Annaly Capital Management Inc (NLY) 2016 Q3 法說會逐字稿

Good morning, and welcome to the Annaly Capital Management third-quarter 2016 conference call.

(Operator Instructions)

Please note this event is being recorded.

I would now like to turn the conference over to Jessica LaScala from Investor Relations. Please go ahead.

Good morning, and welcome to the third-quarter 2016 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 filings.

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.

During this call we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our earnings release.

Please also note that this event is being recorded.

Participants on this morning's call include Kevin Keyes, Chief Executive Officer and President; David Finkelstein, Chief Investment Officer, Agency and RMBS; Michael Quinn and Jeffrey Thompson - Co-Heads of Annaly Commercial Real Estate Group; Glenn Votek, Chief Financial Officer; and Tim Coffey, Chief Credit Officer.

I'll now turn the conference over to Kevin Keyes.

Good morning, everyone. Following the third quarter in which Central Bank bond purchases reached their fastest pace since 2008, the global bond market is headed in one direction to start the fourth quarter.

In keeping with October's reputation for difficult markets, yields sold off dramatically, leading to the worst month of losses since the 2013 taper tantrum. The 10-year US treasury is up 25 basis points with nearly half of the move realized in the past 10 days. Yet, global bonds are still outperforming, headed for their best year of returns since 2009.

The push and pull in the global markets and relative asset valuations rolls on, while the mountainous debate of its causes and effects continues: structural versus cyclical, growth versus inflation, and the Central Bank's daily appetite for continued stimulus versus a potential prescription for a newly found diet plan.

Amidst this market's turmoil and lack of fundamental direction, in our minds, the third and start of the fourth quarter have not been surprising at all. These times represent the type of challenging environment we've been preparing for, and as I've said many times, these are the types of markets that, over time, separate the haves from the have-nots in every industry.

In the US, the market has been confused, or at best kept guessing, about the cost of money, the path of interest rates, and the technical effects of the debate I just described. For yield oriented strategies in the equity market, this lack of clarity has impacted valuations and conviction in various income producing sectors.

As we speak to current and potential investors, we believe it is prudent to keep reminding the market that the two of the most revealing indicators of performance for any yield manufacturing strategy are stability in earnings and durability of book value. Over the past 2.5 years, Annaly's diversified platform has churned out core earnings per share between $0.29 and $0.34 every quarter, representing a range of only 17%, which is over 80% more stable than the rest of the Agency mortgage REIT industry combined.

More importantly, in my mind, as illustrated in our most recent investor presentation, when compared to other are widely owned strategies in the equity market, Annaly's range of earnings proves more stable than not just all of the other mortgage REIT sectors, but also we've produced much more consistent earnings than the banking, utilities, asset management, equity REIT and MLP industries. However, even with this unmatched stability of core earnings, Annaly remains at a significant book value discount in yield premiums to these other indices.

In addition to the stability and relative yield of our core earnings stream, we have also begun to stress to investors more and more the durability of our book value, especially in this current environment. To put it candidly, the market continues to overestimate the relative impact of rising rates on our portfolio. Our portfolio which is constructed and managed much differently today and with different expertise than in the years prior to the taper tantrum.

As a direct result of our comprehensive diversification efforts, which now include 25 investment options across four businesses, our more sophisticated hedging strategies and enhanced liquidity, Annaly's interest rate sensitivity has been significantly reduced. Our current book value is over 50% less sensitive to a larger sell-off in rates than a portfolio similar to Annaly's in 2012 made up of 100% Agency assets.

While our diversification strategy and asset management expertise has provided stable earnings in core and durable book value over time, Annaly's platform is designed to capitalize on numerous market opportunities, resulting from today's regulatory environment. The impact of regulation is now more obvious than ever in all of four of our businesses, our position to fill the emerging void in the investment and financing markets caused by the new regulatory play-book.

