Annaly Capital Management Inc (NLY) 2009 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 like to inform you that this conference is being recorded and that all participants are in 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 forward-looking statements within the meaning of Section 27-A of the Securities Act of 1933 and Section 21-E 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 the 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, and if available the term of any financings; 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 by 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 result of any revisions which may be made to any forward-looking statements to reflect the occurrence of unanticipated or unanticipated events or circumstances after the date of such events.

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

Thank you, Ken. Good morning, everyone. I will read the opening comments and then we'll move right into the Q&A.

Through a Glass Darkly, the title of my remarks today is taken from one of the most beautiful and mysterious passages in the New Testament, 1 Corinthians 13.12. For now we see through a glass darkly, but then to face to face. Now I know in part, but then shall I know even as I am also known. In the context of the biblical passage, the sentence implies that we in the present can only have an imperfect view of ourselves as if we were looking at our reflection in a distorted and cloudy mirror and that we will only have complete self-awareness in the fullest of time.

While we may have debates over how this applies in a theological context, I believe this concept of knowing the truth about ourselves now and in the future resonates in an economic sense as well.

In an economic context, the struggle for self-awareness is best summed up by Milton Friedman's so-called permanent income hypotheses published in 1957, which in essence holds that people tend to make consumption decisions in the future based on what they consider the permanent income today and that any temporary windfalls like lottery winnings, inheritances, or checks from the government will be disproportionately saved. Moreover, permanent income is not based just on current income but also on expectations for future income.

Friedman concluded that lower wage earners who typically have less transitory income such as big bonuses or tax refunds actually have a higher propensity to consume because their expectations can be more easily set by their current income. Higher income earners in contrast, have a lower propensity to consume due to more transitory aspect of their income.

To me, in adapting Friedman's permanent income hypothesis model to the current economic conditions, the key determinant of consumption is an individual's real wealth as opposed to his or her current real disposable income. Even today, the vast majority of real wealth on the United States consumer's balance sheet is real estate, which in the post World War II era has generally always gone up in value. Permanent income is determined by a consumer's assets, both physical assets like stocks, bonds, and property, and human assets like education and experience. The constant ebb and flow of these assets influence the consumer's ability to earn income. Once a consumer makes an estimation of anticipated lifetime income, spending patterns emerge across the different needs and incentives available in the economy.

Today this perspective on current income has been proven to be nothing more than a reflection in a distorted mirror. While asset values were rising, households were fooled into thinking that the transient was in fact permanent and they consumed accordingly. During Annaly's earnings calls of 2005 and 2006, we discussed the larger market's critical error in thinking that home price appreciation and improved debt service were the result of rising incomes and earnings performance rather than poorly underwritten liquidity in both the debt and the equity markets.

As every American taxpayer knows, coming into 2005, the bulk of a family's balance sheet was firmly entrenched in real estate. For most of the past 60 years, the US more or less supported a homeownership rate of about 60% of the population. In the misguided drive to give the incremental buyer the opportunity to achieve the American dream, that rate was lifted to about 70%. Not by growing income but rather through creative financing techniques enhanced through the largest unregulated insurance market in the world, the derivatives market.

Since rising incomes did not sustain the homeownership rate, rising and risk appetites filled the gap, some by government policy and some by private sector actions. To demonstrate the distortion that took place in housing, check out figure 2.1 from the second edition of Robert Schiller's book Irrational Exuberance.

Schiller tracked down US inflation-adjusted home prices, building costs, population, and bond yields going back to 1890 and it is clear from the data that the 21st century bubble in home prices was caused by something other than supply and demand issues, income growth, expense increases, or inflation. It came from debt formation. The chart is available on our website for those of you following along online.

Today in the shadow of de facto unemployment rates of more than 17%, states and municipalities under growing pressure from shrinking revenues are rising taxes and slicing and dicing budgets across the country, impairing the long-term growth of income. In the haste to stimulate a stuttering economy, the federal government is setting a course to further impair incomes as the need to service the sharply rising federal debt will ultimately be met with frozen spending and then rising taxes and fees.

In 2005, we described the future crowding out of the private sector with the growth of the public sector debt and we illustrated this distorting effect on economic conditions in our first quarter 2009 earnings call, you can't always get what you want.

The dark mirror of Friedman's concept of permanent wealth is stunningly demonstrated when looking at the year-over-year change in real consumption and real wealth since 1960. Real household wealth has been very volatile in recent years. As the graph on our chart and website suggests, it is difficult to make future consumption decisions when the present is so well impermanent.

The distorted mirror of flawed statistics that is driving current policy and the electorate's disfavor with those decisions can be summed up by the election results since 2006. Even as recently as the Scott Brown upset in Massachusetts, the electorate is not voting for any party or an ideology. It is voting to throw out incumbents linked to years of juggled books and misallocated debt-fueled financial decisions. To draw the circle back to Friedman's permanent income hypotheses, the voters have looked at their balance sheet, they have seen their primary assets collapse in value and know that their future lifetime incomes are going to be impaired by higher taxes to pay for this mess. In short, they are voting with their pocketbooks with a vengeance.

