Annaly Capital Management Inc (NLY) 2008 Q4 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the fourth-quarter earnings call for Annaly Capital Management Inc. At this time I would now like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the Company we will open the conference up for questions and answers after the presentation.

The earnings call may contain certain forward-looking statements within the meaning of Section 27a of the Securities Act of 1933 and Section 21e of the Securities Exchange Act of 1934. Forward-looking statements which are based on various assumptions, some of which are beyond our control, may be identified by reference of a future period or periods by the use of forward-looking terminology such as may, will, believe, expect, anticipate, continue, or similar terms or variations on those terms or the negative of those terms.

Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors including, but not limited to, changes in interest rates; changes in the yield curve; changes in prepayment rates; the availability of mortgage-backed securities for purchase; the availability of financing, if available; the terms of any financing; changes in the market value of our assets; changes in business conditions and the general economy; and risk associated with the investment advisory business of FIDAC including the removal by FIDAC's clients of assets FIDAC manages, FIDAC's regulatory requirements and competition, and the investment advisory business; changes in governmental regulations affecting our business; and our ability to maintain our classification as an REIT for federal income tax purposes.

For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements see risk factors in our most recent annual report on Form 10-K and all subsequent quarterly reports on Form 10-Q. We do not undertake and specifically disclaim any obligation to publicly release the results of any revision which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statement.

I will now turn the conference over to Mr. Michael Farrell, Chairman, CEO, and President of Annaly Capital Management. Please go ahead, sir.

Good morning, everyone, and welcome to the fourth-quarter earnings call. I am joined here today by Wellington Denahan, our Chief Investment Officer and the Chief Operating Officer; Kathryn Fagan, our Chief Financial Officer; Nick Singh, our General Counsel; and Jay Diamond, a managing director.

As usual we will open up with some opening comments and then we will open it up to Q&A to go through the numbers and your questions. Some brief comments first. The title of this missive is 'just save baby, just save.'

As we sit on the precipice of the greatest fiscal stimulus package in our nation's history the question we are asked most often during our discussion with market participants is, when will it end? Well, we can't tell you the exact date but I can believe that a precursor to the stabilization of mortgage flows will be the clue. I can say that with certainty because from where we sit with the current instability and the economy began showing its teeth in the mortgage market in 2002 and it will ultimately end once those cash flows stabilize again.

When this occurs at some uncertain future date, property valuations will have found a bottom and new run rates and GDP will have been established. The sooner this happens, the better. But in the interim we, as a nation, are faced with policies designed to maintain the consumption during the course of our domestic economy.

My view that this is what got us into the problem in the first place and it runs counter to what Americans are now doing as rational economic human beings. We are reducing consumption and increasing savings.

The following is a construct of Newton's principles, for every action there is an equal and opposite reaction. We are witnessing the reaction of America's primary gross domestic component, its consumers, as they retrench and repair their own balance sheets. As the title of these remarks infers, I believe that consumers are embarking on a reversion to the mean of the national personal savings rate as a percentage of disposable personal income, or the savings rate.

The average since 1953 has been almost 7% but with a very sharp downward trend at the end of the subsequent half-century. The average savings rate from 1953 to 1989 was 8% with peaks over 12% in 1975 and 1982. In the 10 years ended December 2008, however, the average has been less than 2% with a low of a minus 2.7% in 2005. In the closing months of 2008 terrified consumers have pushed this rate positive again.

The just released data for December shows a savings rate of 3.6%. The average for the fourth quarter is the highest quarterly average since the second quarter of 1999. A rising savings rate is consistent with slower economic growth. According to Merrill Lynch's David Rosenberg, because multiplier affects every 1% rise in savings takes away about 1.3% in consumer spending. In the mid-1970s and the early 1980s the savings retrenchment lead to negative GDP trends as consumers acted to preserve their balance sheets.

Encouraging savings to preserve the nation's fiscal house is exactly what is needed to right the capsized ship of capitalism and truly secure the national interests. As a citizen, one would hope that in its noble rush to save the economy the Obama administration would also be considering the long-term solution of the nation funding its own dent by jumpstarting the savings rate instead of the consumption rates.

At the same time I recognize that it would be very painful to initiate such a program as there is clearly no corporate or political constituency for a remedy that virtually guarantees a recession. It would be a recognition that the thriftiness of Aesop's ant is purposeful. It also mean fewer cars in the driveway, fewer travel vacations, fewer dollars allocated to private education choices, fewer dinners out, difficult choices about healthcare, smaller homes that are colder in winter and warmer in summer, fewer must-have electronic toys, delayed retirements, and in general tougher choices about personal disposable incomes to the detriment of consumption-based and export-based economies.

