Ellington Financial Inc. (NYSE:EFC) Q2 2022 Earnings Conference Call August 5, 2022 11:00 AM ET
Company Participants
Jason Frank – Deputy General Counsel & Secretary
Larry Penn – CEO
J.R. Herlihy – CFO
Mark Tecotzky – Co-Chief Investment Officer
Conference Call Participants
Trevor Cranston – JMP Securities
Doug Harter – Credit Suisse
Mike Smith – KBW
Eric Hagen – BTIG
Crispin Love – Piper Sandler
Operator
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 opened for your questions following the presentation. [Operator Instructions]
It is now my pleasure to turn the call over to Jason Frank, Deputy General Counsel and Secretary. Sir, you may begin.
Jason Frank
Thank you. Before we start, I would like to remind everyone that certain statements made during this conference call may constitute forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical in nature. As described under Item 1A of our Annual Report on Form 10-K, forward-looking statements are subject to a variety of risks and uncertainties that could cause the company’s actual results to differ from its beliefs, expectations, estimates and projections. Consequently, you should not rely on these forward-looking statements as predictions of future events.
Statements made during this conference call are made as of the date of this call and the company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
I’m joined on the call today by Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, Co-Chief Investment Officer of EFC, and J.R. Herlihy, Chief Financial Officer of EFC.
As described in our earnings press release, our 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 end notes at the back of the presentation.
With that, I will now turn the call over to Larry.
Larry Penn
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 continue 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 US 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 three plus billion dollars 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 and Rocky markets. And in return, EFC can buy at wholesale prices from LendSure if 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 widen 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.
So 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 principle 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. So 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. And we also benefited from significant net gains on our interest rate hedges and credit hedges. So while overall decline for the quarter was certainly significant. Our divers, our diversified portfolio and discipline hedging help prevent further losses.
The silver lining of the market sell off is that loans and payoffs, particularly on our short duration loan portfolios between our residential transition loan, commercial mortgage loan and consumer loan portfolios. We received principle 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 nine QM loans and credit, 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 Stacker 2021-HQA1B2 a CRT bond, and under $0.78 on the dollar in May. This bond had traded above $0.102 on the dollar in January. So that was a 350 basis points widening since January.
So while our net interest margin has recently compressed, our NIMS 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, but 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 triple a Tran 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 nine 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 in liquidity management.
I’ll move next to adjusted distributable earnings or ADE for sure. We previously referred to this non gap metric as core earnings. We’re reporting 41 cents per share of ADE for the quarter, which is up a penny from the previous quarter. Well, there are a few reasons why it’s not yet covering our dividend, which will get into. We do project that ad will cover the dividend as we get fully invested and turn over the portfolio at today’s hiring investment yields.
But there will be a lack 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 and interest rates and spreads like we’re seeing today and where liabilities are repricing faster than assets like they did this past quarter, but 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, by design, doesn’t generate much a D this includes our short term trading portfolio, including TVs and our equity stakes and loan originators ad 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 210,000,005 and seven days coupon five year unsecured debt deal.
And 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 months book value per share.
I’ll now pass it over to J.R. to discuss our second quarter financial results in more detail.
J.R. Herlihy
Thanks, Larry and good morning, everyone. I’ll start on Slide 3 of the presentation. For the quarter ended June 30, 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 is not changed. So it’s valid to compare a current period ADE to prior period’s 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 and with the ATM issuance in March and early April, our share account 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. And even though we have a lot of floating rate loans in other short duration assets in the credit portfolio, the asset yields on our invested assets lag the increase in financing costs this past quarter, especially for fixed rate RTL and [ph] 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 4, 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 30th, which is up from 82% in year end. And it’s about the highest split it’s been for FC.
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. And 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 five, 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 compared a gross income of $0.28 per share in the credit strategy and a gross loss of $0.34 per share in the agency strategy. And the prior quarter as Larry summarized, the main drivers of these losses were UNEC securitized, 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 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, 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 six during the second quarter, our total long credit portfolio grew by 16% sequentially to 2.6, 6 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 seven, 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% a quarter end driven by higher short term rates and a full quarter of interest expense on the five and seven eighth 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 a larger portfolio.
Our recourse debt to equity ratio increased to 2.6 to one from 2.3 to one in the prior quarter. During the second quarter, we marked down our five and seven, eight senior notes by two points to $96 and 50 cents as a liability.
