Ellington Financial Inc. (NYSE:EFC) Q3 2023 Results Conference Call November 8, 2023 11:00 AM ET
Company Participants
Larry Penn – Chief Executive Officer
Mark Tecotzky – Co-Chief Investment Officer
JR Herlihy – Chief Financial Officer
Conference Call Participants
Crispin Love – Piper Sandler
Trevor Cranston – JMP Securities
Eric Hagen – BTIG
Matthew Howlett – B. Riley
Operator
Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial’sT hird Quarter 2023 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 following the presentation [Operator Instructions]. It is now my pleasure to turn the call over to [Aladdin Chile]. Please begin.
Unidentified Company Representative
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 Part 1 Item 1A of our annual report on Form 10-K and Part 2 Item 1A of our quarterly report on Form 10-Q for the quarter ended June 30, 2023, 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 obligations 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 Larry 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 third quarter earnings conference call presentation is available on our Web site, 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 backs of the presentation.
With that, I will now turn the call over to Larry.
Larry Penn
Thanks, [Aladdin], and good morning, everyone. As always, thank you for your time and interest in Ellington Financial. I’ll begin on Slide 3 of the presentation. For the third quarter, we have reported net income of $0.10 per share and adjusted distributable earnings of $0.33 per share. Steady performance from our credit portfolio, along with significant net gains on our interest rate hedges exceeded net losses in agency MBS, and we delivered a positive economic return in an extremely volatile market. On this Slide 3, you can see the strong contribution from the credit portfolio, which was led by positive performance from our residential transition, non-QM and commercial mortgage bridge loan businesses and our credit risk transfer securities. Our agency strategy, on the other hand, contributed a loss of $0.16 per share for the third quarter in what was arguably the most challenging environment for agency RMBS investors we’ve seen since March of 2020. During the quarter, long term interest rates rose sharply and volatility spiked as the market priced in a higher-for-longer interest rate environment and the uncertainty related to a possible gov shutdown. While we did have a significant loss in our agency strategy, our interest rate hedging strategy which included aggressive duration rebalancing throughout the quarter and a positive contribution from our short TBA positions helped prevent further losses. We had entered the third quarter with high levels of liquidity and additional borrowing capacity. And because of that, we were well-positioned to capitalize on the investment opportunities that the market volatility presented. With agency yield spreads near the historical wides, we took advantage by adding portfolio and we also captured attractive yield spreads by expanding our non-QM residential transition loan and reverse proprietary mortgage loan portfolios during the quarter.
Moving forward, I expect that our loan portfolios will continue to grow. But for our agency portfolio, while we grew that opportunistically this past quarter to take advantage of wider spreads, I still expect that portfolio to shrink over time as we redirect capital to credit. Also during the quarter, we continued to ratchet down our commercial mortgage bridge lending, given the ongoing headwinds in the commercial real estate sector. Loan pay downs and payoffs continued to exceed new origination volume in our bridge lending business. While the share of our portfolio represented by multi-family grew to an even larger majority of our overall commercial mortgage portfolio. At September 30th, our commercial loan portfolio was as small as it’s been in nearly two years. But considering the distressed opportunities that we are starting to see at the market now, this portfolio could expand again in future quarters. We will remain patient as the cycle progresses and we will pick our spots. Our Longbridge segment, meanwhile, generated positive results for the quarter despite the volatility. The segment had substantial interest rate hedging gains and those gains exceeded net losses and originations and on the proprietary reverse mortgage portfolio, as well as a net mark to market loss of $8.2 million on the reverse MSR portfolios.
Taking a step back for a second and actually be a little confusing, however, reverse MSRs are shown on our balance sheet, and I am going to try to clarify that. Now some of our MSRs appear on our balance sheet just as individual MSR assets, and those are straightforward enough. However, our biggest MSR comes from the billions of dollars of HMBS securitizations that Longbidge has done over the years. And since we consolidate those HMBS securitizations, those MSRs don’t actually appear on our balance sheet as MSRs per se. Instead, those MSRs are basically represented by the difference between our on balance sheet HMBS assets and our on balance sheet HMBS liabilities. That’s why in our public filings and financials, we refer to our HMBS related MSR as our HMBS MSR equivalent. From our GAAP financials, you compute the value of the MSR as the value of certain assets minus the value of certain liabilities, and that result is equivalent to the value of the HMBS related MSR. Okay. Getting back to that $8.2 million mark-to-market loss on our reverse MSR portfolios, let’s dig a little deeper. That was actually a result of offsetting factors. The loss primarily reflected the difference between, on the one hand, a large markdown on our existing MSRs, including the HMBS MSR equivalent. And on the other hand, a less large markup on the MSR portfolio that we acquired out of a bankruptcy proceeding on July 1st.
First, I will address the MSR markdown. To value our MSRs, we get input from two of the most widely respected reverse MSR valuation experts in the industry. Despite that fact, we concluded that a couple of their assumptions in their fair value assessments were too aggressive. First, we decided that it was appropriate to use a higher yield to discount the future projected MSR cash flows as compared to the yield that they used. Second, based on our observations of where HMBS tails have been trading, we decided that it was appropriate to assume lower exit prices for future tail securitizations as compared to the tail prices that they assumed. In addition, we also assumed that we would incur higher future sub-servicing expenses as compared to what we were told previously were the standard expense assumptions. In order reflect sub-servicing expenses that we think we’ll actually be able to obtain and maintain. So all these factors explain the markdowns on our existing MSRs. Second, as to the MSR market. We apply these more conservative MSR pricing assumptions to that MSR portfolio we acquired out of bankruptcy in early July. While this resulted in an evaluation that was considerably lower than our third party experts valuation, the valuation was still considerably higher than the distressed price of which we acquired that MSR portfolio went to the markup. In summary, we believe that our more conservative assumptions more accurately reflect fair value. And our belief is further validated by several offerings of reverse MSR portfolios that we have seen recently in the secondary market. With the notable exception of that distressed acquisition of ours in July, these recent MSR offerings ultimately did not trade because reserve prices were not met.
