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Ellington Financial LLC (NYSE:EFC)
Q3 2019 Earnings Call
Nov 7, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the Ellington Financial Third Quarter 2019 Earnings Conference Call. [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 -- Deputy General Counsel and Secretary

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 14,2019, 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 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 third 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.

Laurence Penn -- Chief Executive Officer & 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 begin with an overview of the third quarter. Next, JR will summarize our financial results. And then, Mark will discuss our portfolio positioning and performance, recent market trends and our investment outlook going forward. Finally, I will provide some closing comments, and then we'll open the floor to questions.

Ellington Financial had another strong quarter, led by our proprietary loan businesses, most notably non-QM loans, small balance commercial mortgage loans and residential transition mortgage loans. We also benefited from strong performance in our Agency portfolio, where our focus on high quality specified pools and disciplined interest rate hedging generated excellent results despite a challenging environment for Agency RMBS during the quarter, that included wide swings in long-term interest rates, increasing prepayment rates, and an inverted yield curve.

Our common equity raise in mid-July was well timed, as it provided us with dry powder to capitalize on some great buying opportunities that emerged from the market volatility in August, in addition to providing capital for our ongoing high yielding loan pipelines.

We opportunistically added a significant amount of specified pools at wide yield spreads following the broad market sell-off in August, but of course, it was our credit portfolio that absorbed the majority of the additional capital, with the largest growth in our non-QM and residential transition loan strategies where we are seeing highly accretive return on equity.

We fully deployed the capital from our July common equity raise in only about seven weeks. So we struck a good balance between getting invested quickly to avoid a material drag on earnings and being patient enough that we were able to take advantage of the excellent buying opportunities that emerged in the wake of the August volatility.

I'm proud of both the pace and quality of our capital deployment this past quarter, which again demonstrated the strength of our origination of sourcing capabilities. As evidence of this, I am pleased to report that despite all the fresh capital, both our net income and our core earnings, not just core earnings in absolute dollars, but even core earnings on a per share basis, grew sequentially in the third quarter and both metrics continue to exceed our dividend run rate, as you can see on Slide 4. So we didn't miss a beat with the additional capital.

Our annualized economic return for the quarter was 7.1%, but excluding the one-time dilution from the raise, it was a solid 11.4%, keeping us on pace with our strong performance during the first half of the year and setting the table for continued strong performance going forward.

Finally, the average daily trading volume of EFC stock has increased significantly since the July raise and that was another objective of the raise, namely to increase liquidity for our stockholders.

On Slide 4, you can also see the significant growth for our credit and agency portfolios, both of which grew by double-digit percentages looking at total assets.

In terms of capital invested, as I mentioned before, the majority of the proceeds from our July equity raise was used to grow our credit portfolio, especially our non-QM and residential transition loan portfolios reflecting strong flow from those pipelines.

Turning now to Slide 5, you can see that our capital allocation to Agency, increased to 22% as of September 30, which is toward the upper end of the historical range for us. The larger Agency allocation is a combination of the investment opportunity we capitalized when spreads widened in August and is also an anticipated outgrowth of the REIT conversion as we've discussed on previous calls. Over the long term, I expect the Agency share of our capital allocation to decline as our loan portfolios continue to grow.

On the bottom of Slide 5, you can see that our overall debt to equity ratio or leverage was unchanged from the prior quarter at 4 to 1, while our recourse leveraged increased just slightly over the course of the quarter to 2.921 from 2.821. However, this takes into account our continued accumulation of non-QM loans during the quarter. And given that earlier this week, we priced our fourth non-QM securitization, when that securitization closes, it will meaningfully lower our recourse debt to equity ratio.

Finally, after quarter end, in October, having fully deployed the capital from the July common equity raise, we raised additional capital through our inaugural preferred equity raise, which I'll discuss in more detail in my concluding remarks.

And with that, I'll turn the call over to JR to go through our third quarter financial results 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 September 30, 2019, EFC reported net income of $17.3 million or $0.53 per share compared to $12.6 million or $0.43 per share for the second quarter.

Total net interest income increased 6.3% sequentially to $20 million from $18.8 million.