Politicians and policymakers who recognize this and are willing to bite the bullet and align with these values are the winners for the foreseeable future. These are indeed changes of biblical proportions and the economic data are only darkening the looking glass. Last week's GDP release was a topline positive but to me there are many struggles ahead of us. There are about as many people receiving emergency unemployment benefits, 5.7 million, as there are on regular unemployment. The average duration of unemployment is over 29 weeks, a postwar record. Real incomes are down from the 2007 peak.

The housing market is truly on life support with a vast shadow of inventory of homes on the path to foreclosure waiting to hit the market and over 95% of all mortgages needing some form of government guarantee in order to be originated. Mortgage delinquencies are still rising and the newest wave of option ARM resets is due to rise throughout 2010 and to peak in 2011. Debt deflation continues in all sectors but government debt.

The FDIC stepped down its -- stepped up its rate of bank seizures in 2009 and showed no sign of slowing down and the bank sector as a whole is still playing defense. Their loan-loss coverage ratios have fallen to about 60% from historical average of over 140% despite increasing their reserves and they are now sitting on as much cash on their balance sheets as they have in C&I loans.

The mirror will become less distorted over time as the new statistics flow through the data and clarify the new decision-making processes and provide evidence of a healing, but in the meantime it's going to be a long, painful adjustment for everyone.

In conclusion, this is not a pretty picture for our country but it is an environment that rewards prudent balance sheet management, favors capital that can take advantage of debt restructuring and renegotiations, and invest alongside governmental efforts to revive the economy.

That said, we now open up for Q&A.

(Operator Instructions) Bose George.

Great quarter. I had a couple of little things. One was your percentage of fixed rate securities increased to 74%. I'm curious what's driving that. Are you doing more with CMOs to control duration? Or I was just curious what is driving that.

Yes, we continue to swap out a majority of it but we are not going to go into great detail about how that fixed rate is broken down. But it has been fairly consistent when you account for the swapped out nature of the portfolio. We continue to go along the lines of roughly two-thirds adjustable floating to one-third fixed.

The other thing I was curious about was just the asset duration. You usually give that at the end of the year in your K. I was just wondering if I could get that?

It is approximately two years without the swap portfolio and one with the swap portfolio.

Great, thanks a lot.

Andrew Wessel.

Good morning, thanks for taking my question. I guess just first in terms of expectations that the Fed is kind of coming to a halt here and I think our strategist is saying 30 to 40 basis point widening in spread, for fixed-rate collateral at least, kind of what are your thoughts? Is the Fed definitely going to end in March and what are your thoughts -- kind of going forward through the year or the end of the year in terms of positioning the portfolio after that kind of stimulus wears off?

You know, I would point you first off we put a blog blast out last night on our website discussing this very topic from our perspective. It's pretty conclusive that we don't expect any major dislocations to come from the Fed's planned exit to get out on 3/31. The way that we viewed their market presence over the past year and a quarter has been that they are essentially replacing the balance sheet strength that was in the market from Fannie Mae and Freddie Mac's balance sheet around $1.2 trillion in assets, which is roughly about 20% of the overall agency market that's outstanding.

So that said, I think you can see from the characteristics of the portfolio that Wellington and the team have I think expertly positioned going into this time of volatile decisions by government authorities -- that's the best way to say it -- that we would love to have spreads widen out dramatically. We think those asset yields would be very accretive for our shareholders and for our earnings, but we are not very clear that that is going to happen in the market. We think the Fed is going to be continuing to support the market at the margins and if it sees big dislocations, will continue to come in. But I will [Welly] to expand (multiple speakers).

Yes, I think that there is plenty of cash out there, anticipating the end of the Fed's intervention. They haven't really said that they're going to go beyond March, which is a good thing. I think they have had a lot of conversations with the market trying to figure out what type of interest rate move they may -- we all may experience once they step away and my hope is that we would see pretty good widening. My anticipation is it is probably not that much.

There is a lot of cash on the sidelines. I think you have a lot of other things that may weigh in, whether it's faster prepayments potentially that get pulled through when Fannie and Freddie start buying more loans out of pools. It's also the anticipation of them ultimately stepping up their reverses with the market. So I think those things may weigh more heavily and we are looking forward to the opportunity to take advantage of any of the volatility that comes through.

Mike Widner.

Good morning, guys. Congrats on a solid quarter. You know, that was a pretty chipper commentary. Are you getting any less bearish on the economic outlook or is it pretty much the same? It's very consistent I would say with what we have been hearing for the past couple of years from you.

