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Ellington Financial LLC  (NYSE:EFC)
Q4 2018 Earnings Conference Call
Feb. 21, 2019, 11:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial Fourth Quarter 2018 Earnings Conference Call. Today's call is being recorded. At this time, all participants have been placed in a listen-only mode. Then, the floor will be opened for your questions following the presentation. (Operator Instructions)

It is now my pleasure to turn the floor over to Jason Frank, Corporate Counsel and Secretary. Sir, you may begin.

Jason Frank -- Secretary and Corporate Counsel

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 filed on March 15th, 2018, 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 statement, whether as a result of new information, future events or otherwise.

I have on the call with me today, Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, our Co-Chief Investment Officer; and JR Herlihy, our Chief Financial Officer.

As described in our earnings press release, our fourth 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 endnotes at the back of the presentation.

With that, I will now turn the call over to Larry.

Laurence Penn -- Chief Executive Officer and President

Thanks, Jay, and good morning everyone. As always, thank you for your time and interest in Ellington Financial. On our call today. I'll start with an overview of the fourth quarter. Next, our CFO, JR Herlihy, will summarize our financial results; and then Mark Tecotzky, our Co-Chief Investment Officer, will discuss our portfolio positioning and performance, recent market trends and what our investment outlook is going forward. Finally, I will discuss our reconversion, which we've now completed, and which is retroactive to January 1st, 2019. Then, we'll open up the floor to questions.

During the fourth quarter, a confluence of factors steadily wait on the markets, including fears of a looming trade war, recessionary and global growth concerns, and worries that the Federal Reserve and other central banks were finally ending their accommodative monetary policies. Market volatility spiked including interest rate volatility, all this led to a slighter (ph) quality. The 10-year treasury declined 55 basis points over the last seven odd weeks of the year and yield spreads in virtually every fixed income sector widened relative to treasuries and interest rate swaps with many sectors finishing the year at or near their two-year widest levels.

Despite this challenging market environment, Ellington Financial preserved its book value. Thanks to our hedging strategies and diversified portfolio. These two attributes, our disciplined hedging and our diverse sources of income continued to be differentiators for EFC in the fourth quarter. We registered a slightly negative economic return of minus 20 basis points for the quarter, which we believe represents an outperformance in what was a very difficult quarter for the credit markets.

During the fourth quarter, we had strong results from several of our loan strategies, including consumer loans and non-QM loans, where we completed our second non-QM securitization in November. We believe that many of our loan strategies In addition to providing us with a pipeline of investments over which we have greater control and visibility, have the additional benefit of being relatively insulated from interest rate movements and global macroeconomic events.

We also took steps to further solidify our proprietary pipeline of loans. In December, we closed on another strategic equity investment, this time in a consumer loan originator from which we have been steadily purchasing loans since early 2015. In conjunction with the strategic investment, we expanded our forward flow purchase agreement with this originator. Thus locking in a steady supply of high yielding, relatively short duration loans. And with the strategic equity investment, we will also be able to participate in the upside of this originator as their overall business grows.

Additionally in the fourth quarter, we continue to participate in the asset ramp up for Ellington's fourth sponsored CLO. And moving into 2019, we have also begun participating in the asset ramp up for the first planned Ellington-sponsored CLO transaction in Europe. I'm very excited about the growth of our CLO business and believe it will be an important contributor to EFC's earnings going forward.

Turning to Slide 4, you'll see that our credit portfolio actually decreased in size quarter-over-quarter, which was its first sequential decrease in more than two years. The two main drivers of this, where the closing of our non-QM loan securitization in November along with sales of some of our non-REIT qualifying assets in preparation for the reconversion, which will JR will get into in more detail. But while the portfolio was slightly smaller, and our net investment income declined due to some one-time expenses, we were still able to continue growing our adjusted net investment income. So our adjusted net investment income continued to grow and in fact it covered our $0.41 quarterly dividend for the quarter. Finally during the quarter, we also took advantage of our discounted stock price by repurchasing more than $5.5 million of our common shares.

Looking back on the 2018 full year, I'm very pleased with our performance and the year marked by extreme and sudden credit spread widening, both in the very beginning of the year and throughout the fourth quarter. Our credit portfolio still delivered positive economic returns each and every quarter. We ended up delivering a very solid overall economic return of 9.2% and grew book value per share even after payment of $1.64 in dividends.

