Annaly Capital Management Inc (NLY) 2011 Q4 法說會逐字稿

Good morning and welcome to the fourth quarter earnings call for Annaly Capital Management, Incorporated. (Operator Instructions). 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 pre payment rates, the availability of mortgage-backed securities for purchase, the availability for financing, and if available, there terms 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, our ability to maintain our classification as a REIT for federal income tax purposes.

Risks associated with the broker dealer business of 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 results of any revisions 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 call over to Ms. Wellington Denahan-Norris, Vice Chairman, Chief Investment Office and Chief Financial Officer. Please proceed.

Thank you, Valerie. Good morning, everyone, and welcome to the fourth quarter 2011 earnings call for Annaly Capital Management. I'm Wellington Denahan-Norris, and joining me on the call today is Kathryn Fagan, our Chief Financial Officer. Our call will start with some prepared remarks after which we'll open up for questions, but before I begin, I wanted to take a moment to let everyone know that Mike Farrell sends his thanks for expression of support and good wishes for his recovery.

He's doing well and we look forward to him leading our next earnings call. As usual, the opening remarks to our call today will be posted on our website and will include a few referenced graphs. The title of the today is called Paradise Lost. There was a time when the market was the market, a large collection of free thinking participants who independently evaluated cash flows, earnings, and economic data, among many other things, in an effort to establish value.

A time when skilled and ambitious Manager's could successfully outperform their less diligent competition through creative interpretation of all that was happening around them. A time when very few people outside of the Bond Market new the name of the Chairman Federal Reserve. A time when a eccentric group of practitioners called Fed Watchers would figure out the price of short-term money by closely observing the supply and demand of it each day.

A time when Bond Market participants would determine long-term rates based on levels of debt, credit worthiness of the borrower, and inflation expectations. A time when recessions were a painful yet natural part of the business cycle, a call for businesses to evolve or die, or for companies and employees to retool, reeducate and reevaluate the inputs of success. In the past, we all had a sixth sense, call it common sense, that protected us more than today's ever creeping rules and regulations would suggest.

We knew a hot cup of coffee was hot. Today, we have a Fed that not only tells us it's every short-term intentions, but in circular fashion finds it necessary to put out long-term predictions of future policy responses to its own economic forecast.

The Fed's own history of economic forecasting would suggest these that these are hard to model, I will remind everyone that Sir Allen Greenspan was talking about the virtuous cycle of growth related to the productivity in December of 2000, only to quickly follow it up with unusual inter meeting easing to respond to the inevitable and well-predicted bursting of the tech bubble in 2001.

Greenspan also ignored both economic and antidotal data that would suggest his slow and steady policy of small incremental tightening from 2004 to 2006 was insufficient to reign in the growing housing bubble. Minutes to the 2000 FOMC meeting shows that there was barely a perception of a problem in housing, and his successor, Mr. Bernanke was tightening policy in the face of overwhelming evidence that the housing bubble was in full deflationary mode.

He held the Fed funds target rate at 5.25% well into 2007, when so many cracks had already occurred, then finally began emergency easings in September of 2007. I'm not advocating he should have come to the rescue of all that he did, but if that was his intentions, he was very late. Within 14 months the Fed was at the zero balance and we have been perched her ever since.

If the Feds telegraph policy response to its central tendency can be relied upon, we will be here for at least another three years, as we know, the Fed isn't engineering this environment just with its policy rates. It now owns over 20% of the short end of the Treasury market, and almost a quarter of everything ten years and longer. By the time Operation Twist is done, the Fed is estimated to own 35% of the long end of the Treasury market.

The Fed also now holds about a fifth of all agency mortgage backs, up from zero just three years ago. Now I fear we only need to look to the East, to Japan to see how long we may find ourselves in this predicament. At a Fed sponsored conference in 1999, a bank of Japan policy member issued a warning to his largely American audience.

Do not put yourself into the position of zero interest rates he said, I tell you it will be much more painful than you can possibly imagine. Of course, there's differences between the two Countries and their respective markets, but its instructive to compare them. Like us, they've been in an extended period of zero bound monetary policy and they have engineered multiple traunches of quantitative easings. The BOJ now owns 9% of the JGB market which is equivalent to 15% of Japan's GDP.

