Good morning ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial second quarter 2022 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 open for your questions following the presentation. If you would like to ask a question during that time, simply press star, then the number one on your telephone keypad. If at any time your question has been answered, you may remove yourself from the queue by pressing star two. Lastly, if you should require operator assistance, please press star zero. It is now my pleasure to turn the call over to Jason Frank, Deputy General Counsel and Secretary. Sir, you may begin.
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, 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 am joined on the call today by Laurence Penn, Chief Executive Officer of Ellington Financial, Mark Tecotzky, Co-Chief Investment Officer of EFC, and JR Herlihy, Chief Financial Officer of EFC. As described in our earnings press release, our second quarter earnings conference call presentation is available on our website, ellingtonfinancial.com. Management's prepared remarks will track the presentation. Please note that any references to figures in this presentation are qualified in their entirety by the endnotes at the back of the presentation. With that, I will now turn the call over to Laurence.
Thanks Jay and good morning, everyone. As always thank you for your time and interest in Ellington Financial. The challenges of the previous quarter intensified during the second quarter of 2022. The Federal Reserve sought to slow inflation by accelerating its interest rate hiking cycle and initiating the runoff of its balance sheet, while recessionary and geopolitical concerns also weighed heavily on markets. Interest rates continued to surge, and interest rate volatility spiked to levels not seen since the COVID liquidity crisis in early 2020, and before that, not seen since the global financial crisis in 2009. Prices fell and liquidity dried up in most markets, including the securitization markets. Volatility really was the great equalizer across asset classes this past quarter, as most everything sold off in concert, even agency MBS and U.S. Treasuries.
Ellington Financial had an economic loss of 6% for the quarter. This was mainly the result of losses on our unsecuritized non-QM loans and agency RMBS, where we were hurt by rapidly rising interest rates and widening yield spreads. We also sustained significant mark-to-market losses on our investments in loan originators, where unrealized losses totaled $26.5 million or $0.44 per share during the quarter. LendSure was again profitable in the second quarter, but it further revised downward its earnings projections for 2022, which led to a mark-to-market drop in the value of our equity stake in the company. However, we believe that LendSure is well-positioned to emerge from the current market volatility with increased market share and stronger earnings prospects. The partnership between Ellington Financial and LendSure continues to be highly synergistic.
We believe that LendSure's underwriting standards are absolutely top-notch, as demonstrated by the stellar credit performance of the $3+ billion of loans we've bought over the years from them. Meanwhile, EFC provides a reliable takeout for the non-QM loans that LendSure originates. That's no small benefit for LendSure in rocky markets. In return, EFC can buy at wholesale prices from LendSure, not retail, and have confidence in the underwriting. In the second quarter, during our typical commitment and warehousing period while we were accumulating non-QM loans from LendSure and others, the non-QM securitization market widened substantially. In other words, our securitization takeout economics deteriorated between the time that EFC committed to buy loans from LendSure and the time that we actually completed the securitization of those loans.
Our timing was perhaps a bit unfortunate, but the good news is that the origination market has now fully repriced to the wider securitization markets and then some. As a result, we now find ourselves in a market where we're again seeing very healthy net interest margins on the non-QM loans we're currently buying, both during the warehouse period and projected post-securitization. In the reverse mortgage market, we have seen HECM yield spreads grind wider throughout the year, and that has weighed heavily on profitability at Longbridge. Longbridge had a significant net loss for the second quarter, driven by a further reduction in the value of its MSR portfolio and losses on its pipeline of committed loans. However, on the bright side, securitization spreads are showing signs of stabilizing, and Longbridge continues to add market share.
As we saw during the economic turmoil of 2020, demand for reverse mortgages can surge in a challenging economic environment because reverse mortgages provide liquidity to borrowers without the requirement to make monthly principal and interest payments. The challenging market conditions also adversely affected performance of some of our other loan originator affiliates, most notably an agency mortgage originator. The Freddie Mac 30-year mortgage survey rate increased by more than 2.5 percentage points over the first half of the year, skyrocketing to its highest level since 2008. As a result, most of the existing mortgage universe now has no refinancing incentive, and so we've seen prepayment rates plummet. Furthermore, supply shortages have kept housing prices strong. With mortgage rates much higher, housing affordability has been absolutely pummeled.
Home sale volumes have been dropping fast to levels not seen since the depths of the COVID crisis. Putting it all together, given the extreme weakness in both refinancing volume and home purchase volume, this environment is about as challenging as possible for conventional mortgage originators. For Ellington Financial, however, only a tiny fraction of our originator investments relate to conventional mortgage originators. The vast majority of our originator stakes are in more specialized sectors, reverse mortgages, non-QM mortgages, specialty consumer finance, residential transition loans, and commercial mortgage bridge loans. In these particular markets, we project stronger growth and more durable profit margins over the long term. Meanwhile, we continue to see strong performance in the second quarter from our short duration loan portfolios and our retained non-QM interest-only securities. We also benefited from significant net gains on our interest rate hedges and credit hedges.
While our overall decline for the quarter was certainly significant, our diversified portfolio and disciplined hedging helped prevent further losses. The silver lining of the market sell-off is payoffs, particularly on our short duration loan portfolios. Between our residential transition loan, commercial mortgage loan, and consumer loan portfolios, we received principal pay downs of $177 million during the second quarter, which represented nearly 15% of the combined fair value of those portfolios coming into the quarter. During the second quarter, we deployed some of this dry powder. Our loan origination businesses provided much of our asset acquisition volume during the quarter, but we also took advantage of the market sell-off through secondary market purchases of discounted non-QM loans and credit securities, most notably credit risk transfer bonds, or CRTs.
