Annaly Capital Management Inc (NLY) 2012 Q4 法說會逐字稿

Good morning and welcome 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 a listen-only mode. (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 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 Wellington Denahan, Chairman and Chief Executive Officer. Please proceed, Ms. Denahan.

Thank you, Andrew. Good morning and welcome to the Annaly fourth-quarter earnings call. Joining me on the call today is our CFO, Kathryn Fagan.

I want to briefly recap the market backdrop over the past quarter and I will start by reminding everyone that the Federal Reserve's weekly purchases of agency mortgage-backed securities exceed the amount of new originations each week, which has driven volatility to record lows, kept overall dollar prices elevated and compressed spreads. The outright purchases by the Fed have also put strains on the supply of high-quality collateral in the repo markets resulting in attractive financing rates for collateral providers like us.

The recent selloff has been a welcome event and we look forward to more of the same. Mortgages have recently come off their highs by about an average of about 2 points, which bodes well for spreads going forward. Chatter out of the Fed more frequently incorporates talk of an exit, so the January minutes release due out February 15 will be of great interest.

After three bouts of quantitative easing, the housing market has gotten off its back and looks to be moving to stronger footing while the job market seems to have stabilized. All this progress comes at an economic price. The challenges of today's markets are far-reaching. Desperate public pension funds are being enticed to engage in the risk parody trade as some practitioners are calling it while large corporations are being forced to divert otherwise economically productive capital to shore up pension plans that have been battered by the low interest rates. As evidenced in the most recent GDP numbers, this does not bode well for future demand.

Regulatory reform has met with some cold reality. The collateral needed to post on derivative contracts may far exceed the collateral available to do so. The Basel committee on banking supervision extended by four years the date for full compliance with its liquidity coverage ratio and loosened rules on what constitutes high-quality liquid assets when they realize what some of the consequences may be.

As policymakers in the markets work their way through this morass, I think we can all agree that rates of return are going to be under pressure for the foreseeable future.

But before I begin discussing the release, I want to briefly comment on the CreXus transaction. This proposed transaction represents a major step for us to expand our presence in the commercial mortgage space. Over the last four years, we have been participants in the commercial space through our public equity ownership in CreXus. If successful, this transaction will not only provide us with attractive cash-on-cash returns but also help simplify our approach to diversifying our capital allocation.

As we expand our capital allocation into assets other than just agency mortgages, we understand the need for increased disclosure on all of our business lines. So starting this quarter, we have included a supplemental presentation along with our release. I will focus on a couple of key data points and some of the supplemental information and then answer questions following.

I will start out by addressing our leverage. One thing to note about the snapshot of leverage, it was higher in the quarter mainly due to our share buyback and loss of mark-to-market on the principal paydowns received during the quarter. Absent these two influences, it would be largely unchanged.

I will also address our interest rate spread. Our annualized interest rate spread of 95 basis points represents income for the period divided by annual earning assets for the period. It annualizes one period's experience. The spread at period-end is generated by using a three-month CPR at amortized cost to calculate the yield expected for the remaining life of the asset. The drop in spread during the quarter is largely attributable to lower coupon income as we took gain and rebalanced the portfolio. New money spreads would be around 150 to 200.

One thing I will note is that we have a large swap position in our two-year bucket of about $18 billion that will be rolling into the lower interest rate environment. Just to put that into context, that two-year bucket is about 182 basis points over where current swap levels are. So there is a lot of potential value to be gained as those liabilities roll.

The other thing I would like to address is the change in book value. The payout of gains taken during the quarter and the loss of mark-to-market on the paydown balances were the largest negative impacts on book value. The changes in market value on the mortgage portfolio were largely offset by the changes on the value of our swaps.

I will address the fact that we did release a supplement and in that supplement, I think the main areas of focus for all of you will probably be the disclosures surrounding our portfolio. We have three slides in the supplement dedicated to disclosure. The first slide really deals with the breakdown of the portfolio into four main buckets. We break it into fixed-rate passthroughs, adjustable rate passthroughs, CMOs and a small portion of IO and inverse IO. The fixed-rate component is by far the largest part of the portfolio, so I will focus on that.

The next two slides really deal with the breakdown of the portfolio on the fixed rate portion. And we break it into not subject to HARP and subject to HARP. The non-subject to HARP portfolio is the largest component of our portfolio and we break that into 15, 20 and 30-year buckets.

Within those buckets, we break it into generic and call protection or just other characteristics with respect to -- we have in there jumbo conforming. The general takeaway that I want everybody to have is that we generally try and strike a balance. I know I have spoken about this on prior calls. We try and strike a balance between having too much protection and not enough cash flows in the selloff and having not enough protection and too much cash flows coming in in a rally. And as you can see, the portfolio composition will address those. Nothing addresses it perfectly and I know I have said that time and again.

