Annaly Capital Management Inc (NLY) 2014 Q4 法說會逐字稿

Good morning, and welcome to the Annaly Capital Management fourth-quarter 2014 earnings conference call.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Willa Sheridan. Please go ahead.

Good morning, and welcome to the fourth-quarter 2014 earnings call for Annaly Capital Management. Any forward-looking statements made during today's call are subject to risks and uncertainties, which are outlined in the Risk Factors section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the forward-looking statements disclaimer in our earnings release, in addition to our quarterly and annual filing. Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date of this earnings call. We do not undertake and specifically disclaim any obligation to update or revise this information.

Participants on this morning's call include Wellington Denahan, Chairman and Chief Executive Officer; Kevin Keyes, President; Glenn Votek, Chief Financial Officer; David Finkelstein, Head of Agency Portfolio; and Bob Restrick and Michael Quinn, Co-Heads of Annaly Commercial Real Estate Group. I will now turn the conference over to Wellington Denahan.

Thank you, Willa. Good morning, and again, welcome to Annaly Capital's fourth-quarter 2014 earnings call. We have a few prepared remarks, and then we will open the call for questions.

I would like to start by summarizing the global landscape with a few statistics that were compiled by WallStreet Research department. Global central bank assets now account for $22.5 trillion, a sum larger than the combined GDP of both the US and Japan. The Fed balance sheet represents 23% of the US GDP. Since Lehman Brothers collapsed in the fall of 2008, there have been 550 rate cuts worldwide, which is equivalent to a rate cut every three business days. All of which is largely responsible for the next set of statistics.

52% of all government bonds in the world currently yield 1% or less. 83% of the world's equity market capitalization is supported by zero interest rate policies. There was approximately $7.3 trillion of negatively yielding government debt in the eurozone, Japan and Switzerland before the most recent sell-off. When a Fed governor was asked recently if he saw any evidence of an obvious bubble, he replied, and I quote: I don't think there's anything on the scale of the housing or Internet bubble right now; the only candidate is bonds, government debt and other kinds of debt, but I'm not counting that, I guess, because that's us. End quote.

As is often the case with humanity, we fancy our present selves as the most intellectually sophisticated, and tend to look back upon our predecessors as somewhat naive in light of our current knowledge base. There are certainly good reasons for that attitude. Here are a few examples. Up until the late 1800s, bloodletting was a popular prescription for many ills. In fact, George Washington was reportedly a huge proponent, and after awakening with a bad sore throat, he asked to be bloodlet. During the next 16 hours, 5 to 7 pints of blood was drained from his body. Four days later, he was dead.

Before microscopes and cell theories, many scientists believed in spontaneous generation as the explanation for how life arose. Right up until the 19th century, scientists still believed in it, and some even wrote recipes for making animals. One such recipe called for basil placed between two bricks and left in sunlight to produce a scorpion. It wasn't until 1859 that Louie Pasteur finally put the popular belief to rest.

I mention these extreme examples of our lack of intellectual sophistication to emphasize how wrong humanity can prove to be with the benefit of time, discovery and hindsight. History is littered with longstanding theories and beliefs that ultimately prove incorrect. My hope is that as policymakers of the world continue to prescribe their remedies for the ailing economic patient, that they do not render it worse off. As with their predecessors, I suspect that there is no doubt in the minds of our central bankers that they are the smartest they've ever been. Yet, I fear that they are not the smartest they will ever be.

Given the time spent to wash in central bank liquidity and the influences it had on the capital allocators, we maintain a healthy dose of concern about its impacts on the market. We have remained conservative with our leverage, and opportunistic with our capital. I will now hand the call over to Kevin Keyes to further discuss the past quarter's results.

Thank you, Wellington. On last quarter's call, we shared some of our specific views on the state of the macro economy. We pointed out that even after $4.5 trillion of quantitative easing, signs were pointing to deflation rather than inflation. I also stated that there were numerous red lights flashing in the global markets, which served as evidence of global economic growth slowing rather than expanding. Since our third-quarter call in the beginning of November, the market moves have certainly validated our skepticism.

