Ellington Credit Company - Earnings Call - Q2 2025

Transcript

Speaker 0

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Credit Company fiscal quarter ended June 30, 2025 results conference call. Today's call is being recorded. At this time, all participants have been placed on a listen-only mode. The floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star one on your telephone keypad. At any time, if your question has been answered, you may remove yourself from the queue by pressing star two. Lastly, if you should require operator assistance, please press star zero. It is now my pleasure to turn the floor over to Alaael-Deen Shilleh, Associate General Counsel. Please go ahead, sir.

Speaker 3

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 non-historical in nature and involve risks and uncertainties detailed in our 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 obligation to update these forward-looking statements. Joining me today are Laurence Penn, Chief Executive Officer of Ellington Credit Company, Gregory Borenstein, Portfolio Manager, and Christopher Smernoff, Chief Financial Officer. Our earnings conference 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 it over to Laurence.

Speaker 2

Thanks, Ellington, and good morning, everyone. We appreciate your time and interest in Ellington Credit Company. Please turn to slide three. Ellington Credit had an excellent quarter, which technically was the first fiscal quarter of our new fiscal year. In this, our first full quarter as a registered closed-end fund, we generated an annualized economic return of nearly 20% net and grew NAV per share. Our strong results were driven by excellent performance across both CLO equity and mezzanine investments, as well as by the timely redeployment of capital following the April sale of our legacy mortgage-related holdings. Thanks to excellent execution by Mark Tecotzky and his team, we successfully completed the disposition of our remaining mortgage-related investments with minimal NAV impact, and then proceeded to grow our CLO portfolio by 27% quarter over quarter to $317 million, as shown on slide three. Please turn now to slide four.

Market conditions were wide-ranging in calendar Q2. Following the surprise tariff announcements on April 2, heightened macroeconomic uncertainty led to sharply lower prices across the board on risk assets. However, after the April 9 tariff pause, risk sentiment rebounded quickly, sparking a broad market rally. By quarter end, both volatility and credit spreads had fully retraced their earlier upsurges, and many equity indices reached their all-time highs. As you can see on this slide, credit spreads on both U.S. corporate high-yield and investment-grade bonds tightened overall in the quarter, with May and June's recovery more than offsetting April's weakness. Turning to the specific sector that we focus on, namely CLOs, you can see on the top of the page that CLO mezzanine tranches, especially triple B rated tranches, also performed well in the quarter, although not quite as well as high-yield corporates. CLO equity also generally performed quite well.

As also shown on this slide, CLO issuance remained high by historical standards, but was lower than in recent quarters, reflecting the impact of all that intra-quarter volatility. At EARN, having sold all our remaining agency pools in early April, our timing was fortunate given the contemporaneous risk-off price action, and we moved quickly to begin redeploying that freed-up capital into CLO investments. While our quickness allowed us to add CLOs at their 2025 lows in April, we also continued to deploy capital into compelling CLO investments throughout the remainder of the quarter. As I noted previously, CLOs didn't actually end up recovering quite as much as high-yield corporate bonds did, and that was a good thing for us given that we still had more capital to put to work.

The key driver of our excellent performance this quarter was strong net investment income from both our CLO equity and CLO mezzanine positions, complemented by opportunistic trading, the redemption at par of two mezzanine positions that we had bought at discounts to par, and the successful reset of a CLO in which we hold equity, all of which contributed to the growth in our NAV per share. We still have ample dry powder today, and putting that to work should boost our net investment income in the coming months. At our current rate of deployment, we project that starting with September, our monthly net investment income will cover our $0.08 monthly distribution. At that point, we'll consider ourselves to be close to fully invested.

With our closed-end fund conversion now behind us, we are now benefiting from all the enhancements that the closed-end fund structure brings us, including the tax efficiency of pass-through RIC taxation and the ability to focus fully on CLO investments. I am confident that our new structure and strategy will support earnings growth and help us capitalize on the compelling opportunities we continue to see in the CLO market. I'll turn it over to Chris now to walk through some more of the financial details. Chris?

Speaker 3

Thanks, Larry, and good morning, everyone. Please turn back to slide three. For calendar Q2, we reported GAAP net income of $0.27 per share and adjusted net investment income of $0.18 per share. The weighted average GAAP yield for the quarter on our CLO portfolio was 15.6%. Moving now to slide six, you can see a breakout of portfolio net income by CLO subsector: $0.12 from U.S. CLO debt, $0.02 from European CLO debt, $0.23 from U.S. CLO equity, and a $0.01 loss on European CLO equity. As you can see in the middle of slide six, each subsector contributed strong net investment income. In addition, our results benefited from significant net realized and unrealized gains on U.S. debt and equity.