Tough as it may be to sell this policy agenda, I submit that that is exactly what the country needs to do to secure its future. Our policymakers, given the information that they now have about the mess that has been created, should include a savings incentive in order to accelerate the long-term healing process for the United States. History has shown us that people will choose this route of their own accord when faced with the uncertainty of job losses, stagnant income, and declining values in financial assets.

The generation that lived through the Great Depression had, as economist at JPMorgan called it, a precautionary savings motive. As for the past decade, Americans haven't had that motive and accordingly have reduced their savings rate for a number of reasons -- the rising value of financial assets, easy access to credit, and the economic stability of 'the great moderation.' Today these reasons are gone.

We are increasing our savings so we can repair the hole in our personal balance sheets, which through the third quarter of 2008 is a cumulative $7 trillion decline from the peak. My argument is that the faster that we get there the faster the repair process will begin. Perhaps tax incentives can be added to accelerate the process.

To strategically direct the increased savings the tax benefit can be structured to target investment in the public or the private sector. We should set a national target personal savings rate of 15% to provide the balance required to properly value and control our domestic economy. The increase to 15% amounts to a diversion of about $1.2 trillion in personal savings away from consumption or a little more than the size of the proposed stimulus package.

Our national security interests are at stake here, not simply the price of our standard of living. We all sense and we know that higher taxes are coming at the federal and municipal levels. Entitlements are going to have to be negotiated. Social Security will be reformatted to reflect that we are living longer and the pool of payers is shrinking. Medicare, Medicaid, and healthcare will be restructured to a socialist model but we still need to pay for it.

At this point in the economic cycle savers are a key to the survival, not consumers. With this in place, the America of the immediate future will look, at best, a lot like the America of the 1950s. If we truly think that there is a short-term solution via consumption then we deserve our collective fate.

The long-term view and solutions are much harder to take in the short-run, but if Americans are incentivized to save their stimulus checks rather than spend them it would help to provide structurally sustainable fiscal health in the long run. This would position the country to win the economic war rather than the current battle. The answer is that we need to swallow the full tablespoon of medicine or to paraphrase Al Davis, the legendary owner of the Oakland Raiders, 'Just save, baby.'

There is a chart on the website that we released with these comments and closing them out here, this is the answer for the long term. It's not one that is easy for everyone to take, but I think everyone realizes that that is what you would do and that is what the nation needs to do.

With that said, close out those comments and we open up the call for questions about the Company's performance in the fourth quarter.

(Operator Instructions) Jason Arnold, RBC Capital Markets.

Good morning, everyone. Mike, as usual, excellent commentary. Depressing and scary, but excellent nonetheless. Just wondering if you could please give us an update on what you are hearing and seeing from your repo counterparties with respect to rates, haircuts, etc.? Then perhaps offer us some color on where you are seeing your portfolio yield at present?

Sure. I will just give you some general color and then I will ask Welli to give you some specific items. In general, what the Federal Reserve is doing is working, it has been working. The results that you see posted for us, as we cautioned in our third-quarter's earnings call at the beginning of October, late October, we took a quarter-over-quarter view.

We extended our balance sheet over year-end because our experience was that every quarter was going to get worse. Certainly, no one expected Citibank, etc., to happen in the month of December. And even though it only was in December, it seems like it was years ago now.

The volatility in funding is now subsiding, I would say, and we are recognizing the benefit of that higher cost money rolling off from our quarter-end results into the first quarter here. And that doesn't mean that we are raising up the go flag and that we think it's full steam ahead. We still think that there is a number of challenges to the market that deserve some caution. I will ask Welli to comment on the rest.

Yes. You know, as everybody is fully aware, the Fed has been a large buyer in the MBS space. Early on in its efforts it did have a meaningful effect of driving yields down, mortgage rates down. With each passing week, though, the effects have become much less noticeable and even their last set of purchases the rates have actually increased.

So just to put it into context, I think there is certainly a lot of confusion in the market place not only about what their activities do to the price of mortgages, but also the resulting refi activity that comes from it. So we have had things kind of moving around a bit and I think there has probably never been a more anticipated release than the release that we are going to get this evening with respect to where real speeds are coming in.

But, nonetheless, I think it's definitely having a muted impact on the market with some of the Fed and Treasury purchases though it still remains to be seen whether they continue on these programs, whether it has the desired effect, whether there are other things that they can do with taxpayers money that would be more effective. As we all sit here and witness the confusion, I think, that is coming out of the administration and the policymakers, it's still early to say.

Okay. Can you offer, I guess, any absolute values around maybe where you are seeing funding costs and maybe yields on the portfolio or would you rather not comment there?

No, I mean, things are kind of all over the place. You could get anywhere from -- if you want a fully-hedged position today, anywhere from 120 basis points to near 400 basis points depending on the risks you want to take. I think it's prudent to have a little bit more observation on some of the influences that are out of the ordinary in the market. But still, in the long run of our business you are still looking at some of the best spread opportunities that you have ever seen.

