Annaly Capital Management Inc (NLY) 2009 Q3 法說會逐字稿

Good morning, and welcome, ladies and gentlemen, to the third-quarter earnings call for Annaly Capital Management, Incorporated. At this time, I would 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.

This 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 to a future period or periods, or 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 the prepayment rates; the availability of mortgage-backed securities for purchase; the availability of financing and, if available, the terms of any financing; changes in the market value of our assets; changes in business conditions and the general economy; changes in governmental regulations affecting our business and our ability to maintain our classification as a REIT for Federal income tax purposes; risks associated with the broker-dealer business of our subsidiary; and risks associated with the investment advisory business of our subsidiaries, including the removal of clients, of assets they manage, their regulatory requirements and competition in the investment advisory business.

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 statements.

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

Thank you, Katrina. Good morning, everyone. I am joined here today by Wellington Denahan, our Vice Chairman and Chief Investment Officer and Chief Operating Officer; Kathryn Fagan, our CFO; Nick Singh, our General Counsel; and two Managing Directors from the Company, Ron Kazel and Jay Diamond.

We have some opening comments and commentary, and then we will open up the call to questions. The title of this commentary is "Central Planners Defend Dirt." There is a lot of curb appeal in restructuring a mortgage to keep voters in their homes. Politicians can puff out their chests and proclaim populist programs, reflect in the afterglow of the media radiance and then turn to their districts, armed for steely debates with otherwise unsatisfied constituents.

On the other hand, there is a lot less to be gained by those charged with America's financial well-being for supporting a high-profile real estate developer or a financier who got in over his head in an office building or a high-end condominium complex or a resort. There will be little or no defense for that in the town hall meeting. Given this fact set, let me explain the title of my paper today, "Central Planners Defend Dirt."

The simplest way to state our case is that all dirt is tied to some sort of taxable authority; in many cases, multiple authorities. Valuations and property taxes make their way through the labyrinth of municipal, county, state and federal cash flows into the mostly leveraged debt service of the entities.

When the tide is rising and carrying all the boats, that is to say when valuations on property, consumer incomes and access to credit are floating in higher and higher levels, there is a virtual bubble erupting right underneath our W-2 forms. The dirt on which we live, commute, work, travel and shop transforms itself into a currency. Lenders lend at higher loan-to-value ratios. Borrowers at all levels take some cash out with which to spend, reinvest and speculate. And taxation authorities adjust the rate of confiscation. Property taxes now account for over one-third of state and local tax revenue, and herein is the problem of property prices and falling property prices.

As the downward spiral of falling valuation punctures the bubble, the weakest link in the chain goes first. Residential property speculators, sometimes also called homeowners or voters, adjust their lifestyles as the lenders take away their home equity loans, raise lending rates and generally tighten credit as the economy slows. Job losses compound the effect on all sides.

Incomes drop, W-2 earners pay less income tax, consumption drops and the spiral picks up speed. The most heavily leveraged towns and states, those that rely on the rising residential real estate tide to service their debt, are the first to report budget crises. California is the current poster child for this state of affairs, but they are not alone. As debt service commands a greater and greater share of the shrinking pie, services are cut, pensions are restructured and the spiral continues.

Realizing the risk to their own livelihood, the revenue bureaucrats in the federal government spring into action. Stimulus packages for shovel-ready projects are hastily legislated into existence. Tax credits for first-time homebuyers, also called residential property speculators or voters, are shoved into the mix to slow this spiral. This step, however cannibalizes, the rental market and the hammering of the commercial and multifamily property market begins.

Our point is clear. The pyramid game of municipal, state and federal taxation is in its death throes. The Treasury and the Federal Reserve are trying to juggle $7 trillion in debt and over $100 trillion in unfunded liabilities for Medicare, Social Security entitlements, not to mention the sums that are backing federal guarantees, that will have to be serviced by a $14 trillion economy.

Time and again, residents are raising their voices about being taxed out. So much so that politicians from Arnold Schwarzenegger to Jon Corzine to David Patterson have actually been forced to verbalize this sentiment in their struggles to steady their respective ships of state. Federal agencies like the FDIC are looking for depositories to ante up early to help shore up the FDIC deposit insurance pool.

