Ellington Credit Company - Earnings Call - Q1 2025

Transcript

Speaker 4

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Operator (participant)

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Ellington Credit Company First Quarter 2025 Financial Results Conference Call. Today's call is being recorded. At this time, all participants have been placed in the listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press the star and one on your telephone keypad.

If at any time your question has been answered, you may remove yourself from the queue by pressing star two. Lastly, if you should require any operator assistance, please press star and zero. It is now my pleasure to turn the floor over to Alaael-Deen Shilleh, Associate General Counsel. Sir, you may begin.

Alaael-Deen Shilleh (Associate General Counsel)

Thank you. Before we begin, I'd like to remind everyone that this conference call may include forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not historical in nature and involve risks and uncertainties that detail in our most recently filed annual report on Form 10-K and our filed but not yet effective registration statement on Form N-2. Actual results may differ materially from these statements, so they should not be considered to be predictions of future events. The company undertakes no obligations to update these forward-looking statements. Joining me today are Laurence Penn, Chief Executive Officer of Ellington Credit Company; Gregory Borenstein, Portfolio Manager; Mark Ira Tecotzky, Executive Vice President; and Christopher Smernoff, Chief Financial Officer. Our earnings call presentation is available on our website, ellingtoncredit.com.

Today's call will track that presentation, and all statements and references to figures are qualified by the important notice and end notes at the back of the presentation. With that, I'll turn the call over to Laurence Penn.

Laurence Penn (CEO)

Thanks, Alaael-Deen. Good morning, everyone. We appreciate your time and interest in Ellington Credit Company. I am very pleased to report that on April 1st, we successfully completed our conversion to a registered closed-end fund. As planned, within days of the conversion, we quickly and efficiently sold our remaining agency mortgage pools and covered our TBA short positions, all with minimal impact on our net asset value. In fact, even with all the market gyrations in early April, we estimate that these pool liquidations had only about a one penny per share effect on EARN's net asset value. This one penny effect was exactly what we had estimated on our last earnings call, and it was the precise and well-timed hedging by Mark Ira Tecotzky and his team that made this excellent result possible.

As a byproduct of our conversion to a closed-end fund, we also changed our fiscal calendar to begin on April 1st. Therefore, on today's earnings call, when we're referring to the quarter ended March 31st, 2025, to avoid confusion, we'll refer to that quarter as calendar Q1. Okay, so now to our calendar Q1 results. During calendar Q1, in preparation for the conversion, we increased our CLO portfolio by 46% to $250 million, while we kept the size of our long agency mortgage portfolio stable in order to maintain our exemption from the 1940 Act right up to the point of conversion.

Also, starting in January, we aggressively ramped up our TBA short mortgage hedges, and so when volatility began to spike in March, we had already completely neutralized our exposure to the mortgage basis, thus saving us from the losses that we would have incurred when spreads widened later in the quarter. This positioning also enabled our agency mortgage portfolio to significantly outperform during those volatile periods leading up to and through our final sales in early April. Turning to slide four, let's take a look at the market backdrop for the quarter. A strong January and February gave way to turbulence in March as investor sentiment soured on fears of tariffs, slowing growth, and inflation persistence. Interest rate and spread volatility surged in March, equity indices declined, and credit spreads widened, including in the CLO market where both Mezzanine Index debt and equity tranches saw meaningful price declines.

You can see in the middle of slide four that spreads on high yield, investment grade, and CLO debt tranches widened, and therefore prices declined across the board during the quarter, with most of that occurring in March. Importantly, the price declines we saw were a function of potential future credit concerns, especially for companies that would be impacted by skyrocketing tariffs and not the result of any current or near-term credit concerns. Let's now move past quarter end and into early April. After selling all our mortgage pools following the conversion, our liquidity and buying power increased significantly, and we got to work ramping up our CLO portfolio. Our timing was fortunate as we were able to add very attractive assets during all the April market turmoil.

