assets is a great way for us to improve our net interest margins without taking on any more risk.

As a great example of how attractive a counterparty EFC is for lenders, you can look no further than the unsecured debt deal that EFC issued late last summer, when we issued unsecured notes at 5 1/4% coupon at par, which we believe gives us among the lowest -- among the cheapest source of unsecured financing (technical difficulty) within our peer group.

Looking ahead to 2018, the market volatility we've seen so far this year is like nothing we have seen since early 2016. The high-yielding short-duration portfolio we brought into this year is performing well, as you can see from the estimated book value per share that we announced, which -- January's return at 1.8% non-annualized.

We have largely stayed away from the most commoditized sectors of structured credit, such as agency credit risk transfer securities, that are most likely to underperform in sympathy with the downturn of the high-yield market. Instead, we have focused on less commoditized, high-yielding, harder-to-source investments that typically have both a barrier to purchase and require extensive analytic expertise to model. These assets are typically less impacted by overall market gyrations.

For our agency portfolio, we were positioned defensively to close the year with moderate overall leverage based -- overall mortgage-based exposure as we didn't perceive pricing as particularly attractive at year-end. That positioning certainly reduced our agency income in Q4 but has been helping us so far this year as interest rate volatility has been very high and MBS have underperformed most interest rate hedges.

I like how EFC is currently positioned. We've grown and are growing our credit portfolio so our earnings have increased, and they could grow more. We're finally seeing some volatility in credit spreads so we're hopeful that we'll be able to add assets this quarter at much higher yields than where assets traded in Q4. Our pipeline of proprietary investments contributed handsomely in Q4 and continues to progress nicely this year.

Meanwhile, our share buybacks magnify all this. With a smaller share count, every dollar of earnings is more on a per-share basis, and buying back our stock at a big discount gives our price to book a tailwind. We are using 2 powerful levels (sic - levers) to drive the most important metrics for our company: continued portfolio growth to drive earnings per share and accretive buybacks to increase book value and further amplify earnings.

The markets have recently been trading with wild price swings and an overall skittishness that can create both landmines and opportunities. We believe that most of the volatility is coming from an increase in inflation expectations caused by a stronger economy that may have hit a tipping point with the passage of tax reform.

For our consumer-focused assets, we are seeing strong performance, and I think most mortgage and consumer loan borrowers will benefit from the rise in wages and increase in deductions. We are focused on capturing the opportunities presented to us by the recent dislocations.

With that, I'll turn the call back to Larry.

Thanks, Mark. Looking back on 2017, our pace of capital deployment was slower than we had originally planned, but we believe that our patience is being rewarded. Given the volatility we've seen in 2018 so far, we believe that staying true to our acquisition standards, continuing to be disciplined about hedging and otherwise prudently managing risk are more essential now than ever.

We made solid progress towards covering our dividend in the fourth quarter, but we're not there yet. I'm very happy with our recent pace of acquisitions, as reflected in our healthy portfolio growth in the fourth quarter, and we still project reaching our desired credit portfolio size around midyear. In the meantime, with our stock price where it's been recently -- and it's way too low, in our opinion -- we plan to continue to supplement our earnings with accretive share repurchases.

Before we close, I'd briefly like to discuss the potential impact of the Tax Cuts and Jobs Act on Ellington Financial. As we mentioned in our earnings release, we are actively evaluating the potential actions we may take in response to the passage of the tax legislation, including possible changes to our investment strategies and even to our structure as a publicly traded partnership.

When we first formed Ellington Financial in 2007, we chose to structure the company as a publicly traded partnership rather than a REIT because it enabled us to own a diversified group of assets, including non-mortgage and non-real estate assets, while also having the ability to hedge credit risk more fully than we could as a REIT. We believe that this flexibility has been a crucial element to our success, for example, enabling us to weather the financial crisis in 2007 and '08 with our book value intact when other credit-oriented REITs were struggling to survive.

While a corporate tax structure or C corp has even more flexibility than a publicly traded partnership structure, we rejected that corporate structure back at our inception because we felt that the 35% federal corporate income tax rate in effect at the time was too steep a price to pay for the advantages of a corporate structure, which I'll get to momentarily.

But now that the maximum federal corporate income tax rate has been reduced to 21%, the idea deserves serious consideration again. We've been hard at work, with the help of our tax advisers, analyzing the ramifications, repercussions and considerations of a possible C corp conversion. And to make it easier for everyone to appreciate these considerations, we'll be posting to our website a list of some of the most significant pros and cons of the C corp conversion.

Many of the other financial publicly traded partnerships, such as the alternative asset manager PTPs like Blackstone, KKR and Apollo, have also announced that they're analyzing the same C corp conversion issue and that it will take them a fair amount of time to settle on any decision.

