Ellington Financial Inc. (EFC) CEO Laurence Penn on Q4 2021 Results - Earnings Call Transcript

Ellington Financial Inc. (NYSE:EFC) Q4 2021 Results Conference Call February 24, 2022 11:00 AM ET

Company Participants

Jason Frank - Deputy General Counsel and Secretary
Laurence Penn - President and Chief Executive Officer
JR Herlihy - Chief Financial Officer
Mark Tecotzky - Co-Chief Investment Officer

Conference Call Participants

Bose George - KBW
Trevor Cranston - JMP Securities
Crispin Love - Piper Sandler
Douglas Harter - Crédit Suisse
Brocker Vandervliet - UBS

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial Fourth Quarter 2021 Earnings Conference Call. Today’s call is being recorded. At this time, all participants have been placed in a listen-only mode. The floor will be opened for your questions following the presentation. [Operator Instructions]

It is now my pleasure to turn the call over to Jason Frank, Deputy General Counsel and Secretary. Sir, you may begin.

Jason Frank

Thank you. 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 as amended, 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’m joined on the call today by Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, Co-Chief Investment Officer of EFC, and J.R. Herlihy, Chief Financial Officer of EFC.

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

Laurence Penn

Thanks, Jay, and good morning, everyone. As always, thank you for your time and interest in Ellington Financial. I will begin on Slide 3. Ellington Financial closed out a strong 2021 by generating net income of $0.61 per share and core earnings of $0.44 per share in the fourth quarter. For the full year, we delivered an economic return of nearly 14% and a total return to shareholders of 26%.

I’m especially pleased with our performance in 2021 given that it followed a successful 2020, when we were able to navigate the market volatility profitably and be in a prime position to play offense in the aftermath of the COVID-related liquidity crisis.

During the fourth quarter of 2021, our investment portfolio continued to expand with our credit portfolio exceeding the $2 billion mark for the first time. By comparison, our credit portfolio was $1.4 billion at year-end 2019, just prior to the onset of the pandemic. So it has grown by over 40% in the past two-years.

Most of this growth has occurred in our proprietary loan portfolios, which have increased by a combined 80% since December 2019. And furthermore, this growth is a direct result of the origination businesses that we have successfully cultivated. Our origination businesses now span across the non-QM, commercial mortgage, residential transition, reverse mortgage and consumer loan sectors.

Notably, we have been able to achieve this portfolio growth while lowering our overall recourse leverage. In part, this reflects that we have been able to grow by substantially expanding our equity base as opposed to just adding leverage.

In the fourth quarter, for example, we executed on two well timed equity raises, namely a common equity raise in October and a preferred equity raise in December. With our GAAP earnings per share nicely exceeding our dividend rate, book value per common share actually rose during the fourth quarter despite the much larger equity base.

Meanwhile, we have been able to invest the proceeds from those recent equity raises efficiently across our diversified portfolio and thereby avoid slippage in earnings. The proceeds of both of our Q4 equity capital raises were invested within about a month each.

We have also been able to add, extend and improve the economic terms of many of our financing facilities, while also significantly ramping up the volume and pace of our non-QM securitization activity. We just closed our 10th non-QM securitization last month, and our securitization pace has now increased to one deal per quarter, which is much more efficient from a financing standpoint.

These securitizations are important to us because they provide low-cost, long-term locked-in financing, which strengthens our balance sheet, while also generating highly attractive retained tranches that have helped enhance our overall earnings. The credit performance of our non-QM securitizations has been among the best in the sector. And in fact, one of our 2020 deals was just upgraded last week by Fitch.

One of the keys to our portfolio growth has been the strategic relationships that we have with our originator affiliates. Through these relationships, we can better adjust both the acquisition volume and the underwriting criteria of our loan investments.

As a result, over the past two-years, our loan portfolios have become among Ellington Financial’s largest, highest yielding and best-performing strategies. At the same time, the profits generated by our equity investments in these origination companies have provided a strong tailwind for our earnings and book value per share. By owning both the ultimate loans produced as well as stakes in the originators themselves, we have two ways to win.

During the fourth quarter, we completed the acquisition of three more loan originator equity stakes, including an investment in the commercial mortgage bridge loan lender, Sheridan Capital, which is our first equity investment in the commercial mortgage originator space.

We have been investing in commercial mortgage loans with the Sheridan team for more than a decade. Over a wide range of market environments, the Sheridan team has provided us with a steady stream of attractive investments while also building their own reputation in the market as a flexible and reliable source of capital for real estate owners.

Thanks to the additional operating capital provided by the strategic transaction, Sheridan is poised for even greater growth. In fact, Sheridan’s flexibility and efficiency were highlighted just this past quarter as it was able to get a number of loans over the finish line to accommodate year-end closing deadlines, which many other lenders were unable to do. Our teams worked diligently up into the final day of the year, and we were able to pick up some very attractive commercial mortgage bridge loan investments.

In recent quarters, we have emphasized the growth of our commercial mortgage loan portfolio as one of our key drivers of earnings. And as you can see on Slide 11, Ellington Financial had $191 million of CRE originations in the fourth quarter, which set yet another record for us and which grew our total portfolio by 30% even after paydowns and resolutions to $458 million. With our emphasis on relatively low LTVs and short durations, the credit performance of these loans has been excellent, including throughout the COVID market shock.

You can see the latest attributes of our diversified commercial mortgage portfolio on the preceding slide, Slide 10. Nearly 90% of our new originations during the fourth quarter were multifamily. And as you can see on this slide, about two-thirds of our portfolio consists of multifamily backed loans, an asset class where we have consistently found attractive risk-adjusted returns. Turning back to Slide 11, you can see the significant quarterly growth of our non-QM and residential transition loan portfolios as well.

Finally, as we announced last night, we have just signed a definitive agreement to acquire substantially all of the remaining raining interests in our affiliate reverse mortgage originator, Longbridge Financial. I will provide more detail on that in my closing remarks.

I will now pass it over to JR to discuss our fourth quarter financial results in more detail.