More recently, significant tariff de-escalations have led to credit spreads and prices reversing course in May, retracing a significant portion of the March and April move. It was great to be able to put fresh cash to work in CLOs while prices were lower. To sum up calendar Q1, while our agency mortgage strategy delivered positive results for the quarter, declining prices on CLO Mezzanine Index debt and equity drove an overall net loss. Nevertheless, our adjusted distributable earnings continued to cover our dividends for the quarter, and we've seen prices come back strong so far in calendar Q2. I'll turn it over to Christopher Smernoff now to walk through some more of the financial details. Christopher Snernoff.

Christopher Smernoff (CFO)

Thanks, Laurence Penn, and good morning, everyone. Please turn to slide five. For calendar Q1, we reported a net loss of $0.23 per share and adjusted distributable earnings of $0.26 per share. Our overall net interest margin increased by 20 bps to 5.27%, supported by our growing capital allocation to CLOs. On slide six, you can see portfolio P&L by strategy, which was negative $0.24 per share from CLOs and +$0.08 from agency. In our CLO portfolio, mark-to-market losses exceeded net interest income and modest gains on our credit hedges. In our agency portfolio, net gains on agency Residential Mortgage-Backed Securities exceeded net losses on interest rate hedges for the quarter. At March 31st, our book value per share was $6.08, and combined cash and unencumbered assets totaled $169 million, or 74% of total shareholders' equity. Our economic return for the quarter was -3.2%.

Our debt-to-equity ratio, adjusted for unsettled trades, declined to 2.2 times at March 31st, down from 2.9 times at December 31st. Over the same period, our net mortgage assets-to-equity ratio decreased to about zero from 2.6 times, driven by a net short TBA position that almost entirely offset our agency Residential Mortgage-Backed Securities holdings at quarter end. Slide nine shows our CLO portfolio increasing by 46% to $250 million at March 31st, and capital allocated to CLOs expanding to 81% from 72% at December 31st. At March 31st, CLO equity comprised 66% of our total CLO holdings, up from 58%, and European CLO investments constituted 14% of our total CLO holdings, roughly unchanged from the prior quarter. On slide 10, we show that our agency Residential Mortgage-Backed Securities holdings decreased slightly to $504 million from $512 million at December 31st.

As Laurence Penn mentioned, we disposed of all of our remaining mortgage positions shortly after April 1st. Slide 11 details our interest rate hedging portfolio, where you can see that our rate hedges were entirely in short TBA positions as of March 31st. Slide 12 illustrates our net Residential Mortgage-Backed Securities exposure, where you can see that our net short TBA position fully offset our long agency pools. We also maintained modest credit hedge and foreign currency hedge portfolios at quarter end related to our CLO investments. Slide 13 illustrates that nearly all of our loans underlying our CLO portfolio are floating rate and, as such, have much lower interest rate duration than agency mortgages. In connection with the conversion, we also changed our fiscal year to end on March 31st, the day prior to the conversion, with our first full fiscal year following conversion to end on March 31st, 2026.

Therefore, the three-month period ended March 31st, 2025, during which time we operated as a taxable C corporation, will constitute its own short fiscal year, and next month we will be filing a transition period 10-K for that short three-month fiscal year. Next, moving forward, as a closed-end fund, we will be making 1948 filings such as NCSRs, NSENs, and NCORPs rather than 10-Qs and 10-Ks, though we still plan to continue issuing earnings releases on a quarterly basis. Finally, as a closed-end fund, we will be reporting a net asset value per share moving forward, which is substantially the same metric as the book value per share we have reported previously. With that, I'll pass it over to portfolio manager Gregory Borenstein to discuss how the CLO market has performed, how we have positioned our CLO portfolio, and our market outlook.