They also embraced in 2003, five years after they first cut their overnight rates to 25 basis points, a series of measures designed to enhance their transparency of monetary policy. The result of all this central banking has been a stagnant economy, deflation, hollowed out savings, a sinking stock market, and microscopic returns. It's not just Japan and the US, and most of the developed world fiscal deficits and easing money policy are the norm.

Now debt to GDP ratios are rising and sovereign credit ratings are dropping, yet interest rates are falling. As I mentioned earlier, there was a time when credit worthiness mattered. In any event, few participants have ever operated in an environment where the cost of carrying your assets was potentially fixed in advance for such a long period of time.

Since the inception of Annaly 15 years ago, we've had to prepare for and navigate the twists and turns of carrying costs that could change at any time. Yet, now it appears that we can rely on the zero bound through 2014. All this apparent certainty comes at a price.

If you look around the world you will see rates of return that reflect this engineered market environment. On a GDP weighed basis for the G7, the average yield on a 2-year sovereign is about 0.5%, while the average 10-year sovereign yield is about 2.5%. The problem with controlled environments is that they stay controlled until, of course, they are not, so the Management Team here will continue to take advantage of what this market has to offer, while keeping a keen eye on the potential risks looming.

However far off they may now appear. There was a time when the equity markets would put into weight to whether hem lines were short or long, or which team would win the Super Bowl. I long for that kind of absurdity over the seriousness with which our policymakers work to control the markets.

Frederick Hayak warned about the effects of this kind of Hubertus in his book "The Road To Serfdom". Near-term, there is opportunity to harvest, but I have to ask, who will save the central bankers from themselves? This concludes the opening remarks and I will now open it up for questions.

(Operator Instructions). Our first question comes from Bill Carcache of Nomura.

Good morning. Thank you. Can you talk a little bit about some of the conservatism underlying your leverage levels, is it just the fact that you are so much larger than your competitors that you feel you could be more adversely exposed to the negative tail of that.. I'm hoping for some perspective on why your leverage levels are so much lower relative to your peers?

As I mentioned, if you look around the globe, rates of return, quality rates of return have diminished dramatically, and you can argue the quality of those returns. Now, the Management Team here, what we're produce in this environment is an attractive level of returns at a fairly conservative leverage level. It says nothing about our size and I would reminded everybody that everybody's is exposed to the same market. We continue to maintain a nimble stance in the portfolio and what I would argue attractive returns relative to everything else that you can do out there.

Okay, understood, but can you give us a sense of what it would take or can you kind of envision a scenario where you would feel comfortable take taking leverings up from current levels? Finally, my last question; we saw a decline in book value per share despite positive earnings. Can you talk about the different things happening in OCI and the share count that contributed to that decline? Thanks.

Book value is impacted not only by, you can take gains that move book value gains into earnings. You also have pre payments that will impact the underlying book value. The market was generally unchanged quarter-over-quarter, so I think the movement was very minimal, given everything that has gone on. What was your other question, I'm sorry?

The other part was just if you could just give some prospective on what it would take for you to potentially, if you could tell us what kind of scenario you would feel

We're constantly evaluating the landscape and one thing that I would personally like to see if us getting through this election cycle. There's always a risk that the Administration will come out with any kind of policy to ensure that it gets reelected, and so you have a lot of, whether you throw it out in a speech or strong-armed the agencies to enact policies to ensure that you get reelected, that kind of overhang in the space as that starts to become a little bit clearer and as I mentioned earlier, I think we've never been in an environment where the Fed has basically said they're going to keep interest rates at zero for several years out. We'll continue to evaluate the market and its reactions to it, and there is the possibility that we adjust leverage accordingly.

I appreciate your prospective and thank you for taking my questions.

The next question comes from Jason Arnold of RBC Capital Markets.

Good morning. Just curious on the pre payment trends over the past couple of months from the GSC pool data for your portfolio and perhaps your outlook of prepaids from an organic prospective going forward. Thank you.

I think pre payments will potentially be impacted 1-2 type CPR going forward based on HARP being fully reflected in the numbers. In the grand scheme of things I think pre payments are well below where they otherwise would be given the level of interest rates. I think you're going to see more of the same.

Makes sense, we're not all that far off on the historical average on that note for sure. One quick follow-up. If you could update us on the swap book. Still higher fixed pay rates on the book. Should we expect more substantial declines in the average pay fixed rate given that it was roughly five years ago that we saw swap rates start to move down?

