Ellington Financial's CEO Discusses Q1 2013 Results - Earnings Call Transcript

| About: Ellington Financial (EFC)

Ellington Financial LLC (NYSE:EFC)

Q1 2013 Earnings Call

May 7, 2013 11:00 AM ET


Sara Brown – Corporate Counsel

Larry Penn – CEO and President

Lisa Mumford – CFO

Mark Tecotzky – Co-Chief Investment Officer


Steve DeLaney – JMP Securities

Michael Widner – KBW

Operator: Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial First Quarter 2013 Financial Results Conference Call. Today’s call is being recorded. At this time, all participants have been placed in listen-only mode and the floor will be open for your questions following the presentation. (Operator Instructions).

It is now my pleasure to turn the floor over to, Sara Brown, Corporate Counsel. You may begin.

Sara Brown

Before we start I’d like to remind everyone that certain statements made during this conference call including statements concerning future strategies, intentions and plans 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 and can be identified by words such as belief, expect, anticipate, estimate, project, plan, should, or similar expressions or by reference to strategies plans, or intentions.

As describe under item 1A or our annual report on Form 10-K, filed on March 15, 2013, forward-looking statements are subject to a variety of risks and uncertainties that could cause the company’s actual result differ from its belief, expectations, estimates and projections. Consequently, you should not rely on these forward-looking statements as predictions of future events.

Statements made during this conference call are made as of the date of this call and the company undertakes no obligation to update or revise any forward-looking statement whether as a result of new information, future events or otherwise.

I have with me today on the call, Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, our Co-Chief Investment Officer; and Lisa Mumford our Chief Financial Officer.

Larry Penn

Thanks Sara. As always, it is our pleasure to speak with our shareholders this morning as we release our first quarter 2013 results. We all appreciate your taking the time to participate on the call today.

We will follow the same format as we have for the past several quarters. First, our CFO Lisa Mumford will run through our financial result. Then our Co-CIO Mark Tecotzky will discuss how the MBS market performed over the course of the quarter, how we positioned our portfolio, and what our market outlook is going-forward. Then, I’ll close our prepared remarks and we’ll take some questions.

In addition to our earnings release, yesterday evening we posted a first quarter earnings conference call presentation to our website www.ellingtonfinancial.com. You will find it right on the, for our shareholders page or alternatively on the presentations page of the website. Lisa and Mark’s prepared remark will track the presentation. So, it will be helpful if you have this presentation in front of you, and turn to page three to follow along.

While you are getting that in front of you, I’m going to turn it over to Lisa.

Lisa Mumford

Thank you, Larry, and good morning every one. My remarks are based on the slides beginning with our P&L attribution table on page three and the two summary slides following it. Looking at the attribution table on page three, you can see that for the quarter, we earned $40.3 million or $1.94 per share which equates to a non-annualized return on equity of 7.8%.

Our Non-Agency MBS strategy provided 98% of our total gross P&L for the quarter. In our non-agency strategy for the fifth consecutive quarter are, income here was driven by interest income as well as net realized and unrealized gains.

During the quarter, we continued to augment yields earned on the portfolio with trading gains. Notably, net realized and unrealized gains contributed to combined I’m sorry to contribute $1.97 per share to our gross P&L for the quarter, returned over just under 20% of the portfolio during the quarter.

Additionally, as of March 31, 2013, net unrealized in the portfolio were in excess of $66 million and as measured by value the bond portfolio grew to approximately $585 million as compared to approximately $557 million as of the end of 2012.

Average holdings based on amortized costs, increased to $514.4 million at the end of March from $494.2 million at the end of the fourth quarter. Weighted average yields based on cost for the quarter was 9.4% compared to 9.7% in the fourth quarter.

In our agency strategy, we earned gross P&L of $734,000 or $0.04 per share. Interest income of $0.30 per share was muted somewhat by net realized and unrealized losses on our agency specified pool as the price premium for these pools relative to generic pool contracted during the period. Our hedges blunted some of the impact of the decline adding $0.04 to agency gross profit.