Ten-year treasury yields have declined another 15%. Global, sovereign yields contracted even more from historic lows by an average of 40%. And even the price of oil, which at the time was at a three-year low, has since fallen by another 35%. Officials at the Federal Reserve seemed to agree with us at their most recent policymaking meeting in January, and in Chairman Yellen's testimony yesterday. We've stated that we view lift-off as inevitable this year, while also reasserting -- and I'll use Yellen's words from yesterday, that, quote: economic conditions may, for some time, warrant keeping the Fed funds rate below levels the committee views as normal in the longer run.

So the past four months have been quite eventful. Our current view on the next four, leading up to June, and the potential Fed lift-off, and for many months to follow, quite frankly, is that more consistent volatility will return to the markets we operate in. Contrary to what certain observers say about the mortgage REIT sector, we welcome and are prepared for the return of vol, which not coincidently, we have expected to arrive following the end of QE in the United States.

I will put it simply -- volatility equals opportunity for Annaly. Given our size and liquidity, we are prepared to be opportunistic during windows of cheaper pricing for our targeted assets. Our current leverage ratio now is 40% below the industry average, a level we expect to increase when clear, relative value opportunities present themselves. One turn of leverage at today's spreads can produce approximately 15% of incremental annual earnings for our shareholders.

As we've stated many times before, we welcome the return of normalcy to the markets. This includes the return of market-driven pricing, and volatility. The timing of the Fed's lift-off does not pre-occupy us. We have maintained our conservative posture as a competitive advantage. We believe this conservatism, which has been ignored during the relative calm over the last few years, will be rewarded as volatility means something once again in the market.

Finally, in addition to our size and liquidity, our diversified strategy helps not only to insulate us from certain market volatility just discussed, but also provides a complementary and durable earnings stream for the Company. Since 2009, we've operated a commercial real estate business. Two years ago, we decided to bring it on balance sheet, well-before any of our competitors in the hybrid space, knowing that commercial credit can serve as a strategic weapon when paired with our agency interest rate strategies.

Anticipating some of the market moves I mentioned earlier, we recently increased the level of our investment activity in the Annaly Commercial Real Estate Group, targeting specific sectors and asset classes which have demonstrated economic resiliency and more visible cash flow growth. We expect to put more money to work in both our commercial debt and equity businesses in the first quarter of this year than we did in all of 2014.

We allocate our capital based on the relative value of interest rate and credit assets. And in the past couple of months, the risk-adjusted returns of the commercial business have not only been relatively attractive, but the investments also add to the durability of our earnings and stability of our book value over time. In today's marketplaces, where almost every asset class is fully priced, this optionality is uniquely valuable to us. Now I'll turn it over to David, who will summarize our agency portfolio performance.

Thank you, Kevin. Regarding agency MBS specifically, we wanted to initially give a brief recap of 2014 and the drivers of our agency performance, before discussing the fourth quarter and beyond. As some may recall from our fourth-quarter earnings call last year, we went into 2014 with an optimistic assessment of both the interest rate landscape, as well as agency MBS valuations. This view led to three primary strategic initiatives which meaningfully added to our performance in 2014.

First, we added nearly $10 billion of assets early in the year. Second, with what we believe to be overly aggressive policy tightening priced into the front-end of the yield curve, we lifted a significant portion of our shorter-dated hedges. Lastly, as our asset purchase strategy throughout the year was focused on high-quality, 30-year specified pools, which were priced at what we believe to be inexpensive levels, throughout much of the year. Strong positioning heading into the year, combined with the direction we took the portfolio throughout 2014, led to a 4.1% economic return for the fourth quarter, and an 18.1% return for the year, while operating at 40% less leverage than the sector.

With respect to the fourth quarter specifically, as you know, we experienced a significant rally in the long-end of the yield curve, and a meaningful pick-up in volatility, this past quarter. While we felt that we were well-positioned heading into the quarter, we did make minor adjustments to the portfolio in light of lower rates and the potential for higher MBS pre-payments. The assets we sold were predominantly 30-year higher year coupons with heightened pre-payment sensitivity, while our purchases were focused on the 15-year sector, where we had been underweight all year. The under-performance of 15 years, combined with the better pre-payment profile, served as a catalyst for us to gravitate back into that sector.