The book will continue to roll into much lower rates.

Is that kind of more of 2012 event, more weighed there or more 2013 perhaps?

I would say it's equally weighed.

Okay, perfect. Thanks for the color and byes to Mike.

The next question comes from Bose George of KBW.

This is Jade Romani for Bose. I wanted to ask if you could comment on where you're seeing incremental spreads and where you see the most relative value in the market right now?

Generally we don't comment on the specifics of where we're concentrating. There's no question that the Feds are doing a good job of engineering a flatter curve and spreads. I don't care who you are, spreads have come in for everybody, and you don't get protection without a price. We continue to balance between all of the options that the market has to offer.

Can you give an indication with the heads ratio you assumed where you would see incremental spreads right now?

Just based on the end of the quarter, we showed 152 basis points. That's a snapshot of the portfolio. The swaps and repo book at quarter end.

Thanks.

Which is still, to put it into prospective, it's historical wide.

Great. And then secondly, are there any updates on the SEC concept release?

We don't have any updates. The SEC hasn't responded yet. We don't expect any adverse outcome for the industry.

Thanks a lot.

The next question comes from Steve Delaney of JMP Securities.

Good morning, Wellington, how are you?

Good morning, Steve. Good.

I realize with repayments and when we talk about averages, like CPR that different cohorts are paying at different speeds, but one thing that struck me looking at the release, CPR went up about 20% to 22%. We had 23%. When I look at the premium amortization, that jumped like 45%. Could you guys help me to understand why, understanding that the speed is just an average of a lot of the different segments, but it seemed that percentage of increase in CPR and amortization, that delta is just too wide?

You can't assume that, let's just say if you have speeds associated with a higher dollar price asset and those speeds are faster than the lower priced asset, then you would get this diverge between what the report of the CPR is and the premium amortization is.

Steve, I'd look to the total amortization in portfolio when you're doing your analysis. I think that the weighed average CPR gives you a good indication of where the trend is. Right. However, back into the number that the absolute value of amortization taken because of the pointing that Wellington made.

It's just one of those things where averages can be, can give you the wrong outcome. I thought that was probably it, but what you're saying is the methodology, everything is being consistently applied, no catch-up, true-up adjustments or anything like that. It was dependent on what paid off in that quarter and what the cost basis was, right?

Exactly. You have to project forward and when you're projecting forward in the yields you'll see that in the end of period yields that I reported and also the amortization because it's a forward-looking projection, the last month of the quarter.

I appreciate that and all the best to Mike.

Thank you.

And the next question comes from Daniel Furtado of Jefferies.

Thank you for taking my question. Would a slow down in CPR's or greater stability in Europe go further in giving you more confidence to take levering higher?

I think a slowdown in the introduction of potential changes to the underlying prepaid landscape. The President threw out there the possibility that he's going to try and HARP other things that are currently commanding pay-ups in the marketplace as a place of safety. I think if there's just some kind of relief from the constant changing of the policy intervention, that would be one thing.

One thing that I would love to see is the economic data continue to get stronger, and potentially put QE3 clearly in the rear view mirror, and potentially the Fed would be in a position where it would start to layout a plan potentially. One of the transparencies I would love to see out of the Fed is what they intend to do with their portfolio going forward.

Understood. Thank Then I guess the other question here is, it sounds like this is really more of a defensive posture from a policy standpoint, but could you help me understand how much of a factor is that IO strip security portfolio had on your approach to leverage here with higher pre pays?

The IO component is very small.

It's had no bearing on your levering whatsoever.

Great. Thank you so much for the time.

Sure.

(Operator Instructions)Our next question comes from Rick Shane of JP Morgan.

Thanks, guys, good morning. Most of my questions have been asked, but I just want to circle back on the swaps question as they rollover. The pay rate has been falling really steadily over the last basically two years, and you indicated that you expect it's going to continue to fall over the next two years and that all makes sense.

It only fell two basis points this quarter. Just curious if there was something, if there was just sort of inflection point in the swap book that caused that or if there was a little bit of a strategic shift there, and sort of how we should think about that trajectory going forward?

You know, we constantly weigh what we are doing in the swap book against not only where the mortgage market is and what the duration of that market looks like or could look like, but also where we think how well the Fed has got a handle on its policy in the future. Now, there's no question that had we had no swaps or a lot less swaps during this period that we would have been better off from an earnings prospective, so we constantly will weigh whether we want to move out on the curve, how we want to do that relative to the underlying assets. There's no set schedule, if you will, but we will constantly balance with what we can get on the asset yields, what they look like, and what they will look like in an environment where potentially rates are higher.