It's our understanding and I think the Fed's probably understanding that they need to keep the yield curve in its fairly steep stance for a long period of time. The repo counterparties are strengthening through time. Organic capital replacement through earnings in a steep yield curve is what it's going to ultimately take and it's in the early stages. But it is improving.

To go back to the opening comments, Jason, those financial institutions they have to save too. The ones that have taken the TARP money they have got to write pretty big dividend checks on the cumulative preferreds with the Treasury every quarter. So that is going to drive into those earnings. It may slow the pace of recovery in the financial system.

But, clearly, it's a big market and from our perspective across the entire credit spectrum, especially as it relates to mortgages and asset-backed securities, there is a lot of opportunity out there because of the uncertainty that has been created through government policy or government intervention.

One thing that people should not do is, I think, for anybody is to annualize the fourth quarter in this market. Everybody does forget, and as Mike mentioned, memories are short about how 2008 finally wound up. I think the Company and I have to hand it to our financing team and everybody involved for doing a tremendous job navigating through this market continuing through everything that we have seen.

Now the economy is really the one that is in the hot seat. The financial sector is on the road to repair. I know it's not always visible to people in the financial sector, but it is getting there.

That is great. That is good color. Certainly one of the most volatile quarters from an asset yield perspective and from a borrowing costs just given all of the stuff that was one on, so definitely good work there.

Another question, I was curious if you could offer us your thoughts on some of the plans that are being kicked around in support of the mortgage markets and maybe your own perspective on kind of prepayment speeds going forward to the degree that you can.

I will give you some -- we have some very, very specific things that we prefer not to discuss on an earnings call. Let me just give you some background behind that statement if I may. We began a project here at the end of 2007 called the involuntary prepay project. Essentially what we did is we began to grind down and create analysis across the country and across different issuers and geographic concerns to try to figure out who was going to be affected most by changes in defaults, delinquencies, and the foreclosures or, as we like to think of it, involuntary prepays.

We knew a lot of it was going to feed back up into the mortgage insurance business as well as into Fannie and Freddie and into the lenders who created some of these affordability products, like WaMu and Countrywide and everything. But we wanted to try to begin to quantify it on a theoretical basis and then perhaps to see how it played out.

In general, and this is a very general statement, with a lot of work and obviously we have been working on it for two years and so we have got some view in this that I think is one of the reasons why people pay us to take a look at the valuations across the curve and why I am very protective of it, is that even though you have had a huge spike in applications that in general roughly 50% to 60% of those applications are being thrown away and not serviced at the originator level for a couple of reasons.

One is some of them don't reach up to documentation standards. The second is that most people don't realize that they are upside down in their house and are therefore are not able to take advantage of any lower rate that is out there. That the speed of those prepayments may be slightly faster on some parts of the existing mortgage curve, but overall it will destroy value may be in selected sectors, which I am not going to identify for purposes of this call, where people are trying to lock in longer-term rates and maybe get rid of their exposure to short-term rates. That kind of thing.

So, overall, I would say we are going to have some wave of prepayments across the board. From Annaly's perspective, especially, I think that the job that Welli and the team has done in terms of lowering the overall historical acquisition cost of the portfolio, the capital raises that we did in the past that allowed us to take on legacy assets that have given our book value for historical purposes a 101-ish handle of acquisition, means that we are very comfortable with the prepayment exposure that is out there in terms of its effect on our earnings from writing down principal and premium.

We don't have much premium in the book. And we are in much better shape than we were in 2003 when we saw a 104 mortgage market, for instance, versus a 101. So I think that the Asset Management Team has done an excellent job of identifying value. I think we have done a lot of work that is proprietary on where we think valuations are going to be occurring or where destruction of capital is going to happen in the mortgage sector.

Clearly, the purchases by the Federal Reserve did not take place until January. They didn't start that $500 billion program until January, so there is a ton of money coming in. The biggest balance sheet in the world is in there supporting this market right now.

I would not say that from my view of doing this for almost 35 years that it is a deft purchasing program that is being executed. It seems to be being handled where need is rather than value, so that speaks to what we think is a great opportunity overall across the entire mortgage spectrum.

Great. That is fantastic color. Thank you. Then one final quick one for Kathryn. I was just curious about the new swap treatment for accounting purposes, kind of the reasoning behind that. Thank you.

We put in the 10-Q that was issued for the third quarter that we decided to abandon hedge accounting treatment for GAAP purposes not for tax purposes because we wanted to take advantage of rates in the repo market that may not necessarily tie exactly to a swap. So the accounting burden to get GAAP swap treatments for hedging purposes outweighed, I guess, the benefits that we were getting in the repo market. So we decided to make a business decision and get the best rates and terms and abandon hedge accounting.