With that, I will open the call up for questions on anything specifically with the release.

(Operator Instructions). Steve DeLaney, JMP Securities.

Good morning, Wellington.

Good morning, Steve. How are you?

Doing great, thank you and really appreciate the supplement that's -- we have seen that with the other companies with CreXus and it is most helpful to us to do our jobs. So thank you and Kathyrn for that.

I would like to go back, if you can give us just some broader color to November's press release, when you announced the initial bid for CreXus, there was also a statement in there -- I hope I interpreted this right -- that the Board was expressing an adjustment to the investment policy where possibly up to 25% of Annaly's long-term capital could be invested in non-agency assets. So I guess I would just like you to comment on that in the context of both the CreXus bid, but is there -- in that -- in framing 25%, should we look at that as just in commercial real estate debt or is it a possibility that you will use Annaly's balance sheet to do other non-agency types of investing? Thanks.

Steve, that's a great question. Thank you. When we set the Company up back in 1997, we allowed for and we put in our original prospectus an allocation of up to 25% of our assets in other than agency -- what has turned out to be agency securities, mortgages. As we went through time, we communicated with investors that if and when we did allocate to that 25%, we would do it in separately capitalized vehicles by shooting down equity capital and then separately capitalizing those vehicles via the public markets.

I should clarify a distinction. At that time, we said 25% of the assets, which would be, at the size of our portfolio, would be about $40 billion. With that release, we made the clarification that we would do 25% of our capital, which is a much smaller number, but it is not a change in investment policy and the Board, it did not need to change the investment policy. It was set out at the inception of the Company.

With that 25% of the capital that we have allocated, we will determine an allocation to the commercial space and with the CreXus bid, that would bring our total holdings on an equity percentage basis somewhere around 6%, I think.

Right, about $1 billion.

So we have a significant amount of room to grow that portion of the balance sheet if we so choose to. The other part is it is a fairly broad spectrum of assets and mind you, we do have three main disciplines out there that we focus on and you should not expect to see a dramatic deviation from that.

Okay, that's very helpful. Now with -- just specifically one follow-up. With the commercial real estate debt space, CreXus has primarily been a mezzanine lender based on the originations to date. We saw a recent transaction a week or so ago with Starwood in purchasing LNR. Do you see the types of investments that CXS will make going forward to be broader such as maybe including whole loans and even B pieces?

By virtue of potentially sitting on Annaly's balance sheet, I think it just opens up the possibilities for CreXus going forward. CreXus is somewhat limited in its capital base currently and the spectrum of opportunity should be exponential sitting on top of Annaly's balance sheet.

One of the great advantages of being on Annaly's balance sheet is the fact that we get a tremendous amount of principal paydowns that come in every single month. And we can allocate to share buybacks, we can allocate to new purchases, we can delever, we can allocate to the commercial space on a fairly regular basis, which CreXus, in its current position, does not have that option.

I see. Well, thank you so much for the comments and good luck with that transaction.

Thank you.

Rick Shane, JPMorgan.

Thanks, guys, for taking my question this morning. Hey, Wellington, if you wouldn't mind, you made some comments about how the portfolio sales, in addition to the regular marks, impacted the unrealized losses on the available-for-sale securities. Can you just walk through that because that was something obviously in terms of the book value I think we all need to understand a little bit better?

I mean what happens -- we received $9.9 billion in principal paydowns during the quarter. If you think about it, that $9 billion was marked to market prior to us receiving it. Once we receive it, it is marked at par and so that loss of mark-to-market was really the significant drag on book. And that is, with any prepayment, that has been always the way it is. If the market was trading at a discount, it would have been an addition to book.

Understood. And so what has happened is the last couple of quarters this has been masked because securities values were going up so much that they were offsetting the reversal from --?

Yes, potentially, yes.

From the reversals. And this quarter, you saw a little bit of drip down in terms of security values and so it essentially amplified what was going on here?

Yes. I mean our swap portfolio -- the change in our swap portfolio versus the change in our remaining mortgage portfolio was essentially unchanged (multiple speakers).

Got it. So that was about $300 million -- $350 million each?

Yes, roughly, roughly.

Okay, great. Perfect, that is very helpful, guys. Thank you.

Bill Carcache, Nomura.

Thank you, good morning. Wellington, you talked about how the recent selloff was welcome. Can you take that line of thinking a bit further and talk about how much more concerned you are today about the risk of -- that rates rise beyond a welcome level as the Fed exits and we get past some of the uncertainty in Washington as we move to the end of this year and into next year? And how much weight is Annaly ascribing to that scenario from a risk management perspective? And then how well-positioned is Annaly for a sharp increase in rates over say the course of the next 12 to 18 months?

