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Edited Transcript of EFC earnings conference call or presentation 7-Aug-18 3:00pm GMT

Q2 2018 Ellington Financial LLC Earnings Call

GREENWICH Aug 20, 2018 (Thomson StreetEvents) -- Edited Transcript of Ellington Financial LLC earnings conference call or presentation Tuesday, August 7, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jason Frank

Ellington Financial LLC - Secretary & Corporate Counsel

* JR Herlihy

Ellington Financial LLC - CFO

* Laurence Eric Penn

Ellington Financial LLC - CEO, President & Director

* Mark Ira Tecotzky

Ellington Financial LLC - Co-CIO

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Conference Call Participants

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* Crispin Elliot Love

Sandler O'Neill + Partners, L.P., Research Division - VP

* Douglas Michael Harter

Crédit Suisse AG, Research Division - Director

* Eric J. Hagen

Keefe, Bruyette, & Woods, Inc., Research Division - Analyst

* Steven Cole Delaney

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

* Timothy Paul Hayes

B. Riley FBR, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Thank you for standing by, and welcome to the Ellington Financial Second Quarter 2018 Financial Results Conference Call. Today's call is being recorded. (Operator Instructions) It is now my pleasure to turn the floor over to Jason Frank, Associate General Counsel of Ellington and Secretary. Sir, you may begin.

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Jason Frank, Ellington Financial LLC - Secretary & Corporate Counsel [2]

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Thanks, and good morning. 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 15, 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 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; and JR Herlihy, our Chief Financial Officer.

As described in our earnings press release, our second quarter earnings conference call presentation is available on our website, ellingtonfinancial.com. Management's prepared remarks will track the presentation.

Please turn to Slide 4 to follow along. Please note that any references to figures in this presentation are qualified in their entirety by the end notes at the back of the presentation.

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

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [3]

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Thanks, Jay, and welcome, everyone, to our second quarter 2018 earnings call. We appreciate you taking the time to listen to the call today. Our prepared remarks today will follow the earnings presentation that we posted on our website last night. Please turn to Slide 4.

Ellington Financial had excellent performance in the second quarter. We were able to build on the strong momentum of the first quarter as we continue to benefit from our growing Credit portfolio, which increased another 9% this quarter. As a result, net investment income is also growing nicely, increasing to $0.36 for the quarter, almost covering the dividend on its own. Overall, Ellington Financial generated net income of $21.2 million or $0.69 per share and an economic return of 3.8% for the second quarter. Adjusted for dividends, book value is now up 8.2% through the first half of the year, or 17.1% annualized.

Based on yesterday's closing price of $16.40 per share, our annualized dividend yield is 10%.

Excellent performance within our Credit portfolio drove the quarter's results. We benefited from strong performance in several of our loan-related strategies, including consumer loans, small balance commercial mortgage loans, European nonperforming loans and non-QM loans. Among our security strategies, U.S. and European CLOs, U.S. CMBS, corporate credit relative value and European RMBS all posted strong returns.

The growth and performance of our securitizations continues to be a key driver of our results. This past quarter, we participated in our third Ellington-sponsored corporate CLO, achieving tighter pricing and a longer investment period than our previous issuances, even in the face of a softer overall CLO new issue market. We believe we have a differentiated strategy in the CLO space. We rely on our deep credit underwriting expertise to find inefficiencies in the lower-rated, less widely syndicated leveraged loan market where there's much less competition for assets.

Moving to our non-QM securitization strategy. During the second quarter, S&P upgraded 3 classes of our inaugural securitization, the FMT 2017-1. This deal has the highest perfect payer percentage of all non-QM securitizations in its vintage as reported by Bloomberg. We are nearing critical mass of product for a follow-on securitization and plan for that later this year, subject, of course, to market conditions.

Please turn to Slide 5, where you can see an overview of the current portfolio across our various Credit and agency strategies. At quarter-end, 80% of our capital was invested in Credit strategies where we're generating a blended market yield of 9.1% and that's before leverage. We continue to focus on investing in strategies that favor our analytics, strategies where there are big barriers to entry and strategies where big banks no longer compete due to postcrisis regulation.

We also have ample liquidity and have kept the duration on a large portion of the portfolio relatively short, so it's constantly returning capital. Our disciplined approach to liquidity management should enable us to take advantage of investment opportunities in periods of volatility.