Turning to our activity in 2015, we've recently completed another meaningful portfolio shift, which merits discussion here today as well. As we spoke about on our third-quarter earnings call, high-quality specified pools exhibited very strong performance this past year. We entered into 2014 with a rate environment where few investors were willing to pay a premium for pre-payment protection and pool pricing, relative to TBAs, reflected this sentiment. As the year progressed and rates trended lower, the market exhibited renewed demand for call protection. And high-quality specified pools outperformed TBAs, even after considering the longer durations of pools, as well as specialness in the dollar roll market.

The persistence of the market rally into January brought specified pool pricing to its highest levels relative to TBA since the Fed's discussion of tapering began in the spring of 2013. As a result, we opted to reduce our pool exposure by nearly 20% in favor of TBAs. This is not to say that we are negative on specified pools going forward, nor are we overly optimistic on dollar roll specialness. Rather simply, recent valuations suggested it appropriate to rotate into TBAs for the time being. In the interest of transparency, we will provide a breakout of the TBA portion of our portfolio in our Q1 supplement. And additionally -- although we do not expect dollar roll income to contribute substantially to Q1 performance, given that we just recently completed the strategy shift -- we will also break out dollar roll income as part of our earnings package going forward.

One other note to follow up on from last quarter's call. We were asked about residential credit and our evaluation of GSE credit risk transfer trades, and we conveyed that the sector was, in fact, on our radar. And in 2015, we have entered into that space, albeit in limited size thus far. But assuming relative returns are attractive, we expect to expand our footprint in that sector. With that, I'll now turn it over to Bob to discuss the commercial portfolio.

Thanks, David. The US continues to be the largest and most liquid institutional commercial real estate market in the world. The competitive landscape continues to expand, as investors from around the world are attracted to the relatively higher yields and perceived safety in our market. Fundamentals are very positive, as the economy slowly expands. Demand for space remains strong, with increasing rents and decreasing vacancies across all asset classes. And in general, new supply remains in check in most markets. However, we see many deals out there today where asset pricing seems to indicate that this situation will continue indefinitely. We know historically that this is unrealistic. So our challenge continues to be identifying and executing on investment opportunities where the current reward matches the risk being taken.

In 2014, we reviewed over $20 billion of transactions, and invested almost $440 million, in both debt and equity. We also had over $310 million in pay-offs, which were all debt, yielding about 9.8%. While our new debt investments were at 8.2%, reflecting the lower return environment we were in. 98% of these pay offs were before maturity, as our borrowers realized their business plans and either refinanced into low-rate CMBS debt, or sold their properties at attractive cap rates. In the fourth quarter we invested $185 million in both debt and equity. And as of the end of the 2014, our portfolio stood at approximately $1.7 billion, with a weighted average yield of 96.

Our strategy in 2015 is to continue the same credit focus we have always had as a balance sheet investor. Of course, in a lower yielding environment, we've accepted low returns in exchange for maintaining our credit standards. As a lender, we intend to continue to originate debt deals with strong sponsors, sound credit metrics and actionable business plan. As an equity investor, we are focused on deals that provide durable current cash flows, with less emphasis on value appreciation.

In addition, these transactions allow us to take advantage of the currently low long-term interest rate debt available in today's conduit market. As Kevin mentioned, so far in the first quarter of 2015, our investment activity has increased. We currently have $250 million closed, with another $200 million in closing, for a total of $450 million -- more than we invested last year. And finally, we have almost $2 billion in the early stages of inquiry that may match our credit and return targets.

In summary, we believe that asset prices seem to fully reflect the current positive operating fundamentals of the market. We believe growth will continue, but not indefinitely. Therefore, we are aggressively managing our credit risk as we invest new capital and continue to pick our spots prudently and profitably for our shareholders. And with that, I'd like to turn it over to Glenn to discuss our financial results.

Thank you, Bob, and good morning, everyone. I'm going to provide a very brief overview of the key financial highlights for the quarter before opening the call up for questions.

Beginning with our GAAP results, we reported a loss of approximately $658 million in the quarter. This was largely attributable to unrealized swaps losses that resulted from the decline in interest rates that we experienced in Q4. Our core earnings -- which exclude realized and unrealized gains and losses on derivatives, assets sales and certain inner non-recurring items -- was just under $300 million, or $0.30 per share. This compares to $0.31 in Q3. And our annualized core ROE was about 9% versus 9.3% for the prior quarter, and about 8.9% for the year, which was up about ten basis points from the prior year.

