Ellington Credit (NYSE:EARN) said the fourth calendar quarter of 2025 was the most challenging market environment for CLO equity since mid-2022, with management pointing to elevated credit dispersion, ongoing coupon spread compression, and year-end technical selling as key drivers of weaker CLO equity valuations.
Chief Executive Officer Larry Penn said the company limited losses to approximately 9% of net asset value (NAV) and “once again” outperformed the overall peer set, crediting active and disciplined portfolio management as well as a strategic shift toward CLO mezzanine debt tranches, which “proved more resilient” than equity during the period.
Market backdrop: dispersion and spread compression weighed on CLO equity
Management cited Nomura Research estimates that the median CLO equity return was negative 9% for the quarter and negative 14% for the full year. Portfolio Manager Greg Borenstein said Q4 was “one of the most difficult quarters for CLO equity in recent memory,” and noted that weakness in CLO equity was more pronounced in the new-issue market than in secondary trading. He said the company largely avoided new-issue equity during the quarter and has participated in only one new-issue equity transaction in the 11 months following its April 1 conversion to a CLO closed-end fund.
Borenstein also highlighted a structural issue for equity cash flows: CLO liabilities generally have longer non-call periods than underlying loans, limiting managers’ ability to refinance or reset debt tranches to capture lower financing costs. Entering 2026, he said more than 40% of the company’s U.S. CLO portfolio consists of deals scheduled to exit their non-call periods before year-end, which could allow refinancings or resets at tighter spreads if conditions permit.
Financial results: GAAP loss, NAV decline, and lower portfolio yield
Chief Financial Officer Chris Merna reported a GAAP net loss of $0.56 per share for the fourth calendar quarter. Merna said significant mark-to-market losses on CLO equity drove the net loss, while CLO mezzanine debt “held up better by comparison.” He described a quarter in which lower-rated CCC loans came under pressure amid elevated CLO reset and liquidation activity and rising defaults, while premium-priced loans continued to refinance at par.
Merna said net interest income declined by $0.02 sequentially to $0.21 per share, driven by lower asset yields and portfolio turnover. The weighted average GAAP yield on the CLO portfolio was 13.7% for the quarter, down from 15.5% in the prior quarter.
At December 31, the company’s NAV was $5.19 per share. Merna reported an NAV-based total return of negative 9.1% for the quarter, and said cash and cash equivalents totaled $24.3 million.
Portfolio positioning: larger mezzanine allocation and active trading
Penn said the company increased its allocation to CLO mezzanine debt tranches following its April 1 conversion, viewing them as offering an “appealing balance of yield and downside protection” due to structural credit enhancement. He said approximately 70% of CLO purchases during the nine-month period following conversion were mezzanine debt tranches, and that the proportion of debt in the CLO portfolio grew to just under 50% by year-end from roughly one-third at conversion.
During the fourth quarter alone, Merna said the company made $66 million of new purchases (60% CLO debt and 40% CLO equity) and sold $19 million of CLOs, consistent with an active trading approach. At quarter-end, CLO equity represented 52% of total CLO holdings, while European CLO investments accounted for 12%, down from 14% at September 30.
Penn also emphasized trading activity and portfolio repositioning, noting the company executed 47 unique CLO trades during the quarter (excluding deal liquidations) and actively managed credit hedges. He said the company redeployed interest payments and equity distributions into “higher quality deleveraging mezzanine debt positions,” while trimming longer spread-duration mezzanine exposures where risk-reward looked less favorable. He added that the company took advantage of spread concessions in the new-issue debt market to add double-B-rated tranches at higher yields, while remaining selective in equity and avoiding more levered, lower-quality profiles.
Management also pointed to realized gains from redemptions: Penn said several mezzanine positions were redeemed at par after being purchased at discounts, generating realized gains that helped offset some of the portfolio growth from new mezzanine investment activity. Merna said that within the mezzanine debt portfolio, net interest income, trading gains, and the impact of deal calls of discounted positions offset most of the mark-to-market write-downs.
Hedges and risk management: protection increased as markets stayed volatile
Penn said Ellington Credit increased credit hedges significantly during the fourth quarter and described corporate credit spreads as remaining tight relative to CLO spreads, allowing the company to add protection “efficiently and at attractive levels.” By year-end, management said the credit hedge portfolio was roughly $175 million of high-yield CDX bond equivalents, or approximately 90% of NAV.
Merna noted that credit hedges were a drag on results during the quarter due to strong performance in broader credit and equity markets. In the Q&A, Borenstein said the hedges are designed for larger drawdown scenarios and that, based on his rough estimate, the run-rate drag from hedges was “probably” around 1% to 2% of fund NAV per year, though he said the figure shifts with market conditions. He also described the tools used for hedging as including broad-based indices and instruments such as CDX high yield index exposure (including out-of-the-money), IWM puts, loan ETF shorts, credit index tranches, and loan ETF puts, while generally avoiding single-name bets.
2026 commentary: continued pressure in equity, more mezzanine buying, and potential financing
Looking back at 2025, Penn said the company’s conversion to a CLO closed-end fund on April 1 was followed by the liquidation of remaining mortgage-related assets with minimal NAV impact, after which the company focused exclusively on the CLO opportunity set. He said the CLO portfolio grew by nearly 50% to $370 million by year-end, and that the company executed 218 CLO trades during the nine-month period post-conversion (comprised of $272 million of purchases and $63 million of sales, excluding redemptions).
On early 2026 conditions, Penn said January and February reflected continued difficult dynamics, with CLO equity under significant pressure while mezzanine debt held up relatively well. He reported that the company ended January with NAV per share of $5.04 and said February was “an even tougher month for the sector,” which management believes has created more opportunities.
Penn said more than three-quarters of the company’s purchases so far in 2026 have been mezzanine debt, particularly deleveraging double-B tranches. He added that the company has been active in exercising CLO call options and has recently “collapsed certain CLOs” where it held discount positions, which he said strengthened the credit profile of the remaining portfolio and helped build liquidity in a volatile environment. He also said the company has selectively increased CLO equity holdings where it sees compelling value, including deals with “mispriced call optionality.”
Finally, Penn said the company is exploring a potential issuance of long-term unsecured debt “in the coming weeks,” which he said could provide additional dry powder. He added that management remains focused on rebuilding net investment income and NAV and believes a substantial portion of recent price declines could be reversible because they reflect yield spread widening rather than fundamental credit impairment.
About Ellington Credit (NYSE:EARN)
Ellington Credit Income Fund (NYSE: EARN) is a closed-end management investment company that seeks to generate current income through a diversified portfolio of mortgage- and asset-backed securities. The fund primarily invests in residential mortgage-backed securities (RMBS) and asset-backed securities (ABS), with additional exposure to commercial mortgage-backed securities (CMBS) and related structured credit instruments. To enhance income and manage risk, the fund employs leverage and derivative strategies such as interest rate swaps and credit default swaps, allowing it to adjust duration and credit exposure dynamically.
The fund is externally managed and advised by Ellington Management Group, LLC, an established investment firm specializing in mortgage credit and structured products.
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