Ellington Credit Company (EARN) Earnings

Management highlights

- Market Environment Assessment * The first quarter 2026 CLO market downturn was driven by technical dislocation (yield spread widening, thin liquidity, heavy forced selling) rather than fundamental deterioration in underlying credit quality. The sell-off was triggered by concerns over AI-driven disruption to the software sector (a small but meaningful component of most CLO collateral pools), amplified by broader geopolitical tensions and a broader risk-off market shift. * U.S. and European leveraged loan prices fell more than 2% from their January 2026 peaks, with CLO mezzanine (especially BB-rated tranches) and equity facing extreme selling pressure. By the second quarter of 2026, market conditions improved, with real money buyers returning, liquidity improving, and spreads tightening, creating a strong tailwind for quarterly performance. - Capital Structure and Liquidity Actions * In late March 2026, the firm issued $54 million of 8.5% five-year senior unsecured notes to extend its liability profile, add non-mark-to-market financing, and build dry powder to capitalize on the dislocated market. Issuance costs of ~$2.3 million were fully expensed in the quarter. Proceeds were substantially fully deployed into attractive new CLO opportunities by the end of April 2026, with the remaining balance used to repay short-term secured borrowings. * As of March 31, 2026, the firm held $57.7 million in cash and cash equivalents. The overall CLO portfolio grew more than 6% to ~$328 million by April 30, 2026 after deployment of the new note proceeds. - Portfolio Positioning and Hedging * Management maintained a bias toward CLO mezzanine debt over equity during the volatility, and increased the credit hedge portfolio to ~$187 million in high-yield CDX notional equivalents as of quarter-end, up from $175 million at year-end 2025. As of March 31, 2026, the notional value of credit hedges exceeded the firm's total net asset value (NAV), reflecting a conservative downside protection strategy. A separate foreign currency hedge portfolio is maintained for European CLO exposure. * After the first quarter sell-off, management actively repositioned the portfolio: rotated out of low-coupon mezzanine positions priced near par (where management believes the market overestimates near-term call probability) into higher-coupon, wider-spread mezzanine assets with stronger credit fundamentals; added longer-duration, high cash flow CLO equity positions with solid covenant cushions, while reducing exposure to shorter-duration, highly leveraged equity positions more sensitive to loan price volatility. * Underlying CLO collateral remains 95% first-lien floating rate leveraged loans, with well-diversified sector exposure (no single sector exceeds 11% of total exposure, led by technology, financial services, and healthcare). Weighted average loan maturity is 4.3 years, with minimal near-term maturities. The weighted average junior overcollateralization cushion for CLO equity tranches declined only 6 basis points quarter-over-quarter to 4.29%, confirming the technical (rather than fundamental) nature of the sell-off. - Full Fiscal Year 2026 Inaugural Achievements * Completed RIC conversion, transitioned the portfolio out of mortgage-backed securities into CLO investments with minimal NAV impact, and scaled the CLO portfolio by 23% year-over-year. Nearly 75% of all CLO purchases have been mezzanine debt tranches, and over 260 trades were executed over the full year to capture relative value across the CLO capital structure. Total declared distributions for the full fiscal year were 96 cents per common share.

Guidance

- Management confirmed that the first quarter 2026 sell-off created a materially expanded opportunity set, with higher investment yields, slower prepayment/repricing activity that relieves prior excess spread compression, and the ability for CLO managers to acquire discounted performing loans that boost long-term return potential for CLO equity. - Management expects adjusted net investment income (NII) to begin an upswing after the second quarter 2026, with an immediate near-term target of reaching low 20s cents per share in adjusted NII per quarter. - The firm's April 2026 monthly economic return was nearly 7%, and the estimated midpoint NAV per share as of April 30, 2026 was $4.29, up from $4.09 per share at March 31, 2026. Management believes a meaningful portion of the first quarter 2026 mark-downs remains reversible as credit spreads continue to normalize, supporting further NAV recovery. - The firm enters the new fiscal year with a flexible balance sheet, ample liquidity, and strong positioning to generate attractive total returns, supported by higher reinvestment yields and improving market sentiment. Management's core long-term goal is to maintain a high dividend with minimal or no book value erosion.

Segment performance

Ellington Credit Company holds only two core investment product segments: CLO mezzanine debt and CLO equity, all within its overall $308 million CLO portfolio as of March 31, 2026. - CLO equity: Made up 53% of total CLO holdings (up 1 percentage point from year-end 2025). It was the primary driver of the quarter's net loss, due to large mark-to-market unrealized losses driven by wider market clearing yields, compressed excess spread from a January loan repricing wave, and broad selling pressure amid sector volatility. Lower projected cash flows pulled the weighted average cost yield on the full CLO portfolio down to 12.5% from 13.7% in the prior quarter, largely due to weakness in this segment. The median industry-wide CLO equity return for the quarter was -13%. - CLO mezzanine debt: Made up the remaining 47% of total CLO holdings. It proved far more resilient to market volatility than CLO equity, as its structural protections and subordination levels limited mark-to-market declines. Net investment income, trading gains, and positive impacts from deal calls of discount positions partially offset the sector's mark-to-market write-downs. During the quarter, 93% of the firm's $30.7 million in new purchases were allocated to CLO mezzanine debt, consistent with management's up-in-the-capital-stack bias during volatility. - European CLO investments accounted for 10% of the total CLO portfolio as of quarter-end, down from 12% at December 31, 2025.

Risks & headwinds

- Key ongoing risks cited by management include AI-driven disruption to affected sectors, global geopolitical tensions and conflict, general recession concerns, and continued volatility in credit and CLO markets. - The first quarter 2026 market environment highlighted the risk of technical dislocations and liquidity-driven sell-offs that can lead to material mark-to-market losses even when underlying credit fundamentals remain stable. - While the worst of the 2025-early 2026 prepayment/repricing wave has passed, spread compression concerns have reemerged to a limited degree as of May 2026, which could pressure CLO equity excess spread.

Analyst Q&A

• Q: After the $54 million unsecured note issuance at the end of the first quarter, how much dry powder remains to deploy, and how close is the firm to being fully invested? /

  A: Management states the vast majority of the note proceeds were substantially deployed by the end of April 2026, after the firm moved quickly to capitalize on the dislocated market opportunity. Only a small amount of additional capacity for secured borrowing on margin remains available. Going forward, portfolio activity will focus on rotating between positions to recharge adjusted net investment income, particularly shifting from lower-upside equity profiles to more attractive equity positions, rather than large new net investments.

• Q: Given the challenging first quarter market environment, how confident is management that it can cover the current dividend with adjusted net investment income over the near to intermediate term? /

  A: Management notes the debt issuance closed at the end of the first quarter, so the positive impact on adjusted NII will not appear until after the end of the second quarter 2026, when adjusted NII is expected to resume an upswing. The immediate next target for quarterly adjusted NII is the low 20s cents per share. Management expects that once this target is hit, active trading and the improved opportunity set will allow the firm to maintain its high dividend with minimal or no book value erosion, which has always been the core goal.