Annaly Capital Management Inc (NLY) 2012 Q1 法說會逐字稿

Good morning and welcome to the first-quarter earnings call for Annaly Capital Management, Inc.

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 prepayment rates; the availability of mortgage-backed securities for purchase; the availability of financing and, if available, the 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 our subsidiary; 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 anticipated or unanticipated events or circumstances after the date of such statements.

I will now turn the conference over to Michael A.J. Farrell, Chairman, Chief Executive Officer and President. Please proceed, Mr. Farrell.

Good morning and welcome to Annaly Capital management earnings call for the first quarter of 2012. I'm Mike Farrell; joining me here today are Wellington, Kathryn and Nick Singh. As usual, I have a few prepared remarks to begin the call, after which we'll take your questions. These remarks can also be found on our website.

Today's (inaudible) is called too much of a good thing. Most humans are uncomfortable in silence. To avoid it modern humans subject themselves to constant stimulation, mostly in the form of information. We used to simply read a few newspapers each day or watch TV; now we're bombarded with e-mails, texts, blog posts, newsletters, tweets, Internet news outlets and cable TV channels for every possible purpose.

Markets efficiently decipher all of this information or so it's believed. Regulators and policymakers are also privy to the same, if not more, data in their quest to provide the guideposts of commerce.

When we started as an investment team back in 1991 the Internet was still a gleam in Al Gore's mind and fax machines were still the norm, but we thought we had all the information we needed to manage our portfolios. I reminisce simply to ask the question, has all this information made us much smarter?

In 2000 the tech stock bubble was in full deflation mode, but, if you think about the information proceeding the burst, you'll recall Alan Greenspan's infamous irrational exuberance warning that was made in 1996. Over the next three years plus there were countless news articles questioning the validity of the rise in prices and the quality of the IPOs being underwritten and yet many people still had a look of shock on their face when they inevitably came back to earth.

The housing bubble started to deflate in 2006 and a simple news search shows that it too had hundreds of articles written about it in the three years prior, stories that called into question the underlying strength of personal incomes to support a home purchase, mortgage structure and availability as well as outright fraud.

It wasn't just news stories that were out there; we were not the only ones that were talking about the end of the bubble in our 2006 quarterly commentary, The Gold Fish is Dead, Senator, and the One Trick Pony.

I also recall attending the [grand] interest-rate observer spring conference in 2007 which preceded the collapse of Bear Stearns, Lehman Brothers and AIG and listening to a hedge fund manager present an interesting picture of how Wall Street was packaging chicken parts into securities and the rating agencies were stamping them with approvals to be sold as stake.

His colorful description of ABS CDOs was a heads up on the impending collapse of the debt bubble in 2008 that kicked off the credit crisis. Again, many were surprised, not only when it burst, but there was also a strong link between debt growth and GDP growth.

As we mentioned on our last call, monetary stewards have spanned the spectrum from Paul Volker's days of unannounced policy actions to Alan Greenspan's ubiquitous opaque chatter and predictable incremental 25 basis point moves to now Ben Bernanke not only speaking clearly and telegraphing his actions, but also disclosing the thoughts behind his every action. You could say we have a new bubble in formation.

The Federal Reserve, in a push for transparency now publishes more detail on the range, central tendencies and inputs into the economic projections of the Board members and bank presidents. The Chairman does interviews and goes on 60 Minutes. In the past the [FYMC] meetings were released with five-year lags and then 90 days during Greenspan's reign it went to three weeks.

Now Mr. Bernanke gives a press conference following the FYMC meeting. I don't think the market is any better at managing with all this information. I would argue that more of it has only intensified the bubble that follows.

As with any topic, whether it's macro or otherwise, it's up to each market participant to glean that which is important from all the information and idle chatter that's out there. One thought I would offer to anyone who is thinking about these things is to find a quiet room without a screen and consider the thought that Milton Friedman popularized, that there is no such thing as a free lunch.

It seems to me that free lunches are being served by policymakers all over the world. And the same could be said for companies and businesses that promise returns without fully acknowledging the risks and trade-offs of the portfolio decisions. The flood of information is its own free lunch. While I don't know exactly how the bill is going to be paid for free lunch, it will eventually will be paid and it will be paid at some point.

With that said, I close out the first part and we open up the call for Q&A.

Jason Arnold, RBC Capital Markets.

First I want to say it's really great to hear your voice on the call, Mike, and I wish you all the best in your recovery.

Thanks, Jason, good to hear from you.