Presumably, you're at this sort of weird juncture where duration on your assets is probably more uncertain than it typically is given Government intervention but once we're through that window, you're in a scenario where durations are likely to be extremely long and relatively predictable. Does that suggest that as you approach that point, you'll increase the swap book because you'll have an opportunity to lock in relatively low rates against long duration assets?

Yes. You always hope that you have a pretty clear picture of how your assets are ultimately going to settle in. There's no question that I think the mortgage market, the Fed has taken a lot of duration out of the market. The big question is, is it going to keep it out, and what is going to remain of the assets that are available for the private sector?

We're still in this very controlled market environment. As I mentioned, it's controlled until it's not, so we constantly weigh the possible outcomes as we continue to rebalance the portfolio or set the portfolio up for what we feel is the best long term stance to get us through whatever may come out of this and when it does come out of its current state.

Got it. Thank you very much, Wellington.

The next question comes from Mike Widner from Stifel Nicolaus.

Good morning, thank you for taking the questions. One thing that strikes me about your guys, you talk about the barbell strategy, at the end of the day it's been the longtime case for you the sizeable majority of your assets are in 30-year fixed assets which obviously puts you sort of alone in the group, and given what's going on, given the environment, given the difficulty of hedging those, the policy risks mostly directed towards that kind of asset, the Fed buying almost exclusively that kind of asset.

Just wondering if you can comment on the relative attractiveness to those today versus other product, 15-year fixed, 5-1 arms, 7-1 arms, also in there the word on the street is that you guys were too big to play in those other areas and that's why you're sort of constrained to the 30-year fixed? Wondering if you can talk about all of that and whether you find the risk adjusted return the most attractive and all of that in that sector still?

We still do. Whether the Feds concentrate in one part of the market or the other, the fact that there is all of that a liquidity is around, it's not like that market is immune to the influences to the liquidity that's being injected into the system. There's nothing in the mortgage market that you get for free.

It's not like one area you didn't pay for the shorter duration that you got, or you didn't pay for the pre payment protection that you got. It may not evidence the cost may not evidence itself in the near term, but that cost does exist in one form or another. So to presume that you're in one area of the market all of the other areas seem to be full of value that Annaly can't take advantage of I think is a silly notion.

We can participate in any part of the market. There is a number of reasons why we do what we do, in the sectors of the market that we do it. I think people are misguided if they think that you somehow get something free out of this mortgage market and because you're not Annaly you're getting it at a much better price. Everybody is at the same price, that's all there is to it, and our size I think is irrelevant with respect to value in the market.

Understood. It's just sort of unusual and a little bit curious at this point that all things considered, you are running the lowest levering but at the same time, you're kind of toward the bottom end of the range in terms of overall ROE. As investors think about it and grapple with the risk of the 30-year, it's policy risk as well as interest rate risk, the difficulty of hedging those, not knowing the duration.

Given all of the induced uncertainty as opposed to the natural economic uncertainty's that maybe the relative attractiveness of the 30-year fixed is otherwise than it would have been. It sounds like you guys don't feel that way at all.

One thing I would tell you, too. This notion that we have 100% fixed, 30-year fixed is not the case. We will always look for the best relative value in the market, whether it's 15, 20, 30-year. There was a point where there was 40-year options, things like that.

You know, from an ROE prospective, one way we like to look at things is for each unit of leverage, what's your ROE, and I think when you look at us relative to others on that metric, I think we outperform. People can do different things. We are in the business of managing for the long haul. If others feel that it's better to enter this market with higher levering or different parts of the curve, great and I wish them all well, but we will continue do what we think' s right over the longer term for the Company and the shareholders.

Thank you. Just one quick final question. As you look at weighing the alternatives of trying to hedge to protect book value, and that's essentially what creates your ability to generate earnings, three, four, five years from now, hedging book value as opposed to hedging current earnings or preserving current earnings power. Would you say today feels different than prior parts of the cycle and where are you guys mostly focused right now on generating dividend or on book?

We've focused on both and if you don't focus on both, I think you're doing yourself a disservice. One thing I will say, there's no perfect hedge. Mortgages are not great trading assets.