Our shareholders were rewarded with a 17% total return on our stock, outperforming virtually the entire mortgage REIT sector. We successfully realized our objective of prudently growing our credit portfolio and our adjusted net investment income, all while setting the stage for our conversion to a REIT.

And with that, I'll turn the call over to our CFO, JR Herlihy, to go through our financial results for the quarter in more detail.

JR Herlihy -- Chief Financial Officer

Thanks, Larry, and good morning everyone. Please turn to Slide 6 for a summary of our income statement. For the quarter ended December 31st, 2018, EFC recorded a GAAP net loss of $2.2 million or $0.07 per share as compared to GAAP net income of $6.7 million or $0.22 per share in the prior quarter. Net investment income declined to $10.2 million or $0.33 per share from $11.7 million or $0.38 per share last quarter.

Net income was down sequentially due to the decrease in net investment income, which was related to the issuance cost of our non-QM securitization and one-time costs associated with the reconversion, and also because net unrealized losses increased quarter-over-quarter driven by markdowns on our interest rate hedges and on several of our credit strategy is connected to the market weakness of the fourth quarter. These net unrealized losses exceeded net realized gains in the fourth quarter and were also up quarter over quarter.

After adjustments, net investment income was $0.41 per share, up $0.01 from last quarter, and covered our quarterly dividends. Please keep in mind that while we view adjusted net investment income as a good proxy for our core earnings power, it does have its limitations as a portion of our capital will always be invested in assets that we hold for capital appreciation as opposed to generating current net investment income. Net investment income also does not capture much of the total returns that we generate with our opportunistic trading.

Please turn to Slide 7 for details on the attribution of earnings between our credit and agency strategies. In the fourth quarter of 2018, the credit strategy generated gross income of $8.1 million or $0.26 per share, while the agency strategy generated a gross loss of $4.9 million or $0.16 per share. These amounts compare to gross income from the credit strategy of $11 million or $0.36 per share, and gross income from the agency strategies of $741,000 or $0.02 per share in the third quarter.

In the credit strategy, total net interest income was $17.7 million, while net realized and unrealized loss was $12 million, as weakness in the credit markets caused many of our security strategies to underperform. However, much of this underperformance was offset by our net credit hedges and other activities which generated a net gain of $8.4 million for the quarter.

Other investment related expenses increased to $5.5 million this quarter from $3.9 million due to issuance costs of $1.6 million related to the non-QM securitization completed in November 2018. In the agency strategy, declining interest rates generated net realized and unrealized gains on our agency assets of $8.5 million, while net interest income totaled $2.6 million. Losses on our interest rate hedges and other activities exceeded these gains, however, as declining interest rates and high levels of interest rate volatility generated net realized and unrealized losses of $60 million.

Turning next to Slide 8. At year-end, you can see that the size of the credit portfolio decreased about 8% sequentially to $1.1 billion. Consistent with prior quarters, these totals are quoted before consolidating the non-QM securitization trusts. In the two charts on this slide, you can see smaller allocations quarter-over-quarter to residential loans and REO, which reflects the effects of the non-QM securitization, and to CLO and non-dollar MBS, ABS, CLO and other, which reflects rotation out of non-REIT qualifying assets in preparation for the reconversion.

At the same time, you can also see the tremendous quarter-over-quarter growth of our requalifying small balance commercial loan portfolio as reflected in the CMBS and commercial loans in REO slides. As a final point, as of mid-February, our non-QM loan portfolio had already grown back to about $160 million.

Turning to Slide 9, you can see that our long agency portfolio increased to $975 million from $944 million during the quarter with the asset mix essentially unchanged.

Next please turn to Slide 10 for a breakout of our borrowings and leverage. At year-end, we had a total debt-to-equity ratio of 3.36:1, up from 3.12:1 last quarter. Our recourse debt to equity ratio actually declined however to 2.68:1 from 2.81:1. Because we consolidate the non-QM securitization trusts for GAAP reporting purposes, all of the non-retained tranches of those deals were not recoursed to us, due constitute liabilities in our balance sheet and thus increase our total debt-equity ratio, but they don't impact our recourse debt to equity ratio.