Well, this is the reason why we continue to have a balanced approach to the portfolio. I have been -- I have said it a million times. The beauty and the curse of having a callable portfolio is that you receive cash flows and sometimes you receive more than you want and sometimes you receive less than you want. So what it provides management is always the opportunity to rebalance into whatever the prevailing interest rate market is.

When you are buying a set of cash flows and this is -- I concentrate on the basis -- when you are buying a set of cash flows, the basis at which you do it is the most important thing really that sits on your balance sheet because as we were just discussing, the loss of mark-to-market on those paydowns, had the basis been at par, it would have been a nonevent. And so when I say a selloff is welcomed, I am really referring to the fact that we are in the business of buying cash flows for the long term and if we can do it cheaper than we could last quarter, it is a much better thing.

Keeping in mind, yes, we do have book value exposure to those moves, but we also have low leverage and liquidity from that. And we do get, like I said, even if pre-payment is cut in half, you are still getting $5 billion in principal paydowns each quarter that you have to reallocate.

Understood. That is really helpful color. Thank you. And a final question is can you talk about whether you guys have any undistributed taxable income? Does UTI give you flexibility or is that just not something that you incorporate into kind of how you think about managing the business?

When we determine our dividend, you have to pay out at least 85% of your ordinary income and 95% of your capital gains by the end of the year to avoid excise tax. So that is the primary goal. We do not intend to run the Company to carry over substantial amounts because we do not want to pay taxes on that. Our final taxable number is not, -- it is not determined until we file the tax return, which is usually September of the following year, after the year is over. So it is really not our policy to carry over anything that is substantial. But you will have some estimate at the end of the year to cover the taxable income not to have excise tax.

Understood. Thank you very much.

Dan Furtado, Jefferies.

Good morning. This is Steve Maltz for Dan Furtado. Thanks for taking my question. I was hoping you could provide some color on how the (inaudible) fund business is developing. More specifically, should we think of this business simply as an entity that provides funding or as an entity that can supply whole loans to FIDAC?

That is a good question and we were certainly more thoughtful in just providing funding for others. It can become a source of product for Annaly going forward.

And is there any volume in that business today and do you have (multiple speakers)?

It has been pretty active and the operation is running very smoothly and we have had a significant pickup month over month in the amount of activity as things have continued to come online. But, yes, it can be a relevant source of product going forward.

Okay, great. And then if you could, any color on how large you think that source could become?

Not yet.

Okay, great. Thank you.

(Operator Instructions). Mike Widner, Stifel Nicolaus.

Good morning. So let me follow up on some of the questions about the potential shift or growing shift away from agencies. You guys have been pretty conservative, and I think appropriately so, on your stance toward the agency MBS market over at least the last year or two just given all that is going on. But, at the same time, I think somewhat -- I don't know that I would say bullish, but may be more enthusiastic on sort of credit assets. And yet, at the same time, you've always had the ability to allocate capital at Annaly and to say non-agency RMBS or whole loans or whatever else and yet you haven't done that.

And even since the announcement, I mean it would be a little early I guess to see anything show up in the December quarter, but do you have any plans on the non-agency RMBS side and again, with conditions very difficult in the agency market and a lot of unknowns, is that something you can see yourselves shifting toward either as the quarter or the year or the half progresses?

Well, one thing I will say is we do have the two public companies out there with the management teams and Annaly's participation has been as an equity owner in those companies. And part of the reason for the CreXus transaction is that we do need to remove some of the conflicts I guess of being able to expand those positions on our own balance sheet while we have these public companies out there that we manage.

So I think in the case of -- Chimera was a hugely active participant when there was really no other at the time following the crisis. With respect -- I think you look across the spectrum of whether it is interest rate risk or credit risk and what I try and discern, and our team tries to discern, is what is the best risk/reward position for us with the relative -- I do speak of the relative compression not only happening in the agency space, but across a broad spectrum of asset classes following the monetary policy and the influence that that has had.

So we try and look at where is the borrower benefiting and how can we benefit from the borrower benefiting and just making sure we keep a keen eye on the credit profile. And we are always aware of what all this liquidity does to the basis, whether it is house basis or commercial property basis or our mortgage position basis. Those are the permanent fixtures on our balance sheet that we will manage around.

So looking really across all three of those asset classes, or really all three of the vehicles that are effectively managed under the Annaly umbrella, which ones do you see as sort of the least distorted or perhaps the most attractive today? Irrespective of where you are putting dollars tomorrow, I mean how do you see feel about the relative attractiveness of say commercial, non-agency residential, jumbos, whatever versus the agency MBS, which continues to sort of be a shrinking pool as the Fed sucks up more than the net supply?