Got you. Okay, thank you so much.

Mike Widner.

Good morning. Good introductory comments, as always. Hopefully some of our folks in DC will listen, although I have a fear that they won't. Let me hit you first with just some number details if you can give them to us. Principal value in the portfolio and weighted-average coupon at the end of the quarter?

Sure. The weighted-average coupon was 564 and the principal value was $54.5 billion.

Great. Thank you very much. Let me ask you a little bit about -- I recognize the turbulence in the marketplace and there is still a lot of unknowns. You guys have been operating at continuously below historical low leverage each successive quarter. I am just wondering if you can provide any commentary on what you are thinking about in the current market. And as we go through 2009, what would get you comfortable coming back up from 6.4 back into the 7, 7.5 that kind of range?

As we have said time and again is we would like to see some participants in the financial sector actually put up positive numbers. And I think there is certainly a lot of gray overhang in the market whether it's with policymakers, new legislation coming into the mortgage market. That it still bodes for a somewhat more conservative stance.

Even with that said you have tremendous been spread. Even at the lower leveraged levels you can still deliver tremendous returns relative to I think a lot of the other options out there so there is no need to really ramp things up. But, again, we continue to monitor the situation and we will continue to do what is best for the Company.

Mike, I think it's safe for us to make a broad statement here that against the backdrop of what is going on globally that there are too many uncertainties out there in too many different economies that may wind up affecting banking counterparts or asset selection across the board. I will give you just a brief synopsis even from this morning's reports that were released by the European Central Bank.

Trichet, in basically four comments this morning he said that he is very worried about inflation, that he is not worried about inflation, he thinks that inflation is diminishing, and that he thinks that they are going to hold rates steady to fight inflation. He basically said that in about four different minutes this morning. So I don't have a great degree of confidence that the central banks of the world, especially the European banks, fully understand the nature of what is going on and how far behind perhaps they are in the curve.

I think Great Britain -- 'Reykjavik-on-the-Thames' (sic) is the article in The Economist. There are real risks across the board in these different countries. You have Russia has to roll over $700 billion worth of debt in an economy that is clearly struggling with recession/depression kinds of influences within it.

This is going to be a broader problem across the global economy. We spoke about it a little bit in the third-quarter's earnings call when we talked about decoupling and how false that is. Everybody is interlinked here. The issues of protectionism and the legislation that is going to be created in the next few months are all going to raise their ugly head. And that is going to cause some more volatility in currencies as well as in interest rates I think.

And I think that the Federal Reserve has been very clear, they are throwing everything including the kitchen sink at this. So you don't fight the Fed. It may influence your decisions about where you want to place your equity or your debt, but you don't fight the Fed. I think we are at least acting as one central bank.

Makes a lot of sense. Appreciate the color on that. One final question on the 133 treatment. I understand this decision to move away from the hedge accounting treatment. As we go forward, presumably if there is any return to normalcy as far as repo rates and LIBOR rates and correlation between swaps and MBS yields and everything else, would you guys envision returning to hedge accounting treatment at some point in the future or is it just a hassle that is probably not worth doing at this point?

Not necessarily at this point. But going forward would you envision returning to it, I guess is the question?

No, I don't plan to. Something would have to change dramatically with the hedges that we have de-designated. We would not go back and cannot go back and give them hedging accounting treatment. New hedges we could, but I do not envision doing that.

So just so I understand, for new hedges you still don't intend to treat them as 133 --?

Correct.

That is right. I think that we -- as you notice, our book value went up during the quarter. We have always recognized everything on a net basis and I think the decision on, especially on the swaps at this point where we are receiving floating and paying fixed. With interest rates at such low rates, this is great timing from a business perspective to just say okay look this is where it is. It might improve going forward.

One thing we can pretty much say with certainty across the board is that the next move in Fed funds will be up. We don't know when that is going to happen, but we can guarantee that they're going to have to tighten at some point. And I would rather be in this position today where everyone understands what the downside is. And I think everybody knows what the upside is and the insurance that is in there.

Just to quantify this from a business point of view and to give you an idea, we have no idea when the bell is going to ring and interest rates in the market are going to run ahead of Federal Reserve and policy or market events and go higher. Our book is swapped out -- 40% of our book is swapped out in this structure. That insurance policy is costing the shareholders about $0.30 per quarter.

We think that's cheap insurance and we think it is worthwhile to have an uncapped floating position in a world where you could have inflationary consequences coming out of this that just emerge at any time. So I think that we have laid that out pretty well, and I think from my perspective with the run rates that they are at today, we are providing a strong middle-teen core ROE. I think we are in pretty damn good shape going into 2009.