JR Herlihy

Thanks, Larry, and good morning, everyone. Please turn back to Slide 3 of the presentation. For the quarter ended December 31, 2021, Ellington Financial reported net income of $0.61 per share and core earnings of $0.44 per share. These results compare to net income of $0.41 per share and core earnings of $0.46 per share for the prior quarter.

Our net income, which includes the mark-to-market gains on our originator equity investments, comfortably cover the dividend for the quarter, while our core earnings per share declined modestly quarter-over-quarter.

The decline was due to a small drag from investing the proceeds from our common equity raise during the quarter as well as incrementally lower overall asset yields on our non-QM loan portfolio and our commercial mortgage loan portfolio.

The lower yields on our non-QM portfolio were driven by faster prepay speeds and lower coupons on new loans purchased. And in our commercial mortgage loan portfolio, coupons on new originations were generally lower than coupons on loans that we resolved.

That said, we have seen non-QM coupons on new originations ratchet up in recent weeks in response to rising interest rates and securitization spreads, and we expect yields to be increasing from here in other - in our other loan strategies, as Mark will discuss in more detail.

Looking ahead, with the continued growth of our high-yielding investment portfolio and the potential upcoming refinancing and upsizing of our unsecured notes, I think that we are well positioned to grow both net income and core earnings from here. In particular, we expect that our core earnings will again cover our dividend rate soon. As Larry will mention, our acquisition of the other half of Longbridge should also be accretive to our core earnings.

During the fourth quarter, we raised a total of about $220 million in equity. This consisted of a common equity offering in October, which we raised near book value and a preferred equity offering in December that priced at a dividend rate of 6.25%.

The new preferred equity Series B was rated A- and our existing preferred equity Series A was also upgraded a notch to A, both of which are designated NAIC-1. These NAIC-1 ratings enabled us to price the Series B at a spread of 4.99% for the 5-year U.S. Treasury, which is among the tightest executions ever in our sector. These fourth quarter capital raises increased our equity base by a combined 20%. And as Larry mentioned, the proceeds from each were invested within a month.

Moving to Slide 4. You can see that we finished the fourth quarter with 82% of our deployed capital allocated to credit strategies and 18% allocated to our Agency strategy similar to how we are positioned last quarter.

Next, please turn to Slide 5 for the attribution of earnings between our credit and Agency strategies. During the fourth quarter, the credit strategy generated a total gross income of $0.91 per share, while the Agency strategy generated a small gross loss of $0.03 per share. These results compare to $0.66 per share in the credit strategy and positive $0.03 per share in the Agency strategy in the prior quarter.

The strong performance of our credit portfolio was led by sequentially higher net interest income, which is the result of our larger high-yielding loan portfolios naturally as well as by significant earnings from our investments in unconsolidated entities, primarily our loan originators.

LendSure, our non-QM loan originator affiliate set another record quarter - set another record for origination volume and profitability in the fourth quarter, capping a tremendous year. Our reverse mortgage originator affiliate, Longbridge Financial, delivered a strong fourth quarter, while our smaller originator affiliates posted solid results as well. In addition, our Non-Agency RMBS and CMBS strategies contributed nicely to our fourth quarter results.

In our Agency strategy, it was a challenging quarter as short-term interest rates rose sharply, actual and implied volatility increased and the yield curve flattened with the Federal Reserve signaling that interest rate increases could be imminent. The Federal Reserve also began the tapering of its asset purchases in November and then accelerated the pace of that tapering starting in December.

Most MBS underperformed U.S. treasury securities during the quarter and higher coupon specified pools and other shorter duration RMBS, particularly underperformed in light of the flattening of the yield curve.

Net realized and unrealized losses on our Agency portfolio exceeded net interest income and net gains on our interest rate hedges. And so the Agency strategy ended up generating a small loss for the quarter.

Turning next to Slide 6. During the fourth quarter, our total loan credit portfolio grew by 22% sequentially to $2.06 billion as of year-end. The majority of the growth occurred in the non-QM residential transition and small balance commercial mortgage loan strategies. And as you can see, their slices of the overall pie grew roughly in proportion.

On Slide 7, you can see that our long Agency RMBS portfolio also increased during the quarter by 10% to $1.7 billion.

Turning to Slide 8. Our overall debt-to-equity ratio adjusted for unsettled purchases and sales, decreased modestly to 2.8 to one as of December 31 from 2.9 to one as increased borrowings related to the larger portfolio were more than offset by an increase in total equity.

The proportion of recourse borrowings did increase slightly, however, and our recourse debt to equity ratio, again, adjusted for unsettled purchases and sales increased to two to one as of December 31 from 1.8 to one. In any case, our leverage and recourse leverage continue to be low, so we have ample room to continue to add assets at what could be just the right time.

We also further extended and improved our sources of financing and leverage in the quarter. In addition to the non-QM loan securitization, we also expanded one of our existing loan financing facilities to include residential transition loans, while simultaneously upsizing that line. Finally, our weighted average borrowing rate declined by three basis points to 1.24% as of December 31.

For the fourth quarter, total G&A expenses declined sequentially by $0.02 per share to $0.14 per share, while other investment-related expenses increased by $0.04 per share to $0.10, mainly due to non-QM securitization issuance costs that we incurred in the fourth quarter but not in the prior quarter. Also during the fourth quarter, we recorded an incentive fee of $3.2 million as we exceeded our net income hurdle for the trailing 4-quarter period.

Finally, our book value per common share was $18.39 per share at December 31, up $0.04 from $18.35 at September 30. Including the $0.45 per share of common dividends that we declared during the quarter, our economic return for the fourth quarter was 2.7%.

For the full year, our book value per share increased from $17.59 to $18.39 and combining this book value per share appreciation with the $1.64 per share of common dividends that we declared during the year, our economic return for the year was 13.9%.

Now over to Mark.

Mark Tecotzky

Thanks, JR. I will first note that we are in a very different market environment today than when we spoke in our last earnings call and as compared to year-end. The Fed’s thinking about inflation, tapering and the current hiking cycle pivoted in Q4, when it made a 180-degree turn in its opinion about the likely persistence of inflation and where its current policy should be in relation to the long-term inflation outlook. We are now seeing the market reaction to that pivot intensify in 2022 as well as in response to other evolving macro and geopolitical factors.