As you can also see on Slide 5, we finished the quarter with a debt-to-equity ratio of 2.77:1, with much of this leverage concentrated in our highly liquid Agency portfolio. This compares to a debt-to-equity ratio of 2.62:1 at the end of the first quarter. So leverage continues to tick up as we grow the portfolio and buy back shares, but I would expect the rate of growth to start to level off as the portfolio approaches its desired size and composition. Of course, not all leverage is created equal and a decent portion of our total borrowings relates to our non-QM securitization deal that we consolidate onto our balance sheet, to our senior unsecured notes and to our term nonmark-to-market bank facilities. These forms of leverage are much less vulnerable to market shocks than short-term repo.

We'll follow the same format on the call today as we have in the past. First, our CFO, JR Herlihy, will run through our financial results. Then, our Co-CIO, Mark Tecotzky, will discuss how our markets performed last quarter, how our portfolio performed and what our investment outlook is going forward. Finally, I'll follow with closing remarks before opening the floor to questions.

But before we get to the financial results, I wanted to mention how excited I'm to have Lisa Mumford, our recently retired CFO, back with Ellington Financial. As we announced last night, Lisa is joining me and the 3 independent Directors on the Board of Ellington Financial, with Mike Vranos stepping down from the board but remaining as engaged as ever as Co-Chief Investment Officer where he and Mark Tecotzky will continue to lead our investment strategy. Lisa's insights and deep understanding of the company will be invaluable as we continue to drive the company forward.

And with that, I will turn the call over to Lisa's replacement as Ellington Financial's CFO, JR Herlihy.

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JR Herlihy, Ellington Financial LLC - CFO [4]

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Thanks, Larry, and good morning, everyone. Please turn to Slide 6 for a summary of our income statement. In the second quarter, EFC generated net income of $21.2 million or $0.69 per share, broken down as follows: net investment income after G&A, management fees and incentive fees of $11 million or $0.36 per share, less net realized loss at $1.3 million or $0.04 per share plus change in net unrealized gain of $12.5 million or $0.41 per share minus allocation to noncontrolling interests of $991,000 or $0.03 per share. Our net income comfortably covered our dividend of $0.41 per share, as we continue to grow the Credit portfolio and rotate capital into higher-yielding strategies.

Net investment income grew this quarter despite a higher cost of funds on our borrowings. By comparison, last quarter, we had net income of $21 million or $0.67 per share and net investment income of $10.2 million or $0.32 per share. We view net investment income as a good proxy for our earnings power, but keep in mind that it has its limitations. At any point in time, some portion of our capital will always be invested in assets that do not generate net investment income. For example, strategic and equity investments and mortgage originators where appreciation shows up in franchise value and thus the contribution to earnings is reflected in unrealized gains. As another example, when we successfully foreclose on a commercial mortgage NPL, we typically recognize an unrealized gain on the value of the real estate versus our basis in the loan, and that's not considered net investment income. Moreover, net investment income will never capture the portion of the total return that we generate via opportunistic trading.

Please turn to Slide 7 for details on the attribution of earnings between our Credit and Agency strategies. In the second quarter, the Credit strategy generated gross income of $24.9 million or $0.80 per share, while the Agency strategy generated gross income of $1.65 million or $0.06 per share. These amounts compare to gross income from the Credit strategy of $25.3 million or $0.81 per share and a gross loss from the Agency strategies of $317,000 or $0.02 per share in the prior quarter.

In the Credit portfolio, the average yield on our assets rose as did our cost of funds as LIBOR continued to increase. As a result, both interest income and other income and interest expense increased quarter-over-quarter, and in total, our net interest income increased to $15.4 million from $13.9 million. Net realized gain and change in net unrealized gain was $11.2 million, down from $12.6 million last quarter with notable contributions from the portfolio of European consumer NPLs, the sale of which closed subsequent to quarter-end, realized gains across most of our strategies and other mark-to-market gains.

Similar to last quarter, our interest rate and credit hedges did not meaningfully impact P&L. In total, net credit hedges and other activities contributed positive gross income of $1.7 million during the second quarter. But the majority of that income came from our corporate credit relative value strategy.

Other investment-related expenses increased to $3.3 million from $2.6 million, driven by higher servicing fees related to our increased holdings and expenses relating to our REO properties. Overall, the Credit strategy utilized about 80% of EFC's allocated equity at quarter-end and generated an annualized gross ROE of approximately 21% based on its contribution of $24.9 million of P&L in the second quarter. This gross return includes financing costs, hedging costs and servicing fees and other investment expenses relating to portfolio assets, but excludes general operating expenses, management fees and incentive fee.