In one sense, the bar for Ellington Financial to decide to convert to a C corp is arguably higher than it is for the alternative asset manager PTPs. Namely, for the alternative asset managers, virtually all of their asset management fee income already flows through corporate blocker subsidiaries. So for the alternative asset managers, that fee income is already taxed at corporate rates whether they convert or not.

So for these companies, the incremental effective tax rate caused by a conversion isn't the full effect of corporate income tax rate because the tax on a big chunk of their income is unaffected. For Ellington Financial, however, since virtually all of our income is investment income as opposed to fee income or similar income, the incremental effective tax rate for us upon a conversion would be close to the full effective corporate income tax rate.

So converting to a C corp would probably be a harder step for us to take than for most of the alternative asset manager PTPs.

Even with that caveat, I can assure you that not only has no decision been made but none is remotely close to being made, and it's just way too early to even speculate on whether or not any such major changes in our tax structure will occur. We, of course, welcome the feedback and input of our shareholders and our potential shareholders.

We also recognize that depending on exactly where our effective overall corporate tax rate shakes out, including not just federal but also state and local corporate income tax rates, it's quite possible that a conversion to a C corp would result in higher after-tax distributions for some shareholders but lower after-tax distributions for other shareholders. The publicly traded alternative asset managers are, of course, also struggling with these and similar issues.

All that said, our publicly traded partnership structure has many, many advantages. And while we will continue to analyze this interesting conversion issue, we are mainly just keeping our heads down and staying laser-focused on continuing to grow our credit businesses and, thereby, our earnings. That is and will remain our primary mission, and I believe this is ultimately what the market will reward us for. I am confident that the fourth quarter of last year and now the strong first month of this new year show that Ellington Financial is on the right track.

And this concludes our prepared remarks. We're now pleased to take your questions. Operator?

(Operator Instructions) Your first question is from Douglas Harter with Crédit Suisse.

Can you talk about -- do the share buybacks, does that change the timing that you would expect to get to a fully ramped credit portfolio?

Not enough. We're -- we haven't pinpointed -- tried to pinpoint that exact time. Obviously, it's kind of a subjective standard anyway. So last quarter, having repurchased, say, 2%, I mean, yes, it will affect things on the margins, but you're not talking about a huge difference, right? Because you're only talking about -- let's say 2% is $12 million a quarter, so that's not going to move the needle too much either way.

Got it. And can you just talk a little bit about some of the placeholder credit assets you talked about? Kind of what is the duration of those? And kind of how do you expect those to -- sort of the roll-off of those with the more longer-term assets?

Doug, it's Mark. So in terms of interest rate sensitivity, they typically have very little interest rate sensitivity, and they're primarily very seasoned non-Agency mortgages and some seasoned CLO holdings. So they don't have interest rate sensitivities, so their prices aren't -- haven't been impacted by rate increases. In a lot of cases, sort of higher expectations for LIBOR from more Fed rate hikes are generally supportive of them.

So they're assets that we've had in Ellington Financial for a long, long time. They used to represent the lion's share of our portfolio. We like them because they have a significant yield advantage over being in cash. But they're liquid enough so you can convert them into capital if you see some higher-yielding, less liquid investments that you can redeploy the capital in.

Yes. They probably have half the spread of many of our more -- target assets at this point, so just to put it in perspective.

It's just really a more efficient way for us to manage our balance sheet.

Your next question is from Steve Delaney with JMP Securities.

And first, let me say -- let me just applaud the buyback activity. That's excellent. Larry, you mentioned mid-2018 for sort of optimizing the credit portfolio or the balance sheet generally. So in year-end, you were right at $1 billion in the credit portfolio. Could you give us a rough idea what the magnitude of that growth in the portfolio might be? In other words, what's the sort of forward target for the size of the credit portfolio?

Sure, yes. And as I said, it's obviously a fuzzy standard to start with. It's more -- I'm [was] going to say optimizing the portfolio, but instead, what I'd say is I think that, by then, we will be able to be covering our dividend, assuming that we continue to have assets yielding what we're seeing right now that are available to us and assuming, you're right, a certain acquisition rate. I think if we can add a little over $100 million a quarter, I think we'll get there by around midyear.

And one thing that's a little difficult in terms of the actual balance sheet number is that it gets a little bit -- I don't want to say distorted, but it gets a little bit muddled by the fact that, for example, when we do the non-QM securitization, those loans remain on balance sheet. And there are obviously arguments to be made for and against looking at it either on a consolidated basis or not. Under GAAP, obviously, we have to consolidate.

So that's -- part of the growth this quarter in the portfolio is due to that as well. And composition is also going to matter as well as we replace these interim assets with -- lower-yielding assets with higher-yielding assets. That is going to look, in one sense, like we're treading water from just an asset growth perspective and, obviously, from an income generation perspective, we won't.