Back to Longbridge’s results for the quarter. While our Longbridge segment was profitable on a mark-to-market basis, including hedges, the segment’s contribution to our adjusted distributable earnings for the quarter turned negative. In a nutshell, challenging market conditions compressed gain-on-sale margins and loan valuations, particularly in the back half of the quarter. As a reminder, Longbridge’s origination P&L is a component of our adjusted distributor learnings, creates volatility in our ADE. This past quarter, it was the negative ADE contribution from Longbridge that caused Ellington Financial sequential decline in overall ADE. Looking ahead, with our updated MSR valuations and our growing proprietary reverse mortgage portfolio and with Longbridge’s increasing market share in the industry, I believe that Longbridge is well positioned to make meaningful positive ADE contributions respectively.
Looking to the remainder of the year, we finished the third quarter with a recourse debt to equity ratio of just 2.3:1, which is still towards the lower end of our historical levels. As you can see on Slide 3, our cash and unencumbered asset levels show that we still have substantial dry powder to invest. Meanwhile, we are full speed ahead on our merger with Arlington and expect to close next month. We have outlined several strategic benefits of the transaction and I will briefly highlight a few of those again now. First, we will be adding a sizable portfolio of low coupon agency mortgages servicing rights, which gets us into the agency MSR business already at scale. These MSRs should perform well in a high interest rate environment, and function as a natural complement to many of Ellington Financial’s existing investments. Second, we will be able to tap into significant additional dry powder to deploy in a market reach with investment opportunities, both by financing Arlington’s currently unlevered agency MSR portfolio and also by monetizing Arlington’s liquid assets and rotating that capital into higher yielding investments. We project the merger to accretive to earnings per share and ADE by the second quarter of this coming year. Third, we will significantly increase Ellington Financial’s capital base in a highly efficient manner, not only with common equity but also with low cost preferred equity and unsecured debt. And finally, by significantly increasing our scale and bringing us a new group of shareholders, this transaction should enhance the liquidity of our common stock, while lowering our operating expense ratios.
With that, I’ll turn the call over to JR to discuss our third quarter financial results in more detail.
JR Herlihy
Thanks, Larry, and good morning, everyone. For the third quarter, we reported net income of $0.10 per share on a fully mark to mark basis and adjusted distributable earnings of $0.33 per share. These results compare to net income of $0.04 per share and ADE of $0.38 per share for the prior quarter. On Slide 5, you can see the attribution of net income among credit agency in Longbridge. The credit strategy generated $0.37 per share of net income driven by an increase in net interest income sequentially and significant net gains on interest rate hedges. A portion of this income was offset by net realized — unrealized losses on consumer loans, non-QM loans, commercial mortgage bridge loans and CMBS. We also had small net losses on investments in unconsolidated entities and credit hedges and other activities. Notably, our loan originator affiliates, LendSure, American Heritage, and Sheridan, all posted strong quarterly profits. Although, the fair value marks for those investments on EFCs balance sheet, which are based on third party valuations of these operating companies, did not increase given the challenging market environment. During the quarter, delinquencies again ticked up on our residential and commercial loan portfolios, but those portfolios continue to experience low levels of realized credit losses and strong overall credit performance. In non-QM, we still realized zero cumulative losses life to date on a population that now encompasses nearly 10,000 loans and $4.4 billion of total UPB dating back to 2015. Meanwhile, for RTL and Commercial Mortgage Bridge, realized losses remain low compared to the amount of capital we’ve invested in profits we’ve generated, which is largely thanks to our focus on first lien and low LTVs with built-in equity cushions.
That said, recently, more loans have progressed to 90 plus day delinquency status and to REO and the story is still playing out on those. We remain very focused on credit performance and managing through resolutions on these sub-performers. Back to non-QM, where our delinquencies have been among the lowest in the entire sector. Recently, the third party servicer of our non- QM loans was acquired by a much larger servicer and as a result, the servicing of those loans was transferred. Unfortunately, the new servicers handling of that transfer has not been smooth. Given the situation, we do expect that delinquencies on our non-QM loans will temporarily increase in Q4, but we also expect that they will revert to more normalized levels in the coming months once all the transfer related issues have been resolved. Meanwhile, the Longbridge segment generated $0.06 per share of net income, driven primarily by gains on interest rate hedges. As Larry mentioned, we had a mark to market loss on the HECM MSR equivalent, partially offset by a mark to market gain on the bankruptcy related MSR portfolio purchase. The Longbridge segment also had mark to mark losses on proprietary loans and a net loss in origination. In origination, the combination of higher interest rates and wider yield spreads reduced gain on sale margins on both HECM and proprietary loans, which more than offset a modest uptick in overall origination volumes.
Our agency portfolio generated a net loss of $0.16 per share for the third quarter as agency RMBS faced the significant headwinds of elevated market volatility and rising long term interest rates. Yield spreads widened and agency RMBS significantly underperformed US treasury securities and interest rate swaps for the quarter with lower coupon RMBS exhibiting the most pronounced under performance. Net losses on our agency RMBS and negative net interest income exceeded net gains on our interest rate hedges, while our delta hedging costs, which are tied to interest rate volatility, remained high.
On Slide 6, you can see a breakout of adjusted distributable earnings among the investment portfolio, Longbridge and corporate overhead. Here you can see the negative ADE from Longbridge that Larry mentioned, driven by compressed margins and mark-to-market losses on prop. Apart from Longbridge, ADE from the investment portfolio segment net of corporate overhead actually increased incrementally. I’ll note here that part of the increase was related to periodic payments on the interest rate swaps associated with Great Ajax that have since been neutralized, and also to the payment of past due interest related to a commercial mortgage bridge loans that converted from a non-performer back to a re performer during the quarter. Our accounting policy is to stop accruing interest income once loans become 90 days delinquent, and only to recognize interest income again, if the loan becomes contractually current and we expect a loan to be fully repaid. In the third quarter, we saw loans move in both directions into 90-day [DEQ] status and out of it across our residential and commercial mortgage bridge loan portfolios. Of course, all P&L catches up upon ultimate resolution of the given loan. But prior to that, this dynamic can cause our interest income and thus ADE to be lumpy over time.