Core earnings for the third quarter was $15.4 million or $0.47 per share, an increase from $13.6 million or $0.46 per share in the second quarter.

Please turn to Slide 7 for details on the attribution of earnings between our Credit and Agency strategies. In the third quarter, the Credit strategy generated gross income of $18.6 million or $0.55 per share, while the Agency strategy generated gross income of $4.1 million or $0.12 per share. These compare to gross income of $16.3 million or $0.54 per share in the Credit strategy; and $2.2 million or $0.07 per share in the Agency strategy in the prior quarter.

Strong net interest income from the Credit portfolio continued to be the primary driver of our earnings during the third quarter. Our Credit strategy generated net interest income of $19.8 million, net realized and unrealized gains of $0.9 million, and earnings from investments in unconsolidated entities of $2.8 million.

Our best performing credit strategies included non-QM loans, residential transition mortgage loans, small balance commercial mortgage loans, non-Agency RMBS, secondary CLOs, CMBS, and investments in mortgage originators.

Investments in retained tranches in Ellington-sponsored CLOs underperformed during the quarter and we incurred a net loss of $1.6 million on interest rate hedges and credit hedges and other activities.

Other investment-related expenses decreased to $3.3 million this quarter, down from $5.2 million in the second quarter. In the second quarter, we had incurred issuance costs for non-QM securitizations, which did not recur in the third quarter. We also benefited from strong performance in the Agency strategy during the third quarter. The Agency strategy generated net interest income of $1.4 million and net realized and unrealized gains of $11.2 million as interest rates declined and pay-ups on our specified pools increased.

Similar to previous quarters, the decline in mortgage rates and associated increase in actual and projected prepayments drove the expansion of pay-ups. Finally, declining interest rates generated net losses on interest rate hedges of $8.5 million, which offset a portion of these gains.

Turning next to Slide 8. At September 30, you can see that the credit portfolio grew 14% to $1.22 billion from $1.07 billion at June 30. As Larry mentioned, most of this was from additional investments in our non-QM and residential transition loan portfolios, which are both in the residential loans and REO slides in these charts.

Also, consistent with prior quarters, note that these totals are quoted after reversing out the consolidation of our non-QM securitization trusts.

On Slide 9, you can see that the size of our long Agency portfolio increased 17% from the prior quarter to $1.57 billion. We continue to concentrate our long holdings in prepayment-protected specified pools and hedge interest rates along the yield curve.

Next, please turn to Slide 10 for a summary of our borrowings. At quarter end, we had a total debt to equity ratio of 4 to 1 and recourse debt to equity ratio of 2.9 to 1, these compare to 4 and 2.8 respectively for the prior quarter.

We added financing during the quarter to accommodate larger investment portfolios, while our equity increased proportionately with the July capital raise. Our recourse leverage increased slightly over the course of the quarter. But as Larry mentioned, we priced a non-QM securitization earlier this week, which will reduce our recourse debt to equity ratio materially.

Finally, our weighted average cost of funds finished the quarter at 3%, down from 3.4% at June 30, as LIBOR declined during the quarter and as we are able to negotiate better terms on a few of our financing facilities.

For the third quarter, our total G&A expenses were $4.5 million, down from $4.8 million in the second quarter. G&A for the second quarter had included about $241,000 of costs related to the REIT conversion that we undertook earlier this year, we had no material costs related to the REIT conversion in the third quarter.

At September 30, our book value per share was $18.81, which included the effects of $0.42 per share of dividends paid during the third quarter as well as the impact of our July follow-on stock offering.

A final note, is that on our balance sheet as of September 30, which you can see on Slide 25, we had higher Investment-related receivables and Investment-related payables quarter over quarter. The increases were primarily related to unsettled purchases and sales of Agency pools at quarter end.

Now, over to Mark.

Mark Tecotzky -- Co-Chief Investment Officer

Thanks, JR. EFC had a solid quarter with broad-based contributions from our diversified Credit and Agency portfolios. We continue to see strong underlying credit performance in our residential, commercial and consumer loan portfolios. Our strategic partnerships continue to deliver high-yielding assets, which increased core earnings.