So some of the growth, as we've been saying, that you've seen this quarter in the portfolio, the 38% growth, was -- you can almost think of that as borrowing from real -- more long-term acquisitions from future quarters.

Okay. And so you've said something that may have clarified something for me. On the securitization -- your NQM securitization, when we -- that -- you're -- I think you're telling me that the loans are, it's in this table on Page 11, on a gross basis, right? In other words, you're showing the total loans not just your retained bonds. Is -- am I hearing that right?

Yes, that's correct.

Okay. So it -- okay. So obviously, you have to consolidate for GAAP, but it's -- that's something we can talk about offline as far as, as you get bigger and bigger with securitizations, just a question of whether the -- an equity allocation is more useful than just the actual gross assets.

Absolutely. That's right. Yes, totally agree.

Okay. And just for clarification. The -- you had been buying back stock under a prior authorization. The board authorized an additional 1.55 million. Or is the 1.55 million now the new total authorization? I'm just trying to understand.

Well, it was effected on February 6, was it? Yes. So -- and I think it's in our, right, earnings release. If you look at the share repurchase paragraph, you'll see that what was announced in the earnings release, what we bought through, I think it was February 12, included 43,000 of shares repurchased between that February 6 reauthorization and February 12, which was when this went to press, so to speak. So that's basically a pretty good number less just what we've been buying for the last few days.

Okay. And about -- set at about 5% of total shares, obviously, which is a good level.

Right. And we can always go back for more authorization when we need it.

Okay. And just one final thing, the book value. We certainly noticed the book value up almost 2% in January, when you put that out here, I think, just last week. But the -- could you just comment generally on what has worked so well in your favor just over this past 4 to 6 weeks? I'm not asking for a lot of detail, but just kind of what asset classes and/or what hedge positions have really delivered that strong performance?

Well, I don't want to get into too much detail. Some of it reflects sort of realized and -- changes in unrealized and some realized gains in the first month that are nonrecurring. I mean, obviously, we're not sitting here saying we're going to be earning 1.8% a month ad infinitum.

So yes, so there were some, you can call them, nonrecurring, but for us, obviously, we do trade the portfolio. We do -- market conditions change, and we have to mark things up or down. So that went in there. I mean, our hedges this year, obviously, are doing well and -- which is about time.

The agencies were (inaudible).

And we talked about agencies had a flat quarter. So yes, I don't want to get into too much detail there.

I understand. But it sounds like a takeaway we might -- that an investor might take is that you guys handle volatility pretty well, and that just is in a general statement. And in the past, when we've had periods of volatility, you've tended to outperform.

That's right. And we -- one thing about the portfolio, Mark alluded to it, is that the assets that now we're favoring and that we're accumulating, they tend to be -- not all of them, I mean there are exceptions, but they tend to be shorter than a lot of the assets that we think have been maybe bid up too high in this market that look to be vulnerable.

So in a downturn, I would say 2 things about them. Number one, they should move less in price, if at all, because some of them, frankly, are just idiosyncratic. Like, for example, if you buy a nonperforming loan on a commercial property and you buy that and you've got massive coverage in terms of property value versus what you paid for that loan, that overall macroeconomic conditions when you expect to resolve that situation within a year are probably not going to have a huge effect.

Our consumer loans also are relatively short term, right? So again, we can dial up or down and change criteria as well, our acquisition criteria, in that portfolio depending upon what we're seeing in market conditions. And not like -- it's not like we're locked in to some 5- or 10-year loans. Things are going to amortize very quickly, right?

So -- and of course, as always, we keep our interest rate duration short on the stuff that is fixed rate. So that type of interest rate volatility that we see is really -- should be a nonevent for us, and it clearly was in the first month.

Your next question is from Eric Hagen with KBW.

JR and Chris, congrats on your appointment. Can you just talk about the pipeline for acquiring more CLO investments and how quickly you might be able to bring new investments into the portfolio? Appreciate it.

Yes. I mean, I think -- so first of all, one interesting development, right, is that the risk retention rules seem to -- right. There was a court case. And at least for, I would say, a large portion of CLOs, including the ones that we've sponsored -- the 2 that we've sponsored, it looks like there's a good chance that the risk retention rules will go away.

Which I'll just add as an aside, with Ellington Financial having participated in those 2 deals, if that does go away, a portion of what Ellington Financial retained from those securitizations will actually become tradable, whereas before, it was non-tradable.

So it -- I would argue that that makes those pieces worth a good 5%, maybe even 10% more in terms of their value. And we have no plans to trade those necessarily, but it's -- that's clearly a positive. And just not having risk retention just makes securitization easier as well.

So -- yes, so I think that a lot of -- this was sort of a -- these 2 CLOs that we did were a little bit niche-y in the sense that the assets that we used are not the ones that are in your typical CLOs, which -- the very large leveraged loans, things like that.