Staying on Slide 7, and moving out of the operating results of the Agency strategy. Gross income for the second quarter was $1.65 million or $0.06 per share compared to a slight loss of $317,000 or $0.02 per share in the prior quarter. During the second quarter, Agency RMBS prices declined again, which led to net realized and unrealized losses on our portfolio totaling $5.66 million or $0.19 per share. However, these losses were more than offset by net interest income and gains in our net interest rate hedges and other activities, which altogether totaled $7.31 million or $0.25 per share.

Please turn to Slide 8. Our Credit portfolio was approximately $1.12 billion as of June 30, 2018, which was about a 9% increase from last quarter-end. These totals back out the effect of consolidating the non-QM securitization trust. The growth of our Credit portfolio primarily came from net purchases in the following target strategies: Consumer loans and ABS; residential mortgage loans and REO; European RMBS, which is contained in the nondollar slice here; and retained tranches in CLO securitizations, which is then the CLO slice.

We also sold a portion of our more liquid, lower risk assets such as U.S. nonagency RMBS and CLO note investments and rotated that capital into our higher-yielding strategies.

Please turn to Slide 9. Our long Agency RMBS portfolio increased approximately 2% to $948.5 million as of June 30, 2018 from $928.2 million as of March 31, 2018. Our asset mix was essentially unchanged and our weighted average coupon increased to 4.08% from 3.97% in the prior year period.

Next, please turn to Slide 10, which shows a breakout of our borrowings and leverage. As of June 30, we had an overall debt-to-equity ratio of 2.77:1, up 2.62:1 last quarter. The higher leverage resulted from increased Credit and Agency borrowings in connection with new purchases and continues to reflect the lighter cash balance that we've been holding on balance sheet in favor of the more liquid, lower risk assets such as certain U.S. nonagency RMBS and CLO note investments.

Finally, GAAP leverage is higher because we consolidate the non-QM securitization for GAAP reporting purposes. If we weren't consolidating the non-QM securitization-related debt, our debt-to-equity ratio would have been 2.61:1.

During the second quarter, we repurchased 242,161 shares or 0.8% of our outstanding shares coming into the quarter at about a 22% average discount of diluted book value per share. As a result of these discounts, our share repurchases were accretive to book value per share by $0.03.

For the second quarter, our general operating expenses were $4.6 million, representing an annualized expense ratio of 3%, which is around where we see our expense ratio going forward. We ended the quarter with diluted book value per share of $19.57. I'll now turn the call over to Mark.

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Mark Ira Tecotzky, Ellington Financial LLC - Co-CIO [5]

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Thanks, JR. EFC had a great quarter with almost all sectors of the Credit portfolio making meaningful contributions and a solid $0.06 per share of gross income from our Agency portfolio, which is only a small part of our capital allocation. Halfway through the year, we have generated a total economic return of 8-plus percent nonannualized. This is particularly impressive given that credit spreads have struggled this year, with the mortgage component to the Barclays Agg down 1% year-to-date through the end of June and the corporate component down over 3%. We accomplished this with a broad-based contribution from all sectors of our Credit portfolio, residential mortgages, commercial mortgages, consumer and corporate.

2018 is an inflection point for financial markets for a few reasons. First, the Fed is now implementing meaningful balance sheet reduction, so investors can no longer ride the Fed's coattails to generate returns. Since yield curve is so flat now, investors can't expect to generate big returns by running a big duration gap, and in fact, that can lead to negative returns when rates are rising as they have over the past year.

Second, because credit spreads have tightened so much over the past few years, we think that in many highly credit-sensitive sectors, most of the returns to be made have already been made. And this year, these sectors are mostly treading water. So you can't just camp out in the most commoditized parts of the Credit market, like Credit risk transfer, and expect further spread compressions to drive returns.

At the same time, there are some tremendous opportunities in other sectors. Loan origination, for example, has a great tailwind from better financing terms on warehouse lines and tighter securitization spreads. We have cast a wide net.

We look at a lot of sectors to find high-yielding assets that can't be commoditized such as [off to run] high-yielding bank loans, then we leverage their yield in our proprietary CLO securitization strategy. We create reverse mortgage servicing, a truly unique asset class through Longbridge, one of our mortgage origination strategic investments.

Through LendSure, another mortgage originator strategic investment of ours, we secure a pipeline of high-yielding, non-QM loans that Fannie and Freddie can't commoditize. In the CMBS sector, we believe that we are one of only a select handful of B-piece buyers with the market knowledge, capital markets expertise and granular research effort to be able to take advantage of yields in that sector.

In the small balance commercial mortgage space, we have developed a network of partners who source commercial real estate bridge loans and distressed loans for us. Our investment team in Europe sources NPL and RPL pools from bank workout groups. In the consumer space, we buy our loans from proprietary origination partners.