The capital markets are going to be forced to invent ways to refinance this deflationary trend to municipal cash flows. From my point of view, the tax code is, for the first time in my life, ripe for a top to bottom restructuring. Even the most uninformed person in the United States can infer that the personal tax rate for all of us is going to go up under the current system.

Profitable corporations like energy companies are being targeted for windfall taxes or reversals of tax credits. The homeowners' mortgage interest deduction, capped at $1 million in the Clinton administration, will come under increasing fire from a federal government determined to close every loophole and redistribute limited resources across its many obligations.

The general theme for investors to remember during all of this disruption and transition is that government's central planners defend dirt. Japan has been trying to do it for 20 years. Let's hope our bankers understand that we can't afford to spend 20 years trying to disassemble that which is tearing the economy apart.

The Japanese had the benefit of a huge domestic savings pool to lessen the downdraft of their spiral, but now their political and demographic systems are in complete disarray while the zombie banking system continues to stumble and stutter through the inevitable social changes needed there. Europe is no different.

America does not have the luxury of waiting 20 years. We don't have the cushion of national savings and we are starting already at high debt levels. My advice to our central planners, first, reform the tax code to a simple domestic flat tax formula, so we can give our kids and grandkids a chance to prosper.

Next, defend the dirt intelligently, not through taxing away the heat, light and water necessary to grow. Last, and above all, never forget that capitalism is the arrangement in which individual freedom and opportunity will flourish.

Please visit our website for a complete version of these remarks, and don't forget to visit our blog at annalyatannaly.com.

With that said, I open up the call for questions.

(Operator Instructions) Andrew Wessel, JPMorgan.

I just had a question about looking at leverage now obviously continuing to run low because of the high current prices on the asset side. Just kind of think -- what are your thoughts about after the Fed program ends, assuming it ends at the end of the first quarter like it is currently projected to, about leverage longer-term. And of course, let's just use a constant and say that funding costs are about where they are today, what would that kind of do to your strategy?

Well, I would refer back to the opening comments. Central Bankers Defend Dirt. Just change it to make it Central Bankers from Central Planners.

The support in the government financing system is increasingly linked towards the sustenance of the taxation system that is underneath it. I think that there are limits to that. I think that the Fed has done an admirable job basically of filling the gap that was vacated by Fannie Mae and Freddie Mac, in terms of taking over about $1.2 trillion.

We think that this is going to be an extremely volatile exit, but there are shifting priorities that are going on at the government as they move from sector to sector and have to support sector to sector. But there are limits, as the rates would infer.

A year ago on our earnings call, we described a scenario -- in this quarter, actually -- that described there would be substantial amounts of support coming into this market from the government because of this premise. And in fact, it did happen in the fourth quarter of 2008, and was extended all the way through this year. Rates have not really moved down materially below that.

So there are limits to what policy can infer. Certainly, if we had told you that the government would come in and buy $1.2 trillion worth of debt and the same kind of assets that we buy, we all would have presumed that rates on spreads would be a lot lower, but in fact they are not.

So these are extremely generous risk-adjusted spreads that are available in the market. Mortgages have the unique capability of being called at any time. We think that the Fed is showing its hand and telegraphing that it is going to begin to stop supporting this market gradually over time. And we would like to see, as a group, the ability to take a look at what the effects of that are going to be.

And we would certainly take advantage of the landscape as it unfolds if it begins to be a much more favorable environment from a Fed perspective on the long end. Right now, you do have the Fed anchoring it somewhat. So I don't think they are going to move short rates anytime soon, and we'll look at it as they start to really get into their exit.

But we certainly have, as you would point out, the firepower to do what we want. Clearly, we have been extremely busy, as evidenced by the rest of the report, and focused on sectors that are also operating off of this premise, whether it is in the commercial side via CreXus or in Chimera.

And we do feel that we are building shareholder value aggressively across the board, and that these numbers on the core business of Annaly of spread income are an extremely powerful return, even at this reduced leverage rate.