Active trading of both assets and hedges including TBAs has and continues to be the focus of this strategy. As of the end of the first quarter, the agency portfolio as measured by value increased to $861 million as compared to $774 million as of the end of 2012.

During the fourth quarter of 2012, many specified pools were trading at all-time highs relative to their TBA counterparts. We took advantage of these historically high levels and actively sold many of our specified pools to capture gains replacing these positions with lower priced non-traditional pre-payment protected position.

Our weighted average holdings of long-agencies based on amortized cost was approximately $833 million in the first quarter compared to $669 million in the fourth quarter.

Our overall average cost to funds declined 19 basis points over the quarter to 80 basis points as our average borrowings were more heavily weighted to our long agency RMBS as we ramp that portfolio up in the latter portion of the fourth quarter of 2012.

Quarter-over-quarter our leverage ratio increased slightly to 1.86 to 1, and we continue to find repo readily available.

Core expenses which includes other operating expenses and waste management fees and exclude incentive fees and financing costs, came in at 2.8% of average equity on an annualized basis and these expenses were in-line with our expectations. We incurred incentive fee expense during the quarter since on a rolling four quarter basis, our results were in excess of the return hurdle.

Our diluted book value per share was $24.78 at the end of March, compared to $24.38 at the end of December. This increase represents growth of 1.6% and that’s after the payment of a quarterly and special dividend that amounted to $1.52 per share or 6.2% of year-end diluted book value.

Finally, we recently declared our first quarter dividend of $0.77 per share which will be paid on June 17, to shareholders of record as of May 31. You’ll recall that our dividends are paid quarterly in arrears and at the end of each year our board will consider our earnings and other factors to determine the amount of a special dividend if any.

Based on our closing price yesterday of $25.95 our dividend represents an annualized yield for the 11.9%.

With that, I turn the presentation over to Mark.

Mark Tecotzky

Thanks Lisa. Two powerful forces drove our performance in the first quarter. First, was the strong risk-on-momentum that happened over the New Year’s holiday driven by the resolution of the fiscal cliff crisis. That risk-on-momentum carried on throughout the first quarter.

The second factor was continued strong housing data that has been aggressively embraced by the market. In addition, we saw many opportunities to upgrade our portfolio in the first quarter that we took advantage of. We precede the big changes and the relative value of many sectors in the market.

Our portfolio management effort attempted to sell securities that had cheap prices with no longer the most attractive asset on a risk reward basis, and replace them with securities that we believe have a better total return potential.

We view our use of an active trading stall to capture incremental returns that’s critical to providing long-term return to shareholders. That is the point of active management, to capture returns above and beyond the market data.

As we are now in a pricing regime, the amount of distress implied by asset prices is significantly less than a year ago, incremental returns become increasingly important.

If you look on slide 10, let’s talk about how the portfolio evolved during the quarter. We added to our non-agency position, we believe that non-agency yields would compress as better housing data became firmly cemented in the psyche of the market. To conceive the green sector, we were able to other expand – as we added to our CLO positions. This has been a new initiative for us, we have added resources and we’ve been pleasantly surprised as some of the CLO opportunities that we have been able to take advantage of.

You can see the market price to portfolio jumped almost nine points. Some of that was a market move and some was a function of active trading as we sold lower dollar price securities and appreciating value and bought higher price points.

This repositioning had to do with the market making such a violent risk on move over the New Year’s Day holiday, when you came into – when you came into your first day of work in 2013, it was a rally in prices but it looked to us as though it was indiscriminant, that securities went out and priced too much relative to some others, we wanted to reposition the portfolio partially as a result.

Page 11, look on the lower right, 6.77% yields. These yields still look attractive relative to other sectors, especially given the strong move up in home price would be of witness. Now that you’re seeing some home prices outpaced core measures of inflation, you have to think about the field and context of the tips market where real yields are negative through the tenure, much wider than high-yield. So there is a lot of fundamental value in the non-agency MBA.

The returns in the stock came from two components, dividends and increases in book value. So, while yield on the portfolio has come down, you’re constructive on the total return potential on non-agencies. We also want to point out now that yields have come down in quarter – I also want to point out, now that yields have come down and closed this volatility, returns are going to be more driven by broad markets moves in the sector and to active trading than they are by yield capture. This quarter was a good example.

