Ellington Credit Company: High-Yield Dividends Amid Strategic Shifts to CLOs

Ellington Credit Company (NYSE: EARN) has emerged as a compelling income play, offering a monthly dividend of $0.08 per share—a 16.47% yield as of July 2025. This payout, however, is not without its complexities. Behind the attractive yield lies a company undergoing a profound strategic transformation, pivoting from traditional mortgage-backed securities (MBS) to collateralized loan obligations (CLOs). The question for investors is whether this shift can sustain the dividend over the long term while navigating market volatility.

The Dividend: Sustainable or a Mirage?

The dividend's sustainability hinges on Ellington's ability to generate consistent Adjusted Distributable Earnings (ADE). In Q1 2025, ADE reached $0.39 per share, precisely covering the quarterly dividend requirement of $0.39. This 1.0x coverage ratio suggests the dividend is fully supported by distributable earnings. However, deeper analysis reveals risks. The cash payout ratio stood at 184.6%, meaning dividends are funded by non-cash items like unrealized gains or capital actions. Meanwhile, net income turned negative in Q4 2024 due to MBS volatility, underscoring the fragility of traditional earnings.

The dividend's backbone now lies in CLOs, which now comprise 81% of assets. These high-yielding instruments, generating an 11.13% net interest margin in Q1, have replaced the lower-margin Agency MBS (3.24% yield). This strategic pivot has been deliberate: CLOs offer higher returns but are riskier, as their performance is tied to corporate credit markets.

The CLO Gambit: Reward vs. Risk

Ellington's shift to CLOs reflects a calculated bet on credit markets. The CLO portfolio grew 46% year-over-year to $249.9 million by March 2025, with a focus on equity tranches (79% of CLO holdings). Equity tranches offer the highest returns but are first to absorb losses in downturns. Management has mitigated this risk through hedging—relying on short TBA positions to offset interest rate volatility—and geographic diversification, with 21% of CLOs in non-dollar-denominated markets.

Yet challenges loom. In Q1 2025, CLO valuations fell due to rising credit spreads and macroeconomic uncertainty. The $0.24 per share loss in CLO performance highlighted the vulnerability of this strategy. However, management argues that the timing of the Regulated Investment Company (RIC) conversion—which freed capital from MBS sales—allowed reinvestment in dislocated CLO markets. This positioning, they claim, will pay off as spreads stabilize.

Navigating Risks: Liquidity and Leverage

Ellington's liquidity remains robust, with $17.4 million in cash and $151.5 million in unencumbered assets as of March 2025. Leverage has also been reduced, with a debt-to-equity ratio of 2.2x, down from 2.9x in 2024. This de-leveraging supports resilience in volatile environments. Moreover, the RIC structure eliminates corporate tax burdens, improving net returns.

Nonetheless, risks persist. Geopolitical tensions, tariff policies, and inflation could prolong credit market stress, pressuring CLO valuations. A prolonged downturn in corporate credit could force Ellington to dip into capital reserves or cut the dividend. The book value per share, now $6.08, has declined from $6.53 in 2024, signaling the impact of unrealized losses.

Investment Thesis: Income for the Bold

Ellington Credit's dividend is a high-risk, high-reward proposition. The 16%+ yield attracts income investors, but the payout's future depends on CLO performance and market stability. For those willing to accept volatility, EARN offers compelling income potential, especially if credit spreads narrow. However, investors must recognize the trade-off: the dividend is not a sure bet.

Conclusion: Proceed with Caution

Ellington Credit's dividend is sustainable in the near term, backed by ADE and strategic CLO growth. Yet, the company's fate is tied to corporate credit markets—a sector prone to abrupt reversals. The stock's high yield reflects this risk. Investors seeking steady income should proceed cautiously, allocating only a small portion of their portfolio to EARN. For those comfortable with volatility and看好credit market recovery, the dividend's allure remains potent.

In sum, Ellington Credit exemplifies the adage: “High yields mean high risks.” The dividend may endure, but the path ahead is anything but smooth.