U.S. Markets closed

Edited Transcript of EARN earnings conference call or presentation 4-May-18 3:00pm GMT

Q1 2018 Ellington Residential Mortgage REIT Earnings Call

Connecticut Sep 11, 2018 (Thomson StreetEvents) -- Edited Transcript of Ellington Residential Mortgage REIT earnings conference call or presentation Friday, May 4, 2018 at 3:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Christopher M. Smernoff

Ellington Residential Mortgage REIT - CFO

* Laurence Eric Penn

Ellington Residential Mortgage REIT - President, CEO & Trustee

* Maria Cozine

Ellington Residential Mortgage REIT - VP of IR

* Mark Ira Tecotzky

Ellington Residential Mortgage REIT - Co-CIO

================================================================================

Conference Call Participants

================================================================================

* Joshua Hill Bolton

Crédit Suisse AG, Research Division - Research Analyst

* Steven Cole Delaney

JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2018 First Quarter Financial Results 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 of Investor Relations. You may begin.

--------------------------------------------------------------------------------

Maria Cozine, Ellington Residential Mortgage REIT - VP of IR [2]

--------------------------------------------------------------------------------

Thanks, Crystal, 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 14, 2018, 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 statement, 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 Residential; Mark Tecotzky, our Co-Chief Investment Officer; and Chris Smernoff, our Chief Financial Officer.

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

As a reminder, during this call, we'll sometimes refer to Ellington Residential by its New York Stock Exchange ticker E-A-R-N or EARN for short.

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

--------------------------------------------------------------------------------

Laurence Eric Penn, Ellington Residential Mortgage REIT - President, CEO & Trustee [3]

--------------------------------------------------------------------------------

Thanks, Maria. It's our pleasure to speak with our shareholders this morning as we release our first quarter results. As always, we appreciate your taking the time to participate on the call today.

The first quarter of 2018 started out much as 2017 ended, with volatility historically low and equities continuing to reach record highs. Of course, we saw all of that change in a hurry in February with investor concerns over inflation and rising interest rates sparking a sharp sell-off in the equity markets. The S&P reached correction territory on February 8, just 9 trading days after reaching an all-time high. The VIX jumped 282% between the start of the year and early February, with its largest 1 day movement on record occurring February 5. The 10-year Treasury broke out of its 2017 range, reaching 2.95% on February 21, its highest point in more than 4 years.

During the quarter, Agency RMBS prices came under substantial pressure with the Bloomberg Barclays U.S. MBS Agency Fixed Rate Index recording a negative return of 1.19%. It's no surprise that Agency RMBS underperformed with all of these jarring forces at work in the broader markets, especially when you consider that the Federal Reserve has increased its tapering of Agency RMBS reinvestments twice since the end of 2017.

Currently, the Fed is tapering reinvestments by $12 billion a month, as it announced a further increase to $16 billion a month in July. In total, expected Fed tapering will require the market to absorb an additional $168 billion of Agency RMBS in 2018. And when combined with the expected new issue supply of $300 billion this year, that's almost $500 billion of net additional supply for private investors to absorb, which is a lot to ask for without putting pressure on Agency RMBS prices.

During the first quarter, we took advantage of the pricing weakness, not only by adding Agency RMBS at higher yields but also by covering a good portion of our TBA short positions. We produced a solid $0.34 per share in adjusted core earnings. And despite the broader sell-off in the mortgage markets, our book value is relatively stable, thanks to our hedges and strong net carry from our portfolio. Our economic return was a modestly negative 1.2% for the quarter, which is significant outperformance relative to the rest of the Agency mortgage REIT peer group, which, on average, had an economic return of negative 4.8%.

With our share price trading at a discount to book value during the quarter, we took advantage of the opportunity to repurchase shares aggressively. We bought back 3.8% of our shares outstanding, which was accretive to book value by $0.13 per share. Despite the wider yields we're seeing on new Agency RMBS purchases, we believe that share buybacks can also be an excellent use of capital.

Last year, we were an issuer of shares when our stock was trading at far higher levels, and so far this year, we've been a repurchaser of shares with our stock trading lower. We want to be opportunistic in our capital management strategy.

We'll follow the same format on the call today as we have on the past. First, our CFO, Chris Smernoff, will run through our financial results. Then Mike Tecotzky will discuss how the residential mortgage-backed securities market performed over the course of the quarter, how we positioned our portfolio and what our market outlook is. Finally, I'll follow with closing remarks, and then we'll open the floor to questions.