Next, please turn to Slide 7. In the third quarter, our total long credit portfolio increased slightly to $2.48 billion as of September 30th. Our non-QM and RTL portfolios grew sequentially as net purchases exceeded principal pay downs and we also net purchase non-agency RMBS during the quarter. Conversely, our commercial mortgage bridge loan portfolio continued to shrink as loan pay downs in that portfolio, again, significantly exceeded new originations during the quarter. For the RTL, commercial mortgage bridge and consumer loan portfolios, in total, we received principal pay downs of $393 million during the third quarter, which represented a remarkable 25% of the combined fair value of portfolios coming into the quarter. This steady stream of principal pay downs bolsters our liquidity and [Technical Difficulty] capital to redeploy where we see the best opportunities. On the next slide, Slide 8, you can see that our total long agency portfolio increased by 5% quarter-over-quarter to $964 million as opportunistic purchases exceeded sales, principal repayments and net losses. Slide nine illustrates that our Longbridge portfolio increased by 14% sequentially to $488 million as of September 30th, driven primarily by proprietary reverse mortgage originations and the acquisition of the bankruptcy related MSR portfolio. These increases were partially offset by a smaller HMBS MSR equivalent, driven primarily by the markdown that Larry mentioned. In the third quarter, Longbridge originated $307 million across [tecom and prop], which is a 3% increase from the prior quarter. The share of origination through Longbridge’s wholesale and correspondent channels increased to 82% from 79%, while retail declined to 18% from 21%.
Please turn next to Slide 10 for a summary of our borrowings. On our recourse borrowings, the weighted average borrowing rate increased by 21 basis points to 6.88% as of September 30th, driven by the increase in short term interest rates. Meanwhile, book asset yields on our credit strategy also increased over the same period and we continued to benefit from positive carry on our interest rate swap hedges where we net receive a higher floating rate and pay a lower fixed rate. As a result, the net interest margin on our credit portfolio expanded sequentially. However, an increase in the cost of funds on our agency strategy exceeded an increase in its book asset yields, which caused net interest margin on agency to decrease quarter-over-quarter. Our recourse debt-to-equity ratio adjusted for unsettled purchases and sales increased to 2.3:1 as of September 30th as compared to 2.1:1 as of June 30th. Our overall debt-to-equity ratio adjusted for unsettled purchases and sales also increased during the quarter to 9.4:1 as of September 30th as compared to 9.2:1 as of June 30th. At September 30th, our combined cash and unencumbered assets totaled approximately $569 million, roughly unchanged from the prior quarter and our book value per common share was $14.33, down from $14.70 in the prior quarter. Including the $0.45 per share of common dividend that we declared during the quarter, our total economic return was a positive 54 basis points for the third quarter.
I will shift now to our terminated transaction with Great Ajax, which we announced on October 20th. After careful consideration, both companies’ Boards approved a mutual termination of the merger. As part of that termination, we paid Great Ajax a termination fee of $5 million in cash and also invested $11 million in the company by acquiring 1.67 million newly issued common shares for $6.50 per share. As discussed on last quarter’s earnings call, we had established hedges upon signing the merger agreement with Great Ajax. With the deal terminated, we have now neutralized those hedges. But I will note that gains related to the hedges covered all of our costs associated with the transaction, including mark-to-market losses on our termination related investment and the common shares of Great Ajax. The results reported for the third quarter included the gains associated with the hedges that we had established related to the potential Great Ajax merger as well as net losses associated with the fixed receiver interest rate swaps that we used to hedge the fixed payments on our unsecured long term debt and preferred equity. The quarterly results also reflected expenses related to the Arlington and Great Ajax transactions.
Now over to Mark.
Mark Tecotzky
Thanks, JR. This was a very volatile quarter and EFC wound up with a slightly positive economic return. This was a quarter where it seemed like there were two completely disconnected fixed income markets, one for rate products and one for credit. Our credit portfolio had steady returns and maintained strong overall credit performance. Macroeconomic data released during the quarter supported the narrative of a surprisingly strong consumer and a resilient jobs market, which kept credit spreads well anchored. Ellington Financial’s short duration portfolio was a lot of floating loans loans and bonds was largely immune from the really violent price movements in the rates market. Investment grade bond indices traded in a relatively narrow spread range [additive] spreads on leverage loans. That stable backdrop for credit spreads and continued strong credit performance of our portfolios drove solid results for our short duration credit strategies, specifically RTL, commercial bridge, non-QM and credit risk transfer. One exception for us, I would say, was in unsecured consumer loans. We see potential headwinds for that sector with student loan repayments restarted, persistent inflation for necessities like food and rent and potentially slowing wage growth. Our consumer loan portfolio underperformed during the quarter, but we have been shrinking that portfolio and don’t have a lot of capital deployed in that sector. At September 30th, our consumer loan portfolio was about one-third the size it was pre-COVID.
For rate strategies, it was a different story. The 10-year treasury yield was incredibly volatile, trading in a massive 85 basis point range with lots of twists and turns along the way and it ended the quarter around its 15 year high. It was a terrible quarter for Agency MBS performance with most coupons underperforming treasury and swap hedges by well over a full point. Interest rate volatility — a high interest rate volatility, money manager redemptions and REIT deleveraging, were all on the minds of the market and pushed spreads to some of the widest levels seen in years despite the tailwind of only modest supply from new home sales and cash out refinancings. We had a loss in our agency strategy that shaved the full percentage point from EFC’s book value per share for the quarter. Following quarter end, the underperformance of Agency MBS actually accelerated in October before posting a strong recovery in the past couple of weeks. The agency portfolio only uses a small slice of EFC’s capital, about 10% at quarter end. But given the volatility we’ve seen all year, I’m happy to report that as of yesterday, our agency strategy P&L was almost flat for the year. Throughout 2023, we’ve remained disciplined in our approach to managing the agency portfolio, trying to manage negative convexity at a time of extreme rate volatility, taking advantage of relative value opportunities and keeping our net mortgage exposure roughly constant and leverage relatively low. Spreads remain extremely wide but are materially tighter than the widest spreads in October. Fundamentals look great and technicals are now starting to improve.