In Residential Credit, a business we brought our balance sheet about two years ago, the GSEs continue to shrink their portfolios as mandated by the government. Given punitive capital charges as a result of regulation, banks have only bought approximately 5% of the $37 billion issued by Fannie Mae and Freddie Mac in the form of risk-sharing transactions since 2013. During this time frame, our Residential Credit portfolio has grown to $2.4 billion in assets and is comprised of five different sectors producing lower levered, floating rate cash flows, which are inversely correlated to our Agency interest rate strategies.

Similarly, in the commercial real estate industry, lending has retrenched by over 25% since the crisis, while these same banks have increased their holdings of more liquid cash and securities by almost 70%. In addition, risk retention rules require the CMBS sponsors to retain 5% of its securitization for five years takes effect at the end of this year, effectively driving origination opportunities our way.

Given these market realities, we have also modestly grown our commercial portfolio initially launched in 2009 and now on balance sheet since 2013. Although we've assumed a more conservative stance throughout most of this year in the sector, due to heightened valuations and relatively lower returns as compared to our other strategies, the Annaly Commercial Real Estate group remains a complementary investment strategy positioned to serve as a non-conflicted, long-term financing partner for private equity firms and other real estate sponsors.

Lastly, our middle market lending business, which has grown to over $700 million in assets, has benefited most recently from Basel III and Dodd-Frank Regulation. Which have been a catalyst to shift the underwriting of corporate credit to firms like Annaly, which specialize in the direct origination of senior secured second-lien and unitranche investments. Since the launch of our middle market strategy in late 2009, bank and market share in the industry has decreased over 50% to only 14% of total underwriting volume last year, a dramatic shift which has led to an increase of supply of potential transactions for our team to evaluate and invested in.

Finally, as we enter the final months of 2016 and prepare to start another year, we reiterate that it is our job to manufacture dependable yield for our investors without taking an inordinate amount of risk. We will continue to balance of the liquidity of our expanded Agency strategies with our lower levered floating rate credit alternatives. We will not just diversify because we can.

Our people are not incentivized nor paid for growth in any of our four asset classes. In fact, all of our senior employees, representing over 40% of the Firm, are participating in a program to purchase stock over the next five years, not sell it.

It is important to stress what Annaly is not. We are not a mono-line business nor limited dual strategy, constrained to making investments in one or two asset classes only while being dependent on a single type of financing. Rather, our diversified and complementary investment and financing options create healthy, internal competition for choosing the best risk-adjusted return alternative.

In these markets, over influenced by Central Bank policy and challenged with structural reforms, Annaly is generating a premium yield with downside protection without taking the type of incremental risks other less liquid, less diversified models, are being forced to take.

Now I will turn the call over to David Finkelstein, who will discuss our Agency and Residential credit results and outlook.

Thank you, Kevin.

After initially rallying to start off the third-quarter, interest rates ultimately trended higher led by the front end of the yield curve, and mortgage assets across the spectrum performed well. The continued attractiveness of Agency MBS yields relative to global alternatives, led to spread tightening in the sector, despite robust issuance, as both banks and overseas investors drove demand. Residential credit benefited from the continued positive trends in housing fundamentals, favorable technicals, as well as attractive valuations heading into the third quarter.

With respect to portfolio performance, both Agency and Residential credit contributed to our book value appreciation. Higher prepayments did have a modest impact on our core earnings. This was largely offset by a lower average repo rate for the quarter as well as reduced swap expense as a consequence of the spike in LIBOR leading up to the implementation of money market reform. As a result, core earnings were in line with the second quarter and in the context of our current run rate.

Turning to our portfolio activity, the most notable shift occurred in our Agency position, as we onboarded the roughly $11 billion of Hatteras ARMs. The acquisition also increased our TBA position, modestly added to our Residential Credit holdings, as well as introduced mortgage servicing rights to our portfolio.