Gregory Borenstein (Portfolio Manager)

Thanks, Christopher Smernoff. It's a pleasure to speak with everyone today. Calendar Q1 presented a number of headwinds, particularly for CLO equity. While payment default rates remained low and fundamentals strong in general, there were several challenging technicals. Continued loan coupon spread compression to start the quarter, coupled with loan price declines to end it, weighed on CLO equity valuations. These phenomena were most pronounced in the U.S., while the impact on European positions was comparatively muted. In CLO Mezzanine Index, while our U.S. positions did experience mark-to-market declines as well, those declines were smaller than on equity, and Mezzanine Index also outperformed most other corporate credit markets on a credit beta-adjusted basis. Meanwhile, for our European Mezzanine Index positions, strong carry and realized gains exceeded mark-to-market losses. We also had gains, albeit modest ones, from our credit hedges.

In CLO equity, early in the quarter, loan coupon spread compression continued to be an issue, with the majority of the loan market trading above par to start the year. This caused CLO net interest margins to contract, which weighed on equity interest payments. On the other hand, some deals were able to benefit from resets and refinancings, and at EARN, we had gains from deals that liquidated, offsetting some of the mark-to-market declines elsewhere in the portfolio. Loan coupon spread compression concerns have since receded, as only 10% of the loan market traded above par by the end of March and just 4% by the end of April. However, with the May rallies, that percentage has begun to creep up again. Loan prices closed calendar Q1 down $0.82 based on the Morningstar LSTA U.S. Leveraged Loan Index, declining in sympathy with the sell-off across credit markets.

CLO debt tranches, particularly AAAs, saw their credit spreads widen in the quarter. This weakness was driven by several factors, including weakness in investment grade and high-yield corporate bonds, CLO ETF capital outflows, heavy primary CLO supply, and elevated macro volatility. Wider credit spreads on CLO debt tranches resulted in CLO equity refinancing and reset options becoming less valuable, which also negatively pressured CLO equity prices. These effects were also more pronounced in the U.S. than in Europe, and as a result, our European CLO equity investments outperformed their U.S. counterparts in the quarter. Meanwhile, our Mezzanine Index portfolio, both in the U.S. and Europe, held in better. Higher quality double Bs remained well-supported by real money investors and hence had relatively limited price declines on the quarter.

While our CLO portfolio had become more concentrated in CLO equity in prior months, we have more recently seen compelling value in Mezzanine Index tranches once again, and we have been directing our excess interest cash flows and sale proceeds into some highly attractive double B investments accordingly. We believe these investments will help balance the portfolio and protect us from the potential of increased credit defaults, given continued uncertainty surrounding tariffs and their effect on the fundamental picture for credit moving forward. The outperformance of Europe versus U.S. and of Mezzanine Index versus equity during the quarter demonstrated the benefits of diversification in our portfolio. We intend to remain active in both the U.S. and Europe and in both equity and Mezzanine Index based on relative value. I believe the market volatility overall has been a big positive for EARN. As Laurence Penn mentioned earlier, we came into April with cash to deploy.

While we experienced some mark-to-market losses in calendar Q1, most of the price declines were driven merely by credit spread widening, as opposed to by accelerating realized credit losses. We were able to be opportunistic with our deployment and take advantage of these wider spreads, and indeed, much of the credit widening has retraced so far in May. Looking ahead, we will continue to prioritize portfolio liquidity and agility, as the current trading environment may demand great flexibility in response to an uncertain credit backdrop. Now, back to Laurence Penn.

Laurence Penn (CEO)

Thanks, Gregory Borenstein. I commend Mark Ira Tecotzky and his team for doing an incredible job rotating out of our agency mortgage positions with minimal impact on net asset value in what was an extremely challenging market around the tariff announcements. We sold our last mortgage pool on April 7th, and as a final tally, our agency mortgage strategy generated positive portfolio income for 2025 of about $2.55 million. In contrast, over the same timeframe, the Bloomberg U.S. Agency Mortgage-Backed Security Index generated a significantly negative return versus Treasuries. With the conversion now behind us, I'm excited to have dry powder for our portfolio managers to deploy in such a compelling market. Since the April 1st conversion, we've bought an additional $51 million of CLO investments through yesterday, and we've also sold some positions at profits that we thought had become too fully valued.