But a lot has changed since quarter end. In October, the rate sell off accelerated. But moving into November, rates now rallied significantly from their October highs. The Fed fund futures market now predicts that the Fed will be complacently sitting on its hands for the next few meetings and the prospect for capital to flow back into fixed income funds and ETFs feels much better with the recent decline in volatility. The Fed is trying to get inflation under control by slowing the economy and recent data suggests that that slowdown is finally upon us. After years of strong macroeconomic performance bolstered by stimulus money and low mortgage rates that fueled price appreciation in residential and multifamily real estate, a much bumpier ride lies ahead. And we actually have been preparing for that bumpier ride since the spring of 2022. We have been more conservative in our RTL underwriting guidelines. We have pulled back from certain markets where we have seen signs of actual or potential pullback in home price from some of the COVID euphoria. Our commercial mortgage bridge loan portfolio has shrunk as pay downs have greatly exceeded new originations given our more stringent underwriting guidelines. Many of the new origination opportunities we’ve seen in commercial mortgage bridge just don’t pencil out given the much higher debt cost, costly tenant improvements, higher insurance costs and slower rent growth. That said, we do think this market will ultimately come to us as cap rates slowly adjust to the new market conditions.
Looking forward, I’m confident and really excited about the potential for EFC to thrive in this weaker economic backdrop. Our current loans and securities are overwhelmingly low LTV and collateralized by real estate that has lots of built up equity. We’ve done a fantastic job avoiding the land mines in the CMBS. We have a lot of experience in using credit hedges to mitigate downside risk. Now we see the potential to play offense in the distress cycle for commercial real estate. Banks and their advisors are beginning to sell loan portfolios and we expect the day of reckoning will come from many properties, including many good properties that won’t be able to pay off their existing mortgage loans when they come due without a capital infusion or restructuring. JR and Larry spoke about the Arlington transaction. I’m looking forward to working with our PMs to integrate and manage that portfolio. And I’m very happy that EFC will now have a stake in the ground in the agency servicing business. We’ve owned non-QM and reverse mortgage servicing for years but this is a much larger stake in a much bigger market. Now, back to Larry.
Larry Penn
Thanks, Mark. I’m pleased with Ellington Financial’s positive third quarter results in a very challenging market. As usual, our interest rate hedging was key in achieving this. Going back to the launch of EFC in 2007, we’ve never tried to predict the direction of interest rates and have instead endeavored to hedge them. In this past quarter with interest rate spiking, our interest rate hedges were again very profitable and that helped offset mark to market losses on other parts of the portfolio. The extreme pace of rate hikes since last year clearly caught a lot of the market off guard, but our hedging has kept EFC relatively unscathed. Our hedging program is one of our core strengths, along with our strong track record underwriting credit risk, our expertise in modeling consumer borrower behavior and our willingness to continually improve our portfolio through active trading and portfolio rotation. Looking ahead, whether we are in a higher for longer interest rate environment or not, I believe that Ellington Financial is well positioned, thanks to our hedging expertise and liquidity management, our short duration, high yielding loan portfolios and a highly diversified array of strategies, which will soon include agency MSRs as well. Thanks to Arlington’s highly attractive MSR portfolio. Historically, we’ve concentrated our investment activities in sectors where banks are less active and where there’s less competition, and we have built up deep and experienced teams and strong track records across market cycles in these businesses, especially in the residential mortgage and commercial mortgage sectors. Add to that, EFC now has access to servicing and workout platforms across a variety of loan businesses by virtue of our strategic equity investments. You can see these business lines on Slide 12.
These platforms have significantly broadened the scope of potential investments that Ellington Financial can consider, as they allow us to deal more directly with any credit issues we encounter in our own portfolio and they provide us with the expertise to take over and stabilize distressed assets that we see in the secondary market. A recent example is the bankruptcy related MSR portfolio that we acquired through Longbridge in July, which was only possible because of Longbridge’s servicing platform and stellar reputation. That investment is already returning strong results and we think it will be accretive to EFCs earnings in the quarters ahead. The ongoing dislocation of the banking sector should continue to generate compelling opportunities for Arlington Financial, both to buy distressed assets and to add market share at our originator affiliates. Banks are under pressure from regulators and from losses on their loans and securities. And with deposits leaving for higher yielding alternatives, we see an inefficient market getting even less efficient. Bank stepping back means less capital available to make or buy loans, which should put upward pressure on the spreads we can earn. The opportunities in distress commercial mortgage loans and CMBS could be particularly compelling. Before I conclude, I’d like to reiterate that we here at Ellington Financial are all very excited to close on the Arlington merger next month. The Arlington shareholder vote is scheduled for December 12th and we would anticipate closing the transaction shortly thereafter. To Arlington shareholders, we hope you agree that this pending transaction will be highly attractive and accretive for you as well. We look forward to introducing ourselves and our company to more of you, and we sincerely hope that your ownership continues.
With that, we’ll now open the call up to questions. Operator, please go ahead.
Question-and-Answer Session
Operator
[Operator Instructions] And we have our first question from Crispin Love with Piper Sandler.
Crispin Love
First off, just with the majority of your small balance commercial portfolio and multifamily, which I believe is primarily bridge and grew meaningfully in 2020 and 2021. Would you expect a good portion of those loans to be extended given the current environment we’re in or would you expect more to roll off as you alluded to during the call?