Our net interest income was relatively flat sequentially, with net interest margins at 156 basis points for the quarter -- excuse me I'm battling a little bit of a cold here. Our margins were down slightly sequentially, but up about 20 basis points year over year. Our net interest spread also experienced a similar trend to that of our margins, for the quarter, as well as for the year. Our G&A expense was up approximately $7 million, the majority being related to new commercial real estate investments, which included the related transaction costs associated with those deals.

Turning to the balance sheet, the agency portfolio was relatively flat at the end of the year, at $82.9 billion. While our commercial portfolio, which includes corporate debt, grew about 7% in the quarter to $1.9 billion. Our book value ended the year at $13.10 a share. This compares against $12.87 for the prior quarter, which was driven by unrealized gains on agency securities. And finally, our capital position, as Kevin eluded, remains solid, with leverage at 5.4 times -- well-below the industry average, and unchanged from the prior quarter. And our capital ratio ended the year at 15.1%.

So with that, Andrew, we're ready to open it up to questions.

(Operator Instructions)

The first question comes from Dan Altscher from FBR. Please go ahead.

Thanks, good morning, everyone, and appreciate you taking my call today.

You know, the press release indicated the expectation for some policy shift from the Fed in the first -- I'm sorry, in this year, and your comments today clearly seem to think that, as well. Is there any thought on, at least the hedge side of the portfolio, of doing something there to account for that expected shift, as opposed to just asset allocation?

I'm going to let David elaborate on it.

Sure, thanks, Dan. What I would say is that a lot of the likely Fed tightening is priced into the market. So when we talked about, for example, last year when we lifted those front-end hedges, there was a very aggressive Fed tightening priced into the market at the time. For example, the two-year note, one-year forward was priced to yield 1.35%. Today, that same two-year note, three months forward now through the passage of time, is about 78 basis points.

So rates certainly are lower, and the expectations for the pace of tightening is not as aggressive as it was before. But nonetheless, we do think that the tightening that is priced into the market is, we would say, not overly aggressive. If anything, we think it will be slightly less aggressive than that which is priced in.

Okay. Thanks for that.

And then, book value was up nicely in the quarter. Do you have just an expectation or a sense of what it was as of January 31 -- in January or even as of yesterday?

What I would say is, I would point to our supplement and the chart on page 20. We break out rate sensitivity, as well as spread sensitivity. And the vast majority of book value fluctuations are attributable to that. Rates are lower, spreads are a little bit wider. So we're probably modestly lower, but not materially, by any means. And I would use that as a road map to help you determine what our book value would be throughout the quarter.

One thing I would add is that -- and I think I speak for a lot of mortgage investors out there. That with the level of interest rates where they are, that a lot of us would benefit more greatly from an earnings perspective than what we would lose from a book perspective, with a reduction in amortization expense. With the curve as flat as it is, as low as it is, that fluctuation of volatility and that expense is far more impactful than modest reductions in book value that would accompany higher rates.

Right. Yes, that totally makes sense. A little bit back-up on the long-end of the curve probably wouldn't necessarily be a terrible thing at this current level.

Not at all.

Yes, totally. And then just a quick follow-up for Bob. It sounds like the commercial side is growing very fast, or relatively very fast, in the first quarter. You referenced $400 million-plus of acquisitions or investments. Can you just give us a sense of color of what those look like, whether it's debt equity, property-type, et cetera?

In the $400 million number that's primarily debt, although we have a lot of opportunities in the pipeline -- not at that stage that are in the equity side.

Okay. Thanks so much, everyone.

Thanks, Dan.

The next question comes from Douglas Harter of Credit Suisse. Please go ahead.

Thanks. I was hoping you could help me understand your thinking around the duration of your hedge portfolio and some of the long tenor of that, given some of your commentary that policy response might be slower. And if that happens, maybe results are more of a flatter yield curve?

Well, one thing I would point out that doesn't necessarily make its way into our hedge table, is the fact that we do have a lot of longer-term repo positions that are in the shorter-end of the market. That are somewhat comparable had we put them in those buckets and marked them, along with swap positions. That they would exhibit the same kind of characteristics had you gone out and hedged in the short-end of the market. And as David mentioned, a lot of the move, with the feds moving in the short-end, is priced into the market. Maybe overly priced into the market, thus far.