You know, my view is that we are not taking the steps that I would like to see as a nation to secure our economic and our defense around our own savings and that what is going on here is an extremely powerful aberration to the past cycles and it is a mistake to use the tools of the past to do this. And the results are that this is extremely good weather for Annaly as a result. So there is an upside and a downside to it.

The result is that we are only at the beginning of what we think is an extremely steep and generous yield curve that will change in nominal rate structure over time but the shape of the curve will continue to be extremely steep because of all the deficits that are being fed into the market. And we have spoken about in the past about the crowding out effect that government debt issuance has on the private sector market and certainly that is taking place and I can see evidence of it globally whether it's in Greece or Portugal or Ireland or Italy, Iceland. So weaker players are being pushed out by the stronger credits even at a national level.

So as much as I would like this to change, it is not going to change for generations and I think that the bottom line is that the country has a big hole to dig out of and only a big technological change will change that.

So against that backdrop, the way the government funds deep deficits, which is what we are in now, is that the market widens out the 10-year, one-year spread for them in basis points. And if you run that chart of the 10-year, one-year spread and basis points versus the federal budget deficit going back to 1962, you will get a sense of how steep this curve is going to look no matter what the front end handles are.

So I feel like this team has done an exceptional job of preparing us for this and creating extremely high returns on equity using the least amount of leverage we have ever reported and taking advantage of a very accretive funding to asset spread yields that are already in the market. There are limits from the government, as we have learned over the past year. They can drive down rates on everything. Mortgage rates are really not materially any lower than they were when the Fed program began.

Right. Thank you, I appreciate that color. Just one other question. If you could talk a little bit about prepays. Actually prepays came in a tad slower than we were looking for this quarter and I know we've got some changes potentially coming up with Fannie and Freddie purchasing loans out of pools. Just wondering if you could talk a little bit about your expectations there?

I think Welly is going to give you the real color on the cash flows, but one of the things that the market should be aware of is that high prepayments have been priced into this market for quite some time from an acquisition point of view and in fact they have disappointed in terms of their speed.

Secondarily, Fannie and Freddie and Ginnie are in a major push to push fraudulent loans back to the originators, so the modifications are not working. They are trying to protect their own balance sheets and they have the right to put these back if there are things that were wrong with the documents on the loans that were created, and that is a major objective of what's going on at the agencies right now.

That will I think offset any progress that you might see from loan modification or release of principal payments.

Yes, each month that we -- they come in slow, we certainly welcome it. We are anticipating that there is a potential that they could pick up fairly dramatically depending on how they execute the buyout program. Again, we will welcome the slowness that we get every single month.

And so, would you have an ability to quantify what you would expect potentially in terms of increases? I mean, because I guess there's two things going on. It's Fannie and Freddie pushing as many loans as possible back to originators that should effectively have an upward push on prepayments speeds I think, just as well as buying more loans out of the pools to make modifications and principal forgiveness and that sort of thing.

Well, I'm not sure that the way that they execute those programs necessarily need any speed up in prepayments per loan. It has been our view since this mess started to erupt in 2007 that the insurance policy that's inherent in the yield wrapper that we take these securities on at from the government is going to give us the money back at par. We are running an extremely low premium acquisition price in the 101 range. So I think we are not as exposed to that, say, as we may have been in 2003 when the private sector was forcing Fannie and Freddie out of the market and eating up a lot of market share through all of the new innovative financing techniques.

So I don't want to -- we are watching it carefully. There may be some spikes along the way, but I don't think it's going to have a material effect going forward.

Yes, and that's the nice thing about it. There is not one consensus view on it, which makes for opportunity in the market. Like I said, we are always anticipating that they will be much faster and we prepare for it and when it doesn't happen, we are very welcoming of that.

Great. Thanks, guys. I appreciate the color and commentary.

Steve DeLaney.

Good morning, everybody. Congrats on another strong quarter. Mike, I wanted to ask a little bit about this proposed TARP tax, I guess I would call it, the 15 basis points. What impacts -- assuming some version of that is passed, what thoughts do you all have about the impact on the repo market overall? And maybe as part of your response, could you touch on how things are going at Ranger and your progress in direct repo?

Sure, thank you. Well, the Financial Times really answered your questions in an article that they released I think yesterday or early this morning, that the repo market will apparently be exempt from any of the fees or taxes or whatever euphemisms we want to use on that spread that's going to be (multiple speakers) with the big banks.

Yes, I saw that, Mike, and I read it to imply on treasury repos. So I need to read it again.

Yes, I think it's treasuries and agencies at the end of the day. The didn't want to disrupt -- the thing that we have heard from regulators across the board, whether they are at the federal level or the local level, is that they do not want to do anything to impede the flow of capital into the housing sector or the commercial real estate sector. And they are looking for new ways to take advantage of that. NAREIT is enacting FIRPTA through Congress to bring in capital from offshore, take down some of the tax hurdles that are out there in the REIT structure for offshore capital and real estate. So the bottom line is that if they put it in, it's naive for anyone to think that it's nothing more than a cost of business that is going to be taken out of the consumer side and transferred over into spread assets. Because as an asset allocator, we and others in the financial world are going to look at this and go it could cost me 15 basis points more, that changes the leverage ratio of allocation that I am going to give my portfolio managers and my traders and they need to back up, which is going to cause wider spreads in effect on the asset side.