To illustrate just how much spreads have widened in CRTs since earlier this year, Ellington Financial itself bought a piece of STACR 2021-HQA1 B2, a CRT bond, at under $0.78 in May. This bond had traded above $1.02 in January. That was a 350 basis points widening since January. While our net interest margin has recently compressed, our NIM should continue to recharge as we continue to deploy our dry powder and our recyclable capital into the much higher yields that are available today. At June 30, our credit portfolio stood at $2.66 billion, which was an increase of 29% from year-end 2021. We still had significant available capital and borrowing capacity to expand our credit portfolio further.
As I mentioned earlier, the non-QM securitization market has not been immune from all of the credit spread widening we've seen. On the non-QM securitization that we completed last week, our execution on the AAA tranche was about 150 basis points wider as compared to our first deal of the year back in January. Nevertheless, I was still pleased to get last week's securitization priced and closed as it moved those non-QM loans off repo, it turned out their liabilities, and it freed up incremental capital to invest in a market environment that's presenting great opportunities. Not every securitization will be a home run, but they represent a stable source of financing that enhances our balance sheet, cushions us against the potential impact of market shocks, and puts us in a position to react quickly to market opportunities.
As such, securitizations continue to be an important component of our risk and liquidity management. I'll move next to adjusted distributable earnings, or ADE for short. We previously referred to this non-GAAP metric as core earnings. We're reporting $0.41 per share of ADE for the quarter, which is up $0.01 from the previous quarter. While there are a few reasons why it's not yet covering our dividend, which JR will get into, we do project that ADE will cover the dividend as we get fully invested and turn over the portfolio at today's higher reinvestment yields. There will be a lag.
In any event, ADE, which is a backward-looking measure, has its limitations as a measure of the full earnings power of our portfolio, especially in a market with large swings in interest rates and spreads like we're seeing today, and where liabilities are repricing faster than assets like they did this past quarter. This is where the relatively short duration of so much of our credit portfolio comes into play in a big way. Also, keep in mind that there's a portion of our portfolio that by design doesn't generate much ADE. This includes our short-term trading portfolio, including TBAs, and our equity stakes in loan originators. ADE is an important metric for us, but over the long term, our GAAP earnings per share and total economic return per share are probably the best measures of our success.
One final note: The market volatility has also enabled us to be opportunistic with our capital management strategy so far this year. Earlier this year, we issued shares out of our ATM, mostly in March, at an average price of $17.66 per share, which was right around book value at the time. In late March, we took advantage of a narrow window that had opened in the credit markets by launching a $210 million 5 7/8 coupon five-year unsecured debt deal. Finally, during all the second quarter turmoil, we took advantage of the market sell-off by repurchasing shares at an average price of $13.20 per share, which was about 78% of the prior month's book value per share. I'll now pass it over to JR to discuss our second quarter financial results in more detail.
Thanks Larry and good morning everyone. I'll start on slide 3 of the presentation. For the quarter ended June 30th, Ellington Financial reported a net loss of $1.08 per share on a fully mark-to-market basis and adjusted distributable earnings of $0.41 per share. These results compared to a net loss of $0.17 per share and ADE of $0.40 per share for the prior quarter. Beginning this quarter, you'll notice that we renamed core earnings as adjusted distributable earnings, consistent with evolving industry practice. Please note that it's a name change only, and the calculation itself has not changed, so it's valid to compare a current period ADE to prior periods core earnings. There are a few reasons why adjusted distributable earnings did not increase proportionately with the growth of the portfolio in the second quarter and did not cover our dividends.
First undeployed capital. We now have interest expense on the new $210 million of senior notes, which amounts to $0.05 per share per quarter. With the ATM issuance in March and early April, our share count increased by 2.6 million shares. Until all of that capital is deployed, it will be a drag on ADE per share. Second, our cost of funds increased sharply this quarter, primarily due to higher rates. Even though we have a lot of floating rate loans and other short duration assets in the credit portfolio, the asset yields on our invested assets lagged the increase in financing costs this past quarter, especially for fixed rate RTL and non-QM loans, and thus our NIM compressed.
Moving forward, however, I expect that asset yields will catch up with the higher financing costs as we continue to turn over the portfolio, and that should expand our NIM again and be a tailwind for ADE. Moving back to the deck, on slide four, you can see that we further increased our capital allocation to credit investments during the quarter with 87% of our capital allocated to credit as of June 30, which is up from 82% at year-end. It's about the highest split it's been for EFC historically. I expect credit to continue growing relative to agency based on the continued growth of our loan origination businesses. Average market yields are up on both our credit and agency portfolio sequentially by about 60 basis points for both categories.
As I mentioned, we expect our own portfolio to reflect these higher reinvestment yields as we continue to turn over the portfolio. Moving to slide 5, you can see the attribution of earnings between our credit and agency strategies. During the second quarter, the credit strategy generated a gross loss of $0.80 per share, while the agency strategy generated a gross loss of $0.20 per share. These results compare to gross income of $0.28 per share in the credit strategy and a gross loss of $0.34 per share in the agency strategy in the prior quarter. As Larry summarized, the main drivers of these losses were unsecuritized non-QM loans, agency RMBS, and originator stakes.
A portion of these losses were offset by strong performance on our short duration loan portfolios, specifically residential transition loans and small balance commercial mortgage loans driven by net interest income, as well as by net gains on our non-performing loan portfolios. In addition, our portfolio of retained non-QM tranches appreciated during the quarter, driven by appreciation of our non-QM interest-only securities as rising mortgage rates again led to lower actual and projected prepayment speeds. We also had significant net gains on our interest rate hedges and credit hedges during the quarter. Agency RMBS continued to face headwinds in the second quarter as durations extended in response to the higher interest rates and elevated volatility contributed to yield spread widening.