We wound up being up 7.8% to the quarter which isn’t always what our portfolio yields over the course of the year.

One thing we have mentioned before was our belief that as the market recoveries yields, and our portfolio would decline which they have or that market recovery would be accompanied by the emergence of new opportunities. Take advantage of new opportunities, you have recently beefed up our residential loan team.

Over the years of VFC, we have always kept align with the loan market. Our opinion was that, once you properly value liquidity, trading opportunities, reap in more risk, modification obligations and all the other factors that make loans much messier than securities, securities provided the better total return opportunities.

Now, you have seen much more supply of loans and the relative value trade-off is a lot closer. We have added a trading resource, we are building our loan models and soon will be actively looking for loans. We will proceed in a measured pace because loans are much easier to buy than they are to sell and can come with servicing obligations, legal risks, and a myriad of other complexities that are not part of securities.

You will see some others move more quickly, but I can almost guarantee that moving aggressively can come with unintended consequences.

Page 12, if you look at the hedging we are very light in ABS, the CMBS the hedge for our cash funds. We were short of some corporate credit that out in the quarter so we heard of, but the size was small relative to our investment in credit sensitive non-agency RMBS.

Page 14, the agency portfolio. Agency pulls cheapened up in a few dimensions in the first quarter. First, ABS and CMBS, both TBA specified pools underperformed their logical non-mortgage hedges, swaps and treasuries. Additionally, the pay-up on specified pools came down without much of a move in interest rates. We added positions, I think that was the logical response.

Because the fed is the biggest buyer of ABC mortgages but unlike every other investor, trying to do profitable trade is not the primary motivation, investor should expect volatility in ABC strategies, we certainly controlled it last quarter by having a large CBA short start of the year. The volatility in agency market will come as investors are going to be hypersensitive and take apart every economic number to see how that impacts their expectations for the tenure of QE3. We think that potential volatility will create some interesting opportunities.

In addition, not really a Q1 event, but in the past week, Mel Watt, has been nominated for Director of FHFA, that will create some volatility as the marketplace tries to infer what represents Watt’s agenda might be if you’re soon to roll.

I’d now like to turn the presentation back over the Larry.

Larry Penn

Thanks Mark. As you know, our goal at Ellington Financial is to capture upside and good markets while controlling downside and rough markets. The first quarter of 2013 was actually a great example of this in a very interesting way. Namely, we captured the upside in our non-agency strategy, when non-agency RMBS performed very well during the quarter and we controlled the downside in our agency strategy and what was actually a rough quarter for agency RMBS.

And as I’ll discuss in a moment, the way that we captured upside and controlled downside in these two markets is just by continuing to focus on those things that we think really differentiate Ellington Financial in the space, active trading, sector rotation, dynamic hedging and rotation of hedges, all informed by our extensive proprietary research and years of market experience.

Let’s start in the non-agency strategy but we captured the upside during the quarter. Now, in non-agencies, we were positioned for prices to rise and they definitely did rise. But as usual, we didn’t just ride the tide. We generated lots of additional income by actively trading the portfolio.

As we’ve noted before, big market moves often result in miss-pricings and therefore big moves often present great opportunities for us to rotate our portfolio. The big upward move we see in the last several months is no exception. Basically, we believe that many of the more distressed lower priced non-agency RMBS has risen too far relative to many of the less distressed, higher priced non-agency RMBS.

So, as Mark mentioned, we actually took profits in lower priced securities during the quarter. I’d like to spend a moment to explain what our thinking is here. We believe that the burnout we’ve seen in the default rates of many non-agency pools will continue. After all, any borrower who has remained current on their mortgage in nearly six full years since the housing crises began is much less likely to default now.

We believe that the market is undervaluing the impact of this phenomenon will have on the performance of some of the cleaner, higher price force. On the other hand, we also think that the market is underestimating the loss severities that will ultimately be experienced in many of the lower priced pools or a higher percentage of the loans have remained in limbo, delinquent of still not for closed down for many years.