For the fourth quarter, our total G&A expenses were $4.7 million, up from $4.2 million last quarter, driven by costs associated with the reconversion. In the fourth quarter, reconversion costs were $615,000, compared to $236,000 in the previous quarter. We estimate that all remaining expenses related to the conversion will total approximately $1.2 million. Excluding the costs associated with the reconversion, our annualized expense ratio for the fourth quarter was 2.7%. We ended the quarter with book value per share of $18.92.

I will now turn the call over to Mark.

Mark Tecotzky -- Co-Chief Investment Officer

Thanks, JR. Against the backdrop of extreme market volatility, EFC performed very well in Q4. Despite a double-digit percentage drop in the S&P and several point drops in high-yield bonds and leveraged loans, EFC's credit strategies made money for the quarter. I attribute much of the strong performance of our credit portfolio, first to the benefits of short spread duration relative to our yields, and second to the benefits of diversification with an asset mix that generally seasoned or low LTV and in many cases both. We consistently evaluate how assets will perform in good and bad markets before we invest, and that discipline in asset selection has given us a very stable portfolio.

The asset mix of EFC's credit portfolio is now largely a non-CUSIP investments, many sourced through proprietary relationship. So the credit portfolio's value has less correlation to liquid credit indices such as high yield. It is precisely for this reason that EFC has gradually reduced credit hedges over the last three years. We just don't need the same amount hedge changes in book value as we used to have and our portfolio mix is more correlated to liquid credit indices.

If you look on Slide 23, you can see that quarter-over-quarter we did not need to make any major adjustments to our credit hedges to ensure their effectiveness this quarter. Q4 is a great example of how our current portfolio does not have a lot of price volatility that requires a lot of hedges to neutralize. Our current basket of hedges did a great job and is appropriately sized as is to be comfortably REIT compliant, which is one factor that shaped our thinking about -- with the REIT conversion.

Turn to Page 8 to see how our asset mix evolved during the quarter. The first thing to note is that the drop in portfolio size was largely the result of the successful completion of our second non-QM securitization of LendSure loans. We launched the deal in November, just these spreads were beginning to widen, so we got ahead of the December volatility. LendSure now has over a 100 employees and its monthly loan volume continues to grow. Our non-QM loan strategy was a significant contributor to earnings this quarter. We also continue to deploy more capital in our commercial real estate strategies, mostly new originations. The commercial real estate strategy within EFC historically has had a great ROE, but the pipeline can sometimes be irregular. This quarter the market came to us and we were able to put a lot of money to work.

As outlined in the supplemental slides detailing the REIT conversion, we opportunistically sold non-REIT qualifying assets, specifically CLO debt and some non-dollar investments. As implied by the dotted line on Slide 20, we expect that REIT balancing out of some lower yielding non-qualifying assets into REIT-qualifying assets will continue at a gradual pace throughout the year, without any reduction in projected portfolio yield.

Our Agency MBS portfolio underperformed during the quarter. And in fact, more than 100% of our overall net loss during the quarter came from the strategy. The volatility in financial markets was extreme in Q4 and dramatic spread widening caused Agency MBS to underperform hedging instruments significantly. However, as is often the case with Agency MBS losses that are caused by volatility induced spread widening, the loss is earned back, the spreads revert to the mean. That's exactly what we have seen so far in 2019 as our agency strategy has already earned back well over half its Q4 loss.

Agency MBS have been consistent -- have been a consistent and diversifying source of returns for EFC since our inception more than 10 years ago, The thing about Q4's performance changes our perception of the earnings power of our agency strategy. In fact, seeing some of the best investment opportunities in more than two years with the wider spreads, we grew our Agency portfolio in Q4, that's shown in Slide 9.

The high level asset portfolio, asset breakdown on Slide 11 explains a lot about our stable credit performance in Q4. In our loan strategies ,we frequently target shortage spread duration assets. Our consumer loan portfolio was very short duration, about one year. Our non-QM loan portfolio consists mostly of 7-year adjustable-rate mortgages. So again there's far less price volatility in 30-year fixed-rate mortgages.

Most of our commercial mortgage loan originations have had one to two-year terms in very high coupons. So again, they've had limited price volatility. Our NPL strategy is focused on quick resolution as opposed to long-term workout plans. We focused on maximizing yield while reducing price volatility, which we achieve in large part by reducing duration. As a result, when credit spreads widen market wide, which is exactly what you saw in Q4, our asset price declines tend to be more modest than a longer duration credit sensitive strategies.