Well, one thing I will say is we, over the last couple of weeks, we can see how quickly return profiles can change and how quickly the sentiment can change. And so we constantly take that into account. We are not looking at these businesses to do a trade. We are looking at the longer-term return profile associated with these and obviously the entry point is hugely relevant. But each one has been influenced by monetary policy. I think, in the case of -- in our bid for CreXus, we are looking for relatively attractive cash-on-cash returns relative to the agency position in a leveraged return profile and what the risks associated with that are. And we try and balance all of that. The agency trade is a hugely positive place to be irrespective of its most recent fundamentals.

Well, great. Thanks. I appreciate the comments and color as always.

Arren Cyganovich, Evercore.

Thank you. Just kind of thinking about the quarter-end, the quarter-end net interest spread being about 25 basis points higher than the average for last quarter. Generally, I would think that that would move towards bringing the next quarter's net interest spread up relative to where you were at the end of the quarter. It didn't really happen; it was kind of the same phenomenon last quarter. It didn't really happen last quarter. I was wondering if you could just comment on why the year-end is so much higher than the quarterly average.

Well, I mean the snapshot at period-end, we will take the yield of that asset over the life of the asset. During the period, we will take the income on our average earning assets and annualize that. And so if you are in periods where you have higher premium assets paying faster, reducing -- even though your overall CPR comes down, it is a matter of what it has done to the underlying yield of that asset. And so trying to reconcile the two is difficult without the benefit of time.

Okay. And then I guess on the premium amortization, it has definitely been elevated the last two quarters. Is there anything specific -- specific cohorts that are driving that amortization? It seems to just be a higher percentage of --.

No, it is just the overall dollar price of the market. I mean -- and I think -- you can look at our portfolio and our portfolio is -- we have it at a lower dollar price than the market in general. I think it is somewhere around a 1.03 (inaudible). So it is significantly below the overall cost of the market. Nonetheless, the impacts of that premium writedown, even with small changes, can be significant.

Okay.

That's why I focus so much on the basis.

And then, lastly, we saw prepayment speeds -- I'm sorry if you said this in your opening remarks; I was a little late getting on the call -- prepayment speeds look to have improved a little bit in last night's reporting from (multiple speakers). So would you expect, with the refi volumes kind of coming down a little bit, that this could be a potential trend in the next quarter or two?

Yes, I mean, all else equal, we would expect, if prepayments were slower, that we would have less amortization drag. And also, as you recycle some of the paydowns into the lower dollar prices in the market today versus over last quarter, you should also have a reduction going forward.

Okay, thank you. And thank you for the increased disclosure too. It is very helpful.

Thank you, all.

(Operator Instructions). Jasper Burch, Macquarie.

Hey, good morning, Wellington and Kathyrn. I just wanted to start off -- thank you for the added disclosure and I definitely appreciate the frankness of the call and sort of how open you guys are being with all the disclosure. It is very helpful.

I guess starting off with -- when I went through the management agreements for CreXus and Chimera and FIDAC, I couldn't find anything that restricted your ability to invest in really whatever asset class you want regardless of what the other companies were doing. But it sounds like on this call -- and it actually sounds -- I read it as sort of language specifically allowing you to invest in the same asset classes. It sounds like on this call you are saying that it is sort of your policy though that if you're going to move into an asset class in bulk that you wouldn't want to compete with I guess one of the companies, any of the companies that you manage. Is that a fair way to sort of understand it?

No, that is not a hard and fast policy. There are always costs to every decision that you make. Even though we do maintain the ability to compete with the public companies that we manage, sometimes it is the better economic choice to forgo those activities in light of prevailing concern. So we can -- we have managed a lot of other vehicles alongside Annaly over the years. There is always complexities that come with even if you have a very well spelled-out allocation policy. And so we have made the determination that it is just easier.

Okay. So it is not necessarily fair for us to make that (inaudible) some of the other public companies that you manage? Or -- I mean --?

I mean we do have the ability to do it if that is what you are asking.

Okay.

Yes, we do have the ability to do it. It is not anything in writing that says that we cannot.

Okay. That's helpful. And then it is usually out in the K, but I was wondering could you guys provide your estimated duration and convexity on the portfolio? Do you have that number?

No, but I always tell people you guys can calculate it based on market value move, if you just take the move in the 10-year, whatever you want to benchmark it to, you could calculate what our empirical is and I would say, with the paydown mark-to-market loss of the book, that you try and back those things out if you just want to get to an existing portfolio to existing hedge kind of comparison.

Okay. I will fiddle around with the numbers. Thank you guys for taking my questions.

Sure. Thanks, Jasper.

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

Thank you all for participating in our fourth-quarter earnings call and we look forward to next quarter. Thank you again.

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 10024273. This concludes our conference for today. Thank you for participating and have a nice day. All parties may now disconnect.