Prepayments were obviously elevated on the quarter and most notably in the ARMs sector. We fully expected this at the outset of the Hatteras acquisition, and we certainly priced this into the equation. At this point, we like the added cash flow diversification ARMs bring to our Agency position. We are now through the summer seasonal in prepayments, and the recent increase in mortgage rates, as well as the steeper yield curve, has and should continue to lead the strong performance of the ARMs sector.

Moving to the MSR portfolio, we grew our holdings from $315 million at initial acquisition to nearly $500 million in market value over the course of the quarter. MSRs are one of two assets that have cheapened this year as various regulatory reforms have significantly impacted bank participation. Similar to other asset classes being affected by regulations as Kevin discussed, bank holdings of MSRs have gone from well over 90% of the sector, pre crisis, to less than 70% in the current environment, in spite of unlevered yields in the double digits as well as providing a good hedge to higher longer-term interest rates.

As we have discussed in the past, our approach to regulation across our businesses has been to identify assets where capital standards or liquidity requirements make it less attractive for banks to hold, and as a result, offers superior risk-adjusted return.

Financing of Agency MBS was favorable this past quarter, given the decoupling of repo rates from LIBOR, as our overall financing rate declined for the quarter even as three-month LIBOR increased by approximately 20 basis points. The advantageous relationship between a repo and LIBOR continues into the fourth quarter, though it's too early to tell how persistent this will prove longer-term.

Regarding our hedges, we took on Hatteras' short euro dollar contracts, which helped cushion the flattening of the yield curve in the third quarter. We maintained a slight steeping bias in our portfolio, which has benefited us into the fourth quarter, as we have all witnessed the slope of the yield curve steepen it back to pre-Brexit levels.

Lastly on the financing side, we have undertaken new initiatives with our broker dealer to further eliminate some of the frictions associated with bilateral repo with the banking community and face cash lenders directly.

With respect to Residential Credit, our portfolio increased to roughly $2.4 billion this past quarter, the majority of which was attributable to the Hatteras acquisition. We also proactively grew our legacy RMBS position, given favorable opportunities in that sector. Another point to note with respect to our Residential Credit composition is that we are now invested in whole loans through the Hatteras portfolio. We have added to that position in the fourth quarter, and we expect it to grow modestly going forward, dependent upon market opportunities.

Again, to continue our theme of positioning around regulatory opportunities, the scope of this initiative will be focused on purchasing loans that o not quite meet the rigid underwriting requirements demanded by commercial banks sold in their portfolios yet are characterized by sound borrower credit fundamentals. Furthermore, we expect to finance these positions through our FHLB membership, which creates a unique advantage for us.

Regarding our views going forward, while we do expect the Fed to raise rates in December, recent FOMC guidance indicates the subsequent pace of tightening will likely be modest, which should help keep interest rate volatility contained and also support housing fundamentals. We expect this dynamic to make for a perfectly reasonable investing environment for both the Agency MBS as well as mortgage credit. Furthermore, the recent steepening of the yield curve has been a welcome development for our portfolio and improves the business model over the near term.

While we do have many risk events to get through yet this year, we like our positioning in the current environment. Our strong liquidity and broad menu of investing and funding options provides us with ample opportunities to deploy and optimize capital depending on how markets evolve throughout the remainder of the year and into 2017.

With that I will hand it over to Mike Quinn to discuss the commercial business.

Great. Thanks, David. The fundamentals of the US commercial real estate market remain stable. While there is evidence of demand slowing in most property types, growth is still positive and supply is manageable.

The publicly traded capital markets were mixed in the third quarter. After hitting an all-time high in early August, equity REIT share prices have declined 15%. Directionally, the market retreat has been in line with an increasing 10-year US treasury yield.

In the debt market, CMBS spread ended the third quarter largely unchanged as new supply remains limited. Transaction volume statistics are also mixed. Acquisition volume recovered to $115 billion in the quarter, representing only a 2% decline on a year-over-year basis. Year-to-date volume is down about 10%.

Large opportunistic and value-add capital sources have become highly selective, but foreign capital sources continue to pour capital into US real estate seeking safety and some positive yield.