I and the other EFC portfolio managers were excited about the REIT conversion, which should open up new avenues of capital to us. It also gives us enough flexibility to generate significant income and importantly enough flexibility with our hedges to mitigate price swings from either rising interest rates or credit spread volatility.

Now back to Larry.

Laurence Penn -- Chief Executive Officer and President

Thanks, Mark. Before we open the call to questions, I'd like to take a few minutes to discuss our tax conversion away from a publicly traded partnership to a REIT, which is now complete and effective retroactive to January 1st, 2019. Our new tax structure should provide substantial benefits to Ellington Financial and its shareholders, and won't require us to materially change our investment or hedging strategies. Our management had, from time-to-time in the past thought about the potential benefits of converting away from a publicly traded partnership, the changes in the tax law implemented toward the end of 2017 along with the evolution of our portfolio in recent years made this the right time for Ellington Financial to take the strategic step.

We've included a few slides on the REIT conversion as an appendix to our Q4 earnings presentation beginning on Slide 15. Here, we list the major benefits of operating as a REIT rather than as a publicly traded partnership, including an expanded investor base, better liquidity for our stock, simplified tax reporting for shareholders, as well as a 20% REIT tax deduction for domestic shareholders. Crucially, we will be able to maintain our core investment and hedging strategies as a REIT, which we view it as a prerequisite to any conversion.

Now I'll touch on each of these benefits in a bit more detail. Please turn to Slide 16. Converting to a REIT should expand our potential investor base and approve the liquidity of our stock over time. Historically, the size of EFC's potential investor universe was limited by the publicly traded partnership structure, and the K-1 it generated. As a REIT, we solve this problem. We'll generate a 1099 instead of a K-1, starting with this tax year. And by doing so, we can appeal to a larger investor base, including traditional REIT buyers, institutional investors whose mandates preclude buying partnership interests, or just the many investors who prefer not to buy partnership interests.

The REIT structure also opens the door to our inclusion in many indices, which is particularly appealing given the tremendous growth in passive index-based investing. As a REIT we will also be able to access additional sources of financing that were not feasible under our previous structure, including convertible notes and preferred stock. And finally, our tax structure now matches that of the hybrid mortgage REITs to whom we've always been compared, which should simplify investor analysis and comparability.

Slide 17 reiterates the point about simplifying tax reporting. Our tax conversion is effective retroactive to the beginning of the year. So, for the entire 2019 tax year, shareholders will only receive a Form 1099.

Turning to Slide 18. As a REIT, our ordinary dividends should qualify for the 20% pass-through deduction for US individuals, which was a big component of the 2017 tax legislation. By the way, in a recent development, this tax advantage now also applies to US individuals who hold our shares indirectly through mutual funds. Again, this provides a substantial new benefit to our shareholders and importantly, levels the playing field for us when competing with other mortgage REITs for investment capital.

Finally turning to Slide 19. The key to all of this was that we could convert to a REIT and still maintain all of our core investment and hedging strategies. Over the past few years, our portfolio had evolved in response to market opportunities with the result that are proprietary loan strategies, most of which are real estate related. We're driving a bigger and bigger portion of our earnings. As this was happening, we were naturally getting closer and closer to being REIT-qualifying.

In addition, most of our loan strategies don't involve large credit hedges and this also made REIT conversion easier. That said, we do continue to maintain credit hedges on certain assets and in a quarter like the one we just had, where credit spreads widened substantially, you can see their importance in protecting book value. The bottom line is that we believe that we can comfortably satisfy the REIT tests while still maintaining our interest rate, credit and currency hedging discipline.

Over the past several months, as we prepare to become a REIT, we have sold a sizable portion of our non-REIT-qualifying assets and shifted this capital into REIT-qualifying assets, but most of the assets we've sold were merely placeholder assets, that is to say, they were temporary lower yielding assets that were not part of our core strategies anyway. Additionally, we intend to continue to invest in our highest conviction non-REIT-qualifying strategies, including consumer loans and Ellington-Sponsored CLOs, the amounts that still allow us to comfortably satisfy the REIT tests.

Looking forward, starting with our first quarter 2019 releases and similar to other mortgage REITs, we plan to report core earnings as an alternative non-GAAP earnings metric instead of adjusted net investment income, which we've been reporting as a PTP. That said, we believe that these are quite comparable metrics. Given what we're seeing in terms of the current opportunities in our core strategies, we think that our prospects for core earnings growth are excellent.