So I think any change in that funding vehicle is going to evidence itself through higher yields on bonds, and I don't think that's a very good outcome. I don't think it's a very well thought out [glass] either, by the way.

Sure. We are back to the zero sum game, right? They're going to pass it on, somebody is going to pay for it.

Yes. It is a mistake for anyone to think that it is a passive thing that just Goldman is going to pay for.

Got it. So how about Ranger? Anything worth sharing there and your efforts on direct repo?

Yes, it's pretty exciting. If you look at -- it is actually RCap is the name that we (multiple speakers) that we arrived on. RCap, for those who are on the call who don't know, is a wholly-owned subsidiary dealer operation that was approved by FINRA last year. It took us about a year or so to go through all the documentation and get it set up.

Today it is the largest lender to Annaly. It accesses the clearinghouses and separate money market funds through the clearinghouses and the clearing organizations like the FICC. It's about an $8 billion or so portfolio of mortgages that go through. It's been an incredibly flexible tool for us in helping us gain access and diversifying our liability stream. And is a real powerful arm of the Company going forward.

As you saw on the releases that we put out last fall, we brought some very talented people over to come into the Company that had been standing by and starting to build businesses around the dealer operation. We've brought in people to do credit as well in the corporate world and do surveillance in the asset world. So we continue to expand the platform and diversify the earnings stream in addition to -- and the growth element -- in addition to the core strategy of spread income.

So we're pretty pumped about it. We think that RCap is unveiling itself to be everything that we thought it would be and more.

Mike, can you quantify -- like if you were to compare a trade, a repo trade to RCap, where you are basically cutting out a primary dealer, can you quantify the basis point savings just roughly versus if you were to do a traditional repo with a street dealer?

You know, I'm really not going to do that but I will just say that it is additive to the Street in that we have replaced balance sheet that has been destroyed while other dealers went out of business like Lehman, etc. So we have in effect built our own balance sheet underneath it. It is an extremely flexible tool in terms of discipline of hair cuts and cash flow management etc., and it is an additional set of eyes from a regulatory point of view and a transparency point of view because obviously now we not only report to the IRS and the SEC, we also report to FINRA, the SIPC. I mean, we embrace liquidity and transparency, and I think RCap is a powerful tool to be in that window.

Thanks a lot for the comments.

Jason Arnold.

Good morning, everyone. Nice job this quarter. Mike, as usual, great commentary. Just one quick one, in terms of hedging the portfolio going forward, do you see a specific tenor attractive for your rate outlook, three years, five years, or longer-term more appealing right now?

You know, we will always look to the market to take advantage of where the cheapest insurance is gained and it continues to fluctuate around and obviously with the Fed's intervention in the market that has kind of changed the dynamic of and the duration of the market. So I'm not going to tell you exactly where we are placing ourselves but we will continue to move up and down the curve and look for the best places to execute hedging to insulate the Company going forward.

Okay, so more opportunistic it sounds like. Great. Then I guess just one additional one. Just wondering if you can update us on the asset management side of the business and what sort of growth opportunities you foresee here for the next several years here ahead?

Yes, we are very pleased that the growth in assets under management and the addition of Merganser, etc., I think those stood at $22 billion in this report. So when you look at the overall Company the way that we look at it from the perspective of Annaly now has three wholly-owned subsidiaries, FIDAC, which has a tremendous presence in the restructuring of assets and the management of assets. It is the largest non-bank issuer of re-REMICs for 2009.

You have Merganser, who deals in credit and in short duration strategies has a very powerful track record and has been building on its relationship with Annaly and is going to grow we think pretty significantly going forward on a separately managed account basis.

And we have RCap, which has been a very strong presence for us, which is primarily put together to give us flexibility and replace balance sheet on the repurchase side, but also allows us to distribute and execute our own transactions through there at an arm's length basis or for clients.

So I feel extremely strong about the ability of the Company to grow over time. When we look assets the year ago, AUM, we had $11.5 billion. At the end of this quarter, we came up with about $22 billion I think. That is pretty dramatic growth and I think that that's going to be a big component of the way that people look at the stock going forward in addition to the core earnings and the yield that come through.

Okay, terrific. Thanks so much.

Douglas Harter.

Thanks, I was wondering if you could talk about sort of your outlook for leverage and sort of what might be the conditions that would cause you guys to start bringing in a little bit?