Over to you, Chris.

--------------------------------------------------------------------------------

Christopher M. Smernoff, Ellington Residential Mortgage REIT - CFO [4]

--------------------------------------------------------------------------------

Thank you, Larry, and good morning, everyone. For the quarter ended March 31, 2018, we had a net loss of $4 million or $0.30 per share as compared to net income of $790,000 for the quarter ended December 31, 2017. The primary driver of the decrease in our net income was unrealized losses on our Agency RMBS investments, which were only partially offset by net interest income and net gains from our interest rate hedges.

The components of our first quarter earnings were as follows: core earnings of $4.3 million or $0.32 per share; net realized and unrealized losses from our residential mortgage-backed securities portfolio of $29.2 million or $2.20 per share as prices of our securities in the portfolio decreased as interest rates moved higher; and net realized and unrealized gains from our interest rate hedges of $20.9 million or $1.58 per share, again because of higher interest rates.

Note that net realized and unrealized gains from our interest rate hedges exclude the net periodic costs associated with our interest rate swaps since they are included as a component of core earnings.

Our core earnings includes the impact of Catch-up Premium Amortization, which, in the first quarter, decreased our core earnings by approximately $150,000 or $0.02 per share. After backing up the Catch-up Premium Amortization from interest income in both the current and prior quarters, we arrive at our adjusted core earnings of $0.34 and $0.40 per share, respectively.

Further compression of our net interest margin this quarter led to a decrease in our quarter-over-quarter adjusted core earnings per share. In the current quarter, our net interest margin, adjusted to exclude the impact of Catch-Up Premium Amortization, was 1.09% as compared to 1.41% in the prior quarter. With the average yield on our portfolio also adjusted to exclude the catch up -- the impact of the Catch-up Premium Amortization Adjustment remained relatively flat at 3.02%, our cost of funds increased from 1.63% to 1.93%. The main contributor to the increase in our cost of funds was our repo borrowing rates, which rose as LIBOR increased during the quarter.

I'd further note that we expect the average yield on our portfolio to increase going forward as we were able to add new pools at higher yields during the quarter, especially throughout the second half of the quarter when asset yields were much higher. This should, in turn, be supportive of our net interest margin.

During the quarter, we repurchased shares aggressively with our share price trading at a significant discount to book value. For the quarter, we repurchased over 512,000 shares at an average price per share of $11.21 and a total cost of $5.7 million and at an average discount to book value of 22%. These share repurchases were accretive to book value by $0.13 per share. Our annualized operating expense ratio for the quarter increased 20 basis points to 3.26%, which was primarily the result of our lower average equity base. At the current equity base, we project our going-forward annualized expense ratio to be about 3.2%.

During the quarter, we turned over approximately 15% of our Agency portfolio as we sought to capitalize on sector rotation opportunities arising from the market volatility. In response to the spread widening, we also added to our loan TBA portfolio by $25.5 million net while covering a significant portion of our TBA short positions towards quarter end when spreads were particularly wide.

Our overall RMBS portfolio decreased by 3.3% to $1.631 billion as of March 31, 2018, as compared to 6 -- $1.686 billion as of December 31, 2017. Although our portfolio was slightly smaller so was our equity base, and we saw a small increase in our leverage. Our overall debt-to-equity ratio adjusted for unsettled purchases and sales increased to 8.6:1 at March 31, 2018, from 8.2:1 as of December 31, 2017. At the same time, our net mortgage assets to equity ratio increased to 7.8:1 from 5.7:1 at year end.

The increase in both these leverage metrics reflected our conviction towards the end of the quarter that we had reached an excellent entry point to acquire more Agency mortgages, which we thought were poised for a rebound. Our Agency RMBS prices dropping -- with our Agency RMBS prices dropping, our assets had significant unrealized losses for the quarter. These losses were particularly offset but were -- sorry, these losses were partially offset but not fully offset by net interest income and significant gains on our interest rate swaps and TBA short position. Our results were also dampened somewhat by strong TBA dollar rolls and muted prepayments, which caused TBAs to outperform spec pools.