Larry Penn
Mark, do you want to take that?
Mark Tecotzky
So with this portfolio, the borrowers have been having to pay higher borrowing costs all this past year as this Fed has been hiking. So as opposed to what you see, say in conduit, where they’re typically 10-year IO loans and then all of a sudden, they’re getting a big shock at maturity. This portfolio, these borrowers, have been having to adjust to the higher rates all along the life of the loan. So, so far, we’ve seen resolutions. These were — what we do in bridge, all the properties are almost by definition in some form of transition. So there’s some number of units that are offline that need some — maybe there was some mold in them or they need some renovation and it’s a plan where you get these things online, you get tenants in, sometimes there’s some CapEx on the property that’s going to bring rents up to fair market rents. So what we do in bridge, pretty much every loan on the multifamily, there’s a business plan and there’s an expectation that they’re going to be growing net operating income, right? So they’ve been growing net operating income and their debt costs have been increasing. So, so far, our resolutions have been fine. If you look at what happened to the portfolio, it’s been shrinking because of resolution. So I expect that to continue.
Crispin Love
And are they — yes, go ahead.
Larry Penn
Yes, I just want to add one thing, which is that I think, we’re not sort of the extend and pretend type. When we do extend a loan, we usually we’ll demand something in return, right? Like we’re very LTV focused and so, we’ll expect if the loan is in maturity, we’ll expect some additional principal pay down or something to compensate us for extending that loan. When we made these loans, we were very LTV focused and that’s something that we’re not just going to just extend for because we’re afraid to take any sort of more aggressive action, whether it’s foreclosure or anything else. Now some of these loans do have extension options built in in those on the part of the borrower and those will be extended per their — in terms of their contracts…
Crispin Love
And the ones that are…
Mark Tecotzky
I was just going to add that part of the reason why that portfolio is shrunk is when we see new origination, we are kind of shining the bright light on it of increasing insurance costs, in some cases increasing property taxes, slowing expectation of rent growth. And I mentioned that we are seeing fewer deals come across our desk that you have that pencil out that sort of work given that SOFR is 5.30% and these are SOFR plus 5.5% or 6%. So that — not skepticism, but that level of caution or that level of conservatism and the underwriting is part of the reason the portfolio has shrunk. It’s just we don’t want to get into situations where you have properties where the owner is having a challenging time covering the debt service cost.
Crispin Love
That makes sense…
Larry Penn
Remember, also — so I just want to say, we mark our portfolio to market, right? So our loans, we will mark those down and recognize a loss that will flow through our income statement and you will see it in our financials, if we think there is an issue, a significant potential issue in terms of that loan defaulting a maturity, for example. And if we think that we are ultimately going to take a loss, that will be reflected in the mark. So it’s already reflected in the mark. And for real estate, the lower cost to market.
Crispin Love
Okay, that all makes sense. But on the loans that are maturing, are they receiving permanent financing through the agencies or elsewhere?
Mark Tecotzky
Yes, some of them are through the agencies. Some of them, they will just get a longer erm loan for another credit source. There has been — there’s an opportunity coming, we believe in commercial real estate as loans come to maturity and certain types of loans we mentioned are going to have a harder time refinancing. But there has also been capital raised to take advantage of that opportunity. So you are seeing — the agencies are certainly active. But there is other pools of capital too that are out there extending credit. It’s sort of filling in the gap left by the retreat of the regional banks.
Larry Penn
And a lot of the loans that we make in multifamily, right, why did they come to us in the first place? Often because they are making improvements to units, could be some sort of renovation, some sort of transition, right? We are a transitional loan for them. So a lot of the times, even with rates higher, they have done what they need to do and so they can get more permanent financing.
Crispin Love
And then just one last question for me. The FDIC has announced that it’s selling some of the Signature Bank’s commercial real estate loans. Are these the types of assets that you would be interested in acquiring? And I guess if you can’t necessarily speak to those specifically, just more broadly, have you begun to see opportunities for blown acquisitions on both the security and loan side?
Larry Penn
Well, on FDIC, in particular, we are absolutely seeing that and we are considering putting a bid in for one or more of those portfolios. Mark, do you want to elaborate on that at all or talk about other opportunities?
Mark Tecotzky
Yes, so I think the FDIC Signature Bank portfolio sales is interesting to us and the teams here have been doing a lot of work on that. And we also think away from sort of that big public portfolio that sort of everyone knows about, you’re going to just see a steady drumbeat of properties. And I mentioned like a lot of times good properties that are coming up to their maturity date and the size of new loan that’s going to be appropriate given current income growth and current debt levels is going to be smaller than the old loan. And the limitation generally isn’t going to be loan to value but the limitation is going debt service coverage. So I think there is a big signature portfolio that’s been well publicized. But there is going to be just constant flow of properties where the debt is hitting a maturity date and they might require some sort of capital infusion or some sort of restructuring. And that’s — I think, we spoke about on the previous call, that was really the bread and butter of our commercial loan strategy for years after the financial crisis. And so that team that drove really exceptional results in that strategy, that workout strategy for us, I’d say, that’s what we were doing primarily prior to 2017. That team is still in place, they’ve pivoted to bridge and they’ve added additional resources in terms of sourcing and workout capabilities, but that team has so much experience in doing these workouts. So we are really, really well positioned and excited about that being the future driver of returns for EFC 2024 and beyond.
Operator
And we have our next question from Trevor Cranston with JMP Securities.
Trevor Cranston
A question about the agency MSR asset class, as you look beyond sort of the initial acquisition of the Arlington portfolio. Can you talk about how you sort of envision being involved there, whether it’s opportunistic bulk purchases or if you potentially look to have some sort of flow agreements on new production MSR?
