Ellington Credit Company (EARN) Earnings Call Transcript

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Credit Company First Fiscal Quarter Ended June 30, 2026 Results Conference Call. Today's call is being recorded. [Operator Instructions] It is now my pleasure to turn the floor over to Alaael-Deen Shilleh, Associate General Counsel. Sir, you may begin.

Thank you. Before we begin, I would like to remind everyone that this conference call may include forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not historical in nature and involve risks and uncertainties detailed in our registration statement on Form N-2. Actual results may differ materially from these statements as they should not be considered to be predictions of future events. The company undertakes no obligation to update these forward-looking statements. Joining me today are Larry Penn, Chief Executive Officer of Ellington Credit Company; Greg Borenstein, Portfolio Manager; and Chris Smernoff, Chief Financial Officer. Our earnings presentation is available on our website, ellingtoncredit.com. Today's call will track that presentation, and all statements and references to figures are qualified by the important notice and end notes at the back of the presentation. With that, I'll turn the call over to Larry.

Thanks, Alaael-Deen, and good morning, everyone. We appreciate your time and interest in Ellington Credit Company, which we often refer to by its New York Stock Exchange ticker E-A-R-N or EARN, for short. Please turn to Slide 3. The second calendar quarter marked an important inflection point for EARN's portfolio. The market sell-off earlier in the year widened credit spreads and significantly expanded the CLO opportunity set, and we moved quickly, issuing unsecured debt in late March, rapidly deploying the proceeds in April and actively repositioning the portfolio throughout. Those actions proved to be well timed. As the second quarter progressed, credit fundamentals improved and active trading and rotation allowed us to further upgrade portfolio quality. For the quarter, we generated an economic return of 8.1% non-annualized, increased our NAV per share and strengthened the portfolio's long-term return profile even as we reduced leverage. Total equity also grew, adding to our balance sheet capacity and financial flexibility. We believe that we are well positioned to grow net investment income in the months ahead as our NII for the full quarter did not yet fully reflect the earnings power of our expanded and repositioned portfolio as of the end of the quarter. The second quarter was about building earnings capacity, and the upcoming quarters are about converting that capacity into higher net investment income and earnings while maintaining our discipline around credit quality, liquidity and NAV preservation. We see 3 primary drivers of net investment income growth. First, deploying our excess liquidity. Greg will discuss the attractive investment opportunities we're seeing, and that's where we're putting our excess liquidity to work. Second, prudently adding leverage. Our strong balance sheet, larger equity base and meaningful remaining borrowing capacity give us the flexibility to further expand the portfolio beyond its current size. We also have the ability to issue common equity above NAV when market conditions permit, finding another source of accretive growth capital. And third, portfolio rotation. We expect to continue rotating capital into higher-yielding investments, pursuing attractive CLO refinancings and resets and actively trading across the CLO capital structure. These 3 drivers, all of which are largely within our control, give us a clear path to grow earnings in the coming months. To be clear, we do not need to reach for yield in order to grow earnings. As Greg will explain, the portfolio repositioning we completed during the second quarter allowed us to increase income potential while actually improving credit quality and in many cases, reducing risk. With that, I'll turn it over to Chris, who will walk through the quarter's financial results in more detail, including how our balance sheet and portfolio are positioned to support NII growth.