I will speak first about the fourth quarter’s performance, and then I will circle back to how we are thinking about with the Fed hiking, tapering and quantitative tightening cycle may mean for Ellington Financial moving forward. Specifically, how are we positioned? What opportunities do we see and what risks are we thinking about?

The fourth quarter move in interest rates was a bare flattener, as the market reacted to the Fed’s new more hawkish stance towards inflation. two year swap rates were up more than 50 basis points over the quarter, while 10 year swap rates were up less than 10 basis points.

Agency MBS underperformed during the quarter as the Fed announced that it would end support for the sector much sooner than it has previously communicated. Despite this underperformance, Ellington Financial’s Agency strategy had only a modest loss of $0.03 per share, while our credit portfolio benefited from both a higher-yielding portfolio as well as increasing value in our originator stakes. And overall, we posted very strong results.

As you can see on Slide 6, we had substantial portfolio growth, and we are able to deploy the additional capital from our preferred and common equity deals quickly and efficiently. As our origination partners have grown, we can now deploy capital more quickly.

We had steady growth in non-QM, RTL and commercial mortgage originations. And we got there with a low leverage, a generally low LTV portfolio, adding mostly short duration loan assets, many of which are now being originated at higher yields or soon be resetting to higher yields.

2021 was a year when income from our stakes and originators helped our overall net income to exceed our core income and for the fourth quarter significantly so. This is a powerful dynamic for EFC because it can allow our book value per share to grow even with the high dividend payout. For other mortgage REITs, it is often the other way around, where GAAP income Trail’s core earnings and the dividend, which leads to book value erosion over time.

Traditional mortgage origination is a cyclical business, and 2021 had some powerful macro tailwinds from most originators that are not likely to be repeated in 2022, including an extraordinarily strong housing market, historically low mortgage rates and stable securitization bond spreads.

This cyclicality is one reason why we focused our engineer stakes in non-traditional growing markets. Also, by owning both the originators and the loan flow, Ellington Financial actually has 2 ways to win, and these different earnings streams can be countercyclical.

Away from our originator stakes, we had solid earnings contributions from commercial mortgage loans, bridge loans, non-QM loans, consumer loans and also from our Non-Agency RMBS and CMBS strategies. It is particularly nice to see that after years of building the business, our residential transition loan portfolio is now growing rapidly and contributing significant income to Ellington Financial. But as I mentioned, a lot has changed since the end of the quarter.

I will now turn back to the Fed hiking cycle, which will likely begin next month and what it may mean for EFC and how we are positioned for it. The first thing I would say is that EFC management has lived through a lot of different interest rate cycles. Our focus has never been on predicting the Fed next move. Instead, our focus has always been, first and foremost, trying to insulate our portfolios against these moves, so our book value is not tremendously impacted by changes in Fed policy.

Secondly, when faced with the new market environment, we try to respond thoughtfully to position the portfolio to capture new opportunities and thrive. The market is already pricing a significant increase in short-term interest rates this year. One month LIBOR is currently only 19 basis points, but the futures market is pricing LIBOR above 2% one year from now, which means that the market is expecting around 7 25 basis point hikes in the next 12-months.

Those are just market expectations, of course, which are more often wrong than the right because a lot of unpredictable things will happen in the next year. But it does tell you that a lot of the Fed’s work has already been done even before the first rate hike has been implemented.

So what does all this mean for Ellington Financial. As the Fed raises interest rates, the coupons on our commercial mortgage bridge loans will also rise as those are virtually all floating rate loans, you can see this on Slide 10, over 99% floating rate, mostly multifamily.

Now we won’t capture all that yield increase because our repo costs go up as well. But because we have relatively low leverage, we should capture a good portion of those rate increases in our bottom line.

Our residential transition loans are also short duration, typically less than a year, but they have fixed rates, so they have a different dynamic. For EFC, that means we will try to push the note rates higher on our new originations to keep generally the same spread over our funding costs, but we might not get there exactly. It is a competitive market. So our pricing has to be consistent with other operators and there is a lot of investor demand in that sector.

Moving to non-QM. Not only have 2- and 3-year swap rates increased significantly in 2022 so far, but AAA spreads have also widened substantially. But non-QM credit performance has remained quite strong, and the spread widening is not specific to non-QM.

Spread widening has occurred across the board in much of fixed income, investment-grade corporates, high-yield bonds, Agency MBS, non-Agency CMBS and the new non-Agency mortgage securitizations. Spreads are wider in all these sectors.

To put this in perspective, 2-year swap rates have increased about 75 basis points so far in 2022, and non-term AAA spreads are wider by about 30 basis points. That means new issue non-AAAs are getting done with coupons about 100 basis points higher than in Q4, just a few months ago. That is a very large move in a very short period of time. Loans that have already been originated but not yet securitized are worth a lot less than what they were worth at the end of the year.

Interest rate hedging recoup is a good portion of that loss, but not all of it, not to spread widening. But after a sometimes painful transition, note rate on loans tend to adjust, it is easy to see this in the Agency MBS market, where the Freddie Mac survey rate has gone from 3.1% to 3.92% so far this year.

And when the non-term note rates do adjust to the new interest rate and securitization spread regime that is supportive of both LendSure’s profitability as an originator as well as our profitability as an accumulator and securitizer.

We are working with our partners to help them adjust to this new pricing dynamic. Higher swap rates and wider securitization spreads means that originators must produce higher note rates to support gain on sale margins.

It also creates new opportunities for us. Non-term prepayment speeds were blazing fast last year. They were slow with higher rates, and that means that some of our retained tranches will be worth more. Generally speaking, higher yields and wider spreads mean more yield on everything we buy, which should help our core earnings.

Now of course, we are going to give back a portion of that with higher financing costs, but the spread widening should mean more yield on assets relative to hedging costs. So once we reach a period of spread stability, we should have a bit of a tailwind to core earnings relative to the very low rate, tight spread environment that have been persisting post-COVID.