In the market where low yields have pushed many credit sectors to the tightest spreads of the year, EFC's proprietary flow channels provided a consistent supply of loans. Having our own sources of loans also allows us to maintain consistent underwriting discipline to keep both credit quality and yields high. Lending standards typically erode several years into a credit cycle when competition for assets is fierce as it is today. The strategic relationships that we have built with our origination and sourcing partners is one of the most important tools to help ensure strong credit quality. This quarter, our loan portfolios continue to grow as our strategic partners leverage Ellington's analytic firepower and credit expertise to grow their businesses. As we've said in the past, we believe that these relationships are crucial to protecting core earnings and creating franchise value for EFC. While at EFC, we don't make directional interest rate bets, many of our strategies are still impacted by the Fed policies and general market conditions. The substantial drop in mortgage rates has improved housing affordability and supported home prices and thereby home equity, which in turn has helped to support the strong credit performance in our non-QM and residential transition loan strategies.

Additionally, lower rates have helped to increase our origination volumes and in fact LendSure had its biggest origination month ever in October at around 60 million in loans closed. We also priced our second non-QM deal of the year this week, which is accretive with robust investor demand.

Our repo borrowing costs have come down significantly recently, thanks to the combination of Fed rate cuts and improved financing credit spreads that we've been able to achieve on several of our financing facilities. In fact, one-month LIBOR is now around 75 basis points lower than it was at start of the year. That's great news for our consumer loan business where our short duration, fixed-rate loans are seeing much stronger levered NIMs as a result of lower financing costs.

Commercial mortgage loans and CMBS was another bright spot for EFC. Lower interest rates have been supportive of commercial real estate fundamentals as lower borrowing costs have helped improve debt service coverage, and meanwhile, occupancy rates and rent levels remained strong, nationally. For as earlier in the year, we have been keeping our CMBS exposure relatively light. We have recently been seeing some attractive opportunities in CMBS in addition to the opportunities we've been consistently taking advantage of in commercial mortgage loans.

With the fresh capital deployed from our October preferred equity raise, we've been putting even more capital to work in CMBS post quarter end. Against the backdrop of volatile interest rates, very fast prepayment speeds and the flat and at times inverted yield curve, our Agency strategy had a very strong performance and delivered $0.12 to the bottom line. Throughout the history of EFC, we have consistently touted the benefits of specified pools for call protection and TBA shorts to reduce negative convexity. While this past quarter, that positioning really paid off, negative rolls on our TBA shorts, meaning that the cost of the monthly pay-down on TBA actually exceeded the positive carry coupon over repo costs with the result being that we were actually paid to be short TBAs this quarter along with predictable well-behaved prepayments in specified pools that we were long continue to drive performance in the Agency strategy this quarter.

Even after the strong third quarter we had in Agency, we see the current market environment as even more favorable for our Agency strategy. Agency valuations are very attractive to us right now both relative to recent history and relative to other high-grade sectors such as investment-grade corporate. Moreover, as we enter late fall and winter, seasonal effects should dampen prepayments and also reduce mortgage supply, both of which are strong positives for mortgage performance, where at the same time, the Fed is buying back Agency MBS in modest size which supports valuations.

With the big pickup in prepayment speeds. It's a great environment for our approach of diving into the prepayment data to tease out the best call protection. There are lots of opportunities now for pay-ups and specified pools to expand and contract in a wide band, which plays right to our strength.

Turning back to the investor presentation, on Slide 8, you can see, we grew the credit portfolio by 14%, much of that in non-QM and residential transition loans. As I mentioned earlier, the consistent work we have done with our origination partners on underwriting and pricing has allowed them to increase their volumes without sacrificing quality.

We also saw growth in our Agency strategy, which you can see on Slide 9 where the portfolio grew by 17%. We welcome the prepayment volatility because it bring some fantastic relative value trades and plays to our strengths. Going into year end, we are very focused on capturing any opportunities created by year-end balance sheet constraints. Should such opportunities arise, we're in a strong position to play offense with ample dry powder from our preferred equity raise and with lots of very liquid Agency assets in our balance sheet that we can easily monetize and convert into credit assets if we see a year-end spread widening effect.