With the mortgage pools gone, our debt leverage now stands at less than half a turn. We started April with a net asset value of $6.08 per share. While additional credit spread widening in April did drive further CLO price declines, the effect on our portfolio was contained, and we ended the month of April with an estimated net asset value in the range of $5.85-$5.91 per share. I am pleased to announce that, similar to what most other CLO-focused closed-end funds do, we have started posting on our website a brief tear sheet where you can find updates of many of our portfolio metrics as of month end. We plan to continue posting these tear sheets on a monthly basis going forward. You can find our monthly tear sheet right on our homepage, www.ellingtoncredit.com, by clicking on the link labeled Monthly NAV and Portfolio Update.

I'll give you a few moments now to open up the tear sheet. As you can see, there's a lot of information assembled on this page, but I'd like to highlight a few things in particular. Near the top, in the Common Stock Data section, you'll see our April 30th range of estimated NAV per share centered around $5.88 per share, as well as our monthly dividend and dividend rate. To the right, in the CLO Portfolio Underlying Loan Data section, you'll see a bunch of statistics on the corporate loans underlying our CLO investments. Moving down the page, in the Portfolio Overview section, you'll see the breakdown of our portfolio as of April 30th, including the fact that coming into May, a full 18.8% of our total portfolio, or about $59 million, was in cash and cash equivalents.

You can see that we had plenty of dry powder to deploy in the aftermath of the April market weakness. Finally, to the right, you'll see the total return performance of our stock in April versus a few relevant indices. Whether measured on a stock price-based total return basis or on an NAV-based total economic return basis, I think you'll find that our April performance compared very favorably with that of other CLO-focused closed-end funds. Moving on to May, I'll just mention briefly that so far this month, we've seen a good amount of credit spread tightening, which, of course, has been a tailwind for our NAV. As of last night, our total CLO portfolio stood at $284 million, up from $250 million at the time of our conversion.

Amid the ongoing elevated market volatility, we continue to add investments selectively in both CLO Mezzanine Index and CLO equity, and we continue to actively trade the portfolio to take advantage of relative value opportunities between subsectors, all while drawing on the disciplined risk management that we're known for. Even as we've been putting capital to work, we have also been maintaining high levels of liquidity, so we can still play offense should we see further market dislocations. This kind of dynamic market environment is where I believe our active management approach will shine. As we continue to ramp up our CLO portfolio, I believe we are in an excellent position to drive strong earnings and unlock value for shareholders moving forward. We will also look to add corporate debt to our liability structure later this year, which should be accretive to net investment income.

Now, let's open up the floor to Q&A. Operator, please proceed.

Operator (participant)

Of course, at this time, if you would like to ask a question, please press the star and one on your telephone keypad. Keep in mind, you may remove yourself from the question queue by pressing star and two. Again, it's star and one to ask a question today. We'll take our first question from Eric Hagen with BTIG. Please go ahead. Your line is open.

Eric Hagen (Managing Director)

Hey, thanks. Good morning. Really great timing with the divestment of the agency portfolio. I think you said $50 million of CLOs have been acquired since the conversion. I mean, how does the yield on those assets compare to the, call it, $250 million that was in the backbook? And then right now, forgive me if I did not hear you guys, but right now, do you guys have dry powder to deploy, or are you fully deployed right now? Thank you, guys.

Laurence Penn (CEO)

Gregory Borenstein, why don't you take the first part?

Gregory Borenstein (Portfolio Manager)

Sure. As you can understand, the market has been in a few different places since April 1st. I think that overall, the weighted average yield that we purchased, I would say, varied from slightly wider to some things were potentially hundreds of basis points back. I think what's important to note, too, is it's not simply like we scaled up the portfolio pro rata. As we spoke about early on, when we started buying CLOs, we were buying a lot of discounted Mezzanine Index paper as we thought that was the best risk-adjusted return. We started shifting more heavily into equity, in particular a new issue. As the market dislocated a bit, new issue investments stopped, and I think that more of the additions were potentially shifting back, balancing into Mezzanine Index.