Well, I appreciate the comments. I think most people would agree with you on the value of the swaps. It is just the bizarre accounting treatment of non-hedge. It just heavily distorts the GAAP results, which unfortunately a lot of folks focus on when they look at the headlines.

Anyway, I do want to say congratulations on a solid year. 17% ROE in 2008 is certainly a track record that a lot of other companies would envy. Anyway, thanks, guys. I appreciate the comments.

Andrew Russell, JPMorgan.

Good morning. Thanks for taking my question. I will keep it short out of respect for the other analysts, so we can get more questions on the call. I guess the only question I have left is about -- goes back to the funding cost issue. In looking at your swap position, it seems like you have obviously had a very doom and gloom outlook through '08, and it was right directionally and probably in the magnitude of the move.

And now looking forward, you seem to still have a pretty -- very true to the economy in that the Fed has very little room to raise rates. For an extreme amount of time, the market seems to agree that LIBOR has come back in line with that expectation. Based on that kind of outlook, has there been talk or thoughts about taking that hedge position down to some extent? Obviously not off, but off of the 40% level internally?

No, we have operated through a lot of different markets successfully using roughly two-thirds adjustable and floating to one-third fixed. And as you can see from -- even though short rates might stay down for a long time that doesn't ensure that long rates will stay there as well. So I think us as managers have to get repaired to fight the next war and with the sheer volume of borrowing that is going to come out of the Fed and Treasury it's hard to say where loan rates are going to be.

Some of the early talk coming out of Treasury Secretary and a lot of that stuff is not helping the US taxpayers cost of borrowing. And so I think we just have to be set to contend with whatever the fallout is from this and, as Mike commentary suggests, that the savings rate needs to rise and that is what is going to help cure the current situation.

Unfortunately, I think that the administration and policy makers are going to try and encourage just an extension of what got us into the problem to begin with. So how that is perceived -- and it seems like globally governments are of the same mindset and so you could have a tremendous debasement of currencies around the world. And, ultimately, there is a price to pay for that.

Okay, great. Thank you very much.

Steve Delaney, JMP Securities.

Good morning. I noticed you got your FINRA finally for Ranger, so congratulations on that. Mike, I guess I was wondering in that regard if you could give us some general color on how you see this direct or crop party repo market evolving? In fact, I assume that is the main thrust of Ranger business thrust.

Do you think that this could be -- given your earlier comments about global instability in the primary dealer community do you think this could develop into a permanent structural change in the way agency repo is done? Meaning that a significant amount of the book may move away from primary dealers direct to the cash providers.

And any guidance you can give us as far as your expectations for Ranger and how much of your funding you will have under your direct control say by the end of this year? Thank you.

Thank you for reading the release all of the way through, Steve.

Okay.

We will begin broker-dealer operations this quarter. Our review has been, and I think we have expressed it in the fourth quarter's earnings call of 2007, has been that in the world that is emerging that transparency, liquidity, and regulatory structures need to be embraced going forward because of all of the finger pointing and blame pointing and rewriting of the rules that is going to have to take place here.

We took the steps in early 2008 to begin accumulating the regulatory structure, the people that were necessary to report the accounting structures in. We have had those people on board here for several months and in place waiting for us to move ahead. As many people on this call know, our view our structure and our organization as an asset management company and that we elect to be treated under the tax laws as a real estate investment trust because we are untaxed at the corporate level.

And I think that that will be a very powerful marketing tool for the Company going forward and it's a smart way to look at the long-term interests of mortgages. It trains our people to think longer-term rather than for the next trade.

The tools that we need in an asset management company to distribute our own fund products and to help streamline our operations with lenders and borrowers throughout the Street, whether they are cash funds, etc., is extremely important in today's world. Obviously, there are a lot fewer primary dealers than there were four years ago. There is a lot more debt to come into the markets.

We intend to provide liquidity for ourselves and others through these structures and distribute our products and services through those structures in the highest degree of regulatory structure that is available in the markets, whether it's driven by new regulation or existing regulation.

So we are extremely excited about Merganser from that perspective from last year who we purchased as an asset-backed securities model that extends our brand into separately managed accounts for asset-backed securities, which is something that we did not do internally. We think that that is going to grow and expand our presence into Boston and that seems to be working out well so far.

We think that the broker-dealer operations are the same thing. We are going to have more opportunities to speak to different kinds of players throughout the world and I want to be able for them to pick which regulatory structure they want to operate under and how they want to view us. I want them to also feel comfortable that we are submitting ourselves right now to the scrutiny of almost every regulatory body that exists in the United States.

And as everyone knows, we have always taken the view in Annaly's operations, in all of the other operations that there is no black box here. Essentially, we are applying knowledge to the asset base and then we use outside sources to mark-to-market.