This marked down generated positive income. However, we had a corresponding loss on the sofa 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 are proprietary stakes and 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% and 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 decrease sequentially by $0.03 cents per share to 14 cents while other investment related expenses decreased by $0.07 cents per share to $0.09 driven primarily by the costs associated with the senior note offering that we fully expensed in the previous quarter.
Also 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 30, we had a net deferred tax asset of approximately 9.6 million against which we took a full allowance.
Our book value for common share was $16.22 at June 30th, down 8.6% from $17 and 74 cents per share at March 31, including the 45 cents per share of common dividends that we declared during the quarter. Our economic return for the second quarter was negative 6%.
Now over to Mark.
Mark Tecotzky
Thanks J.R.. The second quarter had incredible volatility in every dimension in interest rates in credit and agency spreads and 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 negative 6%, not a result you’re used to seeing from us, not a result we want, but not a disaster either. And a lot of it, I think we can earn back because much of the loss was due to spread widening on non-term 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. But 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.
And some reasons 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-term 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 triple A’s priced at a spread of 97 to swaps the added 2.2% fix rate coupon and were priced at par on July 22nd. We priced our most recent securitization in that deal. The triple A’s had a fixed coupon of 5% and they were priced below 99. That’s the spread of 250 to treasuries are more than 150 base points wider and spread than the triple A’s compared to the January execution, lower rated non QM bonds 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-chem 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 financials 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 on, sorry, sorry. One second yeah.
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, and as a result, we have marked down our originator investments. All that said, I think it’s noteworthy that one year 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 compliment to the rest of the portfolio, as opposed to a disproportionate user of capital. And if you consider our cost basis in these investments, they’re an even smaller part of our portfolio.
We believe that lend share 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 Fred are the lowest rate option for most borrowers whose W2 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 W2, we don’t see this changing. We don’t see Fannie Mae go into bank statement loans apart from non-QM in 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 and 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 intrastate movements and interstate 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 issues. 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 FC performance in the second quarter with a loss of about $0.20 per share, but that two perform very well in July in the agency. MBS market today, pre payments 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. So 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 selloff five 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 these 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 a hundred basis points. Tighter CRT is much tighter and there was a deal last week with tranches, 15 times oversubscribed that tighten 60 basis points from the initial talk.
Non-QM has tightened as well and some current deals have been over five times have been, have been over five times. Oversubscribed ever since the July fed meeting the market has had a different tone and has attracted a lot more capital for money managers and insurance companies.
EFC is in a strong position at quarter end. We had ample borrowing capacity in 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 with ma 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 draw down 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 2.6, 6 billion, which I believe is the right thing to do when spreads are so wide. FC is also EFC also has experience 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 now, 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 focus on capturing those opportunities to drive our dividend and grow book value.
Now back to Larry.
Larry Penn
Thanks Mark. I am happy when I hear that there have been some audio issues at the conference call hosting service. They’re having some technical difficulties. So we’re going to look into whether we can post, perhaps post the script somewhere or provide perhaps on the audio replay that will, that’ll have all the content. So we’re going to 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 will be putting out a book value per share estimate for July 31st. So keep an eye out for that update.
Meanwhile, time will tell how long the contraction in the, 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 li their locked loan pipelines, or were under-capitalized or both.
We have seen several mortgage originators, severely scale back operations, and even a couple closed shop while market dislocations have created a drag on FCS book value in the near term. Our strong balance sheet is enabling us to lean into the wider credit spreads and 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 the FCS overall equity, as J. R. 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. So properly sized these investments further diversify our earning 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 lend shore, 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 purchase 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 and 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 nine QM securitization market.
Going back to the earnings presentation for a minute, please turn to slide 12. I pointed this to 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 rate 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 plus or minus 1%.
That translates to an effective interest rate duration of a little more than two years on this portfolio. And that’s even before taking into account or interest rate hedges, we’ve accomplished this by focusing a significant segment of this portfolio on products like one to two year commercial real estate bridge loans, sub one 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 are recently raised five and seven, 8% senior notes to be highly accretive to earnings. Once we 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 patients will ultimately be rewarded.
With that will now open the call up to your questions operator, please go ahead.
Question-and-Answer Session
Operator
[Operator instructions] And we’ll take our first question from Trevor Cranston with JMP Securities. Your line is open.
Trevor Cranston
Thanks. Couple questions on the non-QM market. First I guess, 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 kind of 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.