Overall, our Agency strategy generated a gross loss of $3.3 million or $0.25 per share. Meanwhile, our non-Agency portfolio performed well driven by strong net interest income and net realized and unrealized gains generating gross income of approximately $730,000 or $0.06 per share.

During the quarter, our interest rate hedging portfolio continued to be predominantly made up of interest rate swaps and short positions in TBAs and, to a lesser extent, short positions in U.S. Treasury securities and futures. For the quarter, we had total net realized and unrealized gains of $20.6 million or $1.56 per share on our interest rate hedging portfolio. Our interest rate swaps generated net gains for the quarter as interest rates rose and our short positions in TBAs also generated gains as prices declined during the quarter.

In our hedging portfolio, the relative proportion based on 10-year equivalents of short positions at TBAs decreased quarter-over-quarter relative to our other interest rate hedges.

As you can see on slide 16, TBAs represented only 19.5% of our hedging portfolio at the end of the first quarter as compared to 40.3% at year-end. At the end of the first quarter, we had total equity of $178.3 million or book value per share of $13.90 as compared to $192.7 million or $14.45 per share at the end of the prior quarter.

And as Larry previously mentioned, our economic return for the first quarter was a modestly negative 1.2%.

I would now like to turn the presentation over to Mark.

--------------------------------------------------------------------------------

Mark Ira Tecotzky, Ellington Residential Mortgage REIT - Co-CIO [5]

--------------------------------------------------------------------------------

Thanks, Chris. This was a challenging quarter across most financial markets. The S&P had a negative quarter as did all of the major bond indices: treasuries, investment-grade corporates, high-yield corporates and Agency MBS. At EARN, we think of ourselves as having our own dual mandate: preserve book value in volatile markets during risk-off moves and capture upside in good markets.

We are pleased with how we've preserved book value this quarter in a very challenging environment. After the eerie calm of the bond market in 2017, Q1 was a stark change. It seemed like every corner of the bond market was conspiring to separate investors from their money. Interest rates shot up and volatility roared back. Credit strategies weren't spared with both IG and high-yield down between 1% and 3% for the quarter, and that's on an unlevered basis.

We came into the quarter positioned defensively, with less MBS exposure than the peer group as we didn't think investors were getting paid for owning MBS in front of the increase in the Fed's balance sheet reduction. That allowed us to play at offense when better opportunities arose mid-quarter as MBS got very cheap, and we added a lot of net mortgage exposure.

Look at Slide 5. You can see that the MBS OASs as of the quarter end were right around their 2-year wides, while corporate bond spreads widened during the quarter, but were still below the midpoint of their 2-year range. So far, our aggressively -- our aggressive buying of mortgages towards the end of the quarter has paid off. MBS have done well post quarter end, and our performance in April was strong.

You can see this change in positioning in 2 places in the presentation. On the bullet point on Slide 17, we show our net mortgage exposure, which reflects the market value of our mortgage assets as reduced by our TBA short. That net mortgage exposure increased substantially in the quarter, primarily because we reduced our TBA hedge. And as Chris mentioned on Slide 16, which shows our hedging portfolio, you can see how the percentage of our interest rate hedges in TBA shorts was reduced substantially in the quarter. Dialing up and down our TBA hedge is an important lever we can use to drive outperformance and preserve book value in different market environments.

In the face of a sharp move in interest rates, increased balance sheet reduction from the Fed and wider corporate bond spreads, mortgages could not help but widen this quarter. Given these headwinds, spread widening from the start to the end of the quarter was about 12 basis points. But intra quarter, there were opportunities to buy MBS at wider spreads. We came into the quarter with a substantial TBA short because at the beginning of the year, mortgages looked tight even if you thought the low volatility of conditions of 2017 would persist. Then when mortgages really underperformed during the quarter, we bought back a lot of our TBA shorts and replaced those hedges with Treasury shorts and swaps. We also took advantage of a material discount in our stock to buy back shares aggressively.

Looking ahead, we see good opportunities in Agency MBS. Specifically, there are 2 significant supporters of MBS performance right now that we haven't seen in years. The first supporter relates the relationship between repo rates and 3-month LIBOR. Look at Slide 6, which shows the differential between 3-month LIBOR, which is what the floating leg of our interest rate swaps are indexed to and the actual average cost of our repo borrowings. Recently, we've been executing 3-month repo at 3-month LIBOR minus 40 basis points. This means that our repo cost is about 40 basis points less than what we are getting paid on the floating leg of our swaps. This is a huge tailwind. Just contrast this to 12 months ago when the floating rates we received on our swaps barely covered our repo borrowing rates. We are now pocketing an extra 40 basis points on every turn of leverage.

