Annaly Capital Management Inc (NLY) 2013 Q1 法說會逐字稿

Good morning, and welcome to the first quarter earnings call for Annaly Capital Management. 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 period, 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 Form10-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, Emily. Good morning, and welcome to the Annaly Capital Management earnings call for the first quarter of 2013.

Joining me on the call today is Kathryn Fagan, our CFO. We will review our quarterly results and our earnings supplement today; but before, I want to begin by discussing the recent attention that has been paid to the mortgage REIT sector.

To do so, I want to share the following story. And I'll call it the Summer of the Sharks. On July 6th, 2001 an eight-year-old boy his arm bitten off by a shark while waiting offshore near Santa Rosa, Florida. Shortly afterwards, a New Yorker vacationing in the Bahamas has had his leg severed in a shark attack; and on July 15th there was a third attack, this time on a surfer who was at the spot near where the first attack happened on the small boy.

A media frenzy ensued, culminating in a TIME Magazine cover on July 30th titled Summer of the Shark. The story was huge, and provided an interesting diversion to what was an otherwise slow news summer. But it was misleading. The media attention did not put the risk of shark attacks into proper context.

As it turns out, there wasn't any surge in shark attacks in 2001. It was just an average year. The number of attacks in 2001 -- 76 -- was down from the previous year of 85. The number of shark attack fatalities dropped to 5 from 12 the previous year. And in Florida, which leads the nation in shark attacks in over the last half-century, you would have been 50 times more likely to die from lightning strikes as from a shark attack.

I tell this little story, not to minimize the risk of shark attacks, but to remind everyone that there is always a risk of shark attacks. As a matter of fact, I am deathly afraid of sharks, and yet I still swim in the ocean.

The lesson of the summer of 2001, the summer of sharks, is that fears rose with the level of media attention, even though there had been no actual change in the risks of shark attacks.

Mortgage REITs are going through their own summer of the shark. There have been a number of speeches and news articles that have featured the mortgage REIT sector. I'd like to address the storylines with some factual perspective.

In terms of our market's history, Annaly and some other mortgage REITs have operated through a range of risks, whether it was the refi wave of 2003, the two years of tightening from 2004 to 2006, the financial crisis of 2008 and '09, and the challenges of today -- a period when rates are very low, dollar prices are very high, and the Fed is using agency mortgage-backeds as a tool of monetary policy.

The recent spotlight on the sector doesn't change the risks that mortgage REITs manage, or have managed in the past. The attention the sector attracts today is primarily the result of its growth. The growth of the mortgage REITs has only been made possible by the sector's relative performance and ability to attract and protect private capital.

[For] some more facts. Since 2007, mortgage REITs have raised approximately $65 billion of permanent equity capital. Over the same time period, the aggregate debt-to-equity ratios for agency REITs has declined from 10.1 to 6.5 on average. This represents a core capital ratio of 13.3% for the mortgage REIT sector, which compares favorably to the banking system's current core capital ratio of 9.3, according to the FDIC.

Because of the nature of our assets, mortgage REITs capitalization is clearly superior on a risk-weighted basis. And even at the sector's larger size, the combined assets of mortgage REITs are less than two days of average trading volume of agency MBS, which is a deep and liquid market.

Finally, I do not believe that the mortgage REIT sector poses a threat to the financial stability of the United States. Rather, the facts behind the storylines remain. Annaly has managed its conservative posture in order to be part of the solution to the future of real estate finance in our country.

We are focused on working with all market participants to improve the housing finance system. To quote the FSOC's 2012 Annual Report -- as the GSEs have reduced their investment portfolios, REITs have been a rapidly-growing source of investment capital for agency mortgage-backed securities.

Annaly will continue to evolve and grow in order to enable our shareholders to benefit from these market opportunities.

Before I open the call up for questions, I want to make a few comments on the release, and then discuss some of our recent strategic activities.

During the quarter, we disposed of approximately $17 billion in assets that resulted in about $183 million in gains. The book yields associated with those assets were around 127 basis points, which was included in the spread calculation for the quarter, and contributed to a reduction in reported spread quarter over quarter.

With the high volume of sales in the quarter, and trying to accommodate a repo market starred for collateral, we did not terminate certain of the repos associated with the assets we sold, which resulted in a snapshot on leverage that was temporarily inflated until the repos matured shortly after quarter end. It contributed almost a half a turn to leverage.