Larry Penn
I think it could be both of those. So the agency servicing portfolio that we’re acquiring given where rates are we think is going to be steady high return asset for us, and it gives us the capabilities. And we’ve always had sort of the capabilities on the modeling side, because modeling prepayments is so much a part of sort of our DNA. But now we’re going to have more capabilities on all the necessary infrastructure. So it could be bulk purchases, it could be flow. If I had to guess, I’d guess in the beginning probably more of our focus would be on bulk purchases, but that can be either way, we mentioned in the prepared remarks that we’ve been buying non-QM servicing for years and it’s flowed into the portfolio and it’s been a nice offset for some of the interest rate risk on non-QM loans. And so I think this acquisition gives us a lot of flexibility and a lot of capability on the agency servicing. And with banks potentially being less interested in having significant capital outlay there, I think it’s a natural time for us to be able to acquire more portfolios.
Trevor Cranston
And then on Longbridge, the portfolio there’s been growing this year. I was curious if you could talk about specifically I guess with the proprietary loan bucket, how you think about sort of capital allocation there over time? And if the different cash flow characteristics of reverse loans sort of limit how much capital overall you’d be willing to allocate there?
Larry Penn
Sorry, what would limit — can you say that again, what would limit the amount of capital?
Trevor Cranston
Just the different cash flow characteristics of reverse loans, not getting like the regular monthly payments, like if you want a forward mortgage, if that has any…
Larry Penn
So I don’t think that’s really so much of an issue for us. Given — I mean one of the things we talked about on the call is how much principal payments we got on the rest of the portfolio. So again, it’s a good complement to have something that’s accreting but with a very high yield, right, versus something that is very short and amortizing principle all the time. So that’s actually a good combination of both are high yielding and doesn’t really create any cash flow issues for us. But it is a long term product and we’re not — if you look at the way that we’ve run other loan businesses like non-QM, for example, it’s not really our strategy to hold long term loans and finance them with short term financing sort of indefinitely. So I think that sort of looking to where that strategy is going, I think, it’s probably better to think of accumulating critical — similar to non-QM, right, because those are long term loans too. Accumulating critical mass for securitizations or — and then doing those securitizations and retaining junior pieces, or just home loan sales, right? So — and it’s different buyers potentially for non-QM versus in the whole loan market versus reverse proprietary reverse mortgages. But maybe not that different. I mean, insurance companies have — I think we’ve spoken about this before, have really increased their appetite substantially in the last year for non-QM. And we sort of see that given the long duration, which is something that insurance companies tend to like and the high yielding aspect of these proprietary reverse mortgages, we think that’s a natural home there as well. So I think, I would think of it more in terms of those accumulating critical mass than either doing home loan sales or securitization.
Operator
And we have our next question from Eric Hagen with BTIG.
Eric Hagen
I wanted to check in on conditions for non-agency repo, other term financing for retained securities that you guys retain office securitization. How stable the availability of that capital is and maybe even how rate sensitive you think that financing is going forward?
Larry Penn
I mean, we — go ahead, Mark…
Mark Tecotzky
No, I was going to say in a word, it’s been stable, right? Even with — there was a lot of price volatility and spread volatility in some of the credit products in 2022, there hasn’t been a lot of price volatility in spread products in 2023. But even in 2022 and now continuing this year, spreads have been stable. So that financing to us is basically a spread to SOFR. So the actual rate we’re paying is going up and down with SOFR goes up and down. But what’s been stable is that spread between SOFR and our ultimate borrowing costs. And the pools of capital interested in doing that financing has actually grown. In the last couple years, we’ve expanded our range of counterparties, so on the really short duration or the floating rate loans. Then what you’re really locking in as sort of, ADE or net interest margin is if we’ve got a loan that’s SOFR plus six, we’re financing, it’s SOFR plus one and three quarters. Then every turn of leverage you’re locking in that difference. So 425 beats just for kind of like ballpark numbers. And then on — when you have the fixed rate bonds there, say non-QM, then you’re doing generally a — we’ve had two kind of hedges for non-QM this year. It’s been paying fixed on SOFR swaps or it’s been short TBA, now it’s more paying fixed on SOFR swaps. So you’re paying a fixed rate, you’re getting a fixed rate from the loan, so you’re getting that spread. And then the SOFR we receive on the floating leg of the swap that we’re getting paid that essentially pays to repo counterparties the floating leg, we owe them on the financing.
So they were also still kind of locking in the spread there. It’s just the difference between the fixed rate on the loan and the rate we’re paying on the SOFR swap. But the pool of capital and the spreads to SOFR has been stable. And if anything, it’s actually been coming down a little bit. And I think the reason for that is, is just repo now, given the shape of the curve, is a really high yielding asset. If you can — if you have a repo book at SOFR plus [175], you’re sort of earning 7%, so that — it’s a low LTV loan, it’s daily mark-to-market. There’s a lot of protections repo lenders get that make that a very desirable asset for a lot of pools of capital. And I think that’s why the financing has been stable. If you go back to sort of days when SOFR was close to zero, then it was LIBOR, then the all in yield on the financing just wasn’t that attractive. And then I felt like the financing markets were not as deep as they are right now.
Eric Hagen
I wanted to go back to your comments around the consumer conditions. I think you gave some cautious commentary around the consumer loan portfolio. Like how does that outlook tie into other areas of the portfolio where there’s maybe some more asset level risk, like obviously, the resi portfolio or some aspects of that portfolio?
Mark Tecotzky
So it’s interesting. We were looking at just some charts today that were tracking delinquencies in different loan categories as a function of — whether borrowers had student loans or not and you definitely see the impact of student loans turn on. So I guess what I would say is where we have seen weakness has been lower credit score borrowers. So the difference in performance between lower FICO and high FICO, that’s always been there, but the magnitude of the difference has gone up. And I think the reason why we think that’s the case is just pretty high gas prices and in some parts of the country, very high gas prices, like you look in California. So higher gas prices, higher rent. And now what’s sort of squeezing people a little bit is a little bit slower wage gains. So consumer, we have seen it. You haven’t seen it in Fannie Freddie portfolios if you look at sort of credit risk transfer performance. You are seeing it a little bit, and this is just sort of not because it impacts the portfolio, just it is a useful data point, you have seen it a little bit on Ginnie Mae portfolios. It’s a lower — it’s a higher LTV, lower FICO borrower than what you see on Fannie Freddie. Sub-prime auto, you have certainly see it. So it’s happening.