Turning to Agency MBS. That is the sector that has really been in the crosshairs of a lot of this year’s comments from Fed members. The sector has underperformed so far in 2022, but it has been orderly and has been an underperformance consistent with what we have seen in other parts of fixed income. You can see on Slide 10 that our Agency portfolio did grow in the fourth quarter as our capital base grew, but it grew at a much slower rate than the credit portfolio.

I think there are a few big questions hanging over Agency MBS. First, once the Fed is fully tapered in March, so they are no longer growing their portfolio, how long will it be before runoff starts? What will the pace of that runoff be and will they supplement runoff with outright sales?

Another big question is whether higher mortgage rates will reduce mortgage supply. That happened in 2013 after the taper tantrum, and many people forgot that after their initial swoon, Agency MBS actually finished the year outperforming treasuries.

While there is uncertainty about the Fed Agency MBS are a lot more attractively priced now than they were at the start of the year. Spreads are wider, prepayment speeds are way down and pool pay-ups are much lower. We have a much bigger range of coupons and prepaid stories we can buy without paying very high dollar prices or very high specified pool pay-ups.

So going forward, I’m excited about the opportunity ahead. With Fed support being withdrawn, private capital should be able to demand a higher return on its capital. We are seeing that now, and EFC is well positioned to capitalize on this dynamic.

Now back to Larry.

Laurence Penn

Thanks, Mark. Some of our major goals for 2021 were to continue to build out our loan origination businesses and further capture the benefits of scale operationally in our portfolio and in the capital markets, all of which we accomplished successfully. Our expanding loan origination businesses drove both our portfolio growth and earnings, and we were able to onboard 5 new loan originator investments over the course of the year.

In addition, Ellington Financial’s larger common equity base triggered inclusion in several additional equity indices, including the S&P 600 in May and KBW’s NASDAQ Financial Sector Dividend Yield Index in December, and these provided nice tailwinds for our stock.

Our larger size is also enabling larger and more efficient capital raises, securitizations and financings while helping keep our G&A expense ratio low. For example, we will probably next turn to refinancing and possibly upsizing our senior unsecured notes, and I think we are well positioned there.

2022 has started out strong for Ellington Financial. We completed our first non-QM securitization in January, and we already have another one in the works. Our flow in residential transition loans and commercial mortgage bridge loans continues to grow in leaps and bounds.

In addition, as I mentioned earlier, we have just signed a definitive agreement to acquire substantially all of the remaining interests in our affiliate reverse mortgage originator, Longbridge Financial.

Please now turn to Slides 16 through 19 for details of the transaction. And please note that the completion of this transaction is subject to regulatory approval and other closing conditions. Ellington has been investing in Agency reverse mortgage pools and derivatives since 2012, and our activity in that space led to our collaboration with Dr. Chris Mayer, the CEO of Longbridge, beginning in 2014.

In addition to founding and leading Longbridge, Dr. Mayer is a renowned economist and a thought leader in housing policy generally. Ellington’s relationship with Longbridge has been highly synergistic. And over the past nearly eight-years, Ellington has helped Longbridge develop into a top three reverse mortgage originator today with significant current earnings and significant franchise value.

As you know, reverse mortgages enable seniors to convert a portion of their home equity into cash without having to make regular monthly mortgage payments so they can be valuable retirement tools. With the Baby Boomer generation continuing to age, the advantages of serving such a growing demographic are obvious.

And similar to other markets into which Ellington Financial has expanded, we are not really competing with banks in the reverse mortgage space. This space is dominated by non-banks, largely for regulatory reasons. The barriers to entry in the reverse mortgage origination business are formidable.

Longbridge has achieved tremendous growth and profitability in recent years. From 2019 to 2021, Longbridge more than tripled its annual loan volume to $2.2 billion and increased its net income over fivefold. Longbridge recently ranked as the third largest reverse mortgage lender, both by endorsement volume and securitization volume where it has an 18% market share.

Additionally, Longbridge is one of only two companies to be awarded a Morningstar MOR RVO2 ranking for reverse mortgage originations. Longbridge’s growth has occurred in both its core Agency eligible business as well as in its high-margin proprietary business, which is actually the company’s fastest-growing division, increasing almost fivefold between 2019 and 2021.

As you can see at the bottom of Slide 18, Longbridge posted a return on equity of more than 50% in 2020, retain those earnings to drive further growth and then return more than 30% on that higher equity balance in 2021. Similar to what Ellington Financial does in its non-QM business, Longbridge originates and subsequently securitizes the loans that it originates, taking advantage of the stable long-term financing offered by the securitization markets.

Longbridge then retains the mortgage servicing rights and the loans which it has securitized. In Ellington Financial, we view these reverse mortgage MSRs as highly attractive assets. In fact, about half of Longbridge’s current tangible book value is in these MSRs and Longbridge holds its MSRs at fair value, similar to how we account for our assets.

Given that Longbridge is securitizing about $200 million of loans each month, is producing more MSRs every month, including via a healthy refinancing recapture program. We project that the cash flows from these MSRs will generate high investment yields. And so we expect these MSR assets to be highly accretive to Ellington Financial’s core earnings.

Finally, Longbridge’s origination revenue, along with the unique features of its MSR portfolio should add yet another layer of diversification to our business.

In summary, I’m very excited about this acquisition. We have seen firsthand the quality of the Longbridge management team. Longbridge is in a non-commoditized industry with significant barriers to entry and attractive margins. And it has been a star performer for Ellington Financial over the past few years, generating some pretty incredible returns for us even during the depths of COVID, by the way.

Because reverse mortgage loans provide liquidity to borrowers without the requirement of monthly principal and interest payments, borrower demand for the product actually surged amidst the economic turmoil brought on by COVID. And now with the economic recovery, strong home price appreciation has only solidified the reverse mortgage value proposition.

In fact, the significant nationwide home price appreciation over the last 18 months has substantially increased seniors home equity and thus the size of the potential market. And the reverse mortgage market penetration in the U.S. is only a fraction of what it is in more established markets like the U.K.