Just question wise, you sold down around $5 billion in the MBS portfolio this quarter and I guess around $15 billion over the past couple quarters. I was just wondering if you could share with us what components of the market you've been taking gains in and where you see value in the market here at present?

You know, Jason, we don't break down that information. One thing we will always try and do is, as everybody knows that a pre-payment is a sale at par and the market will obviously pay more for certain things. So we are constantly just evaluating the portfolio and looking for opportunities to rebalance what we own.

Obviously this is a rather interesting market. The pay ups in the market have gotten extreme for prepayment protection, which, having gone through a lot of markets, there's a lot of times where the market will value certain things. I'll reminisce about back in the days re-lo loans or the big pay up, re-performers, Alt-A.

And it's always interesting how once a pay up becomes great enough in the market that somehow the supply comes to meet it. So you always have to be careful about which areas you tend to place value. But we are constantly evaluating it.

Okay. Thanks for the color on that. And then just one quick follow-up. I was just wondering if you could update us with your thoughts on prepayment speeds. It seems like on the organic side prepaids have been slowing relative to the prior quarter and HARP really isn't coming through quite as dramatically as many thought it would either. So I was just curious if you could offer your take on that front, too?

We do welcome any slowing or any less fast than what the market may have anticipated. Again, we are always prepared for it to be worse than it is hopefully.

I would just add to that from what we've seen from the policies that have been implemented, that the prepayments are really going to be a subject of policy matter more than Central Bank or interest rate or house price.

Now clearly there was a story out this week -- I don't know if you got to see it, but houses that were purchased in the last two years are now under water. So you still have deflation in real estate. I think you're still going to see political pressure to do things like HARP. They're talking about moving that now into the '09 and '10 vintage.

I don't think that any of that is going to happen pre the election. But I definitely think that from my perspective, from the things that you can control in the interest rate world, that the Central Bank's pushing back at the administration now and saying we can't do any more to help the housing market, we've done pretty much everything we can do, it's up to you on the policy side.

And I think it's important to keep in mind that a guy like Ben Bernanke has not been endorsed by either party, right. And if you listen to every Republican debate, nobody that gets elected from that side is going to hire him and Obama hasn't really backed him and Geithner is going to leave at the end of the election.

So in my mind, if you're a Central Banker you want to defend your legacy, and your legacy is going to be that we've done a lot here, as much as we can do from interest rates, we've moved them down a lot and we're still not seeing the results. If you guys want to do something about housing it's got to come out of policy and I think that's the real risk in prepayments.

Makes sense, great. Thank you for the color. And again, take care there, Mike.

Thank you, Jason.

Joel Houck, Wells Fargo.

I had actually gotten cut off a little bit registering for the queue. And you had talked about I guess in your opening remarks around a bubble, presumably a treasury bubble. I don't know if that's where you were going with it but I didn't hear all of the comments. One of the things that -- obviously we've had a massive, I guess, tailwind in terms of downward pressure in interest rates for the last decade plus.

And if we get into -- albeit an unlikely environment near term, but if we get into a period of either rapid inflation or just a loss in confidence in sovereign debt and rates start to rise, is there -- would you position the Company differently? In other words, what is the mechanism for which you could mitigate book value declines in a rapidly rising long-term rate environment?

Well, I think you've touched on why we are concerned about the macro environment in general while we may be bullish. At the end of the day I think most people can only fall into one of two camps, right. Either the economy is recovering and interest rates should be rising or the economy is not recovering and we're all going to put the risk on trade on.

I think that all of the intervention that's going on globally, including the Spanish auction this morning, which was pretty much bought entirely by the ECB apparently -- all of this intervention is skewing asset allocation decisions across all of the markets and it's making -- obviously stocks are going to look cheap against that.

You get a bad unemployment number in the morning and the markets will decide to rally equities because you're either going to get QE3 or you're going to get some sort of stimulus out of the Central Bank in order to keep the jobless rate under control.

So having been through the 1979-1983 interest rate rise where interest rates on houses went from say 4.25 in the mid '70s up to 17% in the middle '80s, that that can happen and it doesn't happen with the ringing of a bell. It's a gradual thing that is a loss of confidence in the currency, loss of confidence in the administration or in the Central Bank.

And I think the Central Bank understands that mentality and I think they're being very careful about it. In the portfolio -- I'll turn it over to Welling and she'll explain to you steps that we look at.

Yes, Jason, I know we get a lot of heat about the low leverage that we've been maintaining, but that's one of your better hedges against a rise in interest rates -- sorry, Joel. The other thing that you -- we do have a substantial amount of interest rate swaps that tend to insulate book value somewhat and rising interest rate costs as well. I would caution that nothing works perfectly.