The change in book value was largely due to the loss in mark-to-market on paydowns received of -- during the quarter, of around $0.50 on market value, and approximately $0.13 was a negative market value move on the overall portfolio inclusive of hedges.

For the quarter, our overall dividend yield and yield on core earnings remains at historically high levels relative to virtually all other asset classes. For example, our dividend yield of 11.3 is 967 basis points greater than the ten-year Treasuries. Our historical yield spread since inception versus the benchmark has been around 730 basis points. Our current yield on core earnings of approximately 7% remains higher than even the corporate high yield index, which now stands at about 5.3.

Now I'll turn to a brief discussion on some strategic developments. First, an update on the CreXus tender offer. As previously announced, on April 17th, 2013 Annaly accepted for purchase 55.1 million shares of CreXus, bringing our direct and indirect ownership of CreXus to 84.3%.

Using our top-up option, we will acquire enough shares to enable us to complete the acquisition in a short form merger, which should be completed on May 23rd of 2013. The CreXus acquisition is accretive to the Annaly dividend and represents a meaningful step in the evolution of Annaly's capital allocation strategy -- one that will enable to take advantage of a broader spectrum of investment.

Since the announcement of this acquisition in November, we have continued to build out our commercial expertise, and we remain confident that CreXus' capabilities and growth may be significantly enhanced when coupled with Annaly's broader capital base.

Finally, our externalization proposal is another strategic initiative I'd like to highlight. The proposal assures our shareholders of significant cost savings and caps expenses as we invest in additional resources to diversify and grow our investment capabilities. The proposed fixed management fee of 105 basis points is the lowest in the industry by far, and 30% below our peer group on average. Pro forma cost savings for 2012 amount to $48 million.

And senior management's incentives as further aligned with our shareholders, as they are required to own $38 million worth of Annaly stock.

It should also be noted that the proposal proactively addresses the competitive changes within our industry, and that external management structures are generally viewed favorably by shareholder advisory services.

With that, I will turn the call over to the Moderator for questions.

(Operator Instructions). Jason Arnold, RBC Capital Markets.

First, I'd just like to say, Mike would have enjoyed the shark analogy. Very well done. But, in terms of questions, with CreXus coming into the portfolio here near-term, I was just wondering if you could talk about the CRE opportunities that you see are out there, in terms of loan type, yield, et cetera; and then kind of what we might be able to expect from an asset mix perspective here, for going forward, as well.

You know, Jason, as we have put out in releases when we initially set off on this broader initiative, is, we will be limiting ourselves to 25% of our capital allocated away from the agency mortgage position.

With respect to activity in the commercial space, and pipeline, and specifics, I really want to reserve comment until the close of the merger, which is on May -- projected to be on May 23rd. We will give you a full update at that time.

Okay. Fair enough. And then I guess just one follow-up on the prepay into the equation, assuming the ten-year remains near or above current levels -- you know, it seems to me that refi activity will kind of slowly burn out here. Just curious what your thoughts are on that, into the equation here.

The only thing that concerns me really is that a person like Mel Watt has been put up as a potential replacement for DeMarco. In the portfolio itself, we have obviously seen speeds come down, and just -- to put it into perspective, the securities we did sell during the period had an associated speed of around 34 CPR with them, which dragged down the yield on that overall position.

You know, since quarter end, you have had rates come down a bit. And so, you have to expect that speeds will remain elevated and that policy meddling may get in the way at some point. But overall, your general feel that you should start to get into a burnout position, is correct, if everything else wasn't happening around it.

Okay. Makes sense. Thanks very much for the color.

Steve Delaney, JMP Securities.

I think we'll all keep an eye out for those land sharks in Washington and hopefully avoid getting our leg bitten --

They're big. They're whale sharks.

Getting our leg bitten off. I was just curious, since we're talking about Washington, if you guys are spending any time talking to FHSA about this pilot program, the $30 billion pilot program for credit bonds -- if you think that's viable for the Annaly complex. And, not that it really matters, but if you look at that product, does it fit with Annaly, or is that something that you would rather hold in Chimera?