Net losses on our agency RMBS concentrated in lower coupons exceeded net interest income and net gains on our interest rate hedges, while we also incurred delta hedging costs stemming from the volatility. As a result, we had a significant net loss for the quarter in our agency strategy. Turning to slide 6. During the second quarter, our total long credit portfolio grew by 16% sequentially to $2.66 billion at June 30th. The majority of the growth occurred in our non-QM residential transition and small balance commercial mortgage loan strategies, where we continue to focus on multifamily. On slide 7, you can see that our long agency RMBS portfolio decreased by 11% to $1.3 billion due to net sales, pay downs, and net losses. Please turn next to slide 8 for a summary of our borrowings.
Our weighted average borrowing rate increased by 83 basis points sequentially to 2.61% at quarter end, driven by higher short-term rates and a full quarter of interest expense on the 5 7/8 senior notes issued on the final day of the previous quarter. In addition, we had disproportionately more borrowing secured by our loan portfolios, which carry higher borrowing rates than agency assets. Financing has held up relatively well amid the market volatility, though recently we have seen haircuts increase or financing spreads widen on some of our loan facilities. In conjunction with the larger portfolio, our recourse debt to equity ratio increased to 2.6 to 1 from 2.3 to 1 in the prior quarter. During the second quarter, we marked down our 5 7/8 senior notes by 2 points to $96.50.
As a liability, this markdown generated positive income. However, we had a corresponding loss on the SOFR swaps that we used to hedge that liability, which offset most of this income. At June 30th, our combined cash and unencumbered assets totaled approximately $816 million, which was down from last quarter, but was still well above pre-COVID averages. Slide 10 details our proprietary stakes in loan origination businesses. At June 30th, the combined value of our originator stakes was $112 million, or about 9% of our total equity. By sector, that $112 million was distributed as follows: 53% in reverse mortgage loan origination, 30% in non-QM loan origination, 10% in consumer loan origination, 3% in residential transition loan origination, and 2% each in small balance commercial and conventional mortgage loan origination.
For the second quarter, total G&A expenses decreased sequentially by $0.03 per share to $0.14, while other investment related expenses decreased by $0.07 per share to $0.09, driven primarily by the costs associated with the senior note offering that we fully expensed in the previous quarter. During the second quarter, we recorded an income tax benefit of $7.8 million due to a decrease in current and deferred tax liabilities related to quarterly losses at our domestic TRS, which related to our non-QM securitization activity, as well as our investment in Longbridge. As of June 30th, we had a net deferred tax asset of approximately $9.6 million against which we took a full allowance.
Our book value per common share was $16.22 at June 30th, down 8.6% from $17.74 per share at March 31st. Including the $0.45 per share of common dividends that we declared during the quarter, our economic return for the second quarter was -6%. Now, over to Mark.
Thanks JR. The second quarter had incredible volatility in every dimension, in interest rates, in credit and agency spreads, and the expectations of Fed policy. There was substantial widening in most sectors across fixed income, and it was a very challenging environment. Our economic return was - 6%. Not a result you're used to seeing from us, not a result we want, but not a disaster either. A lot of it, I think we can earn back because much of the loss was due to spread widening on non-QM loans and agency MBS. As is often the case after a quarter like that, the going forward opportunity set looks really good. Today, we see very wide spreads, very high yields, and stable financing, all with less competition for assets. Credit performance as measured by delinquencies, defaults, and credit losses continues to be very strong across our diversified portfolio.
with the sharply increased risk of an economic slowdown, we have been very focused on tightening our underwriting guidelines with a particular focus on keeping LTVs low. HPA has been strong, but there are clear signs of housing weakness, and we have to be prepared for price declines in some regions of the country, given poor housing affordability. During the second quarter, any sector with a lot of interest rate risk, a lot of volatility exposure or where pricing is dependent on the securitization execution got hurt. Not surprisingly then, our non-QM strategy was our biggest drag this past quarter. To put the spread widening on non-QM this year in perspective, consider these two data points. On January 14th, we priced the first non-QM deal of the year. The AAAs priced at a spread of 97 to swaps.
They had a 2.2% fixed rate coupon and were priced at par. On July 22nd, we priced our most recent securitization. In that deal, the AAAs had a fixed coupon of 5%, and they were priced below 99. That's a spread of 250 to Treasuries or more than 150 basis points wider in spread than the AAAs compared to the January execution. Lower rated non-QM bonds have widened even more. When you consider that investment-grade corporate bonds widened only about 35 basis points over the same period, you can appreciate how significant the widening has been in non-QM. We've always been big believers in the benefits of securitization, but given how stable the repo financing market has become, repo is a viable alternative with non-QM securitization spreads currently so wide.
One of the most surprising things about this year has been the relative stability of repo spreads and repo availability in a market where everything else has been so unstable. For that reason, we have continued to expand and deepen our repo lines. I'm glad to report that we are currently close to adding yet another valuable loan financing facilities. Meanwhile, non-QM spreads have started to recover. Another drag on Ellington Financial's performance in the second quarter was our investments in mortgage originators. Everybody knows that mortgage origination businesses are cyclical. We know it. We've been through many of these cycles. Comparing the second half of last year to the first half of this year shows just how cyclical it can be.
In the second half of 2021, you had record high loan prices, so big gain on sale margins and record high volumes for mortgage originators. The product of those two things essentially tracks originator profits. This year is the exact opposite. Distressed loan prices and lower volumes have squeezed profitability, and as a result, we have marked down our originator investments. All that said, I think it's noteworthy that LendSure was profitable this quarter. A few things to consider on these investments for EFC. Our originator stakes are only a small part of our capital base, in large part because we know how cyclical those businesses are. We only want these stakes to be a complement to the rest of the portfolio as opposed to a disproportionate user of capital. If you consider our cost basis in these investments, they're an even smaller part of our portfolio.