Thanks, Larry, and good morning, everyone. Please turn to Slide 4. For the quarter ended June 30, 2026, we reported GAAP net income of $0.33 per share and net investment income of $0.16 per share. Adjusted net investment income was $0.15 per share. Our NAV increased to $4.18 per share at June 30, which, together with the $0.24 per share of distributions during the quarter, produced an economic return of 8.1%. As Larry discussed, significant capital deployment and portfolio repositioning occurred during the quarter. So the resulting increase in earnings capacity was not yet fully reflected in second quarter NII. Please turn to Slide 6 for a breakdown of our quarterly results by investment category. Our CLO portfolio generated strong results across both debt and equity. NII was complemented by substantial net unrealized gains in U.S. and European CLO debt and U.S. CLO equity as credit spreads tightened and underlying loan performance improved. We also generated trading gains on mezzanine debt and benefited from calls on several discounted positions. These gains were partially offset by losses on our corporate credit hedges as broader credit spreads tightened during the quarter. Most of that hedge drag occurred in April when the credit markets rebounded sharply and during the same period in which our long CLO portfolio generated substantial mark-to-market gains. Let's go over a few different yield measures since each tells us something different. The weighted average GAAP yield on the entire CLO portfolio was 11.9% during the quarter, while the weighted average yield on our incremental purchases during the quarter was higher at approximately 14.9%. As of June 30, the weighted average yield projected on the portfolio measured using fair value rather than cost was approximately 16.6%, reflecting the stronger forward return profile of our repositioned portfolio. Meanwhile, attractive reinvestment yields have continued with our weighted average purchase yield so far in the third quarter at approximately 16.8%. Importantly, these higher reinvestment yields do not come from taking on more risk. Rather, they reflect in large part, improving fundamentals in the underlying loan market as well as attractive entry points created by technical selling and capital outflows. As these higher yields work their way through the portfolio, they should provide a tailwind for NII. Please turn to Slide 7. We purchased $64.8 million of CLO investments and sold $35.1 million, growing the CLO portfolio to $334.1 million at June 30 from $307.9 million at March 31. That 8.5% net portfolio growth actually understates the level of activity during the quarter. Significant cash distributions, calls and paydowns provided additional capital for reinvestment while active portfolio rotation further increased turnover, including sales of positions where we believe much of the remaining upside had been realized. As you can see on this slide, our portfolio rotation mostly happened within sectors as opposed to cross sectors with CLO equity representing approximately 54% of the overall CLO portfolio at quarter end, up only slightly from 53% and with the European investments remaining at approximately 10% of the overall CLO portfolio. Slides 8 and 9 provide additional detail on the corporate loans underlying our CLO investments. Our CLO collateral remains overwhelmingly first lien floating rate leveraged loans, representing roughly 95% of the underlying assets. These loans are well diversified across industries and issuers led by technology, financial services and health care with no single sector exceeding 11%. Loan maturities are spread over several years with the largest concentrations in 2031 and 2032 and the minimal near-term maturities, resulting in a weighted average loan maturity of 4.4 years. Facility sizes skew towards larger borrowers with a weighted average size of $1.9 billion, which supports secondary market liquidity. Please turn to Slide 10 for an overview of our credit hedges. At June 30, our credit hedge portfolio represented approximately $132 million of high-yield CDX notional equivalents, down from approximately $188 million at March 31. Greg will discuss the drivers of that reduction. We also continue to maintain foreign currency hedges associated with our European CLO investments. Turning to Slide 11. Total net asset value was $159.7 million at June 30, up from $153.8 million at March 31, and NAV per share increased to $4.18 from $4.09. Cash and cash equivalents totaled $23.5 million. Reverse repo borrowings declined by nearly 9% to $151.9 million from $166.3 million, while unsecured notes outstanding remained unchanged at $54 million. Lower borrowings and a higher net asset value brought our leverage ratios down. Our debt-to-equity declined to 1.29x at June 30 from 1.43x at March 31, leaving us with a stronger, more flexible balance sheet and additional borrowing capacity entering the third quarter. Together with the higher reinvestment yields I mentioned earlier, that additional balance sheet capacity reinforces our ability to grow NII. With that, I'll turn the call over to Greg to discuss the CLO market environment, portfolio positioning and outlook. Greg?