I think that the borrowers that you want to lend to primarily are the borrowers that have locked in low debt costs with a 30 year low interest rate mortgage. So if you look at credit risk transfer performance this year, CAS and [Stacker], it’s been phenomenal. Because I think people pick up on the fact, okay, it’s the floating rate product the investors like, because it floats off a SOFR and SOFR has been high relative to other points in the yield curve. But it’s a floating rate product where ultimate borrower has termed out their debt. And even better than sort of corporate debt or high yield debt, it never rolls, it just amortizes. So those borrowers have sort of had the best and most stable credit performance. And then as you get to sort of, like non-QM is second, but non-QM, you have [Technical Difficulty] delinquencies pick up a little bit and that has nothing to do with servicing transfer, I mentioned in the prepared remarks, but you’ve seen a little bit of an uptick in non-QM. And then when you get to borrowers that are renters that are basically having to deal with rising rents to past year that you have seen a little bit weaker performance.
Larry Penn
And I could just add to that. If you look at, for example, Slide 4, right, and you can see the consumer loan row, $90 million, that includes some ABS, it includes some equity investments. But — so you have gotten basically less than $90 million. I just want to make the point that the remarks that we made were somewhat a little backward looking as opposed to forward-looking in the sense that we have already — if you look at — we are projecting 11.5% yield on that portfolio to where we have marked it. So we have marked it down. And so we think that’s a good yield going forward. And I just — after the mark-to-market price drops that we have put in place, and I also want to point out that most of that portfolio is actually secured consumer not unsecured secured consumer. So I don’t — it’s a small portfolio, it is under $90 million. We think it is marked right, we think it’s going to yield 11.5% and that’s on a unlevered basis. So we feel good about that portfolio going forward and it’s possible that we add to that portfolio if we get some good situations.
Operator
And we have our next question from Matthew Howlett with B. Riley.
Matthew Howlett
Just at a high-level, when we look at the results by segment, the credit was terrific, it was stable, then you had obviously a negative contribution from Longbridge and it looks like the agency was negative, it had negative contribution. Backing those out in normalized, I mean, those are probably going to be — Longbridge, I think, was contributing $0.10 in the first quarter and then, of course, the agency side, you’re shrinking that, but that will likely be a positive contributor. I mean, when I look at dividend, ADE to dividend coverage, I mean, what sort of — you are probably there ex the sort of one time-ish events. I mean, how do I look at it going forward on a run rate basis?
Larry Penn
I think we’re close, right? So — I mean, one way to approach it is Longbridge was 14% of our allocated equity at quarter end, and they’ve certainly had quarters where they’ve contributed $0.05, $0.10 per share of ADE, if they’re contributing 6 to 7, 14% times $0.45. If you add to that, we picked up about $0.38 from the investment portfolio net of corporate overhead. So the sum of those is pretty close to the dividend. We did include in there prepared remarks, I guess, you could say some caveats on how to model or think about ADE in the near-term, because you have some idiosyncratic behavior on our interest income when loans move into delinquency and we stop accruing interest income or when they reperform and we expect to be paid at par and then interest income kicks in again. So — but there will be some noise there and we expect that to continue. But, net-net, I think we’re on track run rate wise. Given October was a continuation of some of the challenges as we saw in Q3, namely rates selling off and volatilities continue to be high, we’re not out with October numbers yet, but wouldn’t be surprised to see some of the same challenges in October that we saw in Q3 and origination channels and agencies that might weigh on ADE in Q4. But all that said, on a normalized basis, I think we should be tracking, if not in Q4 then as we get into next year. And then you add in the contribution from Arlington, including deploying additional dry powder, which would be accretive. So I know there are a lot of pieces there that I threw up, but hopefully that…
Matthew Howlett
No, I’m glad you clarified. I’m thinking about it the same way you are. I’m looking at the book value stability to me what really mattered in the quarter. When we think about Longbridge, I mean, when we think about modeling, I mean, it’s the highest, clearly, one of the highest gain on sale margin channels. When we think about what could impact margins and volumes? Is it very much like — I mean, when we think about it, is it like the conforming conventional side, when we think about spreads, are they track agency spreads, the HECM spreads? I mean, just walk me through — is it all about [HPA] or is it about lower rates, sort of what could influence positively or negatively Longbridge when we get into next year and some of the volatility comes down?
Larry Penn
I’ll address that. Before I do, I just want to point out that – and it’s a great question because it actually impacts what I’m about to say, which is that as long as we continue to see — Longbridge continuing to add market share, right? And to do the things that we think, they need to do so that they will go, I mean, this was a tough quarter from an ADE perspective, but not from a market to market perspective. So we think that that ADE, once it normalizes with Longbridge, that — as JR said, we’re going to be right there in terms of our dividend. So we have no plans to sort of have our dividend fluctuate because of the fluctuations in origination profits at Longbridge, absolutely not. So I think — so from an analyst point of view, I think, yes, you’re going to see — I mean, I hate to sort of even think about another non-GAAP metric. But you could think about our ADE ex Longbridge as another thing to look at. But with this acquisition, with their increasing market share — and yes, it’s been a really tough market. So to get back to sort of what is driving things at Longbridge, we have now the MSR. We feel very good that it’s now conservatively marked and it’s going to generate a great yield. We have — unfortunately, we’re still in a high interest rate environment. And what that means is that the amount — the long term interest rates, especially around the 10 year part of the curve are what drive how much borrowers can borrow in a reverse mortgage, that’s just the way that the program — the HECM program works. And it sort of makes sense, right, because you’re looking at long term gauges of inflation and it just makes sense, right?