These are the ways we're driving returns as opposed to relying on a Fed-driven lower for longer thesis or relying on a bet to commoditize credit spreads will tighten forever.

We've built a portfolio that isn't a one-trick pony. No matter how good your one trick is, the competition eventually figures it out. The sector that has the best performance 1 year often becomes overpriced and has a big drawdown the next. That's why we diversify, diversifying every dimension: consumer versus corporate, securities versus loans, residential mortgage loans versus commercial mortgage loans versus syndicated loans, loans that we buy in the secondary markets versus loans that we manufacture ourselves. We look both in the U.S. and in Europe. We look for value across sectors. We don't have the same risks on all the time. We actively and consciously choose our risks based on a risk-return framework that is continuously reassessed.

As you can see from Slide 8, the long Credit portfolio -- you can see this on Slide 8 the long Credit portfolio. Now you see a pie cut in roughly equal slices. Dissecting our headline return number, almost every strategy of ours made a nice contribution this quarter. The diversified return scheme is important for 2 reasons. First, it should make returns more consistent. Financial terms have a higher sharp ratio. Second, it should make returns more robust. If any one sector looks too expensive or comes with risk we don't think we're compensated to take, we avoid that sector to allocate the capital elsewhere. CRT bonds are a good example. We're not giving them much of an allocation at all right now. Because of the low levels of Credit enhancement, they have almost a catastrophe bond-like risks. For example, last summer's flooding in Houston caused spread widening. That sort of weather or natural disaster risk is something we can't predict, but we can control its impact by limiting exposure.

Slide 11 is a new one for us. Here, we break down our Credit portfolio into the 4 main building blocks: residential mortgages, commercial mortgages, corporate-facing debt and unsecured consumer loans.

To summarize, we aren't riding the Fed's coattails, and we aren't just leveraging commoditized credit data. We are finding highly specialized sectors with high yields using our research effort to model the assets and the risk, building up the necessary expertise and relationships and then capturing the returns. This strategy isn't bulletproof. A big all-encompassing spread widening shock would certainly impact book value, but we feel strongly that this is the safest way to generate high returns while controlling risk. We are convinced that this is the right approach in the current market environment. Now back to Larry.

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [6]

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Thanks, Mark. I'm really pleased with the progress we've made growing our portfolio and the results we've generated so far this year. Our strategy of being patient and diligent in adding assets and building our strategic loan pipelines is really paying off. We've generated an economic return of 8.2% year-to-date, and the total return on our stock is nearly 20% year-to-date. Even with that total return, we're still trading at a 16% discount to last reported book. So we still have room to perform from here.

While we talked a lot today about playing offense by building the portfolio and adding leverage, we see plenty of reasons for some caution. There are the more modest challenges represented by a flattening yield curve and rising interest rates, but the possibility of big shocks is still out there, whether from the prospect of trade wars, slowing growth in China or political turmoil in Europe.

Additionally, as quantitative easing around the globe continues to give way to quantitative tightening, the market will continue to lose an important stabilizing force.

So in light of these risks, we believe that it's as important as ever to be disciplined about hedging and leverage and to keep duration on much of our portfolio relatively short. If the volatility that we saw early this year does return, we believe that this will enable us to take advantage by adding assets at higher yields and trading out of some of the more liquid parts of our portfolio.

The year is off to a great start, but I'd like to reiterate that maintaining the stability of our book value is always an important objective of ours. As you can see on Slide 13, the stability of our quarterly economic returns is unmatched in our peer group.

Slide 14 provides additional insight into our stability. I pointed this out on previous calls, but in this environment of rising rates, it's worth highlighting again our low level of interest rate sensitivity. In the table on Slide 14, the fourth line down, nonagency RMBS, CMBS, other ABS and mortgage loans, captures the vast majority of our long Credit portfolio. As you can see, if rates shift up or down by 50 basis points, we estimate the impact from the Credit -- that the impact in the Credit portfolio on our overall book value would be about plus or minus 75 basis points. That translates to an effective interest rate duration of about 1.5 years and that's even before taking into account our interest rate hedges.

We've accumulated such a short duration portfolio by focusing on products like short-term consumer installment loans, 1- to 2-year commercial real estate bridge loans and nonperforming loans where we prioritize fast resolution. If volatility returns to the market, I think we'll be very happy to see our short-duration assets continue to run off naturally and quickly, enabling us to reinvest in whatever the opportunities are at that time.

As we move into the second half of the year, we look to maintain our momentum. Our primary focus is on executing our business plan, and in particular, continuing to grow our Credit portfolio, emphasizing high-yielding, short-duration assets, and thereby continuing to grow our net investment income, to provide stability of earnings and dividend coverage.