It is the widest spread that we've ever had in our history, with the exception of maybe 2002 fourth quarter. And it is obviously the lowest rate of financing ever. So these credit spreads, if the Fed does exit, would widen out, we think, even more. But if they keep on extending these manifestations to modification or programs that are designed to support housing growth, etc., the tax credits, those are going to have some influence on some parts of the mortgage curve, and we are not going to really discuss on this call what our strategic bent is in exploiting those opportunities.

Okay. Thank you very much.

Don Fandetti, Citigroup.

Good morning. Just wanted to, Mike, get your thoughts on kind of how you are thinking about the Fed and your portfolio. Obviously, your portfolio can perform in a lot of different environments. But are you positioning for the Fed to raise rates at some point, and how would you change the portfolio if your thinking shifts?

I think we have been extremely diligent in providing some protection in the barbell strategy, which is unique to the way that we execute this transaction and that we invest in this sector. Clearly, that insurance has been costing shareholders. As good as these numbers look, there was a price to be paid for the middle part of the barbell (inaudible) on the floating-rate side.

We have been willing, and Wellington has been extremely diligent with their team in executing this, to leave money on the table and to prepare for the inevitable reversal of rates that will happen, I believe, not necessarily -- to speak to the first part of your question -- by the Fed doing anything, but simply that the markets will react in a violent way.

In fact, the third quarter was an extremely violent quarter for the two-year. In short duration trades, you had spreads out there at -- it went out to, I think, about 140 -- 1.4% to zero -- down to like 80 to 70 basis points off. So the third quarter was an extremely volatile quarter, and I think that we had a taste of what that reversal is going to feel like when people begin to realize that rates can't stay at these levels forever.

And market rates will move first and there will be no bell. It won't be announced on CNBC, and I am pretty sure there won't be a headline on Bloomberg, telling everybody get ready this morning for that.

So our feeling is that you have to prepare for that over time. We don't manage for one quarter. We don't manage for one day; we manage over time. And that is how we've been setting out the portfolio.

Okay, and then just sort of on the macro front, do you think -- you've had a good call on the residential housing market over the past several years. Do you think there is any real improvement going on, or is it more just being kind of propped up by various actions?

I would go back to the initial comments, which I think just lift a little bit of clarity on that, is that the markets are not working. There is still not a significant amount of lending going on outside of government-guaranteed Fannie Mae, Freddie Mac or FHA loans.

And in fact I would observe -- and I don't want to speak for others in the sector -- but I would observe that in fact, the FHA has replaced a lot of the subprime lenders that existed prior to 2006, in terms of diluting underwriting standards and extending credit. This is especially noticeable in the multifamily sector.

So I think that it is an extremely dangerous time for the United States as a nation to be taking this credit risk on. I don't think that fundamentally any of these securities are improving. There has been a rapid transition in spreads from very high levels to levels today that are more in line with, say, traditional junk bond spreads. But I think the fundamentals are going to continue to deteriorate here because of rising taxes, lower incomes, deflationary deleveraging that is going to go on in the system.

And it's not just the United States; its globally. We just have more weapons and tools within our economy to slow the spiral. And I think that you need to be patient against that. And I think the REIT structure is a great investment tool by which to be patient in that environment.

Okay. Thank you.

Jason Arnold, RBC Capital Markets.

Good morning, guys. Great results. Great commentary, as usual. I love the Dirt.

Just curious if you can offer on MBS prepayment speeds here going forward, whether from refis or buyouts. And then as a follow-up on FIDAC, just curious about -- the growth in assets under management looked good and what your thoughts are there going forward.

I can -- on prepayment speeds, things have continued to be muted. With all of the policy initiatives out there, you are going to see, I think, a steady stream, although it is going to be somewhat subdued relative to where you would have been had this all been just purely rate driven. So I think things are going to remain to be somewhat slower than they otherwise would be.

I would add to Welly's comments that I think that the models have been pricing in faster speeds in a way to defend ourselves against what went on in 2003, when you had prepayments really spike at unbelievable and unsustainable kinds of rates.