So, when you see that the average dollar price of our non-agency MBS rose during the quarter, keep in mind this was not just some result of rise in prices, it was also the result of sector rotation.

In fact, the average sales price of the non-agency RMBS that we saw during the quarter was in the low 60s area and the average purchase price of the non-agency MBS that we purchased during the quarter was in the low 80s. And remember, the views that informed these and other portfolio maneuvers are not just based on anecdotal evidence, they’re based on hard data.

Yes, the Ellington’s head of research is an economist. But you can’t pen on our recent efforts that old joke about economist for whom the plural of anecdote is data. Our views on borrower behavior and loan loss severities wouldn’t be possible without our commitment to research and analytics, pouring over and analyzing vast amounts of loan amendable data on borrower behavior, servicer behavior, loan loss severities, housing and census data, geographic variability and so on.

With non-agency MBS yields having impressed quite a bit from a year ago, we believe that our ability to differentiate and rotate among these complex securities will be even more important now.

Let’s move on to the agency strategy while we control the downside, actually even made some money during the quarter. As we mentioned on our previous earnings call, as prices and pay-ups were reaching new height in the fourth quarter of last year, we did two important things going into year end. We maintained a relatively low average pay up and we increased our TBA hedges. In fact, coming into the year, our average pay-up was just slightly over half a point, and about 70% of our hedges were in TBAs.

These risk reduction measures turned out to be just the right moves at just the right time, pay-ups ended up contracting, the mortgage base is widened. And as a result, and as many of you know, many reach reported significant book value declines. In contrast, Ellington Financial is actually slightly profitable in its agency strategy during the quarter. I’m really proud of the job that Mark Tecotzky, and his agency pool team did in preserving capital over which was clearly a challenging quarter.

As a result, we now find ourselves superbly positioned to take advantage of some excellent entry points in specified agency pools.

As we look forward, we remain very healthy about the outlook for Ellington Financial. Within our non-agency strategy, the real driver of our returns, the market still offers excellent value and we believe that we will continue to see attractive opportunities to invest in and trade assets. Not surprisingly, as the legacy assets in the non-agency MBS markets, such as legacy sub-prime assets continue to return closer to normalcy, other avenues are opening for us.

We think the CMBS market will continue to provide opportunities for us. We believe that non-performing small balanced commercial loans were currently only a small portion of our portfolio will eventually become a meaningful contributor to our bottom line.

Another growth area for us is residential hold on. This is an area that Ellington already has deep experience in. Since the onset of the financial crisis, however, we’ve just seen far superior value in legacy non-agency securities than in residential home loans. A volume of residential loan sales by banks particularly the sales volumes of distressed loans has been quite low for some time.

In fact we still think that residential loans remain overpriced and that even goes for non-performing and re-performing loan packages. However, we think that a steady supply of distressed residential loans is finally coming, most notably from HUT as it finally comes to grabs, incredibly large number of defaulted FHAVA ones.

We have recently added another residential loan trade at Ellington and we’re gearing up for what we see as an oncoming opportunity.

Finally, we are also actively evaluating, entering the mortgage origination space for four primary reasons. First, lenders are reluctant to lend, even well qualified borrowers are having too difficult a time getting mortgage loans.

Second, we’ll be good at it especially with our deep market expertise. Third, while we would expect that most of our loan production would initially be an agency mortgages, since that still offers the optimal execution and highest profit margins, we would also plan to originate non-agency mortgages and this could eventually become a significant source of new investments for Ellington Financial.

Last but not least, given the market dynamics I just described we strongly believe that this will be a profitable business line. So, what committed at Ellington Financial to take the broadest possible view of our mandate in the mortgage space. We’re not a one-trick pony. And we don’t think that being a one-trick pony is the best way to deliver attractive returns for shareholders over market cycles. Ellington Financial’s flexible structure helps make this possible.

This concludes our prepared remarks. Before I open up the call for Q&A, I would just like to remind everyone that, as usual, we’ll be happy to respond to questions to the extent they are directed to matters related either specifically to Ellington Financial or more generally to the mortgage and asset-backed marketplace in which it operates. We will not be responding to questions on Ellington’s private funds or other activities.