We believe that LendSure is growing market share, and we think it's likely that loan prices will drift up as coupons have now been reset to reflect higher interest rates and wider spreads. Also, our stakes in both residential and commercial originators are critical because they enable us to control underwriting quality. That's becoming more important given the recent economic slowdown. The non-QM market is not going away because it's an important segment of today's overall mortgage market. Of course, Fannie and Freddie are the lowest rate option for most borrowers whose W-2 gives a fairly complete picture of their income and whose loan size fits within GSE limits. But not everybody fits in that box. Post-financial crisis, beyond originating agency mortgages, banks are primarily focused on full doc jumbo mortgages. It's the non-QM originators who primarily serve self-employed borrowers and borrowers with substantial income in addition to their W-2.
We don't see this changing. We don't see Fannie Mae go into bank statement loans. Apart from non-QM and originator stakes, many of our other credit strategies performed really well in this past quarter. RTL continued with excellent performance. Those loans are not dependent on the securitization takeout. They just pay off. They are so short, they don't have a lot of interest rate sensitivity. We have also been able to push up note rates on our recent originations, and it feels as though we have a lot of pricing power. Credit performance remains excellent. Commercial bridge loans also continued with excellent performance. Our commercial bridge loans are all floaters, so interest rate movements and interest rate volatility doesn't affect them much. Despite the excellent performance, we are certainly becoming more conservative on LTVs at current property valuations.
So far in the third quarter, the market environment has been much more favorable relative to the second quarter. Interest rates have come well off their highs. Stocks are off their lows, and credit spreads are off their wides. Liquidity was poor in June and early July but is substantially better now. New issue securitizations are priced quickly, with many tranches multiple times oversubscribed. This is all a huge turnaround from the second quarter. Our agency MBS portfolio was also a drag on EFC performance in the second quarter with a loss of about $0.20 per share, but that too performed very well in July. In the agency MBS market today, prepayments are manageable, yield spreads are wide, and rolls are attractive in higher coupons.
Recession fears tend to help that sector because the sector has no credit risk, and in a recession, the Fed may stop or slow down balance sheet reduction. The market feels like it's in a much better place today as compared to the second quarter. Interest rates have retraced a lot of the second quarter sell-off. 5-year Treasury yields are now over 60 basis points below their mid-June highs, for example. While still elevated, implied volatility has also come down. In addition, spreads have tightened, and the market tone is much better. We're seeing this pretty much across the board in fixed income, not just in structured products. IG spreads are in 20 basis points from their wides, and high yield spreads are over 100 basis points tighter.
CRT is much tighter, and there was a deal last week with tranches 15 x oversubscribed that tightened 60 basis points from the initial talk. Non-QM has tightened as well, and some current deals have been over 5 x oversubscribed. Ever since the July Fed meeting, the market has had a different tone and has attracted a lot more capital from money managers and insurance companies. EFC is in a strong position. At quarter end, we had ample borrowing capacity and excess capital to invest. We have an array of proprietary flow arrangements. That gives us a big say in loan underwriting, which has been critical to our success in the past and which will take an increased importance should the economy enter a deeper recession. We are currently buying a lot of high-yielding loans in many sectors where note rates are 7% or higher.
We estimate that July was a positive month for EFC, and the opportunity set is great. We benefit from diversified and deep financing and sourcing relationships. This year and every year, we have maintained our focus on protecting book value, maintaining strong liquidity, and managing our credit risk. That has allowed us to get by with only moderate drawdowns so far this year, down 7% for the year through June, which is not the result we want, but not a disaster either. Now we plan to take advantage of historically wide spreads and high asset yields to drive returns going forward. We have grown the credit portfolio to $2.66 billion, which I believe is the right thing to do when spreads are so wide. EFC also has experienced management and portfolio managers, which are invaluable in volatile markets.
We have to maintain our focus on credit quality. We have to be prepared for the possibility of an economic contraction and with that, higher default rates. How do we do that? Spreads are so wide right now that there is no reason to stretch into higher LTVs or lower FICOs. We believe we can meet our return targets while focusing on loans with lower LTVs and higher FICOs and on securities with more seasoning and greater credit enhancement. We're seeing some of the best opportunities and highest quality yield spreads that we've seen in the past 10 years and are focusing on capturing those opportunities to drive our dividend and grow book value. Now back to Larry.
Thanks, Mark. Hey, everyone. I hear that there have been some audio issues at the conference call hosting service. They're having some technical difficulties, so we're gonna look into whether we can, you know, post, you know, perhaps post the script somewhere or provide perhaps in the audio replay that will, you know, that'll have all the content. So we're gonna look into that. Okay. Just to conclude, though, so far in the third quarter, volatility has subsided a bit, interest rates have dropped somewhat, and yield spreads in most sectors have retraced a portion of their second quarter widening. Per our normal process, later this month, we'll be putting out a book value per share estimate for July 31st. Keep an eye out for that update.
Meanwhile, time will tell how long the contraction in the origination markets will last and how much more of a shakeout will occur. In non-QM, lower whole loan price premiums and falling volumes have taken their toll, especially on those originators who did not properly hedge their locked loan pipelines or were undercapitalized or both. We have seen several mortgage originators severely scale back operations and even a couple close shop. While market dislocations have created a drag on EFC's book value in the near term, our strong balance sheet is enabling us to lean into the wider credit spreads. Together, this presents the opportunity for us to grow market share at our origination platforms. Long term, we believe that a thinning of the herd will be a net benefit for the stronger origination platforms remaining in their respective spaces.
A final note I'll make on our originator investments is that it's important to keep the size of our originator investments in perspective relative to the rest of our investment portfolio. These originator investments, which are currently spread across nine companies, in total comprise only about 9% of EFC's overall equity, as JR mentioned. In fact, they've typically started out as small VC-type investments. These stakes often have the added benefit of locking in loan production underwritten to our credit specifications. Properly sized, these investments further diversify our earnings stream and should be a powerful differentiator for the Ellington Financial franchise. We've spoken many times before about the benefits of being both a loan buyer and a loan originator as the profit pendulum swings between the two. Non-QM is a great example.