Now back to Larry.

Laurence Penn -- Chief Executive Officer & President

Thanks, Mark. I'm very pleased with Ellington Financial's performance through the first nine months of 2019. Net income has been strong, book value has been stable. And we've steadily grown core earnings each quarter creating a nice cushion to our dividend. While it's true that asset yields in many sectors have compressed this year, wWe've also been able to negotiate very significant rate and spread compression on many of our financing lines.

Some of these financing improvements we achieved just this past quarter, so that should provide another tailwind to our net income and core earnings going forward. Moreover, with our diversified array of strategies and businesses, we always strive to rotate capital out of sectors that we think have run up too far and into sectors where we see the best opportunities.

Also, with some of our loan pipelines, we can dynamically adjust our pricing to turn up or down the flow based on our views on relative value, observe changes in loan performance whether positive or negative and the needs of our portfolio.

I strongly believe that these are important differentiators as we build lasting franchise value for Ellington Financial. In October, after we had fully deployed the capital from our July common equity raise and seeing strong demand from investors in the REIT preferred stock space, we were able to raise additional capital through our inaugural preferred equity raise.

Our preferred stock had net investment-grade rating and saw strong participation from both institutional and retail investors. We were pleased with the execution, which priced at a dividend rate that is among the lowest in our sector and which we believe rightly reflected Ellington Financial's long track record of book value stability, disciplined and dynamic hedging, effective risk management, and prudent leverage.

The preferred equity raise further diversifies our funding sources and we expect that it will be highly accretive to earnings as it should enable us to continue to capitalize on the attractive investment opportunities that we've been seeing across our diversified portfolio, where we're seeing projected returns on equity well in excess of our preferred dividend rate.

For the remainder of the year, we are focused on continuing to grow and diversify our portfolio, including through deployment of the capital from the October preferred equity offering, so as to capture the benefits of scale and continue to generate a consistent earnings stream for stockholders. The continued growth of our proprietary strategies has been the driver to the growth in core earnings we've achieved this year, and the preferred equity raise we just completed gives us extra room for growth in these strategies, and so provides us with a clear path to growing core earnings, and ultimately our dividend further from here.

Finally, as we approach year end, we're excited to have lots of dry powder at a time of the year when we often see significant market dislocations, as we saw last December, for example. That said, if we want to be playing offense and not defense in response to dislocations, we believe that continuing our disciplined hedging and liquidity management practices will be essential.

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

Questions and Answers:

Operator

[Operator Instructions] Your first question is from the line of Trevor Cranston with JMP Securities.

Trevor Cranston -- JMP Securities -- Analyst

All right, thanks, good morning.

Laurence Penn -- Chief Executive Officer & President

Good morning.

Trevor Cranston -- JMP Securities -- Analyst

First question on the resi loan portfolio. We heard from one of your peers the other day that their view was that pricing for the transitional resi loans had become I guess somewhat less attractive versus the non-QM space. I was curious if you guys had any thoughts there and commentary on kind of where you are seeing trends in pricing and returns on the various resi loan products?

Mark Tecotzky -- Co-Chief Investment Officer

Hey, Trevor, it's Mark.

Trevor Cranston -- JMP Securities -- Analyst

Hey, Mark.

Mark Tecotzky -- Co-Chief Investment Officer

That's a great question. So when we started buying RTL loans, your fix and flip loans, we had expected that portfolio to have had more significant growth than we've had, and I certainly attribute that to the fact that we do see some underwriting practices in that space that we consider aggressive and we don't want to compete with. So I guess what I would say if you're thoughtful about your partners and you're thoughtful about other aspects of the underwriting, we see that as a very attractive sector, but I definitely concur that there are certain lending practices going on in that space that to us look like they expose the lender to some more significant risk than what you see generically in the non-QM space.