Many of you may have heard that within the past week, Ellington with Black Stone as a strategic investor priced the initial public offering of Ellington Residential Mortgage Rate, New York Stock Exchange Ticker EARN or earn. Ellington Residential Mortgage Rate with its primary focus in agency RMBS will have a very different focus from that of Ellington Financial, which as you know is primarily focused on non-agency opportunities.

While we are all also very excited about Ellington residential, if you’re interested, we’ll be hosting an informational conference call for Ellington Residential in the coming weeks. Operator?

Question-and-Answer Session


(Operator Instructions). Your first question comes from the line of Steve DeLaney of JMP Securities.

Steve DeLaney – JMP Securities

Hi, good morning everyone and congratulations on an excellent first quarter.

Larry Penn

Thanks, good morning Steve.

Steve DeLaney – JMP Securities

So, I wanted to follow-up on the commentary about the non-agency market that specifically rather than the legacy paper, I’m sure you guys are tracking the new issue RMBS 2.0 market. And we’re seeing, we saw that market back-up pretty significantly in March and I guess we’ve got AAAs now about 170 over-swaps and I compared that to CMBS which you mentioned with AAAs or Super Seniors at 85 over-swaps.

And I was curious, your thoughts about that disparity between those two markets. And if you think new issue is attractive, especially Larry as you tied this into your origination capability which may, cause you to have some of your own paper. But as you look at this market right now at 170, and sort of up and down the capital stack at 170 over, in addition to your general comments, do you see it as a more attractive place for you to be an investor or to potentially be an issuer given those spreads? Thanks.

Mark Tecotzky

Sure, hi Steve, it’s Mark.

Steve DeLaney – JMP Securities

Yeah, Mark.

Mark Tecotzky

So, yeah, I would say, if you look at the non-agency market, if you look at the new origination in non-agency, it’s still – it’s still small but I think what’s interesting is that there are few redwood deals that priced at the end of the last year at really tight levels, small volume. And as they ramped up the volume a little bit, they weren’t able to clear deals at the same spread to swaps as they had been so that caused – that caused the widening.

When we look at those bonds, our view is that we still see better opportunities in legacy non-agencies. And I think the primary driver is the pre-payment function. So if we look at the legacy non-agency market, especially some of the sectors we’ve been buying, there are loans that maybe the borrowers are a little bit under water but not significantly they’ve seen home price gains in the past year. They are chip and wait their loan balanced through amortization. But you can still buy those securities assuming very slow rates of voluntary pre-payments.

On the jumbo side, if you look at the – if you look at what the historical speeds, if you go back to the earlier Redwood deals from, 2011, beginning of 2012, what you see is the pre-payment function that you’re basically buying into those deals generally on par. And what you get is a prepayment function which loans can pay very fast, 35, 40 CPR if there is a rally in mortgage rates.

But if there is a sell-off in mortgage rates you can get extremely slow speeds. So that prepayment volatility is a function of rates on a per coupon bond gives it higher hedging cost and that’s why – even though – it obviously looks more attractive to us now than it did, it was say five months ago. But when we compare that is what we get on the legacy side, but we can buy securities that we think are going to increase in prepayment speeds, we’re buying them at a discount, we’re buying to very close speed assumptions.

And you have this sort of wild card about potential policy changes right, so you can talk about things, you’re representative of what might contemplate if you were to get into FHFA, conceivable, they could do something almost like a heart program for non-agencies which could significantly improve voluntary pre-payments. So we don’t – no, that’s not our base case expectation. But I think that’s sort of an add of the money option where loan can buy in those.

So, I’d say that the non-agency 2.0, it looks closer relative to legacy now than what it did say four or five months ago, because legacy non-agency has rallied and the new issue has widened. We still like legacy non-agency better.

Larry, talked about our interest in origination potentially down the road. I think that will be a bigger part of the origination market, especially if you saw in the further loan balance restrictions out at Fannie & Freddie.

Larry Penn

And I’d like to just add one thing to that which is that, in addition to the much worse prepayment characteristics, the greater risk of extension payment on the new issue. We have to also realize that the new issues, they get ratings, they get fresher ratings right and it’s meant for banks, right. Banks and other people that are basically going to buy and hold them and they need that rating in order to buy them.