There are 2 important points to make here. Firstly, this phenomenon may not persist, but it is likely to be with us to some extent for a while because it's a largely -- because it's largely a consequence of the money market reform of 2016, so it's systemic. The financing benefit is so significant versus early last year that even if half of this benefit went away, it would still represent a very significant boost to mortgages.

The second important point about this financing benefit is that only a levered MBS investor like a mortgage REIT can take full advantage. Most MBS investors don't use leverage. Because this financing benefit only impacts a small percent of the MBS outstanding, MBS pricing has barely reacted to the improved financing conditions.

Mortgage REITs are probably the biggest beneficiary, and with permanent capital earned as a highly attractive repo counterparty, it can get very favorable financing terms.

The second big positive about this market as compared to years past is that you don't need a lot of prepayment risk or incur big payoffs when you add specified pools to generate your net interest margin.

The dramatic decline in premium prepayment risk is illustrated on Slide 7. Here, we imagine a hypothetical mortgage REIT that just owns low loan balance 30-year Fannie Mae 4s and leverages those assets 7:1 assets to capital. We then calculated what percentage of the REITs capital at each point in time was tied up in mortgage premium risk. You can see that back in 2016, as much as 70% of the capital was tied up in premium. That means that whenever a mortgage loan prepayment occurred, the portion of this mREIT's capital that was tied up in that mortgage loan took a full 70% hit. But today, look how low this premium risk is. It's only about 20% of capital. This doesn't make the NIM higher now, but it makes it more predictable, and it makes it more resilient. This should reduce book value volatility. So now after the big spread widening we saw in the middle of the quarter, we've seen NIMs materially higher than at the start of the year, and it doesn't come from taking a lot of prepayment risk.

So going forward, Fed balance sheet reductions should keep mortgages at a level where stable NIM can be attained without a lot of risk. Many investors generally have a knee-jerk reaction and sell into volatility, but it's a volatility that usually recharges the opportunity set. Without volatility, spreads are usually tight, and going forward, returns are low. We finally got volatility this quarter, and we managed through it with only a modest negative economic return. Now we have wider spreads and much better opportunity set. The mortgage market needs capital to take up the slack from the Fed tapering, so mortgage investors are getting paid more for their capital. In addition, the low repo rates relative to LIBOR are providing a huge benefit for levered investors like us. And on top of it all, there is less prepayment risk given the dramatic drop in price premium.

Now back to Larry.

--------------------------------------------------------------------------------

Laurence Eric Penn, Ellington Residential Mortgage REIT - President, CEO & Trustee [6]

--------------------------------------------------------------------------------

Thanks, Mark. We've mentioned in prior quarters that our use of TBA short positions sets us apart from most other Agency mortgage REITs, and along with our other interest rate hedges, serves as an important stabilizer to our book value. Going into year end, we believe that the combination of low volatility, low prepayments and tight spreads was not a compelling environment to add risk, and so we lowered our net mortgage exposure accordingly. This conservative positioning enabled us to withstand the quarter selloff with only limited book value decline. And this, in turn, allowed us to play offense towards the end of the quarter by opportunistically covering TBA shorts and adding asset leverage at more attractive NIMs.

In total, we increased our net exposure to Agency pools by about $300 million in the first quarter to $1.4 billion, resulting in a 7.8:1 net mortgage asset to equity ratio at March 31, an increase from the prior quarter's 5.7:1. Although strong dollar rolls caused TBAs to outperform specified pools this quarter, we continue to believe that the outlook for specified pools is strong. The Fed exclusively purchases Agency pools via TBA contracts, so as it's tapering ramps it will be removing an important technical support for TBAs. We believe that the demand for specified pools will only grow from here, and we continue to unearth new pockets of mortgage pools that we believe are undervalued and underappreciated.

Additionally, despite the quarter spread widening that largely reflected technical factors, the fundamentals for Agency MBS remain strong with prepayment risk low and a multitude of financing outlets providing competitive funding. We believe that the opportunity set in Agency MBS will remain highly attractive, and with the increased volatility we're seeing this year, we will look to continue dialing up and down our Agency RMBS exposure in response to market opportunities. That ability to dynamically dial up and down our mortgage exposure by making heavy use of short TBA positions when we're defensive on the mortgage market and covering those shorts when we're constructive on mortgages, well, that's just a great tool in our toolbox.