Trevor Cranston -- JMP Securities -- Analyst

Got you. Okay, that's helpful. And I guess -- so another question on the non-QM side, we saw in the news I guess last week that one of the larger, independent non-QM lenders was being acquired by another company. So I was curious, I know you guys obviously made some strategic investments in origination partners and we've seen that from some other companies as well. But I was curious if you guys had any bigger picture thoughts on some of the independent non-QM lenders that are out there. If there is likelihood that they could continue to be acquired going forward, you know as investors try and kind of lock-up supply of loans and how that might play into the market in general and the ability to source loans in the future?

Mark Tecotzky -- Co-Chief Investment Officer

Yeah, Trevor. It's Mark again. Yeah, we have seen that and I think if you go back three years, four years ago, when we got started in this space, it wasn't at all clear what volumes were going to be, we made our equity stake before any securitization has gotten done. And so, now you're seeing a consistent securitization market. I think it does -- it makes non-QM origination a little bit of a more mature business.

EFC has -- we have a few equity stakes we made in originators, it's in partnerships that there is an exchange on underwriting guidelines and data, and I think it's -- we look for things where it's symbiotic that our resources, our credit expertise and our ability with data, it helps a partner grow and it's a partner that's receptive to our partnership. So I think if more opportunities like that arise, we're certainly interested in it, but we really look for situations where one plus one is three, that what we bring to the table, coupled with what the originator brings to the table with our involvement makes something better than what they had before, it's not just buying a fully formed originator.

Laurence Penn -- Chief Executive Officer & President

And if I just add one thing, I think the -- some people put RTL fix and flip in that non-QM category roughly. That market is much more fragmented than what we usually refer to as non-QM which are the longer-term financing or just for borrowers that just for whatever reason don't qualify for Agency. So I think though -- I think that market can help to defragment the RTL market, but the non-QM market where we're certainly not looking at if you're asking if there is any if we're looking at buying any others or anything like that. We're very happy with LendSure. Their volumes have been growing substantially, and we, from an M&A perspective, I mean, I don't think there is nothing to talk about there.

Trevor Cranston -- JMP Securities -- Analyst

Got you. Okay, that's helpful. And then last question from me. Mark, you made the comment that you guys have been adding to the CMBS book recently and particularly with the proceeds of the preferred offering. Can you provide any additional color sort of around where you're finding opportunities there, either within the CMBS capital stack or within different sectors of the market? Thanks.

Mark Tecotzky -- Co-Chief Investment Officer

We've always been CMBS B piece buyers, right? So we are comfortable, we've bought B pieces and we're certainly comfortable that we have the expertise and the skill set to buy anywhere in the capital stack. But beyond that, I don't think we've been more specific about parsing out sort of the ratings distribution on those investments.

Trevor Cranston -- JMP Securities -- Analyst

Okay, got it. Thank you. Appreciate the comments.

Operator

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

Crispin Love -- Sandler O'Neill -- Analyst

Hi, thanks for taking my questions. I was wondering if you could give an update on how much of the preferred offering has been deployed so far, and when you would expect it to be fully deployed? Would you expect it by kind of the end of this year? Or would it go into next year?

Laurence Penn -- Chief Executive Officer & President

Yeah. So if you look at the pace that we deployed the July offering, it took us just short of seven weeks and it was a $70 million raise that was 10 week. So yes, if you project that out, that would take us out pretty much almost exactly to year end. I don't want to give too precise an update. But I do want to say that we're so far it's a lot faster than that. So it's going very well to deployment. It is going faster than the deployment in July. Obviously, with year-end coming, we're certainly hopeful and certain hence that there'll be some additional great opportunities available to deploy that capital, even more quickly, but it's going faster and it's going very well.

Crispin Love -- Sandler O'Neill -- Analyst

Okay. And then also the dividend coverage has been really solid this year. I was wondering what your thoughts are regarding the current dividend as it stands now. And then would you in the Board consider a special dividend considering the coverage that we've seen for the last several quarters?