And in Mike's comments we talk about there's no free lunch, there will -- there's virtually nothing that you can do to insulate your portfolio completely from a move and still produce these kinds of returns. We are all in the business of taking risks and it's just a matter of trying to balance the landscape that you're dealing with against the landscape you may be faced with going forward.

And one of the best ways that we have found to do that having gone through some pretty serious markets with some pretty sizable positions is leverage provides you the most flexibility -- or lower leverage, I should say, provides you the most flexibility in dealing with the twists and turns of the market.

Now I would say what we're looking at now, no one in the contemporary market has ever dealt with. And, yes, maybe we've been too cautious for too early and for too long, but ultimately it's are you delivering an attractive return and will you be able to do it in the future.

Right, those are helpful comments. I'm wondering if -- does it make sense to use swaptions given lower volatility to purchase out of the money swaptions so that -- again, it's not a perfect hedge, but it provides incremental protection while it's cheap, if you will, as opposed to (multiple speakers)?

Yes, you know, we evaluate all of the options available to us. And you always have to keep in mind that certain things run out and when they run out -- at the worst possible time. So you just want to make sure that whatever you're doing is going to be durable in use.

I mean part of the discussion I'd like to introduce there, Joel, is that there are changes going on in the CDS market that really deserve some consideration to look at how derivatives in general are handled. And we think in our discussions with policymakers and with clearinghouses and regulators that, at the end of the day -- the Central Bank of Europe, for instance, tried to blow off the entire CDS market and the hedge fund market by making that insurance in valid, right, by going with the selective default options that have -- really saying that Greece is bankrupt.

So as these things are emerging globally -- last summer we were talking about Greece, then we were talking about Italy, now we're talking about Spain. As these things continue to unwind here I think you cannot underestimate the length at which Central Banks will go to mitigate this. And I think some of the new products that are being developed are going to be interesting ways to use that, but you have to be sure that the insurer is on the other side of that policy.

Similar -- I mean I would make the analogy to AIG, right, being in the middle of all of the trades in the CDS market. That certainly did open everybody's eyes, there was one central clearinghouse and it happened to be a private insurance company.

So I think all that stuff is out there. As the Central Bank is looking at things now, one day you have someone from the committee saying that we should be typing and then the next day you have them saying that we need to hit our mandate. They're going to try to introduce this 2% rule. I think all of that is unwinding discussion in the markets that needs to be carefully monitored and brought into the thinking of how you think about how the market will reverse itself and when that might happen.

All right, thank you very much.

Bose George, KBW.

Good morning, thanks for taking the question. Actually this is Jade Rahmani on for Bose. I was wondering if you could comment on where you're seeing incremental spreads and where you see the most attractive value right now? You mentioned prepayment protected bonds as being expensive. What aspect of the market are you focused on and where do you see incremental spreads?

You know, it just continues -- we continue to reevaluate it. As always, we don't tend to go into detail about where we specifically see value in the market, but I can assure you that we weigh all the options and look at the breakevens relative to where the prepayments -- the pay ups are and make that determination across coupon stacks, across the variety of [specifieds] that you can look at to make the best determination about where we see the long-term durable value in the portfolio and what ultimately you're paying up for that you can ultimately get back either through extended periods of low prepayments.

One thing I -- as a mortgage investor there are times when you hope your assets are paying slow and then there's other times when you wish that they would just come in. And so, you're constantly striking a balance between those two wishes and trying to make sure that the portfolio that you're putting together is not too heavily weighted one way or the other for the period of time that you're going through. So we will constantly shift through where we think we should have more heavily weighted positions. But generally speaking we try and strike a balance even within prepayment profiles among the portfolio.

Okay, thanks for that. And secondly, your leverage modestly ticked up. Can you discuss scenarios under which leverage increases further and what level you'd be comfortable running with?

Leverage is a snapshot in time. And again, I'll tell you what, if the current coupon was 8%, we would certainly have our leverage at 12 to 1. And hopefully that wouldn't be through mark-to-market losses. There are -- not all spread is created equal, and 200 basis points from zero to 2% on 10's is far different than 200 basis points at a 4% Fed fund and 6% on 10's.

And any seasoned market participant would understand that. And so we will continue to monitor the outlook going forward on the push and pull between policymakers and the market ultimately trying to be the final arbiter of price discovery.

Okay, thanks very much for that.

Daniel Furtado, Jefferies.