Simply looking at the overall return, in some of these cases, the profile of some of the bonds we were purchasing changed based on investment thesis. Just caveating that it should be broken out by different types of sectors. Overall, it ranged from moderately wider to hundreds of basis points.

Eric Hagen (Managing Director)

Got it.

Laurence Penn (CEO)

Thanks, Eric Hagen. I think, did you also ask about.

Eric Hagen (Managing Director)

Dry powder.

Laurence Penn (CEO)

Dry powder, right. Yeah. Yeah, we still have good dry powder. The other thing that's interesting about the way that I think the way that we manage our risk that impacts dry powder is that we give ourselves, if you will, more dry powder. We have cash reserves, basically, that we keep back. As we add more credit hedges, we actually give ourselves, in a way, credit for having more dry powder, right? We can increase the asset size of the portfolio the more credit hedges we have on. Given that spreads have tightened now, retightened quite a bit, I think you're going to see us putting back on more credit hedges at some point soon, and that'll also kind of give us the way we risk manage the portfolio more dry powder.

We still have lots of room to increase the size of the portfolio from that $284 million figure that I think I mentioned earlier.

Eric Hagen (Managing Director)

Yep. That's really good to hear. Okay, good. I imagine you guys are following the headlines for the asset management industry making a push for 401(k) plans to have better access to the private equity industry. I'm just curious what your perspectives on this are. I mean, does it mean a more efficient market and tighter spreads, and that's a good thing, or is the CLO market so big and growing so fast at this point that a huge influx of demand wouldn't necessarily disrupt this really high and attractive return that you're getting in the asset class right now?

Laurence Penn (CEO)

I think it'll be a while till you see that filter down to the CLO asset class, but in terms of having an impact on spreads, Marc Tecotzky, Gregory Borenstein, do you have any thoughts on that?

Gregory Borenstein (Portfolio Manager)

I'd say that the first-order effect of this can be seen not in the closed-end fund space necessarily, even though there's obviously a lot of retail demand. You've seen in the ETF sector, looking at the growth of overall, especially AAA ETFs, perhaps that's more an appropriate first step in terms of where that type of money would flow into here. Maybe it filters down to this eventually. I think that there are second-order effects. We saw that CLO issuance was incredibly robust exiting 2024 into 2025 as that demand coming into AAAs through the AAA ETFs was tightening AAA levels to increase the attractiveness of securitization. It's a bit of a double-edge.

It can come both ways, I guess, where perhaps it compresses yields at some point if there's demand, but also perhaps that demand is coming into the liability side, which could just be creating an attractive arb for the equity further down. There are several factors at play where we sort of have to wait to see how it shakes out in terms of what the true effect would be.

Eric Hagen (Managing Director)

Always good to get your thoughts. I appreciate you guys. Thanks.

Gregory Borenstein (Portfolio Manager)

Thank you, Eric Hagen.

Operator (participant)

We'll take our next question from Crispin Love with Piper Sandler. Please go ahead. Your line is open.

Crispin Love (Analyst)

Thank you. Good morning. Following up on the dry powder question, Laurence Penn, I believe you said you're at $284 million today in CLOs. First, what does fully deployed look like, and when would you expect to be fully deployed? Were you more aggressive putting capital to work in early to mid-April given the price moves relative to your initial expectations for redeployment?

Laurence Penn (CEO)

Gregory Borenstein, you want to answer the second part, and then I'll come back to the first part?

Gregory Borenstein (Portfolio Manager)

Sure. I am even happy, I mean, it might encompass a little bit more there. I think overall, we were targeting just based around the conversion that we would be putting money to work, and we actually saw things cheapening up very much into the end of March. In fact, I think, as many market participants would agree, similar bonds trading by the time you got to April month end, and now we were rallying pretty aggressively through April month end. The end of April versus early May, it is hard to tell exactly, but things were actually better by the end of April than maybe the end of March in some cases. We did put our foot on the gas more since it was opportunistic. I think we initially were expecting a little bit longer to ramp in.