CMBS volume also rebounded from second-quarter lows; $19 billion of issuance in the third quarter represents a 17% decline from the same period last year, while year-to-date issuance is still down about 35%.

With risk retention rules to take effect at the end of the year, the CMBS market remained somewhat dislocated. High-quality issuers, with strong track records and large balance sheets, appear to be committed to the market by introducing new risk retention compliant deals, but smaller issuers have yet to adjust to the changes.

Turning to valuation, property pricing in the US is slightly higher than last year, up 3% to 5%. Cash flow growth is driving value as cap rate compression seems to be over. Commercial property price indices remain at least 20% higher than the prior peak.

While operating fundamentals have supported this appreciation over the last several years, new transactions require a very high degree of scrutiny. It seems clear that we are at the point in the cycle that mistakes like poor investment decisions or weak execution at the asset level will not be covered up by general price appreciation.

As of September, our commercial real estate portfolio stood at $2.4 billion. Net of leverage, our net economic capital invested in commercial real estate was approximately $1.45 billion and is producing a leveraged yield of 8.6%, and excluding one senior loan held for sale, a leveraged yield of 9.3%. We remain very comfortable with the quality of our loan portfolio as borrowers continue to achieve business plans and look to sell or refinance our loans.

In terms of new business, we are seeing more opportunities as regulated entities scale back new lending, but we are cautious and continue to be highly selective. While the fundamentals remain healthy and the debt markets are not fueling property price growth, like in the last cycle. Slowing demand for space and rising interest rates, may limit any future price gains.

We will continue to focus on lending to high-quality borrowers with cash equity and new deals. Our priority remains the preservation of capital while providing our shareholders with longer-term, primarily floating rate cash flows, as a strategic complement to our Agency portfolio.

With that, I'd like to turn it over to Glenn to discuss our financial results.

Thanks, Mike, and good morning. I'll provide a brief overview of the quarter's financial highlights before opening the call up for your questions.

Beginning with our GAAP results, we reported net income of $731 million, or $0.70 per common share, versus the second-quarter loss of $278 million or $0.32 a share. Major factors driving the quarterly GAAP results included sequential improvements of close to $780 million in the derivatives portfolio, $84 million in fair value investments improvement, and an $80 million increase in NII, with the former Hatteras portfolio contributing close to half of the NII increase.

We also recognized a $73 million bargain purchase gain related to the Hatteras acquisition, as we acquired the company at a discount to book value. We incurred acquisition related transaction costs in the quarter of about $47 million, which accounted for the sequential increase in our G&A expense. Our core earnings were $313 million, or $0.29 a share, which compares to $282 million, or $0.29 a share, to prior quarter. Core ROEs were up to 10.1 % versus 9.7%.

Some key factors contributing to the quarterly core results were higher coupon income of about $50 million, which was partially offset by $30 million of additional premium amortization exclusive of TAA. Both of which largely relate to the higher asset balances following the Hatteras transaction.

Our projected CPR at the end of the period was just over 14%. That compares to 13% the prior quarter. The increase in estimated CPR is largely a function of the change in portfolio mix given the increase in the ARMs portfolio.

Our Q3 reported premium amortization expense was $213 million versus $265 million for Q2, with just $4 million of PAA compared to $86 million the prior quarter. Our dollar roll income was up about $11 million. While our average repo rate declined in the quarter by about 3 basis point, higher balances resulted in a $21 million increase in interest expense. This was partially offset by lower swaps expense as high receive rates reduced our average net pay rate of by about 17 basis points. Other income was over $29 million and was largely comprised of MSR related net servicing income, and this amount was also partially offset by about $22 million of MSR amortization.

Finally, turning to the balance sheet, the investment portfolio was up about $10 billion largely, again, driven by the Hatteras acquisition. Our book value increased almost 3% in the quarter to $11.83 per share. Our leverage metrics ended the quarter largely unchanged.

With that, Katherine, we're ready to open up for questions.