And as a second part of the question, you guys clearly kind of laid out the opportunity on the loan side there with the spread widening are you guys also interested in 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?
Mark Tecotzky
Hey, Trevor. It’s Mark. So I would say that the first question about change in volume. So in terms of securitized volume for the second half of the year versus the first half of the year, I think that’s going to be down a lot. But 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.
So there were a lot of platforms sitting on a lot of four and a half, four through quarter note rate loans that they didn’t securitize in ’21 that they put into the market in 2022. So if you take away that, I think my projection is that just at these higher note rates and also at higher HCA, you’re probably just going to see organic non-QM volume dropped by I would guess at least 30%, I just think it’s fewer borrowers qualify.
If fewer borrowers are looking to buy homes right now, given what the payments are with the kind of double whammy of higher HPA and higher mortgage rates. And if you look at a lot of housing metrics, if you look at like what’s happening to views on Zillow, and I think you’re going to start to see it a little bit in listing times that, I just think there’s sort of an overall, an overall slowdown that you’re going to see in housing. The other thing about buying pieces of other deals.
So the way we think about the when we do securitizations, where we think about that is the, the bonds we sell are really sort of replacing re both. We consider them to a term financing. So 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, we look at those sort of as, investments that the company’s making. So 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. So it’s much more, what’s going to drive the returns on those things is going to really have a lot to do with loan performance as you’re not, it’s not like buying, a more senior security where it’s more like prepayments and spread, what happens to spreads you’re down at the capital structures, you’re exposed to the credit risk and Larry mentioned on the call, but one of the benefits of having these original stakes is you, 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.
So I think we just have a level of comfort on the retained pieces as investments for the securitizations we do. But yeah, like I would just say like away from Wellington Financial, in other pools of capital, we manage yeah. We are find, attractive things in non-term space.
Trevor Cranston
Got it. Okay. That’s helpful. And you guys talked about the challenges that a lot of originators are facing and the impact on your investments in, in some of those companies as, as you look at the originator landscape, are you guys looking at, or pursuing any opportunities to maybe, provide a capital injection to like a good quality company who’s a little bit beaten up right now? Or are you guys just kind of comfortable with the investments you guys have at this point?
Mark Tecotzky
Yeah, we’re definitely seeing opportunities like that. And I think similar to what we’ve done in the past, I think a modest, amount of capital absolutely could be, could be a great use of capital to do that. provide some sort of line of credit or capital infusion in exchange for and then getting forward flow, potentially warrants.
There’s a lot of things that, these companies that are struggling could be, help them basically get through this and provide a great opportunity for us. again, we’re, we’re not the type that usually writes big checks. So as we’ve said but I think this could be a great opportunity to do that and we are seeing a couple of opportunities presented.
Trevor Cranston
Okay. Got it. And then last question on the, 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, and where of all children’s at currently?
Mark Tecotzky
Yeah, so we typically keep the net long in that portfolio, significantly lower than what you’d see from sort of, an agency rate. And part of that is just the philosophical belief that shareholders in Ellington financial are primarily looking to generate returns through credit investments. So historically we haven’t wanted to introduce some of the risks inherent elaborate agency portfolio about volatility and basis widening.
We haven’t wanted that to really dominate returns for EFC given that it’s really credit focused. So I think, and J.R. can correct me. I think the agency portfolio was down roughly 6% on its capital this quarter. Right. So I think that’s sort of like at the better end of what you’re seeing from the agency peer group in part, because 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 a reason everybody knows, right? You have the, the fed stepping back their purchases it’s possible even though, a lot of market participants think less likely, but it’s certainly possible that they could engage in sales. And also, the other thing is Fannie and Freddy greatly increased their loan limits. So the new crop of agency mortgages that are originated in the higher coupons 4.5 and 5, they’re really big loan balances.
So there’s going to be a lot of sort of pot potentially and unfavorable prepayment curve for some of those things. So all that kind of feeds into spreads. I mean, I’d say like right now, if you look at non-QM or a lot, a lot of sectors of credit have sort of had spreads correlated with agency spreads a little bit.
So I feel like EFC has a lot of it’s, it’s taking advantage of wider spreads right now in some of these other sectors. So I wouldn’t say right now, probably that’s where we’d add a lot of risk. Agencies had a very good quarter in July, so they recouped some of that widening. But if we saw credit spreads tighten to the point where they weren’t as attractive as they are now and the agency spreads not, then I think at that point, it’d be a time to really consider increase in the mortgage basis exposure in the, in the agency portfolio and Ellington financial, well, right now we’re in credit spread so wide. I think we’re going to sort of take more of the risk in the portfolio focused on the credit side.