A lot of the legacy stuff is never going to have the type of rating, just by virtue of the way that the rating agencies look at it, it is never going to have the kind of rating that a bank is going to need to be able to hold that in portfolios.

So, if we buy something at a price of 80, right and we think you’re going to return $0.95 on the $1 but that’s not $0.100 on the $1 so the rating agencies are not going to give that the rating that someone needs. So there is always that – what I would call artificial aspect to it as well. Which is for us again draws us to the legacy where there is greater value.

Steve DeLaney – JMP Securities

And that’s very helpful and I just a short follow-up. On the yield that you indicate on page 11, for your non-agency portfolio, using Europe HPA forecast. You’re in a north of 6%.

We see a lot of fixed income research every week, or just a weekly structured finance pieces and everybody is kind of talking 3%, 4%, 5% type of yields on legacy non-agency. What’s the big difference there is it really just the scenario you have for defaults and severity versus what’s probably the dealers or pricing into their bonds? Hello?

Larry Penn

Yes, sorry, we’re just thinking, I’m just going to take the call. So, yes, I think Mark..

Mark Tecotzky

I would say Steve that, we typically, we don’t just buy the market as a whole. If you look at our holdings they’re not representative of the markets. We have very little option arms. We’ve move around our sort of 06, 07 subprime exposure a lot. So I think when we look at the market.

We look at where security head over time. We typically are involved in maybe 1% to 3% of what Jades in the given quarter and we’re selecting the 1%, 2% 3% that we think a couple of 100 basis points wider in the market. So, I think that’s it.

Steve DeLaney – JMP Securities

Okay. It’s really just a specific asset selection and you just, you’re looking at it so granularly. You think you can find basically some hidden gems on their rather than just with the generic yield indication might be.

Mark Tecotzky

The research that you’re seeing certainly doesn’t cover things like manufactured housings, certainly doesn’t cover things like legacy CDOs and those are the two of the...

Steve DeLaney – JMP Securities


Mark Tecotzky

Asset class...

Steve DeLaney – JMP Securities

Yes. Just generic-born AAA pass-throughs, yes. All right, well thank you so much for the comments and again great quarter.

Mark Tecotzky

Thank you, Steve.

Larry Penn

Thanks, Steve.


(Operator Instructions). The next question comes from the line of Mike Widner of KBW.

Michael Widner – KBW

Good morning, guys. I’m wondering if you could talk maybe a little bit more about kind of the things you threw out there on getting into mortgage originations, and I guess just specific couple of questions on that. Where would you see the infrastructure from that being sort of the house from a legal structure? Is that inside of EFC or is that back at the parent company or how might that work and it’s a little different being an operator than it is being a portfolio company and I guess we’ve always thought of you as a portfolio company. So, should that change our thinking at all?

Larry Penn

Yes. No, I mean, I think – look, obviously this is all exploratory at this point, but from a structural standpoint, that’s one of the things that’s great about our structure. It is flexible. We can do things like this. But to preserve our PTP status, our past due tax treatment, we would house this in a corporate subsidiary, right? So any business like this would have to be housed in a corporate subsidiary. Of course, assets that are produced could be upstreams to the parent, but the actual operations would be in a corporate sub. So that’s I think the first sequential structure.

And then just in terms of being an operating company, obviously, we would look to where we to do this. We would look to hook up with the best people in the space and I really can’t say more at this time. That’s really all that at this point. We’re just talking and exploring, but it’s something that we think the long range makes a lot of sense for us and as I mentioned for many different reasons.

Michael Widner – KBW

Got you. I appreciate that. And let me just ask you a little bit, I mean you talked about some of these on the agency side but just maybe looking for some more current thoughts. I mean one of the best trades we see or at least most attractive yield opportunities we see, some of the other mortgage REITs talking about right now are sort of the TBA dollar roll market, foreign purchases, whatever on the low coupon Fannie 30s.