And, Doug, just to add to that. To Welly's point, if we did factor in those longer-dated term repo contracts into the average life of the swaps, it would bring it down to probably about 6.5 years, in terms of average length of the liabilities. Another point to note with respect to the asset side of the balance sheet is that mortgages, as you know, have contracted in duration, with the rally in the market. And so as a result, you would see a little bit of an imbalance between the duration of our swaps and our asset durations.

That being said, when we look at the profile, the cash flow profile, the MBS market and our portfolio right now, in terms of convexity, there is more extension risk in the portfolio than contraction risk at these rate levels. So, while we don't necessarily expect to sell off -- a meaningful sell-off anytime soon, in the event that we did see higher rates, what would happen is, those assets durations would extend more. And then they would be compatible with the average life of that swaps portfolio.

Great, thank you.

The next question comes from Joel Hauck from Wells Fargo. Please go ahead.

Good morning.

Good morning, Joel.

The question has to do with -- I keep asking about the mortgage basis. But typically, during past patterns of Fed tightening, you've got, generally, yield curves shift upward, as the economy is strong enough, or at least there's enough inflation expectations to move the longer-end of the curve. And hence, what we observe is a tightening of the mortgage base that is generally, obviously, good for mortgage REITs. In this case, this year, though, we had ten-year still sitting around two. If the Fed chairperson still goes through with this, it looks like we're not going to have a typical steepening; you'll probably have some type of flattening, or who knows.

What are your expectations with respect to the mortgage basis? Do you think it will hold its historic pattern? Or are there other things that make you nervous, just given that there doesn't appear to be a lot of flexibility here in this tightening cycle? And I use that term loosely, because I don't believe they're going to engage in a full tightening cycle. But nonetheless, even a 25-, 50-basis point hike is something that needs to be dealt with.

Yes, first of all, Joel, with respect to the shape of the curve and what's priced into the forwards, that's a very good question. Obviously with what's going on globally, there's been downward pressure on longer-term US yields. And as a result, when we look out the horizon, for example, three to four years from now, the yield curve is priced perfectly flat four years from now, with the two-year yielding 250 and the ten-year yielding 250. So we have to ask ourselves, over the long-term, do we think that's a realistic possibility or do we believe that story?

And obviously, when the Fed enters a tightening cycle, the yield curve flattens considerably, and even potentially inverts. But there's a couple things different this time around. Number one, the absolute level of rates are very low. So when we think about whether or not a ten-year note yielding 250 -- with very little upside potential from a price appreciation standpoint -- can compete with shorter-term yields of the same magnitude we do question whether or not that private investors who will ultimately be left to be the determinants of value across the curve, will really make that trade-off, and the curve will be that flat. Number one.

Number two, when we think about this normalization of policy this time, it will be unlike times in the past because we'll have both the increase in short-term rates, as well as ultimately, allowing the portfolio to run-off. And so the run-off of those assets will ultimately lead to the re-issuance of longer-term assets, which very likely will put pressure on the long-end of the yield curve out the horizon. For example, in 2018 and 2019, we have approximately $500 billion in run-off between treasuries and mortgages. Two-thirds treasuries, about one-third mortgages, based in our estimates.

So we're not convinced that the market is fairly priced far out the horizon. But nonetheless, over the near-term, we certainly believe the yield curves are going to flatten, like every other investor. It's just, we question further out, and what's priced into those longer-term rates currently. And that also contributes in terms of our longer-term market view as to why we don't hold much duration out the curve. And why that swap portfolio is hedging the vast majority of our MBS cash flows that far out. So that's the yield curve and rates landscape.

With respect to mortgages in the environment you're referring to, typically mortgage spreads do widen in a flatter-curve environment. And we expect that that will be the case as well. We do think that the pace of tightening will be more modest. But we think there'll be more spread and yield in the market.

We've navigated in those environments in the past numerous times, and we'll do so again. So whatever the market offers -- if the agency equation is attractive, we're going to focus on it. But we also have numerous other alternatives in the credit space that we can look to for returns, as well. So we think we have flexibility to manage through whatever the environment looks like.

All right, thank you. I appreciate the response.

The next question comes from Rick Shane from JPMorgan. Please go ahead.