For instance, if you look at CPR speeds in 2003, we had a high of 48% CPR, which is incredible compared to 21% today, which is where it is in this report. Plus, we had a higher premium going into that spike because the markets couldn't believe that all these affordability products that were being generated by the subprime sector and the other lending sources would be so powerful in migrating credit from the government.

So from my perspective, I don't think prepayments will be an issue unless you see another leg down and another restructuring in the government, which it -- is clear that it is just not going to save Detroit, right? It is not going to save parts of the United States that are just way overbuilt, and those are the new ghost towns of America, as we've said in the past.

In FIDAC structure and the asset management structure -- thank you for pointing that out -- we continue to grow that. It is up five times where it was last year at this time. So clearly, while others have been divesting businesses or moving away from sectors, we have been very careful in piecing together the parts that we want and expanding that business.

And I give kudos to the management team here in integrating all of the things that have gone on here. We have been able to really build out a beautiful franchise in there from a fixed income perspective, in my mind. We have diversified it into the asset-backed arena, the CDO arena, the CLO arena. We've added new people in the recent quarter that we brought online. We made an announcement in the beginning of early September about that. I would refer you back to that.

I think we are very well-positioned to continue to grow that business. It is going to be a little volatile, I think, over the next couple of quarters, as you watch people move money around between different sectors. But clearly, the message to everybody should be that dividend stocks, fixed income stocks, are going to be a focus when growth is tapping out and is only being achieved by cutting costs at companies, rather than going in and trying to grow revenue lines.

I would point out a very curious development the other day at IBM, for instance, from my perspective. Here is one of the premier tech companies in the world, an unbelievable service franchise built on top of it; yet they can't find anything better to do with their money than to buy back their own stock. That doesn't speak well for the global economy. The metrics shouldn't work there. If we were really in a recovery, you wouldn't see that kind of metric being priced into that stock, I don't think.

So FIDAC is going to grow. Fixed income is still in the cleanup phase. We are cleaning up sectors. We are a leader in the auction business. We are the leading non-bank issuer of re-REMICs. We've got a very powerful structuring group here at the liability management. I feel very good about the pieces that we've added on that the Annaly shareholders have been paying for over the past few years while we waited for these opportunities to develop.

Fantastic. Thank you for the color. And again, nice job.

Robert Schwartzberg.

Good morning. I had two questions, one more of a footnote. My first question, one of your competitors yesterday talked about renewed competition in the repo market, both on rate and, to a lesser extent, on haircut. And I wanted to see if you were seeing the same thing. So that was question one.

And then question two, I wanted to double check -- did you issue any stock or turn on your dividend reinvestment program? Because it looks like a small amount of stock was issued during the quarter, and I wanted to see what your outlook was for maintaining that program.

We have a direct purchase program that we did implement during the quarter, and we've used that over time as we've seen accretion in the stock price. But it's not something that we rely on each quarter; it is just opportunistic.

Right.

Right, so it was more active in the third quarter than the second quarter, right?

There was none in the second quarter.

Okay, all right. And then do you have any comments on the repo market?

Well, our competitors can speak for themselves. I will speak about it from our perspective, is that the repo markets have been healing. There are fundamental shifts that are going on inside of it. I think it is never going to be as robust as it was in the past, from the numbers of intermediaries, etc. The government programs have added stability in terms of cash on balance sheets.

But we have a view that -- we have a strategic view that is not shared on this call about the way that is going to be created in the future, and I would look at our operations directly to see how we think we are going to exploit that. You've seen that in some of these returns here today. It is just that it is hidden underneath the balance sheet.

So from our perspective, the repo markets are healthy. We think that they are going to change and that the fundamental changes are all going to be part of this new regulatory package that's going to come through in Congress. It is only going to aid the repo markets, but you still need to have things like asset-backed security, commercial paper, etc., come back in a meaningful way to say that there is any competition for it.

That is the reason why all these banks are leaving catch on their balance sheets. There is no demand for credit. That is the problem.

Got it. Okay. Thanks.

Bose George, KBW.