In summary, we are extremely excited to have completed our conversion to a REIT. The benefits of being a REIT should be real and significant and I wanted to thank our entire team for all of their hard work achieving this milestone for Ellington Financial as planned and on time.

With that, we'll now open the call to your questions. Operator, please go ahead.

Questions and Answers:

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Doug Harter of Credit Suisse.

Josh Ramus -- Credit Suisse -- Analyst

Hey, guys. This is actually Josh on for Doug. Larry, now that REIT-conversion is behind you. Can you talk a little bit about the next steps needed in order to be eligible for inclusion in some of the indices that you've mentioned previously? And as a follow-up, what kind of timing could we possibly see until those additions? Thanks.

Laurence Penn -- Chief Executive Officer and President

Sure. So one prerequisite which we hope to complete shortly is -- it turns out is to actually change the state law structure or corporate structure some might call it, from a limited liability company, which we currently are Delaware limited liability company to a corporation from state law purposes to Delaware Corporation. So that's in the works and we plan to do that shortly in the next couple of weeks is our goal there.

And the Russell Index just to name one is -- goes through its REIT balancing later in the second quarter, so we believe that we should be on track for inclusion in some of the Russell Indices that exclude publicly traded partnerships or companies that are limited liability companies or partnerships for state law purposes.

Josh Ramus -- Credit Suisse -- Analyst

Great. Thanks, Larry.

Laurence Penn -- Chief Executive Officer and President

You're welcome.

Operator

Your next question comes from the line of Crispin Love of Sandler O'Neill.

Crispin Love -- Sandler O'Neill -- Analyst

Hi guys. Thanks for taking my question. I'm just curious about the trajectory of the credit portfolio that you would expect over the next couple of quarters. I understand the 8% sequential decline in the fourth quarter, mostly because of the non-QM, but do you guys still think you have room to grow that portfolio or would it be kind of more repositioning within the credit portfolio?

Laurence Penn -- Chief Executive Officer and President

Yeah, I think -- we think that we still have room to grow the portfolio and certainly replacing that 8%. But we think that our leverage is prudent and we can continue, we certainly have access to ample financing. We have our assets that we're not currently financing, that we could finance. So we think that we have continued room to grow the portfolio. The agency part of the book also has room to grow, that's a little bit higher leverage obviously, but we think the credit part of the book also has room to grow as well.

Crispin Love -- Sandler O'Neill -- Analyst

And are you expecting any more REIT conversion expenses in the first quarter?

Laurence Penn -- Chief Executive Officer and President

Yes. So we -- I think JR already mentioned that, we're projecting $1.2 million of expenses that have not yet been included in the financials that you've seen, namely the Q4 that we just released that showed a few cents of expenses, and we think that there is about $1.2 million left as of December 31st of last year.

JR Herlihy -- Chief Financial Officer

Yeah. Hey, Crispin, this is JR. That's right. And I would expect a good portion, not all, but a good portion of those to come in Q1, I think that's our estimate right now.

Crispin Love -- Sandler O'Neill -- Analyst

Okay, sounds good. And then, can you just talk a little bit more about the consumer strategic relationship. I know it's been a relationship since 2015, that you've been getting loans from, but is it personal loans, home improvement, auto, and then do you have any kind of equity partnership relative to size Longbridge and LendSure?

Laurence Penn -- Chief Executive Officer and President

Okay. So I'm only going to comment -- I'm not going to give you all of that detail. The size of the investment was more comparable to the LendSure investment. So it's small relative to the Longbridge investment, for example, and under $5 million. In terms of the space that it's in, I don't want to get into details there, even it's been a steady partner of ours as we -- as I said since 2015 but -- or as I said earlier in the call, but the size of the flow have not been -- it's not our biggest consumer loan provider by any stretch. So we're certainly hoping that with partly with this capital from us and with other plans that we have and they have that the flow is going to grow substantially over time, but I'm not in a position right now to provide any more details on that new investment of ours.

Crispin Love -- Sandler O'Neill -- Analyst

Thank you for taking my questions.

Laurence Penn -- Chief Executive Officer and President

Thank you.

Operator

Our next question comes from the line of Eric Hagen of KBW.

Eric Hagen -- Keefe, Bruyette and Woods -- Analyst

Thanks. Good morning and congrats on the conversion, that's excellent.