Our own stock price has also not been immune to volatility, but that also creates opportunities as we're able to supplement earnings with accretive share repurchases when our stock trades at significant discounts to book value.

The first quarter was a great example of how quickly markets can change and how long-held beliefs that have underpinned the pricing structure of the market for years can be called into question. We are 5 weeks into the second quarter, and the 10-year U.S. Treasury has continued its march higher from the last 2 quarters. More Fed rate hikes are coming, and the Fed's tapering program is scheduled to increase significantly in the months ahead. We also wouldn't be surprised to see even higher volatility should other central bank -- banks take the Fed's lead and begin walking back their wide-scale asset purchase programs.

We believe that EARN is well positioned for volatility, and that our diligent hedging and liquidity management will continue to protect book value while also enabling us to take advantage of new investment opportunities. And we believe that our confidence is validated by EARN's first quarter results in what was truly a hostile environment for the mortgage market.

And with that, our prepared remarks are concluded. We'll now turn the call back to the operator for questions. Operator, please go ahead.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And our first question comes from the line of Steve Delaney with JMP Securities.

--------------------------------------------------------------------------------

Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [2]

--------------------------------------------------------------------------------

And I want to offer my congratulations on the book value performance. I think you would not normally probably jump up and down with minus 3.8%, but we have the final scorecard for the Agency REITs now this morning, and I can confirm the median decline we saw was 7.2%, and your performance was the second best. So well-done on that regard in certainly a tough, tough market.

--------------------------------------------------------------------------------

Laurence Eric Penn, Ellington Residential Mortgage REIT - President, CEO & Trustee [3]

--------------------------------------------------------------------------------

Thank you, Steve. Thank you.

--------------------------------------------------------------------------------

Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [4]

--------------------------------------------------------------------------------

The -- you're welcome. Leverage, adjusted leverage slipped up a little bit. And I realize you took some short TBAs off. And -- but help us get an idea of how much flexibility that you have -- you think you have with respect to leverage, especially in an environment where MBS were to widen out significantly. Because it's -- when I say that, I'm really thinking about true debt to equity rather than long TBAs because what I'm hearing you guys say is your TBA activity may be more on the short side, but when you want to be long, you want to still be long spec pools and not TBA. So it would seem that the true balance sheet leverage is going to be a factor in how big a long bet you can put on.

--------------------------------------------------------------------------------

Mark Ira Tecotzky, Ellington Residential Mortgage REIT - Co-CIO [5]

--------------------------------------------------------------------------------

Steve, it's Mark. So I guess what I would say is the first decision we make when we look at market pricing and market conditions is how much mortgage exposure we want to have in the company. And that -- and we mentioned that number and where it is in the presentation book. So that to us is the biggest thing to get right. Then once we sort of know how much mortgage exposure we want in the company, then we think about what's the best way to get it. Is it long TBA's, is it long specified pools or is it just buying back TBA shorts, right? So what we thought in this quarter was, given rates were rising, given dollar prices were lower, prepayment indices were dropping, to us it made more sense to buy back the TBA short as opposed to adding more specified pools that -- where you're paying up for some prepayment protection. We thought the market would probably put less of a premium on prepayment protection. So a lot of the pools we add -- so some of the pools we added were really pools that had extension protection. So that's why this quarter, we chose to dial up the mortgage exposure primarily by reducing our TBA short. In other environments, we could make a different decision, so it just came down to the view that the reason why mortgages were widening was this fear of inflation fueled by the tax cut and higher rates. And so in that environment, we'd rather reduce the short than increase the long, if the long was going to come with buying more prepayment protection. And also too, just from like a risk management standpoint, it's always riskier to sort of -- it always less -- it's derisking to unwind trades [than] to put on new trades. And so we had that TBA short, that was a big part of our hedging strategy in the fourth quarter, so unwinding that. If we were agnostic on the sort of the value of TBAs versus specified pools, just unwinding the trade and taking it off is sort of -- reduces risk. So it's something that we prefer to do than adding additional risk. We don't think there's compelling reason.