Let me reiterate once again how I believe that it all comes together. The short duration of most of our portfolio, the high current income of our portfolio, combined with our dynamic hedging strategies, liquidity management and diverse sources of financing, should enable us to both sustain performance in the current environment, whether interest rates continue to rise or not, and weather periods of credit volatility.

Finally, as we've discussed previously, we continue to evaluate possible changes to our tax status as a publicly traded partnership. Our options include potential conversion to a C corp; potential conversion to a REIT; and of course, remaining a publicly traded partnership. We will continue to provide updates as our analysis progresses. As always, investor feedback on these issues is welcome.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Doug Harter with Crédit Suisse.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [2]

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On one of those last points you were making about kind of the short duration of the portfolio, can you just talk about kind of where you see the flow of new product creation in non-QM or the consumer loans relative to the kind of the runoff of those portfolios and whether you can continue to sort of grow those in a steady state?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [3]

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Yes. I mean, in -- Mark, you want to take it, the non-QM.

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Mark Ira Tecotzky, Ellington Financial LLC - Co-CIO [4]

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Sure. I mean, non-QM, the volume has increased nicely there in the last few months. Some of that is seasonal, but some of that is just a more mature platform. So I would say, non-QM, when you get to deal size, which is around $200 million, we typically see paydowns in that portfolio when it's relatively new, maybe on the order of $3 million a month and monthly origination volume is sort of 10x that, say, $30-plus million. So that portfolio will continue to grow. Then we'll do a securitization potentially and retain some pieces. On the consumer side, where some of the loans are very short maturity, inside 2 years, it's closer to a steady state where there is material runoff relative to new purchases.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [5]

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Got it. And then, can you just talk about -- maybe help us size the -- kind of the more liquid Credit assets that you have that you would kind of -- you could use to rotate into kind of the non-QM or other target assets, kind of as you're able to source those?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [6]

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Sure. So in terms of market value, those assets in U.S. CLO notes and U.S. nonagencies, it's around $200 million-or-so of market value that's levered. So in the meantime, they provide strong contribution, particularly the net investment income. So I think they're a good investment now, but that they're available to run off as we take assets out of the pipeline and close.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [7]

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And I guess, has there been much of a change in kind of the potential, either ROA or ROE pickup, as you can rotate into kind of your targeted longer-term assets?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [8]

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Yes. I think we said about 2.5% pickup. I think that's still a good number.

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Operator [9]

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Our next question comes from the line of Steve Delaney with JMP Securities.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [10]

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I'm struck by the slide on Page 11. I think that's a new slide. And under the residential mortgages, Larry, I can remember 2 or 3 years ago, you were using some phraseology talking about Ellington being a specialty finance type of an entity. And to that end, you made some strategic investments in some nonbank specialty finance companies with nonconforming type loans. In that 46% of the portfolio, how many of those relationships exist today where Ellington has made some type of an equity or debt investment in the strategic partner?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [11]

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Yes. Well, so in terms of making equity investment, there's 2, but we're working on a third with an existing flow provider. And that's progressing nicely. So I think -- I expect that by the end of the year, that will be 3.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [12]

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Okay. And that answers my -- that was my second question is, do you continue to see that those -- to expand this, whether it's just to expand the volume or different products, that approach of making strategic investments is superior than just be one of multiple flow buyers?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [13]

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Right. And by the way, it just occurred to me we're also considering a fourth, again, with an existing flow provider. So, yes, it could actually be 4 by end of this year.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [14]

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Okay. It sounds like to me, honestly, I mean, the QSub markets and you're looking at everything, but it seems to me that an awful lot of energy and frankly, a lot of the benefit to your improved results and that 9% blended yield is coming from that 46% of the pie?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [15]

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Yes. And just to be clear, right, some of the strategic investments that I just mentioned, the ones that we don't have yet but we're considering are in the consumer loan space. But -- yes. Yes. So that's another slice of the pie there. But -- and I think that when it comes to -- I mean, for example, if you look at under residential mortgages, NPL/RPL but especially rehab and bridge loans and then in commercial mortgages, again, bridge loans and NPLs. That's a very relationship-oriented business, right? Those businesses are not -- you don't call up your broker at Merrill Lynch and say, "Can you show me some bridge loans?" So it's something that we've really spent -- I mean, we've been doing small balance commercial loans since at least 2010, maybe even earlier. So these are relationships and networks of loan brokers and things like that, that we've built up over many, many years now.