Laurence Penn -- Chief Executive Officer and President

Thank you.

Eric Hagen -- Keefe, Bruyette and Woods -- Analyst

The minority investments that you have in companies like LendSure, as a REIT will there be anything preventing you guys from acquiring the entire company if you wanted to ever do that down the road?

Laurence Penn -- Chief Executive Officer and President

Yeah. So the answer technically is no. We can't do that. They're just like with all the other REIT tests right, you would have to satisfy, you have to continue to satisfy the REIT test and generally, right, an investment in an operating company would be held in taxable REIT subsidiary.

Eric Hagen -- Keefe, Bruyette and Woods -- Analyst

Okay.

Laurence Penn -- Chief Executive Officer and President

And so -- and as I'm sure, you're familiar, the size of your taxable REIT subsidiary in aggregate can't exceed certain limits. So not 20% basically, so that would a long way to go and (inaudible) to grow is then that would increase all these limits. So I don't see the REIT test is really getting in the way they are, obviously given the size of these investments. But we certainly have no plans and there had been no discussions about -- just to be clear about acquiring any larger interest than the minority interests that we currently have in any of these companies.

Eric Hagen -- Keefe, Bruyette and Woods -- Analyst

Yeah, I didn't mean to suggest that there was anything like that taking place in the future. Just --

Laurence Penn -- Chief Executive Officer and President

Yeah.

Eric Hagen -- Keefe, Bruyette and Woods -- Analyst

Maybe just the option.

Laurence Penn -- Chief Executive Officer and President

Right. And we do have some options that can actually connect with some of these investments, but again it would never be to acquire majority interest. At least at this point, that hasn't been discussed and that's not on the table.

Eric Hagen -- Keefe, Bruyette and Woods -- Analyst

Got it. Okay, great. And then just a market based question on the non-QM side, how deep is the market for whole loan sales? Are you guys engaging in any whole loan sales or is it really just -- is that not the intention of that strategy?

Mark Tecotzky -- Co-Chief Investment Officer

So this is Mark. By and large when we have sold loans, by far the dominant outlet has been securitizations. From time-to-time, we have been involved in some smaller whole loan sales, but if you think about the market broadly, there are -- there is a whole loan sale activity going on. There are certainly banks that are interested in this shorter duration, higher coupon, higher yielding long-term securities. And I would say that we're also seeing a broadening and a little deepening in the investor base for long-term securitizations.

The volume of securitizations was up last year. There has been -- I would call it robust issuance this year. So non-QM and other post-crisis mortgage securitization vehicles, say, Jumbo deals that are getting done, it is getting a burgeoning sponsorship from a lot of investors that have seen the legacy non-agency market shrink, right, that market has gone from $1 trillion down to $350 billion, $400 billion. So between the credit risk transfer deals, non-QM, RPL deals, Jumbo 2.0 deals, mortgage originations post-financial crisis with more credit enhancement, more considerate underwriting that's getting to be a bigger and bigger part of the market.

Eric Hagen -- Keefe, Bruyette and Woods -- Analyst

Great. Yeah, that's helpful color. Thank you very much.

Operator

Our next question comes from the line of Tim Hayes of B. Riley FBR.

Tim Hayes -- B. Riley FBR -- Analyst

Hey, good afternoon, everyone. Mark, you made some comments around the credit hedges and we saw them increase in the quarter a little bit. Just wondering how you see this portfolio trending as you allocate more capital to non-mark to market loan strategies?

Mark Tecotzky -- Co-Chief Investment Officer

I think for some of the loans strategies like the consumer loan strategy, we typically don't do credit hedges there, where you're more likely to see some credit hedges is when we retain investments from the Ellington-sponsored, Ellington-managed CLOs, and also some of the CMBS investments, CMBS B-pieces, sometimes we think it's optimal to have a credit hedge on those. So I would say that as the portfolio grows, non-QM that is solo LTV and has had really no losses that we typically don't have credit hedges on, same thing with the consumer loans, CMBS B-pieces and the CLO equity that you might see credit hedges go on through just really the pro rata with the investments.