--------------------------------------------------------------------------------

Laurence Eric Penn, Ellington Residential Mortgage REIT - President, CEO & Trustee [6]

--------------------------------------------------------------------------------

And let me -- I just want to add to that. So I think if you look back, and look, I don't have these numbers in front of me, but I can't remember. I think we've been close to 9:1 leverage, maybe we've been a little bit higher at times. But I don't think we've ever been much higher. So yes, Chris, actually just confirmed that. So if you could imagine -- and we've had some TBA hedges. We're a little on the low side now at 20%. We've certainly been at 50% at times, perhaps even a little bit more. So I -- if you want to imagine a market where we thought that mortgages were just pound-the-table cheap, right, I think you can look at that 9:1 level and say, look, these guys have never really been much higher than that before. It's -- we're very conscious here firm-wide at the risks of leverage, been through a lot of cycles where leverage has obviously cost people a lot of money, had to liquidate at the very worst times, right?

--------------------------------------------------------------------------------

Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [7]

--------------------------------------------------------------------------------

Hello.

--------------------------------------------------------------------------------

Laurence Eric Penn, Ellington Residential Mortgage REIT - President, CEO & Trustee [8]

--------------------------------------------------------------------------------

Yes. Are you there?

--------------------------------------------------------------------------------

Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [9]

--------------------------------------------------------------------------------

Yes, I'm here. I just -- it cut out for just a minute. Your voice cut out for just a minute, but I hear you now.

--------------------------------------------------------------------------------

Laurence Eric Penn, Ellington Residential Mortgage REIT - President, CEO & Trustee [10]

--------------------------------------------------------------------------------

Okay. Sorry about that. Yes, so we've been through cycles where we've seen investors punished for overleveraging and, therefore, having to liquidate assets at the worst time. So I think if you -- again, it's hard for me at this point to imagine a scenario where we would both lift all of our TBA shorts and be more than 9:1 leveraged. That's pretty -- so if you want to sort of set a...

--------------------------------------------------------------------------------

Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [11]

--------------------------------------------------------------------------------

A ceiling.

--------------------------------------------------------------------------------

Laurence Eric Penn, Ellington Residential Mortgage REIT - President, CEO & Trustee [12]

--------------------------------------------------------------------------------

(inaudible) we're thinking -- I think that, at least based upon our experience, that's, I think, a pretty good guideline.

--------------------------------------------------------------------------------

Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [13]

--------------------------------------------------------------------------------

That's helpful, Larry. You -- in the first quarter, obviously, a tough environment, but you slightly underearned your dividend on adjusted core earnings. We're thinking about this LIBOR repo spread, and we're looking at it as being more beneficial to the mortgage REITs in the second quarter of this year than it was in the first quarter. And I'm wondering if you see it the same way, and that has to do with the sort of the timing of when 3-month LIBOR moved, and it seems like it's moved a lot more here since March 31. Just curious if you think that will give you an even bigger benefit in 2Q versus 1Q.

--------------------------------------------------------------------------------

Mark Ira Tecotzky, Ellington Residential Mortgage REIT - Co-CIO [14]

--------------------------------------------------------------------------------

Steve, so you're exactly right. The other component to that is when your swaps reset, right? So when you initially do a swap, one leg is set when you -- at trade time, right? So you're going to see swaps reset up. So look, I don't -- we don't expect that this difference between 3-month LIBOR and repo rates gets bigger. We wouldn't be at all surprised to see it narrow. Our point is that it's such a big move that even if it retraced 50%, it's a better operating environment for REITs on that basis than what they've seen in, got to be at least the last 5 years.

--------------------------------------------------------------------------------

Laurence Eric Penn, Ellington Residential Mortgage REIT - President, CEO & Trustee [15]

--------------------------------------------------------------------------------

But you're absolutely right about the timing of all this and that it takes a little while for all this to sink in, a, as your swaps reset; and then b, as your repos roll. So because we rolled our repos in the past at -- sometimes agreeing to spreads that obviously now we can get better spreads. So as those repos roll, we'll be able to lock in better spreads.

--------------------------------------------------------------------------------

Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [16]

--------------------------------------------------------------------------------

And do you link most or index most of your fixed pay swaps to 3-month LIBOR rather than 1-month?

--------------------------------------------------------------------------------

Laurence Eric Penn, Ellington Residential Mortgage REIT - President, CEO & Trustee [17]

--------------------------------------------------------------------------------

Yes, they're all, I believe, off 3-month.