Laurence Penn -- Chief Executive Officer & President

In terms of the special dividends that might be also a little bit of a tax-oriented question. I don't, and we have to wait to see sort of as we get closer to the end of the year, whether one would be necessary. I doubt. I'll just say right now, I doubt that one will be necessary from that perspective. So that's not something that we've been discussing special dividend in terms of where the dividend is now and we have been comfortably covering it as you noted. So I think what I'll just repeat what I've said before, which is without speaking to timing, I'll just say that I do think the next move is up.

Crispin Love -- Sandler O'Neill -- Analyst

All right, thanks. That's all my questions.

Operator

Your next question is from the line of Eric Hagen with KBW.

Eric Hagen -- KBW -- Analyst

Hi guys, good quarter. One more on the dividend. Is core earnings a good proxy for your taxable earnings?

JR Herlihy -- Chief Financial Officer

It's the best proxy that we have and obviously when you -- with one great exception of course is that if anything if you have a realized gains or losses [Indecipherable] capital, then that's -- that obviously in one sense can also affect taxable income. But the REIT rule is a different as regards capital gains versus ordinary. So yeah, I think if I understand I think the real purpose of the question that I think it's, if it is the best proxy certainly that we publish.

Eric Hagen -- KBW -- Analyst

Yeah, that is the purpose of the question. Thank you. As you guys -- and then another one on the non-QM, as you guys have completed these deals, what percentage of the deal are you retaining?

Laurence Penn -- Chief Executive Officer & President

It's still at 6% -- Mark?

Mark Tecotzky -- Co-Chief Investment Officer

You're talking about the QM deal --

Eric Hagen -- KBW -- Analyst

In terms of market --

Mark Tecotzky -- Co-Chief Investment Officer

Yeah, it's mandated by risk retention. Yeah, 5% is obviously the risk retention rule. And I think we've typically retained 6% just where, yeah, I mean, so, and -- that's been in the form of, I mean, this is all in the prospectus and all that we sell, we retain IOs from the deal and we retain I think it's the two junior most B pieces.

Eric Hagen -- KBW -- Analyst

Yeah, what's the unlevered yield on those two junior pieces that you guys hold on to?

Mark Tecotzky -- Co-Chief Investment Officer

So excluding the IOs, generally think of those as very high single digits unlevered.

Eric Hagen -- KBW -- Analyst

Got it. Helpful. Thank you. On the CLO side, corporate credit in general, are you guys seeing any pressure on credit conditions from corporations that might be over-levered?

Laurence Penn -- Chief Executive Officer & President

Yeah, so, absolutely, we are seeing that and I think JR, if you look at our earnings release, that was one of the underperforming sectors this past quarter.

Eric Hagen -- KBW -- Analyst

Which industries within corporate credit do you feel like are beginning to show signs of cracks or again are just over-levered in general?

Laurence Penn -- Chief Executive Officer & President

It's some -- the interesting thing is that in the markets where our CLOs are it's very idiosyncratic. So it's not even really industry-specific in terms of our portfolio. So I don't have a broader answer for you.

Eric Hagen -- KBW -- Analyst

Okay, thanks guys. I appreciate it.

Laurence Penn -- Chief Executive Officer & President

Thanks, Eric.

Operator

Your final question comes from the line of Tim Hayes with B Riley, FBR.

Tim Hayes -- B Riley, FBR -- Analyst

Hey, good afternoon, guys, and congrats on a good quarter. My first -- a few of my questions have been answered, but just on a couple of line items on the income statement this quarter. Servicing expense and comp expense both a little bit lower than they had been running. Just wondering what drove the decline and how to think about that on a run rate basis?

JR Herlihy -- Chief Financial Officer

Sure. Hey, Tim it's JR. So on comp expense, I think we're just updating accruals. If you take as nine months year-to-date and annualize that, that's probably the best proxy as opposed to looking kind of just for three months to three months. On servicing expense, so there are a few pieces here. The first is that we shrink even though overall the loan portfolios grew, one that had relatively high servicing expense actually declined quarter-to-quarter. So that's part of it. Another part is within small balance commercial, we had a resolution of one asset. So the sort of expense associated with that asset came off the books. We converted another loan to REO. And so the management fee or asset management fee on the REO does not show up in servicing expense whereas it did when it was a loan.