Again, I think as we've been communicating with the market for some time now, we kind of want to see what the reaction is going to be of investors when the Fed is ultimately and finally through with their purchase program. And I mentioned earlier a little bit of uncertainty surrounding the prepayment horizon and the potential there for faster speeds coupled with the fact that at some point, I know the Fed has been in testing the reverses with the market and maybe they start to ramp it up again.

We will look to take advantage of the volatility that ensues and we look forward to it. In that kind of the scenario we will certainly what we believe the risks are in balance sheets and in determining where we ultimately feel comfortable with the leverage. But as this report showed, we have incredible earnings. We are a huge beneficiary of the shape of the yield curve and as Mike kind of laid out earlier in his comments, we see it to be fairly persistent for some time now, so we are in no rush to increase leverage and again, we will always keep the door open as we -- as opportunity presents itself.

Yes, with these kind of ROEs and this kind of spread to financing, it really does speak to the power of the earnings model on the basic position. When we think about the business, we think about all the asset management businesses and other things that we do underneath it that help mitigate the expenses and help us grow the business over time through relationships.

But I think most importantly gives us is a view to value in the markets that is unique to us, whether it's in our auction business or through our management contract to Chimera, our management contract to CreXus, we have expanded dramatically over the past year the view of the markets and the valuation of the markets in ways that we think is not currently evident to everybody, which allows Wellington and the team to provide tremendous amounts of asset allocation viewpoints into executing these markets on behalf of the shareholders going forward.

So leverage is the least amount of things on our mind right now. We are earning 240 basis points spread. We think spreads are going to continue to stay to funding at extremely generous levels. If there is volatility in the market because of the shotgun approach that's coming out of Washington, we are prepared to navigate through it. I think this leverage ratio demonstrates a very efficient model for passing along earnings out to shareholders and allowing us the flexibility within our business model to navigate it pretty successfully.

The best thing I can say about the past is that in the first 15 minutes of every investor presentation we used to talk about what would happen if Fannie and Freddie failed. That was basically all the way up until 2007. We now know what would happen. It was pretty much what we thought. We also now know what would happen in reverse, when the repo markets start to get stuck, what the Fed's action and playbook looks like, which we didn't know going into 2007/2008. But now it's extremely clear that even as they remove this stimulus or they remove those programs, they can always put them back in if they feel the market is getting sloppy.

So I think you can continue to see the Federal Reserve and the Treasury active in the mortgage markets in ways that have been already exposed to us and unveiled to us over the past couple of years just maybe in smaller increments. It's up to the private sector to fill that gap.

Just sort of touching on one of the things you said, if you could sort of talk about where you guys kind of see asset allocation across the different businesses that you guys are in right now?

Yes, I think that the agency space and the spread business, even though the Fed has been buying a lot of securities, they have not -- they have been doing it more for policy reasons rather than valued reasons, so I think that there are pockets of value in the $5 trillion envelope of securities that are out there in the mortgage world. Every bond has a story that has opened up a tremendous amount of value across the board. Where they might be destroying value in one sense, they're opening up pockets of value in other senses. I think we have been very opportunistic in that.

When you look at the non-agency world, well, 95% of all issuance came out of the agency world last year, so you are still in the repair cycle there, which is a very powerful element of Chimera's business as well as FIDAC's business in restructuring and loans and taking detailed risk. That remains very strong.

And we think that in the commercial world that the technicals and fundamentals are still being skewed by government intervention and by the stalemate that's going on between the banks and the borrowers on commercial real estate and that the fundamentals will win out over time like they did in the residential side. That is going to continue to keep the yield curve relatively steep. So where the elements are against that, I would say cautious and then we see opportunity across the board in other things.

Great, thank you.

Don Fandetti.

Good morning. Mike, the last time the Fed raised cycle obviously the model or earnings came under a lot of pressure. Do you think there is a much better chance this time around that when the Fed does raise that it's at a much slower pace and therefore your model can handle that and absorb that better and that sort of the bear case on raising rates and the stock is not as dramatic as it might have been in the past?

One thing I just want to point out, the last time we were in a tightening cycle we did not utilize interest rate swaps.

Which are uncapped now. We had cap securities that were floaters in the middle of our barbell, so the value of those securities were a lot more volatile. But if I could just speak about that tightening cycle in 1999 for instance from the perspective of post long-term capital, at the end of that cycle after the Fed had lowered interest rates to save the world and long-term capital in 1998, as that reversed itself during 1999, our earnings actually went up 19% because of the value decisions that Welly and the team made about taking advantage of slowing prepays and a rising yield environment.

Our book value during that period was more volatile than we would have liked it to have been because of spread that was going on and also there was a debate in the market about Fannie and Freddie having their AAA credit line pulled from them during 1999, which was resolved by Congress.

So those two things that you have to look at during that part of the credit cycle was definitely and rising cycle, that was actually additive to the Company because of the value decisions that the team made. In 2003/2005's tightening cycle, that was at a period where we voluntarily withdrew from the markets even though the yield curve looked relatively steep because treasuries were at 1% on the front end and 3% on the long end, on the 10 year.