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

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And are you doing your own servicing on your SBC loans?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [17]

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So, no, we're not doing our own servicing per se, but keep in mind that a lot of them -- so you've got 2 types of loans, right? You've got nonperforming loans where -- you don't have that much in collections, right? They're nonperforming. So with servicing, you're really talking about negotiations with the borrower. You're talking about shepherding through the legal process and the foreclosure process, those types of things. It's very high cut and that stuff we're certainly handling that in-house. Sometimes, we have partners on these deals, some of the people that bring us these opportunities want to coinvest. We like to see them coinvest. We talk about some of the noncontrolling interest. If you look in our balance sheet, a lot of that comes from our partners on these deals that they bring to us and then we certainly encourage a coinvestment by those partners so they have skin in the game.

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

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Great. Just to close out for me. You mentioned -- thank you for mentioning the continued evaluation process for the corporate structure. My question on that is, the decision that may or may not be made. Is this a calendar year type of decision process, whereby if a decision is not made effective for 2019, that -- then if it takes longer or whatever, that if it's not 2019, it's got to be 2020? In other words, it's not something that you would do midyear. Am I thinking correctly there?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [19]

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Yes. So it's a great question. It really depends. So if -- obviously, if we stay, then there's no issue. If we shift to a C corp, that's the kind of thing that can pretty much be done at any time. You just (inaudible) shorter tax year for your -- [if your partners begin], not a big deal. Of course, is it worth it? You're going to have an extra tax return. That's going to add complexities. Is it worth it to do it before the end of this calendar year? And now we're getting pretty late in the calendar year. So anything that we do at this point, I can tell you, would not be effective -- if we do anything, would not be effective until Jan 1, 2019. Now in the case of a REIT, by the way, it gets even more complicated if you try to do it towards the end of, let's say, 2018, because then you have to sort of satisfy your REIT income test in a very short period of time, which puts kind of strain on that analysis. You want sort of the whole year to smooth things out. So again, I wouldn't expect anything to take effect until the beginning of 2019. And as long as we do something relatively in the beginning and not wait too long, I would say it could be worthwhile to do it. It doesn't have to be January 1, but that's something that we've got in the back of our head. It would be nice if we are going to make a change to make one as 1 year -- 1 structure, 1 year the next.

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

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Congratulations on bringing Lisa back in her new role.

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [21]

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Thank you.

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Operator [22]

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Our next question comes from the line of Crispin Love from Sandler O'Neill.

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Crispin Elliot Love, Sandler O'Neill + Partners, L.P., Research Division - VP [23]

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Can we have a little more color on Michael Vranos leaving the board? And kind of what is the rationale for him leaving the board after being on it since 2007?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [24]

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Sure. Yes. So it's really all about Lisa as opposed to about Mike. I mean, Lisa retired in March, and the board, obviously, knows Lisa extremely well. We have tremendous respect for her, and it was really -- this was an opportunity to have Lisa -- have more Lisa instead of less Lisa. That's always a good thing. And even in the short term, I mean, Lisa has got a lot to offer as we just talked about, continuing to consider changing our corporate tax structure. And we couldn't -- so really a positive about adding Lisa. The thing is we couldn't just add Lisa and leave it at that because it's a small board. There's only 5 directors. New York Stock Exchange rules require majority of independents. So if we just added one, Lisa would not be considered independent because she's newly -- she was employed by the management of the company obviously very recently. So that would be 3 3, not a majority of independents. And for those of you who know Mike, you know that he's a trader and a portfolio manager at heart and will always be a trader and portfolio manager. And so as Co-CIO of Ellington Financial, I mean, this made sense for Mike as well. And actually, we have a slide -- or actually, that was a slide -- was it 25? I think yes, [Slide] 25, you can see that management owns 12% of Ellington Financial. I think most of that is Mike. I mean, that's -- he's still as engaged as ever, still owns the shares, still is the CEO of the external manager. So this is really just, I would say, making room for Lisa, and obviously, Mike's voice will be heard as always.

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Crispin Elliot Love, Sandler O'Neill + Partners, L.P., Research Division - VP [25]

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That's helpful definitely with the majority of the independents. And then, a second one. So this is the second consecutive quarter that you've outsized, kind of realized unrealized gains. Can you give us a little color on the key drivers of the gains, and if you can expect them to continue in the second half of 2018? I know, JR, you talked a little bit about it in your prepared comments about sowing kind of the foreclosed properties, but just kind of digging in that a little bit deeper.