Thanks. I really want to tie together Dan's question and Joel's question. Which is, given what you're describing is a very extended time for tightening, and your predisposition to essentially hedge that by going further out on the swap curve. If your expectation is that over the next year, you're going to have greater opportunity to grow the left side of your balance sheet, given volatility, does it makes sense in this low-vol, low-rate environment to even further expand that swap book right now?

You mean in terms of hedge more?

Yes, I mean, I know it's expensive. But if you really think that you're going to have the opportunity to grow the left side over the next 12 months, does it makes sense to get in front of that on the right side with the swaps?

There is a considerable risk associated with that. The way we look at the portfolio is, we try and manage for any scenario. We obviously had a significant rally in January, and that's a meaningful possibility going forward. One concern is, is what the implications are if that were to repeat itself and even move further. So we keep duration on the balance sheet to cushion that eventuality.

Lower rates and a flatter curve would impact, as Wellington mentioned, our amortization expense. So as a result, we think of our duration as a hedge against an environment like that. And we also think of our low-level of leverage as a hedge against a higher-rate environment.

What we do is, we attempt to strike the best balance, particularly right now, given the fact that there is not a strong consensus in the market, in terms of the direction of where we're going. Obviously, global rates are very low. US rates are 100 basis points above the rest of the G7 countries. And that puts downward pressure on our own interest rates, and could lead to further flows into the US market. And they obviously have had a meaningful impact thus far.

But at the end of the day, our economy is doing rather well, particularly relative to Europe and Japan. And we are at a very different stage in the monetary policy cycle than those countries. So there's arguments to be made for lower rates, and also arguments to be made for higher rates. We have to think about all of those scenarios, and manage the portfolio in a fashion that strikes the best balance.

And, Rick, in a perfect world, we would love it if we could time these things perfectly, where we put all our swap book on when rates are low, and then buy all our assets when rates are high. Unfortunately, that's not how it goes. And as David mentioned, from a global landscape, I think the US market, and even our market where it is, looks cheap on a relative basis.

So irrespective of -- and as levered players all these years, we have to constantly strike a balance and be prepared to be wrong with our stance. I don't think that you're going to see runaway type of movements in yields, given the fact that this economy is so dependent on central bank liquidity and central bank policy. So, I think you'll have periods of volatility that the portfolio is well-positioned to withstand. But you're not going to have extended moves in the market that make it difficult to right-size your balance sheet.

Got it. No, clearly it's not easy. The low leverage, frankly, is your opportunity, if it presents itself. So we get it. Thank you.

Thank you.

The next question comes from Brock Vandervliet from Numora Securities. Please go ahead.

Good morning, thanks for taking the question.

I'm surprised it hasn't been asked already, but could you talk about the decision on the dollar roll strategy, how you arrived at that? Was it a broader discussion, or more of just a point in time, given the rally in mid-January and the collapse in specialness that you decided to -- it was a good time to dip a toe in? Thanks.

It's been a discussion for quite some time. We've always had TBA positions, both long and short, for hedges. And we evaluate the TBA market relative to the pool market. At the beginning of last year, for example, as I said, specified pool pricing was very cheap.

Just to give you an example, something common on the run, so to speak, in pool form, are moderate loan balance Fannie fours with a $110,000 loan balance max. Those pools, at the beginning of last year, traded up a quarter point from TBAs. And they were very -- we thought to be very cheap. And you didn't have to hedge them much longer than TBAs because of that very low pay-up. That seemed to us to be the more attractive alternative.

The dollar roll trade might have been the easier trade, with the feds still involved heavily in the market, and their exhibiting some specialness at the time. But the fundamental value equation was in the pool trade.

So as the year progressed and rates trended lower, specified pool pricing relative to TBAs appreciated. Obviously they're supposed to appreciate, given their longer durations. But if you take these Fannie four moderate loan balance pools, for example, they appreciated to roughly 2 points in pay-up form, in late January. So from a quarter point to up 2 points. We think that the differential in the hedging of those pools relative to TBAs is worth about three quarters of a point. So that should be -- that means that the initial pay-up, plus what they should have appreciated, is a point, and the additional point is out-performance.