What people were not factoring in is that pre-payments were extremely high, so we made a conscious decision between 2003 and 2005 to delever the book, take advantage of the profits that were in the book for the shareholders, which was a hit to earnings, but we were also staying out of the credit cycle.

As we emerged from that in 2006 and we were first actors, we were acquiring large amounts of assets at extremely attractive levels that are still benefiting the Company today because of their historical price. So I think that the combination of changing the portfolio, as Welly said, where our swaps portfolio is now an uncapped floater, which is costing us about $0.30 a quarter right now in insurance, if you will, against the volatility in the front-end of the yield curve, as that -- as the market reacts to perceived Fed tightening, the markets will take rates higher first. That will be additive and I think our earnings will be a lot -- a surprise to many people about how substantial they are.

(multiple speakers) And also one of your best defenses against rising rates is to have liquidity. And I know we get a lot of questions about our leverage position. It is another tool that we use to be able to position the Company going forward for any volatility that may ensue.

So just to clarify, you don't really think there's going to be sort of a material pressure on your earnings then as we go into --?

Don, we run all kinds of stresses, the portfolio team runs every different twist and turn and we have a lot of views on how these things might unfold and earnings holds up very, very well. Again, these are modeling and we model all kinds of scenarios, all kinds of prepayments, all kinds of leverage levels, a lot of different mixtures of asset types, and we always try and optimize for the unforeseen.

You know, you don't get the kinds of returns that we just created over the past year without taking risks. Right? And the bottom line is that there are risks in every model, but when you go back and take a look at the total rate of return of stock since inception, since 1997, it speaks for itself.

Throughout all of the different tightening actions that were taken by either the Fed or the market or the noise in the market through the close of business last year, Annaly's total rate of return since its IPO in October of '97 was 468% as compared to Berkshire at 123%, S&P at 53%, and S&P Financials at 1.3%.

So I don't know how much more margin of error you can add than that great beating of total rate of return. Yes, we are not Google. Please, if you think we are Google, sell the stock. But 423% of that 468% came to investors in the form of dividend, cash back in their pocket every quarter which is a value decision that the asset liability team makes every day.

No, over the long haul, clearly you guys have done a great job. I'm just trying to sort of get a sense on kind of how you think where the Fed does raise at some point --?

I think the market is going to raise rates for the Fed and that's going to widen out asset spreads first and that's how everyone should think about what the outcomes will look like. Because once those market rates start to go up, the shape of the yield curve will become a lot more evident as being steeper than it probably is right now and that's going to be additive to earnings.

One thing we try and model, Don, is what's going to happen to everybody else.

Right. Okay, well I appreciate the color and the background. Thank you.

Henry Coffey.

Yes, good morning, everyone. Congratulations on the great quarter. Two things really struck us when we were going through the numbers. Yields came down less than we were guessing and you booked a larger gain on your swap book. Can you give us some insight into what steps you've taken both in the quarter and obviously we are asking more about the future in terms of defending yield.

Henry, we don't go into great detail about the rebalancing that goes on in the portfolio. Again, we will always just continue to run the portfolio through a lot of different stresses and make the appropriate changes were we deem necessary. You guys are all looking at a snapshot and time of one day. So it's hard to break it down.

All right, thank you.

[Robert Spicher].

Hello, great job, guys. My question is could you provide some color on the REIT status and how the Bank of Annaly is pressing against the boundaries and whether or not that will affect growth in your subsidiaries?

We don't have a bank, but --

I do remember one conference call where a CEO referred to you as the largest bank in New York.

Well, no, we were called by Jim Grant as a thrift without walls because he thinks of us as what a traditional thrift business would do.

But anyway, if you could comment on the REIT status and how that affects your model?

One of the most intense things that we monitor is our compliance to all of the rules that affect all of our business and the REIT status is obviously the first one. I would say that the subsidiary businesses are comfortably on their needs challenging anything that would have to do with the REIT status and that our number one goal has always been to have those businesses be additive and to make sure that we are covering ourselves in terms of all the tests that need to be done, which are done on gross assets and gross income inside of the REIT rules.

So we don't perceive any kind of regulatory stress in that regard. Obviously we've been operating for 14 years in this structure. We've got a long history and I'm not sure that there is anything else I could add to that. I would point to Kathryn and see if there's anything she wants to throw on.

You know, I just want to point out that our gross income is around $3 billion for the year, so there's a lot of capacity to have non-REIT income flow through the Company. So I don't see any challenges with the subsidiaries.

So there is a limit on income you can have from the non-REIT subsidiaries and that does limit growth to some extent?

Well, I think if we are testing that limit on a $3 billion gross income level, that would be a great thing for the shareholders.

I think you guys would be partying in the street.

All right, thank you very much.

Daniel Furtado.