With an aging U.S. population seeking to tap into the $10 trillion plus of equity in their homes, the reverse mortgage sector is harnessing some very powerful demographic trends. The opportunity for scale here is significant.

I’m excited about the days ahead for Ellington Financial. Our businesses continue to flourish and grow and integrating Longbridge is just the next step in expanding and enhancing our loan origination businesses, where we can apply our analytics and manufacture our own investments, in this case, MSRs.

Our incremental investment associated with this acquisition is about $75 million, but our entire combined investment in Longbridge will still just be 11% of Ellington Financial’s total equity. As such, the reverse mortgage business will continue to be one of the multiple sectors that Ellington Financial invests in as we continue to manage a highly diversified portfolio.

We also think that this acquisition will offer synergies of its own. For example, Ellington Financial now offers a variety of mortgage financing solutions, including reverse mortgages, non-qualifying mortgages as well as traditional Agency mortgages, which enables a customized approach to addressing each homeowners’ needs. This represents significant cross-selling opportunities for our portfolio companies.

In summary, our upsized investment in Longbridge should be an excellent complement to our non-QM commercial mortgage, residential transition and consumer loan businesses, along with our opportunistic securities portfolios.

Looking ahead, as we see volatility pick up with quantitative tightening underway, we will continue to focus on our dual mandate of growing EFC’s portfolio and earnings while also staying disciplined on risk and liquidity management to preserve book value across market cycles.

And with that, we will now open the call to your questions. Operator.

Question-and-Answer Session

Operator

[Operator Instructions] We will take our first question from Bose George with KBW. Your line is now open.

Bose George

Just first, a couple on the Longbridge acquisition. Is there going to be any goodwill created as a result of the acquisition? And then can you just talk about the correlation between rates and mortgage volumes and gain on sale in that market?

JR Herlihy

It is JR. I will start with your first question about goodwill. The answer is yes. You can see on Slide 16, I believe. Slide 18. We provide summary of financial results for Longbridge over the last three-years. You can see they started 2021 with equity around $92 million, made net income of $31.5 million. So putting those together, yearbook value of about $123 million at year-end.

The transaction hasn’t yet closed is subject to the various regulatory approval and closing conditions, the price will ultimately reflect the latest book value. But if you look at the $75 million we are paying for about half, $150 million is above that $123 million. And so these aren’t exact numbers, but that delta would represent goodwill, which would shop our balance sheet after closing.

Bose George

Great. Thanks.

Operator

And we will take our next question from Trevor Cranston with JMP Securities. Your line is now open.

Trevor Cranston

Hey thanks. Actually, one more question on the Longbridge acquisition. In the financial results you guys show on Slide 18, there is a pretty big range of ROEs. Obviously, it is been very strong in the last couple of years and maybe the company was at sort of a different scale, I guess, in 2019. But can you talk more broadly about how you guys think about the long-term return prospects for their business? Thanks.

Laurence Penn

Sure. Yes. So first of all, actually, let me introduce the answer to that question, and I do want to follow up on for the second half of Bose’s question because it is actually on point to your question as well. And I think the question was really about sort of the rate sensitivity of the origination volumes.

So these are by and large floating rate loans, the underlying reverse mortgage loans. So they don’t have nearly the same dynamic in terms of as rates go up, you are going to see right in the regular conventional market, you are going to see prepayments really slow down tremendously, right. So it is less sensitive to rates from that perspective because they are floating rate loans.

On the other hand, because of the way that you size the loans in relation to the home value as rates go up, you do see just based upon the way the programs work that you will have a smaller loan amount that you will be approved for in a reverse mortgage.

And that does drive a lot of the refinancing activity as well. So we will see fewer cash out refis as rates go up. But it is - we will see some slowdown because of that as well in originations - but let’s say that what is really driving things and what is also correlated to interest rates is home price appreciation, right.

So assuming that the inflation that we are seeing continues to drive home price appreciation. Of course, we have had tremendous home price appreciation in the last 18 months, as we mentioned, you will just have a lot of home equity in this demographic, and that will create more and more opportunities for origination.

So we think that it is on balance, the inflation associated with higher interest rates is probably over time, actually supportive of higher loan volumes. And plus, this is also a market that has very low penetration right now, as you said, compared to, for example, the United Kingdom. So this is a market that is just screaming out for greater penetration and further growth. So that I just wanted to get that answer to Bose’s question, and I think that hit some of the points here.

JR Herlihy

Yes. And I think also in Bose, you asked about goodwill. I went through a calculation that implied a goodwill of about a little under 30%. That is not an exact number, it is actually going to be higher than that. We haven’t disclosed exactly what that amount is, and it is - the final transaction price is also moving subject to book value movements. But the goodwill is an amount higher than just the year-end balance sheet less compared to the $150 million. There are some other factors in play. So it will be higher than that number.

Laurence Penn

Right. Okay, sorry. So if you could repeat your question.

Trevor Cranston

Yes, no problem. So my question was around the long-term return expectations for Longbridge. The last couple of years have obviously been very strong that those are kind of representative of what you guys think is the company is capable of going forward or how we should think about that?

Laurence Penn

Yes, we do. So you have got - they have built up quite an MSR portfolio, and we think that, that is got - it really is almost - you think of it as a yield-bearing assets, you have got a servicing strip. It is a very interesting asset, by the way, not very well understood. You have got a servicing strip which, of course, isn’t paid in cash because the reverse mortgage is accreted.

So that is accreting as well by creating value, accumulating value and then heading to the loan balance. And then you also have the ability in many of the MSR assets to fund future draws by homeowners, and that creates another very important revenue stream as well.

So basically, there is a chunk, if you will, if you look at the tangible net worth of Longbridge and you think of that as really hard assets, I call them, MSRs, loans awaiting sale, all that. So that is going to generate a yield. And that is already pretty big at this point. I think they have around - as of year-end, about $90 million worth of MSRs and growing.