As Larry mentioned, these gains reflected active trading during the quarter, as well as deal calls on two mezzanine positions owned at discounts to par and a beneficial reset of a CLO equity position. Detracting only slightly from these gains were net unrealized losses on our European CLO equity and a modest drag from credit hedges designed to protect against downside risk. In the U.S., leveraged loan prices moved higher quarter over quarter despite a sharp early April pullback. Within CLO debt, higher quality deleveraging profiles posted the strongest performance. However, heavy issuance late in the quarter kept credit spreads from tightening further, and we continue to observe elevated loan credit dispersion, particularly among low-quality borrowers. U.S.

CLO equity delivered strong results, supported by robust investor demand and a decline in market volatility, with new or recently reset CLOs featuring long reinvestment periods meaningfully outperforming shorter tenor profiles more sensitive to loan prices. In Europe, leveraged loan prices posted modest gains but lagged the rebound seen in the U.S. Wider credit dispersion weighed on returns, especially in junior tranches, although stronger investor appetite for non-U.S. credit provided some offset. European CLO equity underperformed U.S. equity over the quarter, reflecting more muted loan market gains and increased dispersion. That said, some investor rotation into European structures helped soften the impact. Slide seven provides details on our CLO portfolio, highlighting the sequential growth. In total, the CLO portfolio grew by 27% to $317 million.

During the quarter, we had new purchases of $91 million, 88% of which were CLO debt and 12% of which were CLO equity, and we sold $16 million of CLOs, consistent with our active trading style. At June 30, CLO equity comprised 53% of our total CLO holdings, down from 58%, and European CLO investments constituted 14% of our total CLO holdings, roughly unchanged from the prior quarter. As Larry mentioned, we disposed of all of our remaining mortgage positions shortly after our RIC conversion, which had an effective date of April 1. The net impact of the dispositions on our NAV was only about $0.01 per share. Slide eight provides details on the corporate loans underlying our CLO investments. As you can see here, the collateral is heavily weighted towards first lien floating rate leveraged loans, which make up 95% of the underlying assets.

Industry exposure is well-diversified, led by tech, financial services, and healthcare, with no single sector exceeding 11%. Maturities are spread over several years, with the largest concentrations in 2028 and 2031 and a few near-term maturities, resulting in a weighted average loan maturity of 4.2 years. Facility sizes skew towards larger borrowers, with 42% in facilities over $1.5 billion and a weighted average size of $1.6 billion supporting liquidity. Slide nine shows additional detail on our underlying loans. The portfolio spans 2,205 unique issuers, 95% senior secured loans, and carries a B plus B average rating with a 3.34% floating rate spread. Currency exposure is 86% U.S. and 14% non-U.S. Our CLO equity positions have a weighted average junior over collateralization cushion of 4.58%. Slide 10 provides a snapshot of our credit hedges as of June 30.

We selectively and opportunistically hedge portions of our CLO portfolio's credit risk using a range of derivative instruments. During the quarter, as credit spreads tightened, we opportunistically added to our corporate credit hedges, increasing their size significantly. At quarter end, we also maintained a foreign currency hedge portfolio to manage exposure related to our European CLO equity and debt investments. Turning to slide 11, at June 30, our NAV was $6.12 per share, and cash and cash equivalents totaled $36.6 million. Our NAV-based total return for the quarter was 19.7% annualized. With that, I'll pass it over to Gregory Borenstein to discuss how the CLO market has performed, how we've positioned our CLO portfolio, and our market outlook.

Speaker 4

Thanks, Chris. It's a pleasure to speak with everyone today. As Larry mentioned, calendar Q2 was ultimately very profitable for EARN, but the path to get there was highly nonlinear. April was incredibly volatile as the announcement of tariffs sent the market into a tailspin, and corporate credit spreads sharply wider to start the month. After the tariffs were paused, which allowed markets to stabilize, credit spreads spent much of May and June grinding back and ended tighter on the quarter overall. In our U.S. CLO portfolio, both equity and mezzanine tranches saw significant gains, while in Europe returns were more muted given the higher starting point. That said, European CLOs have delivered solid performance year to date for EARN, given the outperformance of European CLO notes in Q1.