Good morning and thank you for taking my question. I just want to know if there are any common attributes or themes with the $3 billion and sold securities during the quarter?

We don't comment on that.

And would you be willing to comment on just general discussion in terms of how haircuts have changed on the reverse repos that you provide?

The repo markets actually continue to improve. It has nothing to do with repo. We continually rebalance the portfolio and if the market is willing to give us an outside price that we think is unsustainable, we certainly would take advantage of it.

Okay, great. Thank you.

Stephen Mead.

Yes, could you provide a little color on the fact that the government in terms of its purchases of mortgage-backed securities to the tune of $1 trillion, is there information or is there -- I'm trying to get a sense of what securities have they been competing for or buying in the market? How does that affect what you buy in the market?

Steve, if you are near a computer, punch up the Annaly website and go to a blog release that we put out last night titled Time for the Exit or Heading for the Exit. I forget what we titled it, but it breaks out what they have been buying, the coupons, and the linear relationship of those coupon purchases and how it's been drying up.

But I would say that they have been more of a current coupon buyer. In the old days, I would say that they were working off of the Lehman ag but that certainly has not been their intention as an investor. We don't think of them as an investor. They have been basically providing liquidity for mortgages for about a year. But we detail it at length on that blog.

And then your spread in terms of what the spread was at quarter end narrowed from the average spread during the course of the quarter. Can you comment about sort of what you are seeing since for the quarter?

Steve, those are always just a snapshot, right --.

And last day of the quarter.

That's 12/31. That's what is being audited. That's the snapshot.

There's no question if you look at the spreads to the current coupon, the three-month LIBOR or current coupon to seven-year swaps, five-year swaps, you name it, the spreads there are still very attractive.

And going to be more attractive, I believe, over time.

What was the opening part of the Bible that you were referring to?

Corinthians. I will give it to you in a second. It's not the one that says love is never kind. First Corinthians 13.12.

Got you, thanks very much.

Matthew Howlett.

Thanks for taking my question. Mike, just your thoughts on GSE reform. It looks like they pushed it back a bit, but expect the administration to (inaudible) some proposal shortly. Any idea (multiple speakers)

But you didn't like the one sentence they included? That wasn't enough disclosure?

You know, we have been looking at the government's 10-K and we have a funny feeling that they are doing this with mirrors. You know, my feeling is and actually Welly has been extremely active in [SIPMO] along with others here, we think that the outcome for the GSEs will be that they will be insurance companies.

If everybody could just step back for a second and remember the call for the US mortgage markets to look a lot like the European market, the covered bond portfolios two years ago, the newsprint would say we have one. It's called Fannie Mae, Freddie Mac, and Ginny Mae. It is a covered bond program to the credit of the United States.

So from my perspective, they are in this business for the long haul. They have always been a high percentage of housing guarantees. They lost market share in 2002 to 2006 to the private sector in the form of Countrywide and Indie Mac, etc. and WaMu, and we see the results of that now. And I think ultimately they are going to wind up being insurance wrappers. The portfolio will continue to be run through the Federal Reserve and the Treasury's actions.

So I think GSE reform is going to look like the old mortgage market, 20% down, real documentation proving you are earning money. Maybe a W-2 would be healthy. You know, three appraisers looking at the property, etc.

Right, so no major change?

No, and I think that the capitulation by the Treasury and the Fed in December by pushing it out three years, that's just the beginning.

Yes, it is probably going to be status quo for a while. I just think there's not the political will to make the necessary decisions.

Yes, if you are looking for the new Fannie, Freddie, look at the FHA. 25% of all those loans that have been -- that they have stepped in to provide liquidity to housing are already in problem in the vintage of 2007 and 2008.

Right. Good point.

So we are there.

Wellington, just one question for you. Is there any way to estimate what you think the delinquency levels are on the fixed-rate book? It looks like most of the delinquencies are in sort of 6.5 coupon and higher. I know you have slightly --a little bit below a 6% coupon. Anything you can estimate?

What do you mean? Just in the overall Fannie Mae portfolio or in our own?

Your portfolio, your fixed-rate portfolio.

No, we don't. You just see it evidenced through prepayments and it's not like -- we are aware that there are -- that those are lower creditworthy borrowers in those higher coupons, but it's really for us is a prepayment gain.

Just as it relates to buyouts, Freddie discloses by vintage sort of 2000 -- 6% coupons around 6%. That's Freddie, Fannie may obviously may be a little higher. Could we assume 6%, 7% could be the right number for you?

You could probably. I would say that their experiences are probably very similar.

Okay, great. Thank you.

Steve Covington.

Good morning, congrats on a great year, great quarter, and all my questions have been answered, thanks.

Jordan Hymowitz.

Good morning. You guys always are very insightful in terms of the market. In that regard, what is your view on recisions? Do you have one? In other words, a number of the MI companies have been pushing back a lot of their recisions, saying that things haven't been fully underwritten or the lender is somehow engaged in a fraud or not truthfulness for lack of a better term.