J.R. Herlihy
Hey and Mark, We’re looking at the numbers here. Yeah. The return on equity on the equity that was allocated to the agency strategy was, in the single digits. It was obviously a lot better than you’ve seen from the agency res in terms of their, return on equity. So and that’s due to the fact that in no small part, as you mentioned, we hedge more of the basis risk via TBAs in that strategy than typical agency rate would.
Operator
We’ll take our next question from Doug Harter from Credit Suisse. Your line is open.
Doug Harter
Thanks. Can you talk a little bit more about your comment to hold non QM loans on, on warehouse clients longer? how, 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, just to kind of flesh that out a little bit. Thank you.
Mark Tecotzky
Yeah. Hey, Doug, it’s Mark. So, maybe I didn’t phrase it properly, but I wouldn’t say it’s our intention to hold Mon QM loans on repo because we see a lot of benefits of being securitizer right. We certainly saw it when you went through. COVID how having securitized a lot of our production leaves less marked to market risk in the portfolio and 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 got near a point in July where security, inspiration spreads had widened so much relative to repo that for the first time in years and years, we at least said, let’s look at levered returns just from keeping things on balance sheet, since then securitization threads have come in.
So I would say now, our expectation is that we’re going to continue to securitize, but, 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 guiding the world, securitizer been, at least, an alternative to consider.
Larry Penn
And, Mark, I just want to make one other point which is that one thing that so it’s, so, so yeah, so it’s not, first of all, it’s not like we have a gun to our head right. And need to get these things off REPA right away. One thing that we look at very closely is we look at the relationship between the securitization spreads and where we can buy loans, non QM loans right.
And so when we did the securitization, which we completed last week, 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. So we’re, de-risking by doing the securitization. But we can replace that risk pretty much right away now with non cm loans, right.
That are priced very attractively relative to where securitization spreads are, that wasn’t true, a couple months ago, securitization spreads widened. Right. and it took a while before the primary market where you could buy, where you could originate, where you could originate and, and purchase via forward flow agreements or whatever it is, there was a lag there.
So once that sort of re normalized where it should be, which is that, it should be profitable to originate loans and securitize. So once that got back, 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 purchase today.
Doug Harter
And I guess on that commentary about the ability to source loans, I guess, how do you view kind of the, the timeline to, to aggregate enough to enough size to securitize? How does that compare kind of in the back half to, to kind of what you experienced in the first half?
Mark Tecotzky
Well, it’s compressed a lot for us, it, it look back, we, we, first, we were a year between that I think six months, four months, three months now, I think we have enough flow and inventory, frankly, that, we could be doing deals much more frequently and typical size deal for us is in the $300 million to $400 million range.
J.R. Herlihy
Yeah. Our last deal was about $350 million and we acquired $350 million originated $550 in the second quarter. So that would imply yeah. You share that exactly. Right. Exactly. So I think you could definitely see now every two or three months as opposed to every three or four months.
Operator
We’ll take our next question from Bose George with KBW. Your line is now active.
Mike Smith
Hey guys, this is actually Mike Smith on for Bose. Maybe just one on leverage. If we look at total leverage currently at 3.8 times, 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.
J.R. Herlihy
Sure. So thanks for the question Jr. I’ll start out. And then Mark and Larry obviously supplement as you see fit. So the 3.8 times includes all of the non QM securitizations that we consolidate for gap. So that’s a total leverage statistic, but recourse test equity which we talk about that’s the, that’s the ratio we focus on, cause it excludes non-recourse financing, which is largely the non-QM securitizations that measure did increase from 2.3 to one to 2.6 to one quarter of a quarter.
And 2.6 times 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 two and a quarter. So we, we still had, that’s one of the ways that we measure, dry powder.
Larry mentioned that we closed on the senior notes on March 31st. So that was 210 million of those kind of UN of the dry powders as, as we think about it. So I think it, the, 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, continued to, to, to, to take advantage of investment opportunities. So there are different moving pieces. But I think in short we still have room to take leverage up further. Does unencumbered assets of about $600 million, if you say, let’s just say $400 million is readily financable at attractive rates, and we leverage that one to one or thereabouts that would raise another $400 million plus another say 50 of our cash.