While the drawdown and subsequent retracement in CLO mezzanine were well correlated to broader market moves in credit, CLO equity saw increased dispersion in a few dimensions. In April, we saw cleaner, longer deals remain well supported, whereas shorter deals that are more sensitive to their underlying loan valuations saw a sharper drawdown as loan prices declined. Additionally, equity tranches where the market had been pricing in resets or refinancings underperformed as those options disappeared as CLO debt spreads widened. As we sit here today, many of those options have recovered, but they remain less in the money than they were at the beginning of the year. This is largely because AAA spreads have struggled to return to January-February levels. On the positive side for CLO equity, post-April loan price decreases reduced prior concerns surrounding loan coupon spread compression and any resulting net interest margin erosion.

What's more, loan payment defaults remained low throughout the quarter, ending June 30 at 1.11% on a trailing 12-month basis on the Morningstar LSTA U.S. leveraged loan index. Overall, we have been focused lately on increasing our portfolio's relative concentration to CLO mezzanine. We believe that increasing exposure to these up in credit positions, along with adding credit hedges, helps to protect the portfolio and serve as nice complements to our CLO equity positions. Additionally, we have also shifted our focus more to the secondary market as compared to the primary market, as the dislocation experienced in parts of Q2 created many more secondary market opportunities. In fact, Ellington Credit Company did not participate in any new issue equity transactions in Q2, as we have found better relative value in secondary markets in recent months. As mentioned before, CLO liabilities, specifically AAAs, have struggled to return to their tights.

Meanwhile, as of July 31, a considerable 46% of the loan market traded above par. Significant repricings in the loan market are reigniting concerns about spread compression, and with AAA spreads still struggling to retrace to their 2025 tights, new issue CLO equity arbitrage has come under pressure. Our emphasis on CLO mezzanine investments in the current environment also reflects our concern that the persistence of higher base tariff rates, coupled with ongoing uncertainty around future tariff policy, will continue to drive dispersion in credit for the foreseeable future. As our results show, Ellington Credit Company took advantage of Q2's market uncertainty, reaping the benefits of active trading during bouts of market volatility. On the quarter, we had 79 unique CLO trades, not counting any deal liquidations or credit hedge trades.

I believe the portfolio is well balanced, with core positions built for stability and others offering meaningful upside and attractive optionality. We will continue to shift allocations as the market environment changes, be it between mezzanine investments and equity, primary and secondary, or U.S. and Europe. Now back to Lowell.

Speaker 2

Thanks, Greg. Calendar Q2 was a great quarter for Ellington Credit Company and a great start to our new form as a closed-end fund. We not only put up strong earnings, but we also ended the quarter with a diversified, high-quality CLO portfolio and ample dry powder to boot. Calendar Q3 is off to a strong start, as we delivered another month of excellent results in July, expanded the portfolio, and grew NAV further. As of now, our CLO portfolio stands at around $360 million, up from $320 million coming into Q3. Looking ahead, we see multiple ways to continue to drive performance and expand net investment income. Deploying our remaining dry powder is one way, and as I mentioned earlier, we project that our net investment income will fully cover our distribution rate starting in September.

Another way is by issuing long-term unsecured debt, which we hope to do later this year. The additional leverage supplied by long-term unsecured debt should be accretive to both GAAP earnings and net investment income. Even with our current capital base and debt structure, we expect to increase our CLO portfolio by another $40 million, to $400 million or so. I firmly believe that our rigorous approach to CLO investing, our active trading style, and our strategic use of credit hedges give Ellington Credit Company a unique advantage. With credit markets having recovered so much since early April, we've taken advantage by adding credit hedges at better entry points while still uncovering compelling opportunities in CLO equity and mezzanine debt across the U.S. and Europe. This relative value approach gives us the flexibility to target the best risk-adjusted returns as markets evolve.

To recap, we've built what we view as a high-quality, well-diversified CLO portfolio while keeping liquidity high and lining up multiple levers for earnings growth. Calendar Q2 is a powerful start for EARN, and we are confident in the opportunities that lie ahead. Now let's open the floor to Q&A. Operator, please go ahead.

Speaker 0

Certainly, Mr. Penn. Ladies and gentlemen, at this time, if you would like to ask a question, please press star one. You can remove yourself from the queue by pressing star two. We'll go first this morning to Douglas Harter of UBS.

Speaker 1

Thanks, and good morning.

Speaker 2

Good morning.

Speaker 1

I just talked a little bit about the morning. Talk about the dynamic where why AAA spreads haven't fully retraced, why the underlying loan spreads have.