Let me just switch back to a macro question. Can you give us your view on the longer-term outlook for the GICs retained portfolios? Do you think there will always be a big, subsidized buyer of these assets?

No. I think it is going to be migrated out. They haven't proven any ability to maintain a balance sheet. If you look at Fannie and Freddie's balance sheets at the peak of their power and height, they were at 77-to-1 debt-to-equity, I think, is one of the numbers that we analyzed, when you take in derivatives and everything else that was out there, debentures.

All of that buying power, in my mind, has been replaced by the Fed buying $1.2 trillion worth of assets. That was about the size of their balance sheets. The difference is the Fed has a printing press underneath it called the Treasury and Fannie and Freddie didn't.

Having operated as a friendly competitor to Fannie and Freddie for most of the 1990s and the early 2000 period, I think that model is going to wind up being just an insurance company and an add-on to the structure, and that the private capital markets are going to have to step in and support these assets. And that is certainly something that I think we've proven to be good stewards of capital and return over time.

And then that presumably suggests better secular spreads for private capital in this space.

That's right. Yes. I think that will be true, Bose, from a macro perspective. I think that will be true -- after we get through this rash of tightening, that I think is not based on fundamentals, but based on technicals here -- I think that will be true across all credit curves. I think that the credit curve relative to the risk-free returns in Treasuries are going to stay pretty generous for a long time.

Great. Thanks, and good quarter.

(Operator Instructions) [John Seitz], Sterne, Agee.

Good morning everyone. Thanks for the comment and good quarter. Most of my questions have already been asked.

I was wondering, when you get the take from Fannie and Freddie on prepays, are they going to be breaking out prepays associated with loan modifications going forward so you can better manage that risk?

No, they're not.

They're not?

And actually, as we've pointed out in the past, if you could look at the window then, the prism by which I look at the markets over a 35-odd-year period, Ginnie Mae has always been the subprime lender within the United States government. Most of the prepays that came through the Ginnie Mae sector did not come out of performance and credit; it came out of defaults on loans that were being prepaid at par and basically buried inside the greater budget of the United States.

And Fannie and Freddie, we've had defaults and delinquencies come through the portfolio over the entire 19 years that we've been operating these businesses. They just show up as a par return on capital because of the insurance policy that we purchased.

And you know, I was just going to say that we will see a different type of prepayment characteristic that we could probably characterize as defaults. They typically will not modify fixed rate mortgages. They may have some modifications in adjustable, but fixed rates, they generally would buy them out of the pool.

And if they do modify them in the pool, they would continue probably -- we would get our full coupon and they continue to pay as a normal mortgage.

During the workout period, yes.

Yes.

And then the REO at the government level is going to go way up. They don't like to own houses, they don't like to cut lawns, and they don't like to own dirt, but they have to defend the dirt.

So from my perspective, one of the things that we will see -- and this is one of things that tipped us off during the 2001/2002 period to the excesses that were going on -- is that these modifications will evidence themselves in aberrations and prepays within the sector. And it's up to operators within the sector to determine what exactly the government is seeing and how is this affecting cash flows in general.

Okay. That's all I've got. Great quarter, guys. Thanks.

Matthew Howlett, Fox-Pitt Kelton.

Just to follow up on the buyouts, I think a good portion of your fixed-rate portfolio, the Fannie Mae -- Fannie and Freddie [6's] -- was acquired during -- I think the majority in '06/'07. Any concern that could be where really the delinquencies are and those could be bought out of the pools?

Yes, I think you always have to figure that into your analysis, that that is a possibility. So [we could] prepayment, but the likelihood that you have [faster] because of defaults has to be figured in. We are not ignoring it.

Okay, got you. And then Mike, just a broader question. A lot of -- the sort of the real money investors out there, Bill Gross, etc., they've been underweight mortgages really for a couple of months now. How do you look at relative value rate? I think you said it in your earlier comments it was still pretty attractive.

Would you consider a large-scale asset sale, maybe even take leverage down before the government announces big -- what they are going to do and so forth, and given the concern where the interest rates or maybe buyouts. Is that still on the table, given how really -- really what the money managers say -- how rich the market is right now?