The interesting thing -- because it's -- when they do come out with their ultimate product -- and $30 billion is obviously -- you know, we would allocate however, according to capital needs; but it is something that Annaly could look at. And it is also something that Chimera would look at. And we have been in ongoing conversations with both the agencies as they try and roll out what the new product going forward is going to look like, and also what they're going to do with existing portfolio.

Do you have a sense, Wellington, as to when we might see that first proposed deal and structure? Because I've been trying out, what are -- I keep hearing things like credit linked notes, and maybe they're not really cash bonds. I was just curious if you have any view as to what the actual instrument that you would be investing in, might look like?

Well, there have been a number of things that have been proposed. I do think -- you know, they're still querying participants on where the demand will lie.

Again, for us, and for Chimera in particular, there is the potential that a credit linked note might work fine. The problem is, it is not a good REIT asset in -- so, you have to keep that in mind, on how much -- and we are conveying this to them, so they do understand the limitations of the REIT market's participation in a structure like that. But I do think they are getting serious, and they probably will have something to market by Q3.

Wow. Okay. And in these discussions, are they also trying to address whether the seniors that come out of this will be similar -- treated as whole pools for '40 Act compliance? Because that seems -- that's another important issue.

No, and that is an issue that we raised when we initially went in on the SEC concept release. And it has not -- obviously it has not been resolved, and that comment letter -- there has been no movement on it. But I do think that all the parties understand the need for either a resolution of that outstanding issue, or there has to be a way to have private capital participate, the large part of it coming from the REIT community.

It is an issue that does need to be resolved. But they understand it. They understand it exists, and they're not the only ones that understand it.

That's good to hear. Well, thank you so much for the comments.

Joel Houck, Wells Fargo.

I did enjoy the shark analogy. And I think most people understand that the mortgage REITs are part of the longer-term solution to, you know, obviously, take up a lot of the -- absorbs a lot of the GSE runoff or liquidation.

But can you -- Wellington, can you talk about industry repo capacity? Because, on the other side of this, we're hearing a lot of the US repo providers are perhaps -- not -- I wouldn't want to say constrained, but perhaps looking at this with a sharper pencil.

On the other hand, we're hearing favorable things out of Canada and Asia in terms of new entrants coming into the market. So, maybe your perspective in terms of what Annaly's seeing with respect to repo capacity, would be helpful.

Yes. No. I mean, there is no question that the capacity is there for good-quality collateral. And you have also seen an increased demand from lenders for AAA non-agency collateral as well.

The overarching issue I think that is evolving in the market is tri-party reform, and how that is going to impact the ability to leverage your assets as much as you used to in the past.

As far as the capacity, I have to say that it's very robust from our perspective. And you've always had participants -- I mean, you always had Asia come in and out of the market. You know, the -- we are actually seeing the European lenders be rather aggressive in their search for collateral.

So, I -- from our perspective, it is a fairly robust market. We keep in mind that there is reform going on and it will create drag and friction, and slow the velocity of things; but the availability is robust.

Okay. Good. And the second question related to the spread -- I mean, it was 121 basis points in the quarter. Do you have a pro forma spread to take into account the fact that, as you said, a lot of this were lower-yielding stuff that you sold. And if we were to look at this spread at the end of the quarter, ex the stuff you sold, what would it look like, roughly?

Well, the spread at the end of the quarter -- you know, the -- if you just take the assets that we had in portfolio, and if I just look at them, the ones we did not sell, you're around a 260-type of yield, when you add that into the stuff that you did sell, at 127 basis points, with prepayments kind of stabilizing -- they were fast early in the quarter and started to taper off. And so, new money spreads around, if you look at it conservatively, around 240 basis points.

There's no question that this market is not my favorite market. I think I have not been shy about that. But nonetheless, in the framework that we're operating in, and where I think the Fed is in the long term, I think it'll be more difficult for them to exit this market than they think. Yet, I really look forward to it.

But we may -- going forward, we may present an increased disclosure on the actual better spread profile disclosure for you guys, so you get a better sense. Because the spread is generated on all interest-earning assets. And sometimes, if you have cash -- large cash positions -- that is a drag. It's not necessarily totally representative of your mortgage position.

Right. I mean, you guys had $1.8 billion cash at the end of March was -- I think a lot of that's reflected in [sales].

Yes. And we did have $4.9 billion in reverse, as I mentioned. We had repos out there that we didn't necessarily want to force people to break. So, we would reverse collateral in to satisfy those transactions. And that activity would drag down your overall spread.