Just a couple clarifying questions if I may. You had mentioned generally speaking everybody is in one of two camps -- the environment is getting better or it's continuing to stagnate. Do you mind sharing with us kind of where -- just to be absolutely clear, where management stands today on those two camps, please?

Yes, I would say -- our clear view is that the market is an unsettled market with more counterparty risk probably today than there's ever been before in history because you have an entire continent that's at risk, right. So you have a number of banks that are foreign owned banks that play in multinational markets that essentially are watching their interest rates go up.

So from the perspective of developments that are going to happen in the market, I would say our uncertainty is we have more faith in the American markets to recover economically, but we don't see growth spurting out to say 3% plus GDP kind of numbers and nor do we expect job growth to be robust going into the election.

So I think from the perspective of the way we think about this is that -- essentially long rates are at risk here to go either down a lot if we continue to be in deflationary mode, which many people would argue and I would say still is the argument that has to be disproved I think is the best way to look at it. Inflation is definitely creeping in in terms of services and prices and energy, etc., but that's also a cap on the economy, right.

At $4 a gallon of gas, that's definitely going to suppress consumerism and that's still 70% of GDP, that's what they're trying to manage for. I think we've been clear in the past, I've been clear in the past that I think that's the wrong economy to be managing; we're probably in more of a business-to-business economy.

And when I look at the results of companies like Apple, I look at that they're taking market share at the expense of Nokia and other players in the market not growing the entire GDP, right, at 2.5%. This is capitalism at its best. It's eating up market share.

So how long does that rotate and who are the winners at the end of that? I think you're really not going to be -- Apple doesn't hire the same amount of people as GM does when they hit their numbers. So I think we're in a very tentative recovery here, it's very fragile.

And I would agree with Chairman Bernanke in that sense that it is very fragile and that he didn't trust these unemployment numbers that were coming out. And I think that was actually pretty good insight into where the Central Bank is thinking and it would certainly confirmed the way I'm thinking.

Understood, thank you for that. And just also -- so to be absolutely clear on how to characterize your leverage, it sounds like it's -- the conservative leverage ratio is more of a concern regarding assets price levels than it is regarding prepayment expectations or is that not a correct characterization?

That is absolutely correct. I mean --

You're dead on.

I mean, these prepayment levels are nothing compared to what they were in 2003 which we did manage through, just to remind everybody. Where you did have significant prepayments coming in. Asset prices weren't nearly as high but you did have to manage in a different way during that period. Today, given rate levels and where we are, I think prepayments are rather subdued.

Just to add on that point, as you know from 2003, Dan, CPRs went through the ceiling because house price valuations were being mispriced through underwriting, right, bad underwriting. At the time there weren't as many mortgage REITs out there and we literally had a line of investment bankers outside of our conference room here telling us your yield curve is steep, you guys should be taking as much money as you can here.

When in fact if you go back and look at our issuance history we -- the most violent argument we had as a management team was the fact that during that period we actually turned down capital because we didn't believe the prepayment rates and we thought there was more risk from that perspective.

So I think that's a good way to segue into that mindset that you wanted to describe at the beginning. Is that when you see these things you have to judge them in the context of what is driving this?

And against the backdrop of $6 trillion or $7 trillion worth of stimulus being put into the economy by the Central Bank, you still have house prices falling generally across the country, which means that tax revenues are dropping for municipalities, etc. Those things have to weigh on the private sector in some way, shape or form that's so GDP driven by the consumer.

Yes, there will be a point probably in the not too distant future where everybody in the mortgage market is wishing their assets would speed up.

Which brings me to the next question, if I may, and thank you for your time. In an environment where rates start to move higher, really the performance delta of a specified pool versus a TBA security should whittle away or is that not the right way to --?

Yes, I mean the differential between specified pool pay ups change -- it can change dramatically. If it's not TBA deliverable even though you paid 2 points up for it, you can't deliver it into TBA in a selloff, you will lose not only the 2 points you paid, but you can also be trading back of TBA at that point.

Understood.

I think that's a good insight, Dan.

Yes, no, I appreciate that. And thanks for your time today.

Ken Bruce, Bank of America.

This discussion around leverage is interesting from a lot of different perspectives. I'm hoping you might be able to shed a little bit of light on the other side of the counterparty situation within the repo market specifically.

Are there any changes or proposed changes that might come about that could alter the demand for repo lending on the part of the large banks, whether that be Basel or this whole discussion around a central clearinghouse and the like? Do you see any issues as it relates to where banks will be on the other side of lending in the repo market?