But then they have really come into their own in terms of their origination income as well. And I think that that is running at over $30 million a year, I think going forward, we will probably be a little more conservative in our projections. So we feel really good about what kind of net income this can continue to generate for us.

I know you are going back maybe you are looking a couple of years back. The company is just much bigger than it was back then and origination volume is much higher and profitability, much higher. So we are - and there is, of course, economies of scale like there are in almost any business. So yes, so we feel really good about the future income stream from our from Longbridge.

Trevor Cranston

That makes sense. And then on the relationship with Sheridan, can you maybe talk a little bit about what the potential is for loan acquisition volume for EFC’s balance sheet in the near term. And the sectors you guys would be looking to get exposure to are likely to be kind of similar to what you have been doing on the small balance commercial side, which has been skewed to multifamily or if it might be a little bit more diverse than that?

Laurence Penn

Yes. We will take what the market gives us. And for a long time, multifamily, we actually - we like multifamily for a lot of reasons, right? We have talked about how there is a housing shortage in this country. We have talked about it in prior earnings calls.

You don’t have the issues with retail and malls and things like that. But for a while, it was tough for us to get the flow there. And you have seen in the past couple of quarters that is actually now changed nicely, and we are able to see some flow. And yes, so I would say that it will be I think we are going to be able to get as, I think, as much small balance commercial flow as we can handle.

Of course - so one thing I should mention is that we do share. We have not just Sheridan. We have many other vendors that - and brokers, et cetera, and we have an origination team here at Ellington from which we source small balance commercial loans and other Ellington clients as well do share in that flow. So - but I think that - at this point, given what we are seeing in terms of the overall flow here, I think Financial will get as much as a handle. I don’t know, Mark, if you want to add anything to that.

Mark Tecotzky

I guess the one thing - just the one thing I would add is that what we have liked on the multis, it is not sort of new construction aiming for higher rent. It is sort of Class B, Class C properties that were built a while ago, properties where the acquisition cost of the real estate is well, well below what new construction costs would be.

So it is been in sectors where we don’t see any new competition coming online and a lot of demand for it. And it is been something we have been doing for a long time that is sort of thematic to a lot of our view on housing that in the shortage, there is going to be a strong demand for it.

And so I mean, Sheridan, we have partnered with them for a long time. We have done a lot of multi with them, but we have also done a little bit of office, a little bit of retail, a little industrial - they just have a lot of relationships. They are extremely thoughtful in how they analyze potential loans and how they think about credit risk. And I sort of were like-minded with them in how we think about credit.

And it is sort of similar to the way we are sort of like-minded with the management team at LendSure. It is just been a good fit, and we have been with those guys for ups and downs in all different market cycles and COVID. And so we are extremely financial with that team, what they are capable of doing. And I think it is fantastic for us to have this equity stake where it just deepens and strengthens the relationship between the firms.

Trevor Cranston

Got you. That is helpful. And last thing for me, the increase in value of the equity investments in originators this quarter. It looks like a fairly large chunk of that came from LendSure in particular. I was just curious if that was primarily driven by LendSure’s strong results in the quarter or if there was anything else going on there like a change in valuation multiple?

Laurence Penn

Well, there was a change in valuation multiple, but it was driven by kind of a continued - now if it was just one quarter of improved results, right, then you wouldn’t see that, but sort of a strong, so many together now and the growth - I mean by every metric has been better and better throughout 2021, you are succeeding quarter. So putting all those things together, the - there was absolutely multiple expansion there, yes.

Trevor Cranston

Makes sense, thank you.

Operator

We will take our next question from Crispin Love with Piper Sandler. Your line is now open.

Crispin Love

So first question, Mike, is on the growth of the Agency portfolio. The 10% growth in the quarter, is that partly placeholder assets from the recent capital raises, which you would expect to deploy some of that into some credit strategy assets over the near term? Or is that not the right way to think about it?

Mark Tecotzky

Crispin, it is Mark. So I would say if you look at how our capital base increased from the common deal as well as the preferred deal the credit portfolio went up sort of roughly proportionately the same as the increase in the capital base. The Agency portfolio, we didn’t bring up at the same rate, right. So that didn’t grow proportional to the increase in capital and it didn’t grow as quickly as the credit-sensitive part of the portfolio.

A lot of what we did buy in Q4 were - I would characterize it more as sort of very low pay-up pools. We had not been fans of higher pay-up pools for a while. So it is liquid. All pay-ups have come down, but when your pay-up is just a couple of ticks a handful of ticks, it doesn’t have much to go for it to be TBA. So we bought things that are, by and large, extremely liquid, very low pay-ups.

When we think about what percentage of the portfolio we want to have in Agency strategies versus credit strategies, it is been sort of bouncing around that kind of at the low-end, 15%, at the high-end kind of 22%, 23% for a while. We are a little bit at the low-end now. It is something we always revisit and we sort of make those adjustments in response to market opportunities.

Laurence Penn

Let me just add that it also helps with some of our tests, REIT tests, 40 Act tests to have that Agency portfolio. So I do think you will continue to see that trend down, but it is been a while if ever that it is been below 15%. I’d probably have to go back many years before that was true. And we could get there again, but we like having that.

It really does help with the test. It really does give us a liquid portfolio that we can tap into like we did in COVID, where we reduced that portfolio with minimal friction and then we are able to not only get through but play offense on the back end of that liquidity crisis. So I think we have certainly no plans to just have that continue to shrink down to offering.

JR Herlihy

Yes. And that is an interesting observation, too, that pre-COVID, the Agency portfolio was nearly $2 billion in size, and it is now $1.2 billion. So as the credit portfolio is 40% higher, the agent percentage is actually still meaningfully smaller than, say, year-end 2019.

Crispin Love

Great. I appreciate all the color there. And then just on interest rates. Thank you, Mark, for kind of walking through all of the kind of the businesses and impact on rates on the asset side and the liability side. But if I just kind of take a holistic picture of ESC, how would you characterize the company as asset sensitive versus liability sensor, do you think should be slightly asset sensitive where you benefit a little bit more from a higher rates. I’m just trying to - just wondering how you are thinking about that on a full company basis?