--------------------------------------------------------------------------------

Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [18]

--------------------------------------------------------------------------------

All right, great. Okay, good. Well, we don't remember talking about this, Trevor and I, going back over however many years, more than a decade. We don't remember talking about this phenomenon. And it was usually, there were times, back during the crisis and everything, where repo was well above LIBOR. And if it does hold, it would just seem like 20 basis points, if it becomes kind of built into the systems, and people have a high percentage of their repo hedged with fixed pay swaps, it would seem, if leverage is 7 to 8 times, we're talking about over 100 basis point contribution to return on equity, I would think just from this financing benefit.

--------------------------------------------------------------------------------

Mark Ira Tecotzky, Ellington Residential Mortgage REIT - Co-CIO [19]

--------------------------------------------------------------------------------

Yes, it's a big deal. I remember back 2, 3 years ago when the banks were operating -- starting to operate under the regime where they had to have more capital, people were talking about the return on equity from Agency repo wasn't good for banks. And people worried about repo going away, and repo costs then were -- 3-month repo was above 3-month LIBOR. So [we're in] a materially better environment, and I guess -- and the counterpoint is that you've got the Fed getting its balance sheet back, so there's a lot of supply. But our point is that the supply is priced in the mortgage market now because every investor feels that. But it's only a very small part of the mortgage market that takes advantage of this financing ability. Now most of the mortgage market is banks, it's money managers, it's insurance companies. It's not levered in the repo market.

--------------------------------------------------------------------------------

Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [20]

--------------------------------------------------------------------------------

No, understood. And you're correct, it would be mortgage REITs and hedge funds, and I don't think the hedge funds are in the trade that much anymore with the Fed in play with raising rates, so.

--------------------------------------------------------------------------------

Operator [21]

--------------------------------------------------------------------------------

Our next question comes to the line of Doug Harter with Crédit Suisse.

--------------------------------------------------------------------------------

Joshua Hill Bolton, Crédit Suisse AG, Research Division - Research Analyst [22]

--------------------------------------------------------------------------------

This is actually Josh, on for Doug. Just one on share buybacks. Larry, curious how you think about the balance between accretive share repurchase and shrinking your equity base further and increasing your expense ratio. And if you could just remind us what the current buyback authorization is, that'd be great.

--------------------------------------------------------------------------------

Laurence Eric Penn, Ellington Residential Mortgage REIT - President, CEO & Trustee [23]

--------------------------------------------------------------------------------

Sure. Yes, the current buyback authorization is 1.2 million shares. And you saw that our expense ratio ticked up 20 basis points in the first quarter versus last quarter, but part of that was due to timing of expenses. So as I said in my script, we expect for the 2018 year that our expense ratio will be roughly 3.2%. And so it's something that we are obviously mindful of as a small company. We saw this as a great opportunity to repurchase shares in the last quarter. But -- and as Chris mentioned, the effect on our expense ratio was not -- and I didn't want to imply that buying 3.8% of our shares caused our expense ratio to go up 20 basis points. That's absolutely not the case. But it does have a marginal impact, and we need to be mindful of that as well. So our stock price is now somewhat higher on a price to book ratio as we speak, so all these things are taken into account as well as the opportunities that we're seeing. So we'll -- we -- as we mentioned on the call, we really want to be opportunistic about our capital management strategy and have that ability to buy back when stuff is really cheap, when we're trading below 80% of book and be less aggressive about that when we're trading higher.

--------------------------------------------------------------------------------

Operator [24]

--------------------------------------------------------------------------------

At this time, there are no further comments. I will now turn it back to the presenters for closing remarks.

--------------------------------------------------------------------------------

Laurence Eric Penn, Ellington Residential Mortgage REIT - President, CEO & Trustee [25]

--------------------------------------------------------------------------------

I think we're good.

--------------------------------------------------------------------------------

Operator [26]

--------------------------------------------------------------------------------

Okay. This concludes today's conference call. You may now disconnect.

--------------------------------------------------------------------------------

Laurence Eric Penn, Ellington Residential Mortgage REIT - President, CEO & Trustee [27]

--------------------------------------------------------------------------------

Thank you.

--------------------------------------------------------------------------------

Operator [28]

--------------------------------------------------------------------------------

You're welcome.