As a result of all the market turmoil, we've been able to acquire lots of non-QM loans this year, including not only from LendSure, but also from certain originators who are burned by the big market swings and unloaded inventory at discounts. As I mentioned before, securitization spreads widened after we purchased some of these loans, and this hurt us in the second quarter. Nevertheless, we continue to lean in. We have recently been able to purchase new non-QM loans with mid- to high-7% coupons. With interest rates lower over the past few weeks, the economics on these new loans look very attractive, especially relative to the stabilization we're seeing in the non-QM securitization market. Going back to the earnings presentation for a minute, please turn to slide 12.
I pointed this out on previous calls, but in this environment of rising rates and market turbulence, it's worth highlighting again our low level of interest rate sensitivity. In the table on slide 12, the fifth line down, non-agency RMBS, CMBS, other ABS and mortgage loans, captures the vast majority of our long credit portfolio. As you can see, if rates shift up or down by 50 basis points, we estimate that the impact from the credit portfolio on overall book value would only be about ±1%. That translates to an effective interest rate duration of a little more than 2 years on this portfolio, and that's even before taking into account our interest rate hedges.
We've accomplished this by focusing a significant segment of this portfolio on products like 1-2-year commercial real estate bridge loans, sub-1-year average life residential transition loans, and short-term consumer installment loans. Particularly as market volatility spikes and spreads widen, we're very happy to see our short duration assets continue to run off naturally and quickly, enabling us to reinvest that capital at higher yields. As we move into the back half of the year, we still have dry powder to deploy. In particular, I expect our recently raised 5 7/8% senior notes to be highly accretive to earnings once we've fully invested the proceeds. We're trying to be patient and pick our spots, looking for the right levels on the security side while continuing to support our origination businesses.
Our credit performance statistics remain strong, but we're keeping vigilant on underwriting standards, especially with housing affordability down dramatically and with economic growth turning negative. Given the abundance of investment opportunities available today, we believe that our patience will ultimately be rewarded. With that, we'll now open the call up to your questions. Operator, please go ahead.
At this time, if you would like to ask a question, please press the star and one on your touchtone phone. You may remove yourself at any time by pressing star two. Once again, that is star and one if you would like to ask a question, and we will take our first question from Trevor Cranston with JMP Securities. Your line is open.
Hey thanks. A couple questions on the non-QM market. First, I guess, you know, after the substantial increase in rates on non-QM products, and the disruption to some of the originators in that space, can you talk about kinda how much origination volume you're expecting to see in that product over the second half of the year compared to the first half of the year? As a second part of the question, you know, you guys clearly kinda laid out the opportunity on the loan side there. With the spread widening, are you guys also interested in, you know, buying some of the up in the stack securities from other non-QM deals? Or are you really more focused on the loan side at this point?
Hey Trevor it's Mark. I would say that the first question about change in volume. In terms of securitized volume for the second half of the year versus the first half of the year, I think that's gonna be down a lot. Part of the reason is a lot of the securitized volume for the first half of the year were loans that were really originated back in 2021. There were a lot of platforms sitting on a lot of 4.5, 4.75 note rate loans that they didn't securitize in 2021 that they put into the market in 2022.
If you take away that, I think my projection is that just at these higher note rates and also at higher HPA, you're probably just gonna see organic non-QM volume drop by, you know, I would guess at least 30%. I just think it's fewer borrowers qualify, you know, are looking to buy homes right now given what the payments are with it, the kinda double whammy of higher HPA and higher mortgage rates. If you look at a lot of housing metrics, you know, if you look at, like, what's happening to views on Zillow, and I think you're gonna start to see it a little bit in listing times, that, you know, I just think there's sort of an overall slowdown that you're gonna see in housing.
The other thing about buying pieces of other deals. When we do securitizations, the way we think about that is so the bonds we sell are really sort of replacing repo, so we consider them sort of term financing. When we do our own deals, depending on what tranches we retain, and some of it we're retaining because there's a risk retention obligation, but sometimes we'll retain in excess of the risk retention obligation. We look at those sort of as, you know, investments that the company's making. To the extent that we can replicate those investments on other people's deals, that's something that's of interest to us. One thing I would say is that the pieces you retain on securitizations are pretty low down in the capital structure.
It's much more, you know, what's gonna drive the returns on those things is gonna really have a lot to do with loan performance as, you know, it's not like buying, you know, a more senior security where it's more like prepayments and spreads, you know, what happens to spreads. You're down in the capital structures, so you're exposed to credit risk. You know, Laurence mentioned on the call, but one of the benefits of having these originator stakes is we have an active dialogue in terms of underwriting standards and how we should be reacting to changes in the market and changes in the housing market. I think we just have a level of comfort on the retained pieces as investments for the securitizations we do.
Yeah, like I would just say like away from Ellington Financial, in other pools of capital we manage, yeah, we are finding, you know, attractive things in non-QM space, definitely.
Got it okay. That's helpful. Yeah, you know, you guys talked about the challenges that a lot of originators are facing and, you know, the impact on your investments in some of those companies. As you look at the originator landscape, are you guys looking at or pursuing any opportunities to maybe, you know, provide a capital injection to like a good quality company who's a little bit beaten up right now? Or are you guys just kinda comfortable with, you know, the investments you guys have at this point?
Yeah. We're definitely seeing opportunities like that. I think similar to what we've done in the past, I think a modest, you know, amount of capital absolutely could be a great use of capital to do that. You know, provide some sort of line of credit or capital infusion in exchange for and then getting forward flow, potentially warrants. You know, there's a lot of things that, you know, these companies that are struggling could be, you know, help them basically get through this and, you know, provide a great opportunity for us. You know, again, we're not the type that usually writes big checks, so as we've said. I think this could be a great opportunity to do that, and we are seeing a couple of opportunities presented.
Okay got it. Last question on the agency portfolio. Can you talk about how you're thinking about the overall net long exposure, kind of given where spreads are in the agency market and where volatility's at currently?