And just wondering how you view that on a risk-adjusted return basis. I mean is that something that – I mean it’s hard to play that. I guess intuitively, it seems hard to play that as a hedge. I mean you’re already sure a bunch TBAs but I’m just wondering if you could talk a little bit how that trade, if you will, might fit into your strategy.

Larry Penn

Sure, I think, there are definitely times when those trades makes sense in size because the fed – because of the size of its purchases and the fact that it creates a lot of short squeezes but then they’re using the mortgage market as the transmission mechanism of fed policy. They’re not like every other investors trying to make money so it created these short squeeze but they don’t monetize it so it opens the door for others to monetize it.

So I think those trades can definitely make some sense part of a portfolio. I think that people need to realize that it is the premise of those trades and the attractiveness of those trades, our premise on people’s expectations of how long QE3 is going to stay in place potentially. So if you had a crystal ball and you knew when QE3 was going to end, that would definitely inform your opinion of that trade. We don’t have that crystal ball. So that’s why I think when it makes sense, it would make sense for us in – as part of a portfolio strategy but not the dominant one.

I also think that those trades can get people away from their core competence and that we have a lot of prepayment data here. We think we understand a lot about how services behave. We understand a lot about how credit scores impact borrower’s ability to prepay, how LTVs impact borrower’s ability to prepay, how loan level price adjustments increase, impact borrower’s ability to prepay.

When you get into the TBA market, you’re no longer leveraging that base of knowledge or that experience. So that’s another reason why for us, I think it can make sense, but as part of a portfolio, not as a dominant thing because it’s a commoditized trade. There’s no barrier to entry in it. The things that we have put a lot of our resources into and research about, trying to be thoughtful in understanding the payments, they don’t come to bear in that trade.

I definitely think that they can look attractive and they make sense, but for us, because those – because of the fact that is very much – that attractiveness that’s very much contingent on the length of QE3, which we don’t have insight above and beyond market participant and the fact that it doesn’t leverage off any prepayment expertise would cause to keep it in a relatively small size.

Michael Widner – KBW

That makes a lot of sense. And then, in essence, your – it’s like a paraphrase, I mean you’re sort of going into mindless trade that just happens to be generating great yields and great effect of returns right now but it’s just too unpredictable to make it a core part of the strategy in this particular vehicle?

Larry Penn

I don’t think it’s mindless at all. I think there’s lots of ways to be a good manager in the space. But predicting interest rates, predicting Fed behavior, that’s not something where Ellington has put significant resources. So we don’t want to take significant risk on trades that the outcome is largely determined by those factors.

I think they’re definitely managers in the space that put a lot more – general mortgage managers, that put a lot of resources into being thoughtful about direction of interest rate, shape of the yield curve, Fed policy activity. And I think if you put resources there and you have a good track record of doing it, I don’t consider it mindless. I just think that we haven’t built of our resources to predict Fed behavior the way we built up our resources to understand prepayment. And so for that reason while it looks attractive, we would limit the size of it.

Michael Widner – KBW

Yes. Well, so I didn’t mean to be as integrating as it might have sounded with the term mindless but just really purely from the standpoint that it’s hard to find anything at all. And I’m not sure there is anything at all in the agency MBS space that month-to-month assuming the Fed’s going to continue QE Infinity that I just don’t see anywhere else you’re getting that kind of yield.

So it’s a less complicated place to get month-to-month yield I think than trying to be very selective about specified pools and so on and so forth. To mindless just from the standpoint that it’s easy, it’s just you don’t know when it’s going to end.

Larry Penn


Michael Widner – KBW

Look, I appreciate the thoughts and comments as always, guys, and congrats on a solid quarter.

Larry Penn

Thank you.


There are no further questions at this time. I would now like to turn the floor back to Larry Penn for any closing remarks.

Larry Penn

Okay. Thanks, operator. Look everyone, we had a really strong first quarter building on our actual results in 2012. And as you can tell, there’s no shortage of interesting things to do in this market and we’re very excited about how the rest of 2013 is shaping up. So thanks everyone for participating on the call


Ladies and gentlemen, this concludes today’s Ellington Financial first quarter 2013 financial results conference call. Please disconnect your lines at this time and have a wonderful day.

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