Mark Tecotzky

I mean, I guess I would say that we try to run the company in a way where we are trying to insulate the book value from changes in interest rates and the REIT rules allow us anything necessary tools to do that, either interest rate swaps, short TBA, treasury futures. So whether interest rates are very low, like they were last year or still low but materially higher now?

We are not trying to be predictive about it. We are just trying to sort of neutralize our exposure to interest rates and trying to make our dividend sort of agnostic to the direction of interest rates. We have had a bias towards shorter duration floating rate assets. That is why I made those comments on that the commercial bridge portfolio, right? Because that is a floating rate portfolio.

And so what you are starting to see is all those coupons are going to go up. And we don’t have a crystal ball to tell you whether the forward curve is going to materialize. But if we have a loan with the margin of LIBOR plus six and last year, LIBOR was essentially nothing or coupons six. If a year from now, LIBOR is 2%. Our coupon is 8%. And so you are going to see that. We are positioned to sort of benefit from that.

Other sectors that are sort of short duration, but not explicitly floating, and I mentioned the residential transition loans, there it is going to be a little bit of an open question whether note rates are going to be able to increase commensurate with the increase in funding costs because we don’t typically securitize those.

And on non-QM, my expectation is it is a little bit a market in transition. So we are not there yet. I think you are going to see note rates increase by at least as much as this move in interest rates because securitization spreads have wide sort of the last thing I said in my prepared comments is that you are having a Fed that is going to stop putting money into the system.

And I think what that means is that our capital and other private capital is more valuable now and it will be able to demand a higher return on capital because the world is not going to be flooded with sort of easy money the way it was from right after COVID to kind of you sort of start to feel it sort of ebbing away kind of end of the third quarter last year. So I think, look, the market has been extremely volatile this year, and it is spreads widening across the board in fixed income, big changes in interest rates, reflected delta hedging costs.

So it is not been an easy environment, but I see on - you always tend to go through this kind of a bit of tumult and then you will get some stability. But I see like where we are going to settle in, I think, is higher rates, wider spreads and with capital being a little bit more precious than the way it fell sort of last year.

And I think those are all good things for us, and it is good press on the CUSIP side, and the partnership we have with our origination partners. We are constantly in dialogue with them about where securitization markets are and where note rates should be. So I think it is going to be good for them as well.

Laurence Penn

Yes. If you wouldn’t mind, you could turn to Page 13 in the deck, which is our interest rate sensitivity analysis. So there, you can see that looking at the bottom line here in terms of what we think a 50 basis point decline or increase in interest rates will mean to our common equity per share. You can see that we have basically - the way we look at it is, we have managed this portfolio down to close to 0 duration.

Now we are a little bit negatively convex, but that is basically the case. So you can almost think of it as we have this portfolio, a lot of its floating rate loans, a lot of it is fixed rate loans, but we have interest rate swaps on that where we are paying fixed and receiving floating, so kind of - and we have stuff leveraged and financed.

But when all is said and done, one way you can kind of think of the company is that we have got a whole bunch of assets that are - we have basically converted through our hedging to a floater, a floating rate asset at LIBOR plus 15%, let’s just say, right? So we have got a bunch of assets that through leverage and hedging and other - we have converted to LIBOR plus 15%. I mean these are just illustrated these numbers.

And then we have got - by the way, we have some assets that aren’t really yield-bearing assets, like our investments in loan originators that are going to contribute to book value, but not necessarily core. But so you take that LIBOR plus 15% and then what are you going to subtract them that you are going to subtract your G&A, you are going to have some slippage through hedging costs and things like that. So you are going to get back to the dividend, right, which for us has been around 10%.

And LIBOR has been very low, so close to zero, right. So that is close to LIBOR plus 10% on that. And that is where we have been, and LIBOR has been very low. But as Mark just implied, when short interest rates, whether it is SOFR, LIBOR or have you want to measure it, as those start to rise, now all of a sudden, that is going to provide support for our overall core earnings, right. Because we have effectively converted so many of our assets to a LIBOR floater.

So if you do the math, right. I mean, if short rates go up 2%, right, on a book value of roughly 18, we will just do some monster math here, that is $0.36 a year - is that a second. Yes. I mean those are some big numbers. So yes, so that can be really very supportive of our core earnings. So I think just it illustrates, we obviously were not benefiting having a LIBOR floater, if you will, by having rates so low for so long, but now we will actually benefit from that, and that should provide even more support for the dividend.

Operator

We will take our next question from Doug Harter with Credit Suisse. Your line is now open.

Douglas Harter

First, just on the Longbridge acquisition, is that more of an opportunistic acquisition because you had the other partner looking to sell or does this reflect kind of a change in your approach to some of your equity investments?

Laurence Penn

Look, we had a willing buyer and a willing seller. That is - I think that is maybe the best way to put it. There was no gun to anyone’s head. But I think they - JR, correct if wrong, but I think even on their earnings call, they talked about it being a non-strategic asset. Is that right.

JR Herlihy

Yes, more or less.

Laurence Penn

Yes. So I think it was a good fit for both of us. And we can - and the fact that now we can consolidate the MSR and other things. And it is just - look, they were a great partner. I don’t get me wrong, and really helped Longbridge evolve into a terrific operating company. And I thank Home Point for that. But now having come there, there are going to be some great synergies and flexibility now in having control.

Douglas Harter

And then I know you have talked a little bit about spreads widening on securitizations. Can you just talk about what you might have had in the pipeline to be securitized and kind of the earnings risk from that pipeline? And just I guess, around expectations as to when note rates on new loans or loans that you are buying might reflect the new securitization economics?

Mark Tecotzky

Doug, it is Mark. So I can give you some general things. One Larry mentioned, we are sort of at a pace now to do one securitization a quarter. We did one in January, which was relatively good timing. It was before you saw a lot of the spread widening occur. But we have a pipeline that we are always buying.

So we kind of cleared the decks of some of the holdings in January, but they are still holding. So I think it kind of - you can kind of based on sort of that average deal size of 300 to 400 and we just got one done in the quarter, you can kind of get a sense of what might have been on the balance sheet.