Speaker 2

Sure. It's Greg. I'll take that one. To be clear, I think that it's just simply AAAs are not receiving relatively maybe the same demand that they were earlier in the year. Some of the things we've spoken about previously, our focus is around the growth of the ETF market and just a very diverse, even foreign buyer base. Perhaps it's with the idea that a rate cut may happen and maybe some rotation around floating rate. AAAs had screened CLO AAAs the tightest of the cohort when you compare cross-structured products and credit earlier in the year. Overall, you could maybe make the argument that they were relatively pricing very tight. They're simply anywhere from 10 to 15 basis points back now. I think overall, it's just a little bit of a technical. There's just a little bit less demand for a variety of reasons.

The further point I would make is as much as loans have rallied back around par, you don't see the same amount above par that you did earlier in the year, when you were at some point close to 70% above par on the loan side. I think it's, while it's been noticeable, it's within a range where there's enough sort of margin for error in terms of the spreads catching up.

Speaker 1

Great. Appreciate that. Assuming that dynamic doesn't change, would you expect your allocation to be kind of similar to what it was in the June quarter, more toward debt and equity?

Speaker 2

I think that if the ARB continues to stay challenged to this point, there are a number of factors that can obviously come into this. If secondary markets become tighter and less attractive, removing that opportunity may also see some rebalancing. Overall, I think that we've tended to not like creating at new issue. If the assets and liability math calculation doesn't change, it's hard to see why we would allocate more to it. I would tend to agree with that.

Speaker 1

Great, thank you.

Speaker 0

Thank you. Just a quick reminder, ladies and gentlemen, star one for questions this morning. We go next now to Jason Weaver of JonesTrading.

Speaker 1

Hey, guys. Good morning. I think in the beginning of your prepared remarks, you were talking about issuance trends and how they were muted in the first quarter of 2026 just due to the volatility. Since some of that's come down, some uncertainty's been reduced, and we may see some monetary relief on the horizon, would you expect that trend to reverse into calendar year end?

Speaker 2

In regards to, you're saying CLO issuance?

Speaker 1

CLO issuance in general.

Speaker 2

Sure. I thought that new issue, end of the year and the beginning of this year, when the ARB looked a little more attractive, you were seeing more happen. Part of it is, right, are you going to see loans versus debt spreads become attractive again to see true new issuance? It's really hard to say. The market's seen much more resets and refis. What could make that change? Perhaps if you see monetary easing and it leads to perhaps a little more spread coming from the asset side and loans, that could help reignite the new issue market. It is hard to say where I think that right now new issue desks and a lot of investors have simply been focused on refis, resets, liquidations, and have struggled to pick back up new issue.

If you see AAAs come in, assets move out, it's just hard to say exactly how those components will change based on some of the uncertainty around what we've seen in the fall.

Speaker 1

Got it. Thank you. To clarify a little bit of what Gregory Borenstein had said on the relative value between mezzanine investments and CLO equity here, any sort of perception of an increased risk to equity tranches? You did mention tariff announcements in the prepared remarks.

Speaker 2

Right. I think if you take a look, tariffs are going to create winners and losers. There's uncertainty around different sectors, around different companies. I think that we see equity as having more risk and exposure to tariffs, being that they're a first loss tranche. If there's a handful of names which are adversely affected, a subordinated mezz position will remain above the fray from a small amount of losses. If losses become so great that it starts to get through that attachment point and your mezz starts to perhaps look like equity there, which we've seen at certain rare occurrences in the past, periods such as COVID or the financial crisis.

If it sort of remains a tail issue, which if you look at credit markets, it's sort of been just a tail of companies that have had problems, that continues to be a lower correlation event and overall is something that would generally force us positions such as CLO equity to underperform versus positions further up in the capital structure that are more spread sensitive and maybe less credit or fundamentally sensitive.

Speaker 1

Got it. That makes sense. Just last one, I'll hop off. Do you have an updated quarter-to-date NAV estimate?

Speaker 3

Just when we posted?

Speaker 1

Yeah, we posted July 31 last night.

Speaker 3

A range around $6.16 plus or minus $0.03.

Speaker 1

Yeah. 6.16.

Speaker 3

That's right.

Speaker 1

Is through the end of the year. I must have missed that, but thank you. I'll hop back in.

Speaker 2

Great, thank you.

Speaker 0

Thank you. Gentlemen, that was our final question for today. We would like to thank you all for participating in the Ellington Credit Company fiscal quarter ended June 30, 2025 results conference call. You may disconnect your line at this time and have a wonderful day. Goodbye.