And accretion, these borrowers are not going to be making payments, right? So you want to make sure that you’re earning a market interest rate and then some on the loan. And so the long term part of the curve is going to drive that and it’s going to discount and it’s going to create a lower principle amount that the borrower can draw as rates go up. So that’s been hurting all the entire reverse mortgage business. And so it’s a different reason that versus why it hurts the regular forward market. But nevertheless — so you’ve seen the market shrink but then again, you’ve also seen one very notable player and other smaller players sort of go by the wayside. So we see Longbridge as having a larger market share in a market that is smaller, but then the prop business has a lot of room for growth, right, because now you’re tapping into borrowers that, A, have much higher value homes. So that’s just more profitable on a loan-by-loan basis. And you’re talking about borrowers that may not be as sensitive about taking out less proceeds. So looking forward, like the long term prospects we think are really good for Longbridge and they continue to gain market share. But it’s been a tough market and with — you’re right, with agency spreads wide that’s affected — and volatile — that’s affected the execution on the HMBS that Longbridge and all the other participants issue on a monthly basis. And so the gain on net sale margins aren’t what they could be. And so if spreads normalize there, ultimately, that should also normalize as well. So you’ll see short-term volatility, I think in our ADE coming from volatility from Longbridge origination profits. And so that’s something that I think the market will have to adjust to for us.
Matthew Howlett
I appreciate that, you clarify, it makes a lot of sense now. And not to get too complex on this call, but the MSR related to reverse, it has no prepayment. So just the higher rates negatively impacted that. I mean, going forward and is that going to perform the same way a conventional MSR perform, we get lower rates or…
Larry Penn
It is complex. So first of all, a lot of the value is in a regular old servicing strip, right? And it’s not quite as prepayment sensitive as a forward mortgage strip will be. But when rates go down, people do sometimes refinance their reverse mortgages to take advantage of lower rates. As home prices appreciate, they sometimes refinance to do cash out refi. So it’s sort of a lot of the similar factors affect that. So there is a prepayment aspect to it, which is mildly negatively correlated to interest rates. So that’s actually good for that portion of the MSR high interest rates. But then there’s a couple other portions but most notably there these future draws where the borrower can take out more money on their reverse mortgage and a significant portion of the value of these MSRs is the profit you’re going to have from turning those into Ginnie Mae’s, these are so-called tails. And that is also not — it’s really sensitive to spreads and rates, but more spreads. So yes, there’s also maybe a correlation going the other way there. And yes — so there are sort of offsetting factors.
Matthew Howlett
So I think Longbridge is going to be a home run for you guys, and I look forward to next year. Real quickly on, does — did I hear you correctly on the MSRs, you’re going to begin to leverage with bank lines and some of the MSRs they have there, because I know they report something called MSR financing receivable. I take it’s like a nexus, MSR. But what type of leverage — if you are, what type of leverage can you get — will the banks give you on MSRs? And then I think you said you want to put even some corporate debt like you preferred or something on once the deal closes. Just go over those two points.
Larry Penn
I think when — the preferred [Technical Difficulty] saying that Arlington already has preferred stock and unsecured debt outstanding on those travel with the merger, so we inherit that, so that will become our preferred and our unsecured debt. And those are — we’re done in a different environment, so that’s very attractive, financing or future financing for us. And then in terms of financing the MSR, yes, there’s forward MSRs are — there’s a lot of financing availability for those. I think, you can get financing north of a 50% advance rate, but I think we would probably in practice stick to around 50%. So one turn — you could call that one turn to leverage.
Matthew Howlett
We look forward — but the timing was terrific. Look forward you to closing the transaction and look forward to continued success. Thank you.
Operator
And we have our next question from George Bose with KBW.
Unidentified Analyst
This is actually Frankie filling in for Bose. Just one question. On Slide 14, you provide interest rate sensitivity. Can you talk about how sensitive your agency MBS position is to the changes in spreads? And then just a follow up, how much do you hedge the agency spreads? Thanks.
Larry Penn
It’s sensitive to spreads or to rates?
Unidentified Analyst
The spreads.
Larry Penn
You can’t see that on this Slide. But if you look to the that shows the — yes, exactly. Yes, I think 22 is the place to go. Slide 22.
Unidentified Analyst
Okay, thank you…
Larry Penn
Yes, if you turn to that, I will elaborate. So you can see that when you net out our TBA shorts, which really had spreads dollar-for-dollar on the equivalent amount of longs, right? You can see that our net agency we call net agency pool assets to equity ratio was 5.4:1. So then you can go and basically say, okay, what does that mean? Well, actually, if you look on the slide, you can see there are net long exposure to agency pools of $698 million. And so if you think about 10 basis points in spreads on the portfolio. Mark, would you say that’s 10 basis points is what, is it 0.5-ish? What do you think?
Mark Tecotzky
Yes, that’s exactly what I was going to say. Yes, five year spreads…
Larry Penn
So you are talking about spreads move by 10 basis points then half a percent of $690 million is about $3.5 million. So 10 basis points is — it’s a significant move in spreads. We could see 20, it’s possible to maybe, but we are already near all-time wide. So it is not — I think in the context of our entire portfolio, it’s not a huge exposure. But it is one that we like right now given that as we said, I mean, spreads are pretty close certainly on a notional basis, but even by other metrics. But certainly on a notional [Technical Difficulty] back close to where they were right after COVID hit. So it’s measure wide.
Mark Tecotzky
And another kind of rule of thumb or shortcut you could take is the prior Slide 21, you could see that 35% of our interest rate hedging portfolio is in TBA at September 30th, up a little bit from 32% at 6/30. But you can roughly say that, that 35% is also addressing the spread widening risk whereas the swaps don’t. So as that fluctuates you can see how much of the mortgage basis were hedging through TBAs versus not through swaps.
Operator
And that was our final question for today. We thank you for participating in the Ellington Financial’s third quarter 2023 earnings conference call. You may disconnect your line at this time and have a wonderful day.
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