Cash is higher relative to NAV than it typically is that that math would get us to the high twos before accounting for securitization. So 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. And just to reemphasize what J. R. 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. And, but the amount of, 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. So when we do a $350 million securitization and well, in the old days, we would retain, 20 million worth of assets, usually mostly IO, non-QM, and some subordinate tranches as well.
Mark Tecotzky
Right? So that blows up your recourse leverage by $350 million, which is not a small number given, we have a billion dollars of equity, but in terms of how many really sort of assets you’ve added to the balance sheet it’s a, that’s a relatively small number we’re retaining more now, so that that percentage has increased, but still relative to the size of the balance sheet, the amount of retained tranches, that we add when we do a securitization is still pretty low.
So again, I think focusing on the recourse number, which is what we think of, especially in terms of our liquidity management and, and making sure that we can withstand market shocks and things like that is, better to focus on
Mike Smith
Great, that’s really detailed and helpful color. And then maybe just one on, on strategy and, and, the potential for M&A, I’m just wondering how strategic of an asset is, is earned to Ellington the manager. Just wondering if, EFC could ever look to acquire earned and, maybe to increase scale, or could you ever look at any other strategic transactions we saw peer put themselves up for sale assets. I’m just wondering, if you could provide any color on the backdrop for M and a, that would be helpful. Thanks.
Mark Tecotzky
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. but it’s not on the radar screen right now, and I wouldn’t want to comment more than that.
Mike Smith
Great. Thanks for taking the questions.
Operator
We’ll take our next question from Eric Hagen with BTIG. Your line is open.
Eric Hagen
Hey, thanks. Good morning guys. Hope you’re. Well I, 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 want to hear you kind of talk about it and say it, and then 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.
Larry Penn
Yeah. So J. R., why don’t you handle the question about that deal coming due, right. And then Mark will handle, yeah, I think we see it as we, we, we planned liquidity wise to, to, to pay it off here in a few weeks. And there was nothing really more nuanced about that. It’s going to be, ordinary course that we’ve planned to, to pay it off that maturity and we’ve planned on the liquid excited you, so, yeah.
And if, rates hadn’t spiked and spread out right after we did that other, secured note deal, we probably would’ve used those proceeds to, pay off the five and a half coupon even sooner, but five and a half coupon, which was looking like a expensive, short term funding in just in in March, it was now looking pretty attractive shortly thereafter, so we decided to keep it on. And we could’ve paid it off at any time, but it, it certainly looks like we’re just going to pay it off in maturity with cash on hand. Mark, you want to repeat maybe the second half of the question,
Mark Tecotzky
Right? No, I think I got it with the yeah. So with the bank statement loans, that’s sort of, I think that’s sort of one differentiator among different non originators is how they think about bank statement loans. And I think the NCHE originator, we own lends shore has a very good process there.
It’s a really deep dive into that you and people are, self-employed, it’s really deep dive into the economics of that business. It’s looking at multiple years of bank statements and so the performance there has been excellent. And in a lot of ways you wind up learning more about those borrowers financials than you do just on the regular full doc.
So we’re totally comfortable with bank statement underwriting at show 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, and there, sometimes we can get comfortable with it.
And there’s times we can’t it, when I think about sort of the opportunity set, I think you’re talking about in non-retained pieces versus CRT, CRTs, like, more liquid and it’s got pretty good financing terms. I think they’re both attractive, like for a long time, I’d say, like last year, the year before we didn’t find CRT particularly attractive because it wasn’t that wide things at par.
And it always sort of has a little bit of this cat bond that catastrophe, catastrophe bond quality to it that, the enhancement levels are so thin that flooding in Houston was an issue for CRT. You could see wildfires being an issue for CT. 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 just regular diversified loan portfolios. So what’s changed for us about the CRT market now, and when we’re refining more attractive investments is that it’s seasoned some. So 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 prepayment. So, 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 de delivered so much. Or there are times where, the LTVs are now marked to market 20 points lower than where it was and the deal got done.
And so there’s significant enough enhancement levels in parts of the CRT market that sort of mitigates, or sort of NES 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, weather and fires and floods. And so when we know the models are taking into something into account, but we know what they’re not taking into account can be, 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. So those changes though, the build-up and credit enhancement, the much lower LTV because of HPA. Now we’re finding attractive opportunities there. Larry referenced one of them in his prepared remarks. So I like both them for EFC. I like EFC having loans, as well as having securities loans are proprietary.