Yeah. You know we typically keep the net long in that portfolio significantly lower than what you'd see from sort of, you know, an agency REIT. Part of that is just a philosophical belief that shareholders in Ellington Financial are primarily looking to generate returns through credit investments. Historically, we haven't wanted to introduce some of the risks inherent in a levered agency portfolio, you know, about, you know, volatility and basis widening. We haven't wanted that to really dominate, you know, returns for EFC, given that it's really credit-focused. I think, and JR can correct me, I think the agency portfolio was down roughly 6% on its capital this quarter, right?
I think that's sort of like at the better end of what you're seeing from the agency peer group, in part because, you know, it's fully hedged and also doesn't have as much mortgage exposure. Yeah, mortgages are certainly wide right now, but they're wide for, you know, a reason everybody knows, right? You have the Fed stepping back their purchases. You know, it's possible, even though, you know, a lot of market participants think less likely, but it's certainly possible that they could engage in sales. Also, you know, the other thing is Fannie and Freddie greatly increased their loan limits. The new crop of agency mortgages that are originated in the higher coupons, you know, 4.5s and 5s, they're really big loan balances.
There's gonna be, you know, a lot of, sort of potentially an unfavorable prepayment curve for some of those things. All that kind of feeds into spreads. I mean, I'd say, like, right now, you know, if you look at non-QM or a lot of sectors of credit have sort of had spreads correlated with agency spreads a little bit. I feel like, you know, EFC has a lot of. It's taking advantage of wider spreads right now in some of these other sectors. I wouldn't say right now probably that's where we'd add a lot of risk. You know, agencies had a very good quarter in July, so they recouped some of that widening.
You know if we saw credit spreads tighten to the point where they weren't as attractive as they are now and agency spreads not, then I think at that point it'd be a time to really consider increasing the mortgage basis exposure in the agency portfolio in Ellington Financial. Right now, when credit spreads sit so wide, I think we're going to sort of take more of the risk in the portfolio, you know, focused on the credit side.
Mark I just you know, JR and I are looking at the numbers here. Yeah, the return on equity on the equity that was allocated to the agency strategy was, you know, in the single digits. It was obviously a lot better than you've seen from, you know, the agency REITs in terms of their, you know, return on equity. That's due to the fact that, you know, in no small part, as you mentioned, we hedge, you know, more of the basis risk via TBAs in that strategy than typical agency REIT would.
Yep okay. Thank you guys.
Thanks Trevor.
Thanks.
We'll take our next question from Doug Harter with Credit Suisse. Your line is open.
Thanks. Can you talk a little bit more about your comment to hold non-QM loans on warehouse clients longer? You know, how you kind of think about the risk of that and kind of do you plan to kind of just be more opportunistic around the securitization market? Just to kind of flesh that out a little bit. Thank you.
Yeah. You know, hey, Doug, it's Mark. You know, maybe I didn't phrase it properly, but I wouldn't say it's our intention to hold non-QM loans on repo because we see a lot of benefits of being securitizers, right? We certainly saw it when you went through COVID, how having securitized a lot of our production leaves less mark-to-market risk in the portfolio in volatile times. I also think you build a brand. Excuse me. You get, tighter spreads over time. Just sort of a virtuous cycle there.
I was just making the comment that, you know, you got near a point in July where securitization spreads had widened so much relative to repo that for the first time in years and years, we at least said, "Hmm, you know, let's look at levered returns just from keeping things on balance sheet." You know, since then, securitization spreads have come in. So I would say now, you know, our expectation is that we're gonna continue to securitize. But, you know, I would just say the stability in repo has sort of, for the first time in a long time, at least to us, and we're kind of dyed-in-the-wool securitizers, been, you know, at least, you know, an alternative to consider.
Mark, I just wanna make one other point, which is that, you know, one thing that So yeah. It's not— First of all, it's not like we have a gun to our head, right? Need to get these things off repo right away. One thing that we look at very closely is the relationship between the securitization spreads and where we can buy loans, non-QM loans, right? When we did the securitization, which we completed last week, you know, one of the things that I think contributed to our wanting to do that securitization, even though spreads are obviously a lot wider than they were early in the year, is that we can replace that risk, if you will, right? We're de-risking by doing the securitization.
we can replace that risk pretty much right away now with non-QM loans, right? That are priced very attractively relative to where securitization spreads are. That wasn't true, you know, a couple months ago. The securitization spreads widened.
Right.
It took a while before the primary market where you could buy, you know, where you could originate and purchase via forward flow agreements or whatever it is, you know, there was a lag there. Once that sort of renormalized where it should be, which is that, you know, it should be profitable to originate loans and securitize them. Once that got back, then it was like, okay, let's do the securitization because we can now replenish that risk in a profitable way in terms of the loans that we are seeing available for, you know, for purchase today.
I guess on that commentary about the ability to source loans, you know, I guess, how do you view kind of the timeline to aggregate enough size to securitize? How does that compare kind of in the back half to kind of what you experienced in the first half?
Well, it's compressed a lot for us. You know, it. Look back, we, you know, first we were a year between, then, I think, 6 months, 4 months, 3 months. Now, I think we have enough flow and inventory, frankly, that, you know, we could be doing deals, you know, much more frequently. You know, a typical size deal for us is in the $300 million-$400 million range.
Yeah. I mean, our last deal was about $350, and we acquired $550, originated $550 in the second quarter. That would imply.
Yeah. You could
You know, faster than a.
Exactly. Right. Exactly. I think you could definitely see now every two or three months as opposed to every three or four months.
Great. Thank you.
We will take our next question from Bose George with KBW. Your line is now active.
Hey, guys. This is actually Mike Smith on for Bose George. Maybe just one on leverage. If we look at total leverage currently at 3.8 x, just wondering if we get some macro clarity in the back half of the year, just wondering how high you could look to take leverage.