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JR Herlihy, Ellington Financial LLC - CFO [26]

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Sure. So as I mentioned, we had a sale of consumer NPLs in Europe that closed subsequent to quarter-end, so it appeared as an unrealized gain at June 30. And then in the subsequent quarter, that will move into realized, in the reverse that as unrealized. So that's one of the big drivers. In terms of realized gains really across the portfolio, we had realized gains in nearly every bucket. We have -- the reason that in the attributions table, you see that it's not that meaningful is because there is -- our corporate credit relative value strategy actually had a big unrealized gain and offsetting realized loss, so we have, kind of, long/short strategy. So that [skews] the number a little bit. But suffice to say, we had healthy realized gains across most strategies, not really any one particular driver on the realized side. And then, the unrealized, we had some mark-to-market gains, again pretty evenly distributed across a handful of strategies with the one notable exception, the European loan trade that I mentioned.

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Crispin Elliot Love, Sandler O'Neill + Partners, L.P., Research Division - VP [27]

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Okay. And then, what kind of growth are you guys expecting for the Credit portfolio in the second half of '18? Is kind of the 7% and 9% that we saw in second quarter, like around there or a little bit less than that?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [28]

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I think it's really hard for us to predict. I mean, first of all, if we do a non-QM securitization, by some measures that number goes up; by some measures it goes down. JR mentioned we got $200 million of these lower-yielding, more liquid assets that are sort of available to turnover at any time and probably would apply a little less leverage to the higher-yielding assets than we're applying to the more liquid assets. I just think it's really hard. We think the important thing maybe to take away is just that we don't think that we're -- we don't think that we're capped out by any stretch, and we should continue to grow overall. But if you look at the trends, you'll see that we're leveling off. Really, I'm not comfortable kind of putting a number on the growth for the rest of the year.

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Crispin Elliot Love, Sandler O'Neill + Partners, L.P., Research Division - VP [29]

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Okay. And do you think the Credit portfolio should be fully ramped by the end of 2018? Or it could even see some growth going into '19 as well?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [30]

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Yes. I mean, that's certainly what we are targeting this to be -- to have it be at that full level by the end of the year. But a lot can happen between now and then. But yes, absolutely. Maybe even before.

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JR Herlihy, Ellington Financial LLC - CFO [31]

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This.

And this, like big picture. If you look at where we were at the end of 2016 in the Credit portfolio and then you look at where we are 18 months later, it's more than doubled. So I mean, I wouldn't project that level of growth to continue.

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Crispin Elliot Love, Sandler O'Neill + Partners, L.P., Research Division - VP [32]

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Okay. And then just one last one for me. At the current valuation, would you expect to not be repurchasing shares or -- because I saw you haven't repurchased any in the third quarter so far?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [33]

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Right. Yes. So -- and I wouldn't necessarily read too much into that, other than to reiterate what we said before which is that at 85% -- and we're close to that now, so -- I think we're at -- would you say we're at 84%-ish right now?

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JR Herlihy, Ellington Financial LLC - CFO [34]

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Correct.

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [35]

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Yes. So at 85% of book, we're not really interested in buying back shares. I mean, it's just not accretive enough to book value, to justify given the cons of [the effect] on our expense ratio, liquidity of our stock, just smaller company is worse than a bigger company. So we're certainly where we are now. We're not really too interested. Below 80%, as we've said, we're really interested. We kind of didn't trade below 80% very long. This past quarter, we kind of bought what we could. Of course, the parameters of our 10b5-1 programs, which we've talked about as we put in place for the blackout periods, which -- another one is about to end basically, shortly after this call. So those kind of affect things in terms of where we exactly we place those parameters, because those have to be automated. So -- yes. So I just think that given what we're seeing now in terms of investment opportunities, given where we're trading now, which is close to 85%, we wouldn't be buying stock back here. As we get closer to 80%, certainly below 80%, yes. Close to 80%? No. We'll see. It will kind of depend upon the parameters of the 10b5-1 program and what we're seeing. So I think that's pretty good guidance. (inaudible) And if you look over longer, I'm sure this is 1 past quarter or say 1.5 quarter that you're looking at. But if you look over a longer period of time, I think since last December, we've repurchased around 6% of our shares, again, discount of around 20%, maybe even a little bit more average discount. Just we reloaded our share repurchase program. I think that's disclosed in the earnings release. Yes. So that 1.55 million shares, we're certainly not -- never reluctant to reload that but -- so that's available. So I think it's going to be consistent with our prior guidance.

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Operator [36]

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Our next question comes from the line of Eric Hagen with KBW.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [37]

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Could you actually say what the total income contribution was from equity investments during the quarter?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [38]

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No. No. We don't break that out.

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JR Herlihy, Ellington Financial LLC - CFO [39]

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You mean the strategic investments?