They’re a little bit more work. So a lot of times sort of the pot gold at the end of the tunnel, when you do everything is a little bit higher yield, but a lot of times securitizations mark, securities can overshoot, they can get cheaper than loans.
If there’s for selling or whatnot or turbulence, like you’ve seen this year. And 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, they have liquidity to them, it’s easier to monetize gains. So I think there’s a big role for both those things in the FC. That was some really good stuff to think about.
Operator
We’ll take our next question from Crispin Love with Piper Sandler. Your line is open.
Crispin Love
Thanks. And thank you for taking my question. One question on the NIM for the credit portfolio I saw, I was about 2.7, 5% second quarter down from about 3.6% in the first. I’m just curious how you’d expect that to, to rebound in the third quarter, and then should it kind of steadily increase off that base as investments for higher yields begin, begin to make of the larger part of the portfolio as the, as the portfolio turns over Chrisman, thanks.
J.R. Herlihy
So, I would say that, I think we mentioned in our prepared remarks that financing costs on our portfolio adjusted more quickly than asset yields overall as, as an average of, of both sides of the portfolio. And we expect NIM to expand going forward as asset yields pick up. And we do have a short duration portfolio, especially in loans where some loans are floating rate.
And so those are adjusting real time. But others are technically fixed rate, but might have a six month average life, for example many of our RTLS. And so if you have a six month loan that has a fixed rate, it’s going to take that time to turnover, whereas it’s financing might be floating to for LIBOR.
So hopefully it’s a short term phenomenon in asset yields catch up and we mentioned that we’ve been able to push spreads and we’re seeing higher yields and spreads in the market, and 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 expected to kind of catch up going forward.
Crispin Love
Okay, great. Thanks for the color Jr. And just one last from me I appreciate all of your comments that you’ve made on the securitization markets. And I just have one clarification on what you said on the non-deal in July versus January. Could you say 150 basis points wider.
J.R. Herlihy
Yes. In spread. So obviously much, much higher yield, much, much higher.
Mark Tecotzky
And the coupon, and the coupon was a 2.2 coupon in January and it was a five coupon in July and the five coupon on July traded about a point lower than the 2.2 coupon.
Crispin Love
Okay. Okay. Sounds good, Mark. Thanks.
Mark Tecotzky
So that’s a big move that’s like, wow.
Crispin Love
Right. Absolutely. Thank you for the color and the clarification. That’s all for me.
Mark Tecotzky
And Crispin, just to add one more thing. while we definitely look at a D when thinking about our dividend we’re also looking at looking forward right. And seeing where we see where we see these metrics going, including a D in others and earnings and where so it’s, I, I wouldn’t necessarily focus too much on that, necessarily over the near term. We’re looking at market yields that are very high.
We’re going to turn over the portfolio. We still have an agency portfolio that from a relative value perspective, we really like a lot of that was put on at lower yield. So I think you’re going to see over the next quarter or two, a lot of turnover in movement. Some of it is just the, the natural recycling of capital on those short duration loan portfolios.
We talked about, some of it is just taking advantage of the right time to sell some of the agency pools that we have and replace them, just, naturally which whatever is in the market at time, but that’s going to recharge and the other thing I want to mention is that it hasn’t been that long where and they’re still going to be going up where short term, money market rates are higher. And that’s also a boost because that all that cash that we have, and, if you will the benchmark off of which are floating rate assets are yielding us.
Those are all going up and going up quite a bit, several hundred basis points from where they were literally last year. So that’s also a good tailwind for that has not, absolutely has not been fully factored in yet.
Crispin Love
All right. Thank you for the call, Larry. Okay.
Operator
That was our final question for the day. I would like to turn the call back over to Larry Penn for any additional or closing remarks.
Larry Penn
Yeah, no, thanks everyone. I just want to add, we’re going to we’re going to take a listen to the audio and if there was something that we considered significant in terms of a GAAP based upon this issue that the hosting company had we will definitely look into hosting the script the prepared remarks on our website and for the Q&A, I think it seems like the audio was didn’t gap there. So I think we’re going to be okay in terms of just the normal services, then post those transcripts, but we will look at posting the prepared as appropriate.
Operator
We thank you for participating in the Ellington Financial second quarter 2022 earning conference call. You may now disconnect your line at this time and have a wonderful day.
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