Ellington Credit's Bold Bet: A New Era of Risk and Reward

In the ever-shifting landscape of finance, Ellington Credit Company has made a bold move. The company, once a real estate investment trust (REIT) focused on residential mortgage-backed securities (MBS), has completed its conversion to a Delaware-registered closed-end fund. This transformation, effective April 1, 2025, marks a significant shift in its investment strategy, pivoting towards collateralized loan obligations (CLOs) and operating under the Investment Company Act of 1940. The question is: will this gamble pay off, or will it leave shareholders holding the bag?



The company's strategic shift towards CLOs began in earnest on March 29, 2024, when its Board of Trustees approved a transformation of its investment strategy. This move was accompanied by a rebranding to Ellington Credit Company and the revocation of its election to be taxed as a REIT, effective January 1, 2024. The company's CLO portfolio has since grown to approximately $108 million, representing about 50% of total capital allocation. This growth is a positive sign, contributing to half of the company's capital allocation and driving strong interest income.

However, the road to this transformation has not been smooth. The company reported a net loss of $0.04 per share for the second quarter of 2024, with net losses on Agency RMBS exceeding net gains on interest rate hedges. The agency MBS portfolio generated a modest net loss, contributing to the overall net loss for the quarter. Weak agency MBS performance impacted results, though the portfolio nearly broke even due to liquidity focus and risk management.

The company's Chief Executive Officer and President, Laurence Penn, remains optimistic about the future. He stated, "We are excited to begin this new chapter as a closed-end fund, which we believe will enhance our ability to generate strong risk-adjusted returns and unlock additional value for shareholders. Given recent market volatility, our timing may prove advantageous, positioning us for a potentially attractive investment environment in the months ahead."



The potential benefits of this transformation are clear. The company's focus on CLOs, especially mezzanine debt and equity tranches, aligns with its strategic transformation. The conversion to a closed-end fund will allow Ellington Credit Company to sell its remaining Agency MBS pools and acquire additional CLOs, which are expected to be a more lucrative investment in the current market environment. The company's net interest margin expanded to 4.24%, and it expects its adjusted distributable earnings to cover its dividend in the upcoming third quarter. The book value per share stood at $6.91 at the end of June, reflecting a stable financial position.

However, the potential challenges are also significant. The company's ability to convert to a closed-end fund/RIC and maintain its exclusion from registration under the Investment Company Act of 1940 is subject to numerous risks and uncertainties, including changes in interest rates and the market value of investments, market volatility, changes in default rates on corporate loans, and changes in government regulations affecting the business. Additionally, the company's net loss of $0.04 per share for the second quarter of 2024, with net losses on Agency RMBS exceeding net gains on interest rate hedges, highlights the potential risks associated with this transformation.

The company's cautious approach to promising higher dividends in the future, focusing on maintaining the current dividend level, further supports its strategy of generating strong risk-adjusted returns in the months ahead. However, the question remains: will this gamble pay off, or will it leave shareholders holding the bag? Only time will tell, but one thing is clear: Ellington Credit Company is betting big on CLOs, and the stakes could not be higher.