And I mentioned that we have for years had interest rate hedges on non-term loans, and it certainly - it costs a lot of money in 2020 when short rates plummeted. This year, it sort of has helped save us money, but we generally take that sort of spread widening or spread tightening risk. I think that is hard to hedge. So that is been a component this year. So that is obviously a negative.

I did allude to one thing that is a positive. A lot of what we retain when we do the securitization is sort of a credit as people call it, it is excess spread off the deal, but it is subject to credit losses. And so, JR mentioned in his prepared remarks, just how we did have a little yield compression in Q4.

And one of the things you pointed to was fast speeds on retained non-QM pieces necessitating a value adjustment. So that is going the other way. So we are going to have some retained pieces that are now going to look to us as having greater value than how they looked at year-end just because you are already seeing slower speeds on non-QM. So lot of moving parts.

And there is, in addition to the loans that EFC has in our balance sheet, LendSure our origination partner like every originator has loans that they are financing on warehouse lines that they haven’t sold - so there is - there is pros and cons. It is been a big repricing. I think we have tried to be disciplined about it, but it is hard for me to really quantify it.

Laurence Penn

You can see in our Slide 4 that non-QM was $735 million at year-end. I think our deal in January was $417. But that $735 million also includes our retained tranches. So we cleared the decks of I guess, most of the loans that we came into the year with. And we obviously continue to accumulate and look to securitize again. But that is - yes, that gives you an idea of the deal in January relative to where we started the year.

Mark Tecotzky

Yes. And of course, from an interest rate perspective, we have hedges on against those, but the spread widening, that is a little different. But like a lot of things, we think we have got time until our next securitization, and we will see what happens.

Operator

And we will take our next question from Eric Hagen with BTIG. Your line is now open.

Eric Hagen

I will try my hand at a long bridge question too. When you guys bring the portfolio on the company will go from being able to retain and build capital, which appears to have, I think, clearly supported its growth up to this point to presumably having most of its earnings distributed as being fully part of EFC.

Do you guys think that sort of changes the way you think about the capital structure of either Longbridge by itself or Ellington more generally? And would you say that the growth opportunity looks any different if it kept on a trajectory of being able to retain capital?

Laurence Penn

Right. Well, actually, it can retain capital even as part of Ellington Financial because even though it is consolidated for GAAP for tax, it is inside of TRS and this is really necessary. I mean if you look at other mortgages as well that have origination subsidiaries, you are going to find them in a blocked TRS.

So there is no specific requirement or time frame to distribute earnings out of that TRS. Obviously, as the TRS grows, there are - is a so-called TRS test for REITs in terms of limiting their size. But we have a lot of runway there.

So we can actually continue to retain Longbridge’s earnings in Longbridge. We can also dividend those up, in which case, they will - those dividends will represent taxable REIT income and presumably, therefore, be distributed, of course. But until they are actually distributed up from the subsidiary, from the taxable subsidiary.

we actually can continue to retain the earnings there. And this is - we haven’t completely mapped out in terms of the future in terms of when we want to distribute those earnings. It will depend on a lot of factors. But that is - it is an option, but it is not a requirement.

Operator

And we will take our next question from Brock Vandervliet with UBS. Your line is now open.

Brocker Vandervliet

Just going back to LendSure. I’m not sure I heard this correctly, but there was a step-up in that valuation. How material was that to the book value calc?

Laurence Penn

Yes, it was material. You can see it on the fair value of LendSure at 12/31, it is on Slide 4, $45 million, which was an increase of about $18 million from September 30.

Brocker Vandervliet

Up $18 million. I will go back and calc that. Separately, just in terms of the non-QM market, not the residential transition space, but just non-QM, we are seeing a number of existing players plus some new ones to look at the space, probably consistent with the uptick in rates. How large would you size this market to be? Or what could it be at this point?

Mark Tecotzky

Yes. It is Mark. So I think a little bit depends on what you see out of FHFA. It is like part of the reason non-QM growth. So we started LendSure back in 2014. We have been at it a while, right. And the investment hypothesis back then was post financial crisis, both Fannie and Freddie were very focused on essentially full documentation and the way their automated underwriting engines work, desktop underwriter and loan prospector.

The way they were set up and the technology they were using really served borrowers that were had a salary. That was sort of the kind of borrower that would sell through their underwriting and could avail themselves of the relatively low rates in the Agency mortgage space.

And so we saw at the time then, there were a lot of self-employed borrowers that didn’t fit for a number of reasons into the automated underwriting engines, and they were really good borrowers, and they were low LTV and they had high credit scores and a lot of demonstrable income that you could see on bank statements. And so we started originating those loans with LendSure before the first non-care deal got done.

And then there were other sort of addressable parts of the mortgage market that weren’t well served by Fannie and Freddie. One is that investor properties where the borrower is an LLC as opposed to an individual. Fannie don’t serve that part of the market.

And so they sort of a few different sectors of the market that we thought maybe were 15% of the housing market that could be better served and better addressed with non-QM mortgage framework with has a little bit more flexibility.

It is a little bit more complicated to underwrite than just an automated process, right. And we never tried to go after borrowers that we thought fit well into the Fannie-Freddie underwriting technology because you can get a Fannie, Freddie loan, that is the best rate and that makes sense.

And then what you have seen now from FHFA since you have had the transition from Trump to Biden is they have sort of had - they pulled back from the investor space a little bit with the PSPA caps, then they remove them, but they have increased costs on second homes. They have increased costs on jumbo.

So they are sort of pulling back a little bit. So I do think that opens up non-QM market. The market has certainly grown, but I think you could certainly see it double from what it was last year. But part of that growth is going to be a function of FHFA policy. And I think the trend is that they are being a little bit less expensive than what they have been in the past, which I think that is sort of good news for non-QM volumes.

Operator

That was our final question for today. We thank you for participating in the Ellington Financial fourth quarter 2021 earnings conference call. You may now disconnect your lines at this time, and have a wonderful day.