Laurence Penn -- Chief Executive Officer & President

Hey JR, can you just explain why the servicing -- why the resolution in the small balance commercial space, all that goes into service.

JR Herlihy -- Chief Financial Officer

Sure. So we, at the beginning of the period, we had a loan and we are paying monthly servicing expense on it. And once we resolve the loan, which was actually a positive P&L on the realization bucket, the loan simply comes off the books. So there is no more servicing fee associated with that loan.

And then we also, within the consumer bucket, one of the portfolios is considered for GAAP the securities rather than loans and as such the associated servicing expenses is showing up, net of the waterfall. So, and obviously when we buy a CMBS bonds, their servicing expense within that CMBS, but we don't show the servicing expense on our income statement, it's netted out of the distributions that we take on the bond, but in either event, it's showing up the same way in core earnings. So those are -- that was probably a pretty detailed description, I'm happy to take that offline, but those were kind of the main drivers of servicing expenses quarter-over-quarter decline.

Tim Hayes -- B Riley, FBR -- Analyst

Yeah, no, that's helpful. And I appreciate the granularity. And then I guess you mentioned one of those two factors was an asset moving to REO. And was that the same I guess asset that was sold during the quarter, say at $1.2 million of realized gains on REO, just wondering what type of asset that was, what market and if that was you just being opportunistic or if there are any other potential asset sales in the pipeline?

JR Herlihy -- Chief Financial Officer

Sure. So I know you've clearly done your homework. So it's different, but we did have -- one of the drivers of the strong performance in small balance commercial this quarter, which includes loans in REO, was the resolution of an REO at a pretty attractive realized gain, so that happened, that's different from what I just described. So we took another asset REO and it's -- we don't give too much detail on individual assets and markets and property types for REO besides saying that in some cases when we're -- so the SBC strategy has originations that at par performers. But we also have NPL acquisitions as part of the portfolio and as one of the potential life mitigation strategies. It's taking REO and then typically selling that REO. So that's kind of the path that we took on one asset is taking into REO and we can hold it, as a REIT, we have more flexibility of just holding it if it's generating positive income, positive rental income above whatever carry expenses.

Laurence Penn -- Chief Executive Officer & President

Yeah. And there are going to be times when we take over an REO and the optimal resolution strategy and as JR said we can be patient is to do some things, that could be some capital improvements, that could be things to improve occupancy.

Tim Hayes -- B Riley, FBR -- Analyst

Right

Laurence Penn -- Chief Executive Officer & President

-- to improve occupancy, but that can -- if things go according to plan there and our first impulse on when we have an REO is not necessarily to be an operator. But if the risk-reward is compelling, then we absolutely will take those additional measures to improve the ultimate resolution and that often can lead to a very nice realized P&L in the back-end.

Tim Hayes -- B Riley, FBR -- Analyst

Got it. Yeah, that makes sense. Well thanks again for taking my questions and congrats on a great quarter.

Laurence Penn -- Chief Executive Officer & President

Thank you.

Operator

Thank you. Your final question comes from the line of Steve Delaney with JMP Securities.

Steve Delaney -- JMP Securities -- Analyst

Good morning, thanks for allowing me a quick follow-up to Trevor's questions. You guys I'm sure probably saw a article on Bloomberg, first thing Monday morning about n-QM delinquencies and we've gotten some questions from clients on that. I guess a couple of quick things that -- the author suggested 3% to 5% 30-day delinquencies on the n-QMs on general matter, just curious, your reaction to that? Do you think they will in fact -- are you seeing them in that range of that high relative to less than 1% for Agency loans?

Mark Tecotzky -- Co-Chief Investment Officer

I mean, it's Mark. Hey Steve.

Steve Delaney -- JMP Securities -- Analyst

Hey, Mark.

Mark Tecotzky -- Co-Chief Investment Officer

So we expect non-QM loans are going to have higher delinquency than Agency loans.

Steve Delaney -- JMP Securities -- Analyst

Sure.