You're dealing with a very interesting asset class that anybody would profess that they can hedge book value and earnings and not be concerned whatsoever, I think they're sadly mistaken on the true nature of what they're investing in. So we tend to continue as always to focus on both.

But as you just said, you're delusional if you think you can hedge both. So I guess the question is

Do you think you can do it without any, that you're going to successfully hedge every little movement in both, it's not possible.

Right. So I guess the question is really just do your priorities feel any different today given the level of uncertainties that book is more important than earnings and you'll sacrifice a little earnings power if that's what it takes to ensure your ability to generate earnings in the future? It sounds like you're not going give me an answer which is fine, I didn't expect one, but just wanted to hear your views on that topic.

And the next question comes from Matthew Howlette of Macquarie.

Great. Wellington, what would you say is the excess capital position of Annaly, I've asked this before, and it's gone through traditional the last few years, there's capital and taxable subs, then other REIT investments. I guess where could that leverage go inside the REIT if you were to sort of maximize the leverage today as to expand?

Just to address the question of excess capital. When you get to form 10-K, we do market values to collateral pledged, so you can easily calculate the excess capital at these low leverage spans. There was obviously lots of excess capital, even with the taxable resubs.

Okay. I guess you obviously, we've asked this question before, but would Annaly, if QE3 does end up happening long into the yield, Bernanke gets his way, would Annaly consider policy alternative investments, obviously on agencies or other REIT investments? There's other things that you could look at for to point that excess capital?

You know, Annaly always considers based on our view here through our relationship with both. We have a pretty broad view of the returns that are available, and we always keep it in mind of what is the best long-term thing to be investing in for the shareholders.

Now, I have to say that given this broad view that we have had over the last couple of years with respect to mortgage, not only interest rate risks but credit risks and things like that, that it would take a lot for the agency part of the market to render itself not as attractive as it is, even given everything that has gone on. It's still one of the best places to be.

I like to remind people that these kinds of returns and the quality of the returns that you're getting from the entire REIT sector, the entire REIT mortgage sector compare attractively to any other thing that you could be doing. If you look at the high yield interest for interest or one of the high outfield ETFs, you're looking at a 6%, 7% type of yield.

As I mentioned in my comments, in my opening comments, if you just look around the world and see the debt, that the credit worthiness is clearly deteriorating, yet the yields are also deteriorating, and what you have with the cash flows underlying the mortgage REIT sector, yes, they're coming from the housing market and they are ensured by the Government, yet they are backed by actual credit worthiness of the underlying borrower, however weak that may appear at times is still I think is a much better credit than a lot of your other options out there, and the returns associated with that credit I think are incredibly attractive.

It certainly has been, just at the levering. Today where it's been in the last several quarter is still tremendous drag on earnings and the earnings power of Annaly, and at some point if the world doesn't change and again QE3 would presumably really rich in agency, but potentially could we be in an environment where maybe it makes sense to put some capital elsewhere and wait for a better opportunity in agency NBS?

I guess in other words, how much longer are you willing to stay at five turns of leverage for the opportunities to arise in the agency? How much time are you giving?

How much longer are we willing to stay at 15% ROEs?

Right.

That's not a hard place to stay, I have to let you know that.

Fair. When you look at the leverage of some of the peers, they're much higher and earning at similar or higher ROE.

Well, they should be earning higher ROE at the higher leverage.

Right.

I just, again, I feel very comfortable with the kinds of returns we are delivering at the leverage levels that we're delivering them, and the longevity of that kind of portfolio I think it should be very attractive. It's certainly I think, again, competes very well with anything else you could be doing, and if our peers in the space would want to run at higher levers, that's fine, they can do that, but the Management Team here is going to continue to do what it thinks is right for the long-term environments. I don't think, I'm not going to apologize for the kinds of ROEs that we're delivering at the leverage levels that we're delivering them.

I guess we'll wait for more clarity on that. The last question. Did the elevated repo rates some of the peers had mentioned that the repo rates were elevated towards another year did that have an impact on funding costs in the fourth quarter?

No.

No. Very slight.

Great. Thank you.

Sure. Thank you all for listening to our call and again, hopefully you won't have to put up with just me next time, and Mike will be back again. We look forward to speaking to you in the next quarter. Take care.

(Operator Instructions). This concludes our conference for today.