As we sit here today as a management team in the meetings that we have had with different players in the market, we can make three definitive statements that we don't believe any other financial manager can make. One is that we can trade our assets. We know where our markets are. We have the largest balance sheet in the world $500 billion in there buying and trading in there, investing in there. So we know we have liquidity from that perspective.

We can price our assets. We were priced by outside sources. It's a very clean procedure. We have done that since day one and it has always worked that way and because of the work of the Federal Reserve we can finance our assets.

So with those kinds of powerful tools in our weapon belt we want to make sure that we have the broadest regulatory structures and the cleanest way to approach clients and to interact with all of the changing landscape players that is out there. And this will be a very powerful tool I think in that regard.

We are very excited. It we will begin operations this quarter. It may be a permanent change in the way the landscape looks, but we are embracing that which exists and we think that is what is going to fix it.

Mike, would you consider going down the road, as Ranger is up and operating, would it makes sense to share with us sort of as far as your funding how much of your funding you are sort of controlling through your own BD as far as counterparties versus just the Street in general?

It will all be disclosed, but obviously it's a little too early for us to determine whether or not we can make big inroads in here. We have had great relationships with our lenders throughout this entire mess. We work very hard at that. Kathryn and Jim work very hard on the credit side. Welli directs meetings with these teams of people that we have been dealing with for 20 years on what we are doing. We were very available. We meet with these people on a constantly basis for coffee, drinks, lunch, or any other libation that we can throw into the mix to make sure that they understand there is a moving part to it.

But I have to say that the repo guys that we are talking to are the guys who are making the most money in a lot of these banks right now, especially as regards risk-free, credit free risk assets. They can make a spread. They can earn a spread. It's a good use of the regulatory capital while they are trying to figure out and then raise themselves from the destruction that has happened in the past year.

I met with the CEO of one of the major banks last week and he congratulated me on running the third-largest capitalized bank in New York.

Not by design.

It was interesting from his viewpoint that both of us had avoided taking TARP money in some way shape or form, but we are now benefiting in a parallel mode from all of the changes that were taking place at a regulatory level. I think we are going to continue to influence that discussion and I like our business model laying out the way it is.

I think you are looking at the birth of a new financial structure and I would definitely say that we are still in the lab. But as you are aware of, Steve especially having covered the firm for a long time, there is still about four different business plans I still want to complete here within the next few years that will fill in different pieces in the way we are expanding that plan. And now we have the regulatory structure by which to do it.

That is great, Mike, and very helpful. Thank you.

Ken Bruce, Bank of America Merrill Lynch.

Good morning, Mike, Welli. A lot of my questions have been answered, but I would like to address a couple of bigger macro issues if you would. You have got Fannie and Freddie which are obviously still in the game with their portfolios. It looks like right now the regulators still wants them to start downsizing at the end of this year. And that is obviously going to take a big buyer out of the market, even though we have got the Fed that is in the market and we are not sure when they are going to get out.

How are you looking at what the impact of Fannie and Freddie stepping out of acquiring the MBS for their own principal account is going to have on the markets for you?

It's just a huge opportunity. It's a $5 trillion market that needs to be serviced and operated. I would agree with you, in our discussions with the agencies it's clear that they are more focused on the social agenda of monetary policy today rather than on the aspects that we care about which is net interest margin and understanding value in the asset and liability structures.

Fannie and Freddie for years we have always viewed as friendly competitors and we have to view who is going to fill the gap in the markets. We think the private sector is the solution. I think that Secretary Geisener agrees with that. I think that President Bill Dudley of the New York Fed agrees with that. I think that as better levels of understanding come out about what the needs are to support that market and to drive the coupon down to a level where people can feel free to invest, hedge out risks, but also take advantage of some of the social benefit of lower interest rate costs for homeowners throughout the United States that that is quick to open up and continue to open up huge opportunities for Welli and the team here in terms of identifying how to make great interest rate margins out of it.

I am very pumped about that. I think that -- when I looked at the chart this morning I compared the return on NLY from 1997, the end of 1997 when we first went public, through the end of 2008 when we just reported with these numbers today. And I ran a comp analysis against some competitors but I will just deal with the S&P. For that period, if you bought Annaly in the IPO in October of 1997 and just held onto it, your total rate of return was 376% roughly for an annualized equity return of 15.22%.

The S&P during that period was a minus 6.8% from price appreciation. Its total return was 11%. The difference between Annaly and the number on a net basis is 265 minus 98. So the total return on the S&P was basically flat and we were up 15.22% annual. I think that speaks a great deal to the skill of Welli and the team and the ability to navigate the same markets that every other company, including Fannie and Freddie, have been through over the past 10 years.