I think the real developments that you're going to see out of companies like us is going to be on the liability side of the business. And I think we've made really good strides here that will be evidenced over the coming orders about how we think about the liability side of the business.

Certainly there is -- let's just throw out the most argued about thing, let's talk about money market funds, right, and the tri-party system which is under assault by the regulators. That keeps on coming out in newsletter items now that the Central Bank, the SEC are all concerned about how money market funds don't break the buck and how they report and whether or not those issues are disclosed and how the collateral is held and actually how that collateral has now gone from a very diverse system.

I can remember when there were six clearing banks that banks could use, you're really down to two, [BoNY] and JPM, who are formidable balance sheets, but there's a lot of concentration risk similar to what happened in 2008, that concentration risk that grew in AIG can be very damaging in terms of business decisions, etc.

So a lot of the money that turns around in the money market funds today goes into the repo markets. Certainly we're at the long end of the liability curb, but think about every small bank in the United States that has demand deposits that are earning zero, right, or maybe 10 basis points or 1 basis point, whatever they're paying you and they might lose their ability to transfer that capital into a tri-party. So now that's even going to grow into a larger base of too big to fail and clearing.

So I think that all of this regulation is kind of hung up in the political discussion about how to move the economy forward. But I would say in the discussions that we've had with policymakers and regulators, the very least that you can think about is more disclosure. And we think there's plenty of that that's going to be asked for across the board from every company, right -- this whole argument about how GAAP accounting works versus non-GAAP accounting, etc.

That's focused in on your bank, how do you account for debt that you have outstanding that today, because it's been downgraded, you can buy it back and it adds to your company's profits. Those kinds of questions are all part of this growth by regulators to try to use one measuring stick for entirely different sectors, whether it's mortgage REIT or banks or securities dealers, etc.

And I think that a lot of that is hung up right now because of the political situation and the gridlock in Washington. But as soon as that starts to clear, either we did -- dealt with or it will become clearer to the markets how it will be dealt with. Certainly if a large bank in Europe blows up, right, they are all linked. We are still a globally financial robust system in today's world but only because the Central Banks are defending it.

Can you elaborate on any of the developments that you're expecting to see from Annaly on that as it relates to that comment?

I would say that you'll see us develop the liability side of our balance sheet pretty strongly over the next couple quarters. And that's where I'd like to leave that.

Okay. And then, you remain very close to Washington in your comments about possible policy decisions that could basically have implications for the mortgage market, are you inclined to think that they may do something around some [mash] refi or something that would be kind of I guess struck like that by the market? Or are you looking at it from the perspective of principal forgiveness and trying to accelerate that side of it? Where to do think there's more likely move on the policy side?

Who's going to get the most votes.

Yes. How about if you're a student and we just keep your interest rates at 0%, just if you're 18 make sure you vote. There's definitely a mood of gridlock where the House is not going to pass anything that makes them look unaccountable for the budget.

And I think that the administration is making it clear that they are going to try to keep the cookie jar open for everybody when at the end of the day all it's done is continue to have this slow drain of price deflation continuing to hit the markets, right, which eventually shows up in the banks' balance sheets. And I think the banks are definitely arguing that very strongly.

If you want to look at just what's going on in the FHA, right, they're increasing fees, they're increasing insurance, but they're still underwriting loans in the 3% to 5% range, 10% range. Those kinds of underwriting standards on the residential side are only going to continue to make people maybe who should be renting go out and become buyers when they shouldn't be buyers because they have long-term interest or not to own a house.

So we still have to get all that supply off. And then demographically, I think this is a very important thing to understand, is that the baby boomers are going to be selling 30 million houses over the next few years -- let's say the next 10 years as they consolidate and move into multi-families or back with their kids or have their kids move in with them. And our population growth is only going to create 12 million new household formations.

So you have that weighing on it as well as the price stagnation in housing. All of that doesn't add up to I think much of a policy action by Washington that can direct all of those different issues.

Thank you for your comments. Very glad to have you back on the call, look forward to speaking to you soon.

Thank you, Ken, see you soon.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Farrell for closing remarks.

Well, thank you very much. Thank you for joining us here today and I'd just like -- on a personal note, we'd like to thank all of the hundreds of people -- literally I can't get back to all of you -- who have sent me such kind words, kept me in your thoughts and prayers. I'm really grateful for that, my family is grateful for it. We look forward to seeing you in the next quarter.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 877-344-7529 or 412-317-0088 with an ID number of 100-133-49. This concludes our conference for today. Thank you for participating and have a nice day. All parties may now disconnect.