Laurence Penn -- Chief Executive Officer and President

I'd like to just add one thing, which is just to clarify. Our loan strategies, in fact, all of our strategies are mark-to-market. We mark-to-market through the income statement and that's just very important to know. Obviously when you've got a concept like core earnings or adjusting the net investment income which we -- historically we're publishing, that doesn't take into account on generally speaking unrealized gains and losses. But when we have, for example, a loan that becomes non-performing hasn't happened at non-QM, but it certainly has happened, for example, in consumer loans. We absolutely do take a mark-to-market hit on that through the income statement.

So I just wanted to make that clarification and that won't change just because we are a REIT now. We're going to continue to use mark-to-market GAAP accounting through the income statement. So I just wanted to clarify that.

Tim Hayes -- B. Riley FBR -- Analyst

Okay. I appreciate the clarification there and the color around that. And then just since you touched on adjusted NII, you covered the dividend this quarter with adjusted NII and you've made some comments around your outlook for NII and portfolio growth going forward. Is your expectation you'll be able to cover the dividend with NII going forward?

Laurence Penn -- Chief Executive Officer and President

Yes.

Tim Hayes -- B. Riley FBR -- Analyst

Okay, got it. And then just a quick housekeeping question. On Slide 5, you gave the weighted average market yields for the different asset classes within your portfolio and they seem to jump around a decent amount. I'm just wondering, this quarter if that was related to the market volatility or if there's any impact from portfolio repositioning or leverage in there at all?

JR Herlihy -- Chief Financial Officer

Yeah, hey Tim, it's JR. So some of that dynamic will be the mix of assets within a given row. So as an example, CMBS -- the first one, CMBS and personal mortgage loans. It varies point of time that will have different portion of CMBS versus small balance of commercial. And then within commercial loans, sometimes those will be origination, sometimes there'll be NPL. So I think a lot of the movement quarter-to-quarter you're seeing is probably related to the composition of these usual categories.

Residential mortgage loans has non-QM, it also have some resi NPL, RPL. So I think you've probably seen that dynamic across few different loans (ph). If there's specific yields you noted that you wanted to talk about, we can get into the detail there as well.

Tim Hayes -- B. Riley FBR -- Analyst

Yeah, I'll save that for -- I'll take it offline, but I appreciate the color there and I'll hop back in the queue. Thanks.

JR Herlihy -- Chief Financial Officer

Great.

Operator

Our final question comes from the line of Mikhail Goberman of JMP Securities.

Mikhail Goberman -- JMP Securities -- Analyst

Hi. Good morning, gentlemen, and congrats on the REIT conversion. Well done.

Laurence Penn -- Chief Executive Officer and President

Thanks. Good morning.

Mikhail Goberman -- JMP Securities -- Analyst

Good morning. Just a two part question kind of related. Within the credit space, given the spread widening that we saw in the fourth quarter, where do you guys see the most attractive returns in that space? And also kind of within that, what's your outlook on growth and non agency residential loans for the year?

Mark Tecotzky -- Co-Chief Investment Officer

So, non-agency residential loans, if I think about just what we expect out of LendSure. I'd expect, we'll see their volumes probably grow 40% to 50% this year. They've been adding staff, they've been adding market share. That's our projection there. In terms of where's the best, what's sort of risk adjusted ROE, I'd say that we value diversification. So when you look at how the portfolio changes quarter-to-quarter, it's generally incremental. We certainly saw in Q4, a lot of interesting opportunities on commercial real estate side. So I think that's likely to persist.

JR talked about how we've been ramping up the non-QM portfolio, so that has an attractive ROE right now. Consumer loan strategy has been performing very well. And you know Larry talked about our fourth CLO, so all those sectors I expect are going to contribute assets.

Mikhail Goberman -- JMP Securities -- Analyst

Okay. Thank you very much.

Laurence Penn -- Chief Executive Officer and President

Thanks.

Operator

And ladies and gentlemen, that does conclude our Q&A session and today's conference call. Thank you for your participation. You may now disconnect and have a wonderful day.

Duration: 39 minutes

Call participants:

Jason Frank -- Secretary and Corporate Counsel

Laurence Penn -- Chief Executive Officer and President

JR Herlihy -- Chief Financial Officer

Mark Tecotzky -- Co-Chief Investment Officer

Josh Ramus -- Credit Suisse -- Analyst

Crispin Love -- Sandler O'Neill -- Analyst

Eric Hagen -- Keefe, Bruyette and Woods -- Analyst

Tim Hayes -- B. Riley FBR -- Analyst

Mikhail Goberman -- JMP Securities -- Analyst

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