I think we have validated in everybody's mind the asset management structure that exists within Annaly. And I think at these rates of return when the rest of the world is cutting dividends and slicing estimates going forward that we are sitting here saying we are comfortable what we are operating at. And not only that during this period we have grown our business including Merganser and our broker-dealer operations and we continue to be on the offense.

So a lot of people have lost a lot of money betting against America over the years including King George back in 1774 and I think that is going to happen again. We are preparing for the rebirth here and that is what I feel good about.

Are you seeing the banks get any more interested in the asset class or principal accounts along with their willingness to finance it?

There is definitely a renewed vigor on trying to figure out what to do with all the deposits that are coming into the banking system. We estimate that there is $8.5 trillion worth of cash earning anywhere between zero and 1%. It's stuck at the banks. It's in money market funds for purposes of fear right now.

The same problem that the borrowing sector has had with the lack of banking participation as well as the numbers of banks being depleted through mergers and acquisitions, etc., that the lenders have the same problem. They want diversity too and they want more access. So all of the tools that we have put in place are designed there to go out and get that and to provide them with products and options to do that in. We wouldn't have done that and we wouldn't have spent that money if we didn't think that that opportunity was there for us.

Just lastly, how are you, generically speaking, tackling the weighted average price down on the portfolio? Looking at the screen, you have got mostly 102, 103 handle type --?

Ken, one thing I always cautioned people is just because you have a low price doesn't mean you have eliminated your risks. There is always a trade-off and we will constantly weigh those trade-offs. If the models and expectations on prepayments are far greater than reality, you are justified in some of your higher coupon stuff. So if there has ever been a time where, as I mentioned earlier, where that the anticipation on the release of speeds across the cohorts we are going to get it tonight.

But I just think that anybody that thinks as long as you just buy lower dollar priced stuff you are okay. You are taking on some other risk and you have to balance those things out.

No, I don't think I would want to be taking the extension risk on some of these low coupons.

There is always something you have to deal with. So it's just to focus solely on one aspect of your portfolio and that is just price. You are totally missing a lot of other things.

So if I can just interpret that it appears that you are willing to take a little bit of balance sheet risk where you think you have got a better edge on prepayment, the actual prepayments relative to what Street expectations may be and what is priced for the assets.

It's either you take book value of you take earnings risk and, ultimately, one of them can turn into earnings and book value risk. So you have to be able to balance the risks according to the landscape and we will do what we think is right. There is no question that we can underestimate prepayment or overestimate them, but there is a lot of opportunity among the coupon stack to basically take advantage of what you think is being misinterpreted by the model right now. So we will see, we will see.

Tying some strings together there, Ken. One of the cautions that I would put out there and just tying our strings together is that sometimes because the rules allow you to take more favorable treatment of accounting purposes, it doesn't necessarily mean that you should allow that to influence your economic decisions in judging valuations.

In most of the bank portfolios that we have been involved in in the past or credit portfolios we have been involved in in the past where people have screwed up, it's because they let accounting rules drive their business decisions because they didn't have to face up to the test of amortization or prepayments at a certain time. They were allowed to smooth it out.

I think those games are over, but there are still people playing by that rule and most of them are in the banking sector. That provides opportunity when people are trading with two different sets of rules and that is what makes markets work. But, ultimately, one of the things that frustrates everybody about Annaly is that its dividend moves up and down.

But our view has always been that we want you to understand the nature of what is going on in these cash flows because they are tied to the consumer. And that is 70% of the US GDP. With the stimulus package that is being passed they are going to try to make that 70% of GDP unless they take my opening caution to save it. But I don't think that is going to happen.

Once those cash flows are interpreted correctly, you can judge value correctly. We are watching very carefully and as I said earlier we have been working on this for two years. We have some very strong opinions about where value is no question about it.

As always thank you very much, appreciate those comments.

Stephen Mead, Anchor Capital Advisors.

I have got two questions. The first one is just a little color on as you talk about the volatility in terms of the yield and the cost of funding, I was wondering could you contrast what is going on more recently in January and early February versus what you exited the year at and some of the forces driving that?

Then the second question is the broader issue. You did a piece on Fannie Mae and Freddie Mac earlier in 2008 where you looked at the spread income and the income from the insurance side of Fannie Mae and Freddie Mac and sort of made the assumption that there is an earnings stream there. But I was wondering how that looks today in your eyes and how much Fannie Mae and Freddie Mac in terms of their additional call on the taxpayer to meet the obligations on the insurance side. Do you have a perspective on that?

Well, the volatility what I would say is there have been two major influences as it relates to Annaly. The first is that the move to 0% interest rate policy. Obviously, our cost of funds was higher because we made decisions about balance sheet access and quarterly, end of quarter financing much earlier in the quarter than other people did. We started in the end of September and the beginning of October to trade what they call in that market the turn, which is the 12/31 close.