Mark Tecotzky -- Co-Chief Investment Officer

Definitely Fannie, Freddie, but when we look at outstanding performance out through now you're getting a bigger body of data, right? You've had securitizations for the last, you go back to beginning of '16. We haven't seen a worrisome uptick in delinquencies, certainly in our deals, we've been -- our deals, we've been very pleased with the performance. I do think with any mortgage, right, as loans season, as loan age, you're going to see higher delinquencies, right? You have a -- you're going to see the dynamic of better borrowers curing and maybe now qualifying for Agency loans and then you're just going to see life events, illness, loss of income, divorce and so, as deals factor down, it's not unusual to be expected that delinquency rates will get higher, but if you look at losses in that space relative to origination balances, it's been -- which demonstrates very strong performance so far.

Steve Delaney -- JMP Securities -- Analyst

Mark, the rating agencies defined the guidelines for n-QM or securitizations such that it's a tight box and essentially all n-QMs are being created equal or would you say there is variation in quality from some lenders' programs versus others?

Mark Tecotzky -- Co-Chief Investment Officer

So I think the rating agencies have been relatively conservative in the capital structures they're associating with non-QM deals. We look the lot at, if you go back and you look at the early days of Alt-As, 2003, 2004, those loans looked a lot like today's non-QM, those deals you were seeing AAAs with 5-odd percent credit enhancement. Today's non-QM deals, you're seeing credit enhancement in the 30s. And if you look at how those early Alt-A deals performed, the first year-and-a-half or two years they are alive, so looking at them say from 2003, 2004 up ending 2006, so really before the housing crisis, their delinquencies were very similar to what non-QM deals are now. So I would say that -- I would characterize the capital structures from the rating agencies as relatively conservative. Now they have sort of tried and true metrics, they look at LTV, credit score. And so you certainly see those applied to non-QM capital structure. So if you -- two deals that look similar in terms of credit score, but one might have 5% or 6% higher in LTV, you'll certainly see that reflected in the capital structure from the rating agencies in non-QM, so they've -- they're using their traditional metrics of credit. But I think they're applying them with a lot of conservatism, which I think was prudent given that it was a new asset class, three years or four years ago, and certainly they've gotten unambiguously too aggressive on mortgage capital structures right before the crisis, but I think one thing it's interesting is you've seen a lot of upgrades in that market because that combination of fast prepayment speeds with delevered structures and strong performance.

Steve Delaney -- JMP Securities -- Analyst

That's great. That's all very helpful. Thank you for let me hop on at the end. And we look forward to seeing you next week.

Laurence Penn -- Chief Executive Officer & President

And Steve, I just want to add that --

Steve Delaney -- JMP Securities -- Analyst

Yes, Larry.

Laurence Penn -- Chief Executive Officer & President

Two things, which is number one, no surprise, we're very LTV conscious I think probably more than others. And I do think that our performance, well, what if you see an uptick in the industry, I don't think that you can necessarily extrapolate that to us since -- certainly not in terms of the losses, right? So we are --

Steve Delaney -- JMP Securities -- Analyst

Exactly --

Laurence Penn -- Chief Executive Officer & President

Yeah, we're very comfortable with where we have our non-QM loans marked and obviously we are fully mark-to-market through the income statement. So we haven't seen any reason at all at this point, especially given. I think the types of LTVs that we underwrite to and just what I believe are better underwriting standards than others in the industry to sort of reevaluate our loss projections or anything like that. Our performance has really been excellent.

Steve Delaney -- JMP Securities -- Analyst

Thank you, Larry.

Laurence Penn -- Chief Executive Officer & President

Thanks, Steve.

Operator

[Operator Closing Remarks]

Duration: 44 minutes

Call participants:

Jason Frank -- Deputy General Counsel and Secretary

Laurence Penn -- Chief Executive Officer & President

JR Herlihy -- Chief Financial Officer

Mark Tecotzky -- Co-Chief Investment Officer

Trevor Cranston -- JMP Securities -- Analyst

Crispin Love -- Sandler O'Neill -- Analyst

Eric Hagen -- KBW -- Analyst

Tim Hayes -- B Riley, FBR -- Analyst

Steve Delaney -- JMP Securities -- Analyst

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