So we looked at that, and we said to ourselves -- given this out-performance, and given these high pay-ups -- which is a risk in the portfolio -- pay-up is exposure, is something we have to hedge with longer durations, more expensive. And we evaluate it in terms of risk and return from that standpoint. We opted, given performance of pools, as well as that pay-up, we opted to reduce our exposure in the sector.

Now, we don't expect meaningful dollar roll specialness in the TBA market this year. That was not the value proposition there. We do think that production coupon TBAs do have a little bit of a tailwind, with the Fed still involved and money managers reducing their underweights to overweight, or to closer to neutral. And they are typically dollar roll investors.

So there are some positive technicals in the TBA market right now. But we're not banking on extreme specialness like we've seen in the past. They are financing -- current coupon pools are financing very slightly negative right now, and that's better than short-term repo financing. So we're comfortable with it.

Got it, okay. Thank you.

The next question comes from Steve Delaney from JMP Securities. Please go ahead.

Thank you. Good morning, Wellington, and congratulations to the team on a strong performance in 2014.

Thank you, Steve.

You're welcome. I just have one strategic question for you this morning. And it's interesting, with the comments that David had made about the GSE risk transfer. That's kind of where I'm going here. The managers now approaching the broad mortgage market with two distinct pools of capital. And of course, at one point, you had three separate entities. And as you look out, as this market evolves over the next couple of years, can you envision a scenario whereby Annaly shareholders -- to where you think they would benefit from the manager being in a position to face all segments of the mortgage market with a single and larger capital base?

Of course. That is the general idea behind how we set the Company up. And that is, anybody who's been following us for a long time understands how we approach these markets and how we segregated the risks. But in light of everything that has gone on over the past six years, from a policy perspective and a regulatory perspective, that that model certainly creates issues internally for us, as we try and allocate capital.

Now, I will say that even though we do have another public company out there that we do manage, that there's internal allocation policies, with respect to opportunities that arise. And Annaly has always had it, and have in virtue of our ownership in the stock of Chimera, we've always had exposure to the mortgage credit space. Certainly both companies are of a size to take advantage of opportunities in the market alongside each other.

Relative to the allocation procedures that you mentioned, you now here in first quarter are doing the GSE, the credit risk transfer trades. Could we expect that moving forward, that you could even move into whole loans or other credit-related assets within the Annaly portfolio, using that allocation system, and being fair to both sets of shareholders?

Yes, absolutely. And it's really driven by the economics, and the overall economics, not just fleeting economics -- in how we would approach those businesses.

I think what you're saying there, there needs to be a business there and not a trade?

Sure. I mean, I think that it's going to be interesting at some point, what the world ultimately looks like absent so much influence from central bank policy, I can see a time when regulators start to re-think. And I think they're doing it on the edges right now, to try and re-engage. They've encouraged the banks to get out of so many businesses, yet they penalize those opportunistic entities that are trying to fill the gap.

So, I think there's still a lot of murkiness with respect to how these things ultimately will play out. And we probably won't get a good clear picture until you get market-base pricing, and a lot of the legal overhang ultimately dissipates.

Steve, it's Kevin. I would like to take out my wedge and chip in here with one comment. I mean, it cuts both ways in this market, where 8 of the 10 hybrid or non-agency companies have greater than 50% of their books in agency assets, right? So in a world of -- we're all looking for returns in similar markets, allocation procedures for every company, I think, is prudent, not just us.

I think everybody's searching for yield and opportunity. I think where we are differentiated is our size and our relative low leverage. So if we want to move on something, we have the lines drawn -- legal, accounting, everybody. It's very clear what we can do, when we can act and how we can do that. And I think it's going to be an issue not just for us -- less for us, but more for others that don't have our capital base and don't have our liquidity.

Your comments are really helpful and appreciated. It will be interesting to watch how the opportunities unfold. My personal view is that a more flexible, diversified Annaly is going to be seen as very attractive by the investment community. So thank you.

Thank you. We think so too, Steve. Thank you very much for your question.

This concludes our question-and-answer session. I would like to turn the conference back over to Wellington Denahan, Chairman and Chief Executive Officer, for any closing remarks.

I just want to thank my team for doing a tremendous job again in challenging markets. They really have exceeded my expectations, and I am very proud of all of them. I also want to thank the shareholders for taking the time to listen to our call. If there's any questions you need to ask, please feel free to give us a call. And we will speak to you again next quarter.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.