And Welli very aptly described it as you just had to go forward with the assumption that every quarter in the fourth quarter was -- as an example of this -- was going to be worse. They were going to be some black swan event out there in the fourth quarter; it wound up being Citibank.

So that volatility and that cost of funds has definitely dropped and is dropping off of our balance sheet now. We are getting the benefit of the move by the Federal Reserve to lower interest rates and by the market recognizing that. There is still some gaps from day to day and it's still different between LIBOR, etc., but we feel pretty good about the quarter that we are in right now from that perspective without having to take on additional leverage or do anything creative in the asset selection or purchases of sales.

As regards Fannie Mae and Freddie Mac, our feeling is that just on a broad basis, and this is our speculative view and I will confine it to my head if it's okay, is that Fannie Mae and Freddie Mac could have been saved in 2007 with a proper injection of capital and with some very cautionary steps in terms of stopping them -- exactly back to our last discussion. They were trying to manage the two masters.

That is the point of that piece that Jay Diamond wrote. They were managing to two masters. They were managing to the government and they were trying to manage to the capital markets and they were being treated like a thrift.

From an insurance point of view that cash flow stream, right now they are clocking it. They are just clocking it. They can charge pretty much whatever they want as a mortgage insurer across the board. Any new origination that comes in, any refinancing that comes in is mitigating some of the move by interest rates because that is an ongoing cost of mortgage insurance in the portfolio.

So we think that that is a healthy -- if you were looking at Fannie and Freddie as investments and you could stand back from some of the delinquency and default and foreclosure and social issues that are going to be extrapolated on them, that they are making pretty good money as a mortgage insurer. I think the bigger issue for Fannie and Freddie going forward is exactly what business are they in and how are they going to be separated.

As one of the earlier analyst points out, the company is going to downsize its portfolio. We see the Fed and the Treasury taking on larger roles here in terms of financing them and we see Fannie and Freddie taking larger and larger steps on the social side to provide, I would say, the soft touch of keeping people in their houses.

I think that that from my perspective is where most of the market is going to be focused on Fannie and Freddie in the immediate future. That they are working hard on the social agenda. Congress has them and is strangling them with these kinds of initiatives. At the end of the day it means we still get 100 cents on the dollar back. The question is how is that hundred cents on the dollar going to play out and be reinvested into the market. So I don't see them growing that part of the business anymore.

Okay, thanks.

[Bryce Silver], [Silver Capital].

Hello, good morning.

Good morning. You are going to be the last question because we are trying to keep this to about an hour.

Okay, I will make it quick. The government has been talking about 4% to 4.5% flat mortgages. How would that impact your spread and how you do business?

It's obvious that if you are looking at a 4% mortgage at par and you are financing it at even, let's say, 1% -- not 0% or 25 basis points -- you have got a positive carry of 200 basis points or 300 basis points for every dollar that you are running. The question is what are you going to do with that 4% mortgage when interest rates go back up to 8% and what is that destruction going to look like?

I would bring the caution to the point there that I don't think that a 4.5% mortgage rate in the United States really moves the needle of people who are able to go out and take advantage of it. And this is also, by the way, the opinion and the very strongly held opinion of some of the major originators and participants in the market after looking at this for Congress because it's not accessible. In order for you to take advantage of today's mortgage rates you have to have a FICO score of 720 or 740 or higher, you have to have an 80% loan-to-value ratio for conforming loans, and you are not buying it as a second property.

So what you need to take into consideration as an investor, and I think all investors had to do this, is that the housing stock in the United States probably peaked at around $12 trillion or $13 trillion worth of value at the peak of 2005 when the savings rate was below, minus. It was a minus number, when it was below zero. So these assets and that market is now shrinking. It's still substantial.

The government is going to reach in there and fill the gap with treasuries and agency borrowings, etc., across the board. But from our perspective, a dominant player in the market and well-capitalized player, this is a great market with a lot of size and assets in it that are going to be valuable cash flow instruments going forward. The answer is I don't expect it to affect prepayments.

I don't think you are going to see a lot of loans generated at that level and the real big issue, as I said, in my opening comments is you want stability and cash flows without government interference. We will be the first to see it just like we saw it back in 2002 when we saw prepayments jump up and we knew that that was unsustainable too.

Thank you.

At this time I will be handing the call back to you Mr. Farrell for closing remarks.

Thank you, Wayne. I want to thank you all for being with us here today. We look forward to being able to exploit all the values that was talked about here today in the market. I want to congratulate the management team here, especially our financing desk, for an outstanding job during 2008. You deserve a double pat on the back and I will buy you a beer tonight.

But if you have any questions on a follow-up, you know how to get us through Investor Relations. And we look forward to speaking to you at the end of the first quarter with our first-quarter's earnings call. Thank you.