Overall, in terms of the pace and the dry powder available, some of this, as Larry alluded to earlier, depends upon how much leverage we want to use. Just to come back to that a bit, the point if we were to use credit hedges is not necessarily to put on a local linear credit hedge that is going to weigh down against the dividend. The point of the credit hedges in these vehicles is if we want to use financing on, let's say, a really attractive piece of Mezzanine Index paper, you could potentially use it on equity too, although we are very mindful of that. If we want to use any financing, this will affect how we think about liquidity in the vehicle. It is imperative that in any sort of shock or drawdown that this vehicle stay liquid.

Therefore, the direct objective of many of the credit hedges is to be able to make sure that we have liquidity in these types of market shocks. I think overall, if we see a lot of opportunity and if the math works out where adding some financing to a portion of the market that we want to invest in, including the cost to protect it from a downside perspective, makes sense, I think you'll see us gross up more and potentially be able to leg into even more dry powder. I think right now, we sold off. We've rallied back. We're not back to tights, but we've seen a fair amount of recovery.

I don't think we are being as aggressive as we otherwise could in terms of making sure that every last cent is at work right now, given our feelings on the market.

Laurence Penn (CEO)

Thanks, Gregory Borenstein. I'll just add that if you take the midpoint of $5.88 per share as our NAV coming into May times the latest share count that we disclosed, yeah, that's about $220 million of equity. As Gregory Borenstein alluded to, it really depends a lot on the`` mix between Mezzanine Index and equity in the portfolio. As mentioned, we've sort of been actively trading and looking at different subsectors from a rotational standpoint. I think we could easily be at half a turn of leverage. That would put us over the $300 million mark in terms of CLOs in the portfolio. Again, a lot of it is really almost more dependent upon the way that we risk manage the portfolio. That's really where more of the limits come into play.

The other thing that I haven't mentioned yet in this call, but I think I mentioned it on the last call, was that we are a full derivatives user. What that means is it means we have to comply to all sorts of different tests, which is a little more work on our part, but not a problem. The ramification of that is that we actually can use a repo and account it as a derivative as opposed to as a type of senior security, it's called, or debt, let's just call it, that would otherwise have more severe restrictions in terms of containing our leverage as a closed-end fund.

The bottom line is that, again, it's going to be more a function of the way we risk manage the portfolio and the portfolio composition than it is any of sort of maybe the normal types of leverage restrictions you might see. We could easily get well over the $300 million mark, even just with our current equity base. The last thing I wanted to say was that if we, and I said, we're going to look to issue unsecured debt later this year. Of course, that'll also, from a risk perspective, again, because a lot of it's about risk management from a risk perspective, then that takes a lot of the risk off the table in terms of the short-term nature of repo. Right now, you've got longer-term unsecured debt.

That enables us, again, from a risk management perspective, to have more assets for each dollar of equity.

Crispin Love (Analyst)

Great. Thank you. I appreciate all of the color there. Last question from me. Can you share your latest thoughts on the ADE trajectory? Last quarter, you talked about likely not covering the dividend in the calendar second quarter, just given the Mortgage-Based Securities sales and elevated cash prior to full redeployment and then coverage resuming in the calendar third quarter. Do you have any updates there or any finer details?

Laurence Penn (CEO)

Yeah. Yeah. I think we're still on plan there. Exactly, we might be a little short this quarter, but I think on track for the third quarter.

Crispin Love (Analyst)

Great. Thank you. Appreciate you taking my questions.

Laurence Penn (CEO)

Thank you.

Operator (participant)

Thank you. That was our final question today. We thank you all for participating in Ellington Credit Company's first quarter 2025 financial results conference call. You may disconnect at this time and have a wonderful day.