Thanks, Chris. It's a pleasure speaking with everyone again. As Larry and Chris described, Q2 was a great quarter for EARN and provided a particularly attractive opportunity set. Sharp CLO market volatility in Q1, driven first by weakness in software loans and followed by disruption from the Iran war drove an increase in actionable trading opportunities, and our debt issuance put us in a stronger position to capitalize on them. As always, we weigh opportunities across CLO mezz and equity and actively maneuvered the book with 64 trades during the quarter, not including hedges or deal calls. In particular, we found CLO equity in the secondary market, specifically in the U.S. to be a compelling opportunity. CLO equity NAVs were depressed entering the quarter, but defaults were not meaningfully elevated. In fact, default rates and distressed debt exchange activity both declined modestly in the quarter and loan prices recovered. Further, despite the recovery in loan prices, the share of loans trading above par remained relatively low and much of the strength in loans coming from discounted names. With fewer loans trading above par, par erosion and excess spread compression posed less of a risk, benefiting longer tenor equity profiles with robust interest cash flow streams. This was a welcome change from prior quarters when loan repricing rates were extremely high and reinvestment opportunities for CLO collateral managers were limited. In response to these developments, we continued shifting towards longer tenor, higher cash flow structures during the quarter, while reducing exposure to shorter tenor positions with greater sensitivity to loan price volatility. Meanwhile, as the quarter marched on and CLO debt spreads recovered, CLO equity in deals that were approaching or passing their first call date saw meaningful benefits from the opportunity to refinance liabilities that had originally been set at wider spreads. EARN's CLO equity profile benefited from several of these refinancings and resets during the quarter. This favorable dynamic has persisted so far in Q3 with CLO debt spreads remaining resilient. By contrast, the new issue market for CLO equity remains unattractive in our view, and we again purchased no new issue equity during the quarter. CLO mezz has been a relatively steady performer for EARN, and that trend continued into the second quarter. We rotated out of lower coupon, shorter spread duration positions trading near or above par and into higher coupon, wider spread investments with stronger underlying credit fundamentals. Mezz currently offers an attractive combination of yield, downside protection and liquidity. Our mezz portfolio had a great quarter, led by high net interest margins, and we continued -- we also continue to benefit from calls of shorter-dated mezz bonds. We turn over the mezz portfolio quite actively. And with high-yield corporate bond spreads continuing to trade around 300 basis points, CLO BBs at roughly 2 to 3x that spread continue to offer compelling relative value. Furthermore, these are spreads to maturity, while many of these bonds offer additional upside from deal calls or resets. As a result, higher quality, higher coupon BB at discounts to par has been one of our favorite areas for incremental investments. In Europe, we remain underweight, particularly in equity, which represented less than 1% of the portfolio at quarter end. Concerns about a tightening loan market on the back of increased CLO issuance make us wary of a repeat of what U.S. CLO equity experienced in 2025 with NIM compression and reduced equity cash flows. Between our active repositioning in both CLO equity and mezzanine and the favorable tailwinds in both sectors, I believe our portfolio's long-term earnings power is substantially stronger than it was 3 months ago. Lastly, I'd like to highlight the role of our hedges. We trade our portfolio actively, but it can take time to source CLO positions that meet our investment criteria. When we completed our debt deal in March, one of our biggest risks was whether we could deploy the proceeds at wider spread levels before the market potentially tightened back. Given that the cost of the debt was already locked in, this motivated us to hold a smaller hedge portfolio while we were still deploying the proceeds, and this was the primary driver of the decline in hedge notional amount that Chris referenced earlier. This reduced the run rate drag from our hedges during the quarter. And meanwhile, we continue to carry the CLO positions we previously acquired at wider yield spread levels. Combined with our deployment of the proceeds during the quarter, this all helped minimize the earnings drag associated with the new capital. Looking forward, we're more cautious now that the market has returned to somewhat tighter levels, but loan fundamentals are improving and the CLO equity market looks as attractive as it has in some time. We will continue to value liquidity and the ability to maneuver the book. Now back to Larry.

As Greg's comments make clear, we continue to see plenty of opportunities to actively manage and improve the portfolio. We are already seeing the benefits in our third quarter results. I encourage investors to review the July portfolio update that we posted last night to our website. As reflected in that update, EARN's positive momentum continued into July. We generated an economic return of approximately 3.1% for the month or $0.13 per share. This more than covered our $0.08 monthly distribution and enabled NAV per share to increase by approximately $0.05 in July, using the midpoint of the NAV range reported in that update. I can also report that adjusted NII for July was approximately $0.06 per share, representing a monthly run rate that's about 20% higher than our second quarter figure. This shows that the earnings capacity we built during the second quarter is beginning to translate into incremental NII. And as mentioned, we still see significant upside from there as we deploy our remaining balance sheet capacity and continue to rotate the portfolio. On the topic of rotation, we have remained highly active in the third quarter, executing 38 CLO trades in just the past 6 weeks. This activity reflects the same portfolio discipline we've applied consistently. We've exited positions where we believe we've already captured most of the value, and we've redeployed that capital into investments that we believe offer better yields, stronger structures and better risk-adjusted returns. Our overall portfolio size is roughly unchanged so far in the third quarter as new investment activity has roughly offset stronger-than-projected deal call activity, natural return of investment on CLO equity and opportunistic sales. In conclusion, we believe that the current investment environment is ideally suited for EARN to keep growing net investment income and generating attractive total returns. Even if volatility returns, we believe that our active trading, flexible balance sheet and disciplined hedging strategy will once again allow us to capitalize on market dislocations and create value for shareholders. In either case, we believe that EARN is well positioned to generate attractive long-term risk-adjusted returns across a wide range of market environments. Thank you again for your continued interest and support of Ellington Credit Company. Operator, please open the line for questions.

[Operator Instructions] And our first question today comes from Crispin Love with Piper Sandler.

So you definitely took advantage of some of the dislocation in the prior quarter. And you did comment that the June quarter didn't fully reflect the expanded repositioned portfolio. And Larry, you just called out the $0.06 run rate in adjusted net investment income in July. Can you just discuss the potential trajectory as you look forward as you talked about you could add some leverage, could continue to tap the ATM? And then just with all that in mind, how comfortable you are with the current dividend level?

Yes. Start with the dividend, comfortable with the level, and I'm going to reiterate what I think I said on last earnings call, which is we see us getting to -- into the low 20s on net investment income, adjusted net investment income.

Okay. So getting to the low 20s over the next couple of quarters?

Yes, sure.