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [40]

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Yes. Exactly.

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [41]

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I can tell you that for the year, it's been a strong contributor. But, yes. So -- but it's a small amount of capital, right? We've got, what is the number, maybe not even $30 million-ish?

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JR Herlihy, Ellington Financial LLC - CFO [42]

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Yes.

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [43]

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About $30 million. So it's not -- it's only 5% of our -- and that's not leveraged, of course. These are equity [investments] Yes. So it's done well, but it's really -- those investments are -- yes, obviously, we're happy that this year they've done well, those equity investments, but those are as much about the effect that it has on the asset side -- rest of the asset side of our portfolio as opposed to just as investments per se, although we do think that -- those are some great feeds of possible great returns even on that equity investment. We really believe in these companies, they're small companies. They could be worth a lot of money one day.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [44]

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Yes. Well, actually, the $30 million of fair value that you have between the 2 investments, what is the breakdown between Longbridge and LendSure with that $30 million?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [45]

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Yes. It's -- well, one is around -- LendSure is only around $3 million, I think.

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JR Herlihy, Ellington Financial LLC - CFO [46]

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Yes.

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [47]

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And so there you go. The other is around $27 million. Does that sound right?

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JR Herlihy, Ellington Financial LLC - CFO [48]

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Yes. $28 million.

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Operator [49]

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Our next question comes from the line of Tim Hayes with B. Riley FBR.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [50]

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(inaudible) But just wanted to follow up on Steve's question regarding the C corp and reconversion. Can you just touch on the analysis that still needs to be done? Or just kind of where you are in the process of evaluating those and the feedback you're getting from shareholders at this point?

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Laurence Eric Penn, Ellington Financial LLC - CEO, President & Director [51]

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Yes. Well, I think that -- I think no matter what -- whatever what path we take, tack we take, I think that if -- well, if we do convert either to a C corp or a REIT, I think it will help our share price, right? We've seen that with -- we saw KKR. I think that happened in the second quarter, right? So their stock has done extremely well (inaudible) earlier. So part of it is just sort of watching to see how these other companies, how their share price reacts. Of course, every company is different in terms of the effect on the effective tax rate. In our case, I think that in terms of looking at a REIT, right, the challenge there is that we probably would have to shed a few strategies. And the question is how important are those strategies. And we would -- if we were to do that, then there would be clearly very little friction, right, in terms of from a tax perspective. We would still have -- right now, our effective tax rate is very low, right? I don't even know if it's -- a few percent at most. But if we were to convert to a REIT, we would have to shift more assets to a taxable REIT subsidiary, some of the nonmortgage assets for example. And we might have to shed some of those strategies, which again could be done somewhat by actually selling. It could be done somewhat more organically because some of those are -- there's runoff. But we would have to shift assets, considerable amount of assets into a taxable REIT subsidiary and then those would be that's basically like a C corp for tax purposes so you'd be paying taxes at the corporate rate on that, which is 21%, plus any state and local. So yes, that would have a -- I would say, a definite but moderate effect on our overall tax rate. So that's the con, kind of also having has shed some. But the pro of it being pretty modest. C corp is much bigger in terms of now our effective tax rate really goes up a lot, but we have total flexibility, even more flexibility much more than we have as a publicly traded partnership. We jump through a lot of hoops to comply with publicly traded partnership rules not originating -- not be considered an originator, things like that, other than in the mortgage space where we can do it through our REIT subsidiaries. So it's complicated. I think in terms of the feedback we've gotten from shareholders, it's very mixed. So some of them would be all for it, would love the increased liquidity on our shares, would enable us to grow more, I think. Others, who are frankly, let's say, more ultra long-term holders just from their own selfish perspective might say, "Hey, look, if I'm just going to own this stock for the dividend stream over time, and -- why should I have a slightly lower dividend stream in any scenario, whether it be REIT or -- it would be just slightly lower or -- with C corp it would be substantially lower because of the taxes, why should I do that?" So it really depends on the investor. I think that if we do convert to either structure, I think we would see a turnover in our investor base, right? So -- because I think that the type of investor base that does own publicly traded partnerships, it's smaller, it's stickier. I'd say, it's smaller. We've had a very small, loyal, sticky investor base. So I think we would get demand from a lot more and different types of shareholders, and I think we probably would have some turnover. Right now, we're very attractive to foreign buyers because we don't have the withholding that you have on a REIT, and the company doesn't really have to pay much taxes, as we said now. So it really depends on the investors, so I think we would see some turnover there.

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Operator [52]

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At this time, there are no further questions. This concludes today's conference call. You may now disconnect.