Sure. Thanks for the question, JR. I'll start out and then Mark and Larry obviously supplement as you see fit. The 3.8 includes all the non-QM securitizations that we consolidate for GAAP, so that's a total leverage statistic. Recourse debt to equity, which we talk about, that's the ratio we focus on because it excludes non-recourse financing, which is largely the non-QM securitizations. That measure did increase from 2.3 to 1 to 2.6 to 1, quarter-over-quarter. 2.6 is higher than it's been kind of post-COVID, but not as high as it was pre-COVID. We gave the statistic that unencumbered assets about $600 million and plus cash of another $2.25 million. We still had.
That's one of the ways that we measure, you know, dry powder. Larry mentioned that we closed on the senior notes on March 31st, so that was $210 million of those out of unencumbered, you know, of the dry powder as we think about it. The answer to this question is usually it depends on the opportunities. Having that many unencumbered assets and cash that is above the balance that we typically carry implies that we have more borrowing capacity. On the other hand, we did do a securitization that closed last week, and so that takes recourse financing off our balance sheet, but we've also, you know, continued to take advantage of investment opportunities. There are different moving pieces.
I think in short, we still have room to take leverage up further. You know, those unencumbered assets of about $600 million, if you say, let's just say $400 million is readily financeable at attractive rates, and we leverage that 1-to-1 or thereabout, that would raise another $400+ million another, say, $50 million of our cash. Cash is higher relative to NAV than it typically is. That math would get us to the high 2s, before accounting for securitization. We don't typically give leverage targets, but those numbers might give you a sense of how much borrowing capacity we have remaining if we choose to use it.
Yeah, just to re-emphasize what JR said, when you think about where our leverage could go, I wouldn't focus on that recourse number because the non-QM securitizations do blow up the balance sheet, but the amount of, you know, they don't blow up the balance sheet with incremental risk as far as that financing being pulled, right? That's locked in long-term financing. When we do a $350 million securitization, and well, in the old days, we would retain, you know, $20 million worth of assets usually, mostly IO, non-QM IO, and some subordinated tranches as well, right? That's, you know, blows up your recourse leverage by $350 million, which is not a small number given, you know, we have $1 billion of equity.
In terms of how many really sort of assets you've added to the balance sheet, that's a relatively small number. We're retaining more now, so that percentage has increased, but still relative to the size of the balance sheet, the amount of retained tranches, you know, that we add when we do a securitization, is still pretty low. Again, I think focusing on the recourse number, which is what we think of, especially in terms of our liquidity management and making sure that we can withstand market shocks and things like that, is better to focus on.
Great. That's a really detailed and helpful color. Maybe just one on strategy and, you know, the potential for M&A. I'm just wondering how strategic of an asset is EARN to Ellington, the manager. Just wondering if, you know, EFC could ever look to acquire EARN and, you know, maybe to increase scale. Could you ever look at any other strategic transactions? We saw PennyMac put themselves up for sale last night, so I'm just wondering, you know, if you could provide any color on the backdrop for M&A, that would be helpful. Thanks.
Yeah. All I can say there is nothing's changed. People have asked us that, and it's, of course, if it were right for both companies, it's something that we would absolutely have to consider, right? You know, it's not on the radar screen right now, and I wouldn't wanna comment more than that.
Great. Thanks for taking the questions.
We'll take our next question from Eric Hagen with BTIG. Your line is open.
Hey, thanks. Good morning, guys. Hope you're well. I have a few here. Did you address the unsecured debt that's rolling over in September and how you'll handle that? It sounds like you have enough capacity on the balance sheet. I just wanna hear you kinda talk about it and say it. Can you speak to some of the credit attributes, the quality of the non-QM portfolio? I think a lot of loans or some of them anyway, just for the market generally have been bank statement loans, and how you think about that, including just how you think about it relative to the value of being able to lever something like a CRT.
Yeah. JR, why don't you handle the question about the debt deal coming due, right, and then Mark will handle the-
Yeah. I think it's, you know, we see it as we've planned liquidity-wise to pay it off here in a few weeks, and there's nothing really more nuanced about that. It's gonna be, you know, ordinary course that we've planned to pay it off at maturity, and we've planned, you know, on the liquidity side to do so.
Yeah. If rates hadn't spiked and spreads gapped out right after we did that other, you know, secured note deal, we probably would've used those proceeds to, you know, pay off the 5.5 coupon even sooner. 5.5 coupon, which was looking like a expensive, you know, short-term funding in just March, was now looking pretty attractive shortly thereafter. We decided to keep it on. We could have paid it off at any time, but it certainly looks like we're just gonna pay it off at maturity with cash on hand. Mark, Eric, you wanna repeat maybe the second half of the question?
No, I think I got it.
Got it. Okay.
Yeah. With the bank statement loans, that's sort of one differentiator among different non-QM originators, is how they think about bank statement loans. I think the non-QM originator we own, LendSure, has a very good process there. It's a really deep dive into the you know, when people are self-employed, it's a really deep dive into the economics of that business. It's looking at multiple years of bank statements. The performance there has been excellent. In a lot of ways, you wind up learning more about those borrowers' financials than you do just on the regular full doc. We're totally comfortable with bank statement underwriting at LendSure.
When we start buying loans from other originators, then our team has to do a bunch of work to understand how they do the bank statement underwrite. Sometimes we can get comfortable with it, and there's times we can't. You know, when I think about sort of, the opportunity set, I think you talked about in non-QM retained pieces versus CRT. You know, CRT is like, you know, more liquid, and it's got pretty good financing terms, you know. I think they're both attractive. Like, for a long time, I'd say, you know, like last year or the year before, we didn't find CRT particularly attractive because it wasn't that wide. Things were at par.