Daniel Furtado, Jefferies.

Most of my questions have been asked and answered. I just had one, Wellington, and that's just kind of -- if you wouldn't mind taking us into your thought process, in terms of how you see Annaly, say, five years out from now. And really, the highlight -- the big differences that you expect to see in the organization between today and, say, that five-year period. Thank you.

You're welcome. Thanks, Daniel. No, I -- you know, we made the statement that we will more actively allocate capital away from just the pure agency trade. And I see, with housing reform and GSE reform, I see tremendous opportunities for us as a private solution to be able to take advantage of that. And I want us to be in a position where we have all of the necessary disciplines in-house.

You know, as risk retention rules, and all of the things that are impacting the banking sector -- kind of, the fog clears, and these things become clearer on what the implications are going to be. I want to make sure that us -- we as a Company are positioned to deal with those changes, and also capitalize on them in a way that is -- we have somewhat of an advantage over the historical participants in those markets.

The other thing -- I want to make sure that five years from now, we are still a highly liquid Company, involved in whatever the future of -- and I do think there will be a government guarantee in some form -- whatever the future of the government's participation in the mortgage market is. And so, I think the Company is making very good strides in that direction to be one of the preeminent participants in those markets.

Great. Thank you for the thought process. I appreciate it.

Mark DeVries, Barclays.

I just wanted to follow up on your comment about, you know, it being harder for the Fed to exit than they think. Could you talk a little bit about when you think they'll look to exit, how they'll do it, and if there are risks of disruptions from that process, and how you kind of position your portfolio for that?

Yes. I mean, one thing I do say to them, whenever we have a chance to have conversations with them, is that, don't worry so much about disruption. The private sector will be there. We would -- if everybody hasn't noticed, we haven't gone out and raised equity, because the opportunity set in that market in particular is not as good as it will be when the Fed ultimately starts to exit.

Now, I -- our advice to them, and I think they kind of understand this themselves, is that to allow the portfolio just to amortize down, I think they'd get around $250 billion, based on today's prepay levels -- somewhere around that -- in paydowns each year. And the market could absorb that. You know, it wouldn't be at these prices, obviously; but the market will absorb it.

The reason I say that they may have difficulty exiting is, they are in the game of pulling demand forward. And when you keep pulling demand forward, you leave a hole in the future. And once you get to that hole, you realize, all right, I need to do it again.

And so, as much as they may think that the economy is going to be able to exist without their participation -- I mean, we all see it. We see the liquidity sloshing around. We see what it's doing to investment decisions and business decisions.

I just think, you know, they did put their targets out there. And I hope they stick to them. And we will look -- continue to monitor the unemployment rate and future inflation rate. Given their activities thus far, I think we put -- you probably hit unemployment around 6.4% in 2014, 2015. And I hope they keep their word at that time.

Okay. And just one follow-up on that. I think you mentioned, you know, the ability of the private sector to be there to absorb it. Any thoughts on -- it seems like it's a lot easier for the industry to raise capital when bonds are rich, and harder when they're cheap -- about kind of the ability of that to step up and really grow the balance sheet in the event that you see some really significant spread widening and a more attractive opportunity.

I have to say that one of the -- really, the year that we really grew tremendously in size, was the year in which the Fed was tightening. They had gone through a tightening cycle 2004 to 2005, and Bernanke handed -- was handed over from Greenspan, and he continued to tighten. And mortgages were getting hit.

I think it's just a matter of investors understanding the opportunity set. I mean, at that period of time cash flows were cheaper than they had been in a long period of time. And I think investors are sophisticated enough to understand the difference between various markets.

I do think the amount of capital raised at these levels is indicative of the limited choices that everybody has. And that's why I put it into context -- even our core yield surpasses, almost by 200 basis points, the corporate high yield index.

So, that tells you what is going on, and that's part of the problem we are all facing with the amount of liquidity that's in the market. And the Fed will have some level of volatility when they try and exit. Although, I hope they are not -- I hope they don't get too concerned about that. I think the markets need to be markets.

Okay. Great. That's helpful. Thanks.

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

No. Thank you all for participating in the call, and we look forward to speaking to you after the second quarter. Take care.

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 10027890.

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