What is your view on the ability of the Fannie, Freddie or the MI to continue this policy and what are the thoughts are for the ramifications for the mortgage market?

You know, we have a general theme going on everywhere and that kicked the can down the road. I think with these insurance policies, and even with Fannie and Freddie, it will be a stalling mechanism to try and get themselves made as much whole as possible with the insurance carriers. I think that they are going to try and not pay a claim as all insurance carriers do.

You know, Fannie and Freddie are pushing back loans. There is definitely a push back going back into the private sector that is going to affect bank earnings, MI earnings, originator earnings for the foreseeable future. And it is going to be full employment for the lawyers.

(inaudible) That doesn't tell me any different.

I'm sorry, someone else got on the line for a second.

That's about the summary of the way we think about the market.

Okay, thank you. Congratulations on a very good quarter.

[Stuart Sperling].

First of all, let me thank you. I have been a shareholder for a number of years. In fact, I bought some this morning and my grandchildren thank you. I have a special-needs grandchild who takes the dividend and we use it for his schooling and everything else. So we appreciate what you have done and my question was this. I don't know if it's really a question.

But over the years in the stock market people have said 10% would be the average earnings for everything and if you could do that, you would be doing fine. You are giving 17%. I can't understand why people would not be more into a company like yourself, and I follow the jockey and you guys are the jockeys, just like horse racing.

So I just wanted to thank you and ask you on the dividend when you -- many businesses being ex junior accountant years ago, many businesses can tell you their profits before the year even starts. I know you are not in that type of business, but what is the percentage that you pay out as far as dividends? I know you have to pay 90% out, but companies seem to figure that on a cash flow basis. I don't think you do it on a cash flow basis. And correct me if I'm wrong.

No, you are right. It is our -- it is taxable, the way that we look at it. What do we have to pay out for tax purposes is 90%. It's our policy to pay out 100% of core earnings, which is the spread income that we generate. We may from quarter to quarter because of the nature of the assets, we may sometimes withhold $0.01 or so because we are not sure about the exact cash flows that come through in a different quarter or the timing of the receipt of those cash flows.

We've never understood any business that can project the year's out earnings. I think that has been exposed over the years through managed earnings and then certainly has never been a policy of this Company. We try to express to our investors that the returns that they should expect from our strategy should be 350 to 500 basis points over the U.S. Treasury 10-year as a reliable spread. That has been our first statement that we made on our first roadshow back in 1997 and it's consistent today.

We take what the market gives us and we try to do it as efficiently and with as prudent risk as possible. And our view of business in general is that look, I know people. I come from a middle-class background. I know people who run everything from candy stores to pizzerias to multibillion dollar companies. And over a drink, no one can tell you what their business is going to make in a given month, right? That is why retailers scramble at the end of every quarter and they blame it on the weather because of rain or snow or whatever.

So from our perspective, we try to prepare you as an investor for the fact that our cash flows will be variable but they will be lucrative. The margin that's built into this return is a powerful return. As we grow the Company, larger and larger pockets of capital are attracted to it as we become a bigger part of indices, etc. And we have always been prudent in the amount of capital that we take that we think we can put to work accretively.

Along the profile that you described yourself as an investor, I view this the same way. I have always taken the view that the dividends are supportive of things that I do in my personal life, whether it's provide for a child who does not have the same skills as other children or needs in education. And it's a terrific way to build up retirement income over time. In effect, we are tax-free at the corporate level and if you are in an IRA account or a Roth IRA strategy, you've got a tremendous amount of compounding interest within sight of that.

When I mentioned that number earlier of 458% or 468%, that is an uncompounded yield. By paying out the cash, we let people decide what they want to do with the money. Sometimes they will put it into Google. Sometimes they will put it into Enron. Right.

So at the end of the day, I couldn't be prouder of the people I work with here. They are prudent stewards of capital. They've proven it time and time again and I think the size and dimension of the business is evidence of that.

Well, I appreciate your answer. I had been called away from the phone for a few minutes, so I didn't know if you had already answered the question. But again, let me compliment you and your staff and hopefully I'll be following the jockey for a number of years.

Me too. Take care, Stewart.

Thank you. Have a happy and a healthy -- let me be the first to wish you that.

It's Groundhog Day, and so you are a day late. Thank you, Stewart.

On behalf of the management team, I thank you for participating in today's call. We look forward to continuing to express our views via the different media outlets including the blog. Please watch that carefully because we do express opinions and views that many people I think would link up with our strategy during the course of that. If you care more about the macro side of it, there was an interview this weekend on Wealth Track with Consuela Mack where we will express some of our views about the macro environment.

With that said, I thank you and we will see you next quarter.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 866-233-1854 or 617-614-4949 with an ID number of 30876781. This concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.