It always sort of has a little bit of this catastrophe bond quality to it that, you know, the enhancement levels are so thin that flooding in Houston was an issue for CRT. You could see wildfires being an issue for CRT. You could see a localized economic stress in one or two big MSAs related to a specific industry being an issue for CRT. Whereas it's not when you have kind of, you know, just regularly diversified loan portfolios. What's changed for us about the CRT market now, and one we're finding more attractive investments is that it's seasoned some. A lot of these deals that were done a couple years ago have had the benefits of very high HPA and also very high fast prepayments.
You know, there are instances where all of a sudden bonds have four times the credit enhancement now that they did at issuance because the deals have delevered so much. There are times where, you know, the LTVs are now mark-to-market 20 points lower than where it was when the deal got done. There's significant enough enhancement levels in parts of the CRT market that sort of mitigates or sort of, neuters some of the, that cat bond characteristics that was always an issue for us because we knew it was kind of like a blind spot in our modeling. Like, we don't have models to predict, you know, weather and fires and floods.
When we know the models are taking into something into account, but we know what they're not taking into account can be, you know, significant for that investment, then a lot of times it's just like, okay, we don't feel like we have the analytic tools to properly understand the distribution of outcomes of this security, so it's better not to participate. Those changes though, the buildup in credit enhancement, the, you know, much lower LTV because of HPA. Now we're finding attractive opportunities there. You know, Laurence referenced one of them in his prepared remarks. I like both of them for EFC. I like EFC having loans as well as having securities. You know, loans are proprietary.
They're a little bit more work, so a lot of times sort of the pot of gold at the end of the tunnel when you do everything is a little bit higher yield. You know, a lot of times, you know, securities can overshoot. They can get cheaper than loans, just for selling or whatnot, or turbulence like you've seen this year. When those are the times where we think the securities offer is good or better relative value than loans, we'll buy a lot of securities. You know, they have liquidity to them. It's easier to monetize gains. I think there's a big role for both those things in EFC.
That was some really good stuff to think about. Thank you very much.
Sure.
We'll take our next question from Crispin Love with Piper Sandler. Your line is open.
Thanks, thank you for taking my question. One question on the NIM for the credit portfolio. I saw it was about 2.75% second quarter, down from about 3.6% in the first. I'm just curious how you'd expect that to rebound in the third quarter, and then should it kind of steadily increase off that base as investments with higher yields begin to make up a larger part of the portfolio as the portfolio turns over.
Crispin, thanks. I would say that, you know, I think we mentioned in our prepared remarks that, financing costs in our portfolio adjusted more quickly than asset yields overall, as an average of both sides of the portfolio. We expect NIM to expand, going forward as asset yields pick up. We do have a short duration portfolio, especially in loans, where some loans are floating rate, and so those are adjusting real-time. Others are technically fixed rate, but might have a six-month average life, for example, many of our RTLs. If you have a six-month loan that has a fixed rate, it's gonna take, you know, that time to turn over, whereas it's financing might be floating to SOFR or LIBOR.
Hopefully it's a short-term phenomenon and asset yields catch up. We mentioned that we've been able to, you know, kind of push spreads, and we're seeing higher yields and spreads in the market. Certainly the market yields on our portfolio were both up sequentially by 60 basis points, give or take, on the asset side. Again, we didn't see that yet on our cost yields in Q2, but we expect it to kind of catch up going forward.
Okay, great. Thanks for the color, JR. Just one last one from me. I appreciate all of your comments that you've made on the securitization markets. I just have one clarification on what you said on the non-QM deal in July versus January. Did you say 150 basis points wider?
Yes. Yes, in spread. Obviously.
Yeah.
Much, much higher. Yield much, much higher.
Exactly. Yep.
Right. On the triple A.
Okay.
On the triple A.
Right. Right.
Although everything-
All right.
Yeah.
All right.
The coupon. In the coupon, it was a 2.2 coupon in January, and it was a 5 coupon in July. The 5 coupon in July traded about a point lower than the 2.2 coupon.
Okay. Sounds good, Mark. Thanks.
That's a big move. That's like, wow.
Right. Absolutely. Thank you for the color and the clarification. That's all for me.
Crispin, just to add one more thing. You know, while we definitely look at ADE when thinking about our dividend, we're also looking forward, right? And seeing where we see these metrics going, including ADE and others and earnings and where, you know. I wouldn't necessarily focus too much on that, you know, necessarily over the near term. We're looking at market yields are very high. We're gonna turn over the portfolio. We still have an agency portfolio that from a relative value perspective we really like, but you know, a lot of that was put on at lower yields. I think you're gonna see over the next quarter or two a lot of turnover and movement.
Some of it is just the natural recycling of capital on those short duration loan portfolios we talked about. Some of it is, you know, just taking advantage of the right time to sell some of the agency pools that we have and replace them just, you know, naturally with whatever is in the market at the time. But that's gonna recharge the NIM and the ADE. The other thing I wanna mention is that it hasn't been that long where, and they're still gonna be going up, where short-term, you know, money market rates are higher.
That's also a boost because, you know, that all that cash that we have and, you know, sort of if you will, the benchmark off of which our floating rate assets are yielding us, those are all going up and going up quite a bit. You know, several hundred basis points from where they were, you know, literally last year. That's also a good tailwind for that has not, absolutely has not been fully factored in yet.
All right. Thank you for the color, Larry.
Okay.
That was our final question for the day. I would like to turn the call back over to Laurence Penn for any additional or closing remarks.
Yeah, no. Thanks, everyone. I just wanna add, we're gonna take a listen to the audio, and if there was something that we considered significant in terms of, you know, a gap, based upon this issue that the hosting company had, we will definitely look into posting the transcript, the prepared remarks on our website. For the Q&A, you know, I think it seems like the audio didn't gap there. I think we're gonna be okay in terms of just the normal services that post those transcripts. We will look at posting the prepared remarks, you know, if appropriate. Thank you.
We thank you for participating in the Ellington Financial second quarter 2022 earnings conference call. You may now disconnect your line at this time, and have a wonderful day.