Well, we are always modifying the portfolio at the margin, right? And taking leverage down lower than 5.9 or 6 is always an option, depending on where spreads are. But I think that -- there is two things that I like to point to that are extremely important for investors in our Company to understand.

One is that in early 2006, way before the bubble broke, way before the asset deterioration began to evidence itself, we were capable of raising significant amounts of capital in that first quarter, and expressing this story to early movers and believers, and growing the Company and acquiring assets at extremely cheap and valuable discounts to the market that existed at that time.

And that buildup of that portfolio in 2006, we were able to do that while no other company in the sector was capable of raising the capital because of the embedded value of our asset management business underneath it and the premium-to-book that we enjoyed.

So the core portfolio and the acquisition premium that we have been able to manage through this period, which would be most affected by those fundamentals and technicals that you are discussing, three years ago we made choices, decisions and capital raises that were available to us that were extremely powerful and have given us the ability to better navigate over the past couple of years a lot of this. We think that is going to continue to pay off for investors and shareholders going forward.

That is not to say that other sectors of the market have not erupted into demonstrating value, and I think that Wellington and the team have done an exceptional job of identifying where that value is and using our hub-and-spoke in order to migrate capital and structure and that story over into other areas. And that is the growth that you see within FIDAC, Merganser, etc.

So from my point of view, you have to take that question first, is that we were early, we raised capital, we embedded value, cash flows, and the reinvestment risk is clearly there today.

Bill Gross is making a different decision than we are making. And I would characterize the decision that we have made in the following way, is that if you do a total rate of return of our stock since 12/31 against the Dow Jones or Berkshire Hathaway, we've outperformed the Dow Jones by doubling it since 12/31/08. And Berkshire Hathaway is actually at 4.55% total rate of return compared to our 27.8% total rate of return.

So that value is cash back into the pockets of our investors. That is a real discipline that is evidence of that cash flow. And I think that these rates of return at 18% to 20% ROE are extremely powerful. And historically, that is way at the far end of where these returns should be against the market. So even though the general markets had a powerful return over the past couple quarters, we've way outperformed them and navigated through a lot more difficult issues over these past couple of years.

Those issues are not over. The economy is still fragile. The financial system is still fragile. These repairs are temporary patches. We need to still be flexible. We are not going to move to cash, which is effectively the decision that PIMCO made, to get out of spread products and to move into, effectively, Treasuries.

We've been talking about deflation for five years now. This deflationary era is not over. It is still unwinding. You have $1.5 trillion worth of commercial loans coming due over the next year and a half that have to be restructured. You have collateralized loan obligations that are breaking, and those loans are going into default. They are going to impair credit. All of these aspects are going to be very powerful influences on holding down economic activity, and that is going to evidence itself in the cash flow of these consumer debt instruments, which are mortgages.

So the market is very powerful. Welly's been very opportunistic in taking advantage of it in different structures, allocating capital where it's necessary and where it can get those rates of return. And I think that is going to continue to pay off, and we are not going to do a huge asset sale, because that is not (multiple speakers).

Exactly. You can't assume that you know exactly what is going to happen when the Fed does stop. We just want to be in a position to take advantage of what we think may happen. We could be wrong. We have to be prepared to be wrong.

Right. Well, you certainly did put on a great trade, and I congratulate you for that. But whether or not you free up more excess capital or not, would you consider buying back stock at these levels, given you really -- you are above [buck], but you're really gaining no value for your -- or credit for your FIDAC business or your broker-dealer business, etc.?

I think it is too early to make that decision. And I would say that to say that there is no value, the value is in the operations of the business, and certainly it is evidencing itself, I think, and continue to evidence itself going forward.

The markets are mispricing stocks all over the place. You know, when we first started doing this transaction, we told people that we thought that we could create a 350 to 500 basis points over the 10-year Treasury on a yield spread basis. It is a way overvalued. I think that people are really mispricing, at least as I can speak about our Company, the capabilities that we've done. And I think it is up to us to do a better job of explaining it and to keep on hammering that story home.

Great. Thanks, guys.