We tend to gravitate towards some smaller companies with smaller capital structures but that -- some fallen angels, things that don't really fit into -- they might not be quite yield-y enough for a distressed book, but they're also not -- don't have high enough ratings for your typical CLOs.

So we think that it's an asset class that's actually undervalued. And to a large extent, that business and our continuity to do deals is going to be based upon just how quickly we can find the assets that we like and accumulate them. And it's not so easy. We have to work to do that. So you saw us do a couple deals last year. We certainly are hopeful that we can do 2 or 3 this year, but that's obviously going to depend on market conditions.

Your next question is from Crispin Love with Sandler O'Neill.

So last quarter, you talked a little bit about potentially covering the dividend in maybe the first or second quarter of 2018. I'm just wanting a little bit of an update on that. Have your expectations changed at all? And should this also just coincide when you've reached the desired size of the credit portfolio?

Yes. That's where kind of the goal line that we've set, right, is, when we think the portfolio will get to the level, given the yields that we're seeing and we're accumulating, to be able to cover the dividend largely with just net interest income, right? So yes.

So we're saying about the middle of the year is where we see that taking place. And obviously, the -- in terms of covering dividend, I mean, the first month of the year gives us a good head start, but we're really looking -- and as I mentioned, I think, on a prior caller's question, obviously, some of that first quarter activity and increase in book value was not due to just net interest income.

So that's really where the important place for us is going to be, wherein our portfolio is at the level both in terms of yield and in terms of size where it's just more repeatable and reliable going forward, and we're saying the middle of this year is what we're -- middle part of this year is what we're targeting.

Okay. And then, I guess, also -- so what kind of assets are you seeing right now as the best opportunities in like the next couple of quarters? I know you mentioned SBC and consumer was this quarter and expect kind of the non-Agency to fall off a little bit. Are you kind of still seeing the same opportunities?

Yes. Mark, do you want to comment on that?

Yes. So we have -- like the opportunities presented to us in the nonperforming, reperforming residential mortgage space, same thing on some of the small-balance nonperforming commercial loans, that's been a good opportunity. Europe made a big contribution. There's been some good opportunities there.

And I think, with this volatility, it's just -- we're going to see a little bit less competition for assets. So I think, across the board, we're going to see things we like. We continue to ramp up non-QM. You mentioned the consumer. That portfolio continues to grow through flow arrangements.

So we're dynamic. We change sort of relative thickness of each slice the pie in response to market opportunity. I'm optimistic we're going to see more opportunities in CMBS this year. That was an area last year we didn't see a lot of big opportunities to grow. And I really do think there is this big benefit to diversification.

So having U.S. versus Europe, having some consumer-facing debt versus corporate-facing debts like CLO, I think, overall, you reduce volatility without -- you reduce volatility while keeping your earnings power high. So we're going to keep the portfolio diversified, but those sectors I mentioned is where we've seen some best opportunities for growth.

Okay. Just one last one for me regarding potential changes to a C corp. If I'm reading your comments right, do you think this is something that's kind of more in the next couple of years, if it were to happen, rather than kind of 2, 3, 4 quarters down the line?

I don't want to speculate. It's something that -- it's going to take serious time to consider all the ramifications that I said. I think we would rather -- we're happy to discuss all this, but nothing's going to happen anytime very soon. How about that?

Okay.

Your next question is from Jessica Levi-Ribner with B. Riley FBR.

Most have been asked and answered, but one last one on leverage. So ex the securitization, your leverage is about 2.18x. Is that correct?

Correct.

And what would be your target?

I think it could be a little bigger than that. It could get to 2.5, I think, maybe slightly higher. I think that's -- again, it sort of depends upon which assets you're talking about. The -- when we retain equity or junior tranche on a securitization, those are obviously riskier assets than some others. So it kind of -- and we wouldn't typically leverage those, right?

So it depends on what kind of assets. Some assets we have are -- the ones that we're ramping have lower yields but still good yields, maybe in the 8%, 9% range. And on those -- we could have, obviously, a full turn of leverage on those. Agency versus -- that 2x, does that include -- is that the blend of credit and agency? Or...

Yes. Excluding the securitized (multiple speakers).

Right, but it's a blend, yes. So obviously -- I mean, our agency strategy is very leveraged, very low risk because all the TBAs were short, we believe. But -- so that obviously affects the numbers. We -- I would focus maybe a little bit more on the leverage in the credit portfolio itself.

So if you turn to Page 8 of the presentation and you have 1.4x, which, I think, is 1.2x-ish, let's say, if you excluded the consolidated securitization, yes. Then, I think, that could definitely go up to, let's say, 1.5, and I think that would be probably a good -- a decent target.

Ladies and gentlemen, this concludes the Ellington Financial Fourth Quarter 2017 Earnings Call. You may now disconnect.