John McQuade, private investor.

Good morning. I would like you to just talk a little bit about your wholly-owned subsidiary, I think it is RCap. And basically tell me how it makes its money, what the risks are, how much you think that can contribute to your bottom line in, say, three to five years?

Okay, RCap is a wholly-owned subsidiary that recently began operations this year. It is a broker-dealer. And as a broker-dealer, it has to submit itself to different levels of scrutiny than Annaly does. It is put under FINRA. It calculates capital consistent with the SEC regulations on broker-dealers, etc.

You need to think of RCap as an integrated part of a manufacturing process. The product that we manufacture is yield. RCap is an additive value to that. It will allow us the capability to access systems and capital that would not necessarily show up on Annaly's counterparty list. It will change the nature of the cash flows, give us more flexible tools by which to do that in the clearing systems that are becoming so important to the fixed-income arena through the Federal Reserve.

And as an integrated piece, it will also allow us to make decisions on how we distribute our fund products, which right now, the way that we do that is we manufacture products and we pay others to distribute. Over time, RCap, through its licensing, will go out and distribute those products directly and internalize those costs and benefits.

So you need to think of this as an integrated piece that has added balance sheet to the broker-dealer system, while balanced sheet has been totally destroyed over the past couple years, and has become a valuable entry point for us to migrate credit and to be more flexible in the way we manage the cash flow operations of the Company.

Okay, so it is really an integral part of the main residential mortgage security business that you --?

I think eventually, as we gain more and more licenses, it will be an increasingly larger aspect of the way that we diversify the business over time.

Okay, thank you.

But you have to clearly separate those businesses. For those of you who are ex-Wall Street guys, obviously, there is advisory business, there's public company business in Annaly. That is separated from FIDAC physically -- or rather from RCap physically. And we have just taken more space here in New York to build those businesses out. And we've been paying for that buildout over the past couple of years as those people have come on board.

RCap actually had its weeds about three years ago, and we started to acquire people and talent to put in there and then applied for the licenses. It's a fairly lengthy process that you have to go through. So you've been paying for that as an Annaly shareholder, and I like to think that you are already seeing the results.

Is it self-supporting?

Yes it is. We're making money every day.

Thank you.

[Ben Mackovak], Rivanna Capital.

Great commentary, as always. Your personal view, how likely do you think it is that the Fed program gets extended somehow, in some form?

I think that they -- I don't think they are going to go out and announce that they are going to extend it. I think that they will, in their day-to-day operations, which includes Treasuries and mortgages now, that they will continue to do things like maybe coupon passes where they see weaknesses in the markets or where they want to be supportive. And I think that will be more ad hoc than a formal program of $1.2 trillion.

So I think they will be supportive, for a couple of reasons. One is that, in my opening comments, I did talk about the FDIC. We do think that is in the early innings, that community banks throughout the United States, that model is broken, and they are going to be a big piece of the restructuring that is going to go on. They have already taken over a little over 100 banks this cycle. We expect that to be almost 900 to 1000 banks by the time they are done. So there is going to be more disruptions in the liquidations of those portfolios and assets and liabilities over time. And I think the Fed is going to be supportive, but it will be more ad hoc.

I think there are shifting priorities, and I would personally wonder more about how they are going to support things like California going bankrupt or another state going bankrupt or rising taxes really affecting the overall balance sheets of consumers and dampening economic growth than I would more about the mortgage market.

The mortgage market is $5.6 trillion. They've got about 20% of it. That is about where Fannie and Freddie used to be. We are still a rounding error on that balance sheet, even as big as we are. And I think that the banks and the other guys who hold these assets, they are all playing with fire, especially at the community bank level. There is no loan demand, so they are putting them into securities. That is part of what is driving these spreads higher.

Thank you.

And you have no further questions at this time.

Okay, great. Katrina, thank you. Well, I thank you all for joining us today. I hope that we've answered all of your questions. If not, you know that we are available.

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This concludes our conference for today. Thank you all for participating, and have a nice day. All parties may disconnect.

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This transcript has not been reviewed or approved by Annaly Capital Management, Inc.