(Operator Instructions)

Joel Houck, Wells Fargo.

Good morning, everyone. My question has to do with the -- how you look at the relative risk reward trade-off between commercial real estate and middle market business. Obviously middle market business is smaller and growing but those seem to have similar kind of risk return characteristics but that's at a high level. I'm kind of curious as to how you guys think about it and will we see the middle market lending business kind of catch-up in terms of capital allocated relative to the commercial real estate business?

Hi, Joel, it's Kevin. I'll give you the big picture and then we have -- the experts can weigh in here. These businesses you mentioned relative growth. They've both grown nicely. And we've been doing both businesses for seven years. They grown nicely, but we been patient with the growth so in terms of going forward, that'll just continue.

It's really -- you've heard us talk about it before it's a relative value discussion first. Risk weighted returns across not just those two businesses but frankly how they line up against Residential Credit and Agency. But if you were to compare those two businesses, one of the things the market hasn't really picked up on which is the balance of the portfolios and the strategy behind them. The middle market lending portfolio now represents really a countercyclical stance whereby the commercial real estate business, by definition, is pro cyclical.

So inherently there's a hedge in these cash flows, not to mention their path is levered and their floating rate predominantly and more durable in terms of their duration. But basically we measure the risks and returns at the top line, but we also look at the relative investments and the type of investments that the middle market lending business is taking and those cash flows how they may respond or react in different economic scenarios.

So it's a long-winded way to say it's not just any one answer as you know. It's relative risk [weighting]. It's really liquidity. It's really the liquidity of those strategies -- the illiquidity relative to liquidity of the Agency strategy. But right now what we see in the market, really our comments on regulation, it is clear and present that the opportunity for us is we have a big future to take up the slack that the banks can no longer sustainably fill in terms of financing real estate in middle America.

So long story short, they're both comparable in returns and maybe I'll ask Mike to talk about it first in the commercial real estate business. They're comparable in returns but we really measure it as to how it really supports the portfolio overall in terms of the cash flows.

Yes, and, this is Mike, so I would say in the commercial business, we've been flat to slightly down over the course of the year and I think it has -- there is a number of factors that go into it. I do think the market in general in terms of new acquisitions has been quite a bit slower and we've seen that from the people that we do business with, So not a lot of new deals to bid on.

There has been a significant amount of refinancing in the marketplace and frankly there are others out there that have been more aggressive than us in pricing those deals. But if you step back and take a look at it, as Kevin said, the real estate business is highly cyclical. I do feel like we are at an inflection point in the business where growth from the demand side of things is starting to slow, it's still positive but starting to slow. And I'm not quite sure that is completely priced into the marketplace today.

And so that forces us to be very cautious when we underwrite new transactions. And the last thing I would say is our businesses lumpy. You know we're looking at larger transactions now and they'll be quarters that we won't do any business. And so we're not focused on keeping a volume up for the sake of keeping that volume up.

And I think that's what you saw in the third quarter. In the fourth quarter we've already committed to a couple of transactions and have another deal in closing. So we're not backing away from the market completely but we are being very cautious.

This is Tim Coffey. I think what I would add as it relates to the MML space is that if -- when you take a look at each of the individual investments that comprise the portfolio, they're are quite defensive in posture. So to Kevin's point about contra cyclicality, the investments that we make are made with that being the prevailing theme throughout the portfolio. And virtually everything that we've done today is [this] half of the capital structure. So counter to some of the names that you cover in the BBC space, we operate typically the inverse as to most of the names that apply in your universe within the BBC coverage.

Great.

To put a cherry on top of the answer, nobody's motivated for volume here.

Right.

Right, so no one is paid to grow their books so it's all relative value and as I've said, how the cash flows complement the Agency business.

Again, thank you for your answers.

Thanks, Joel.

Brock Vandervliet, Nomura.

Good morning, thanks very much for taking the question. Just following up on that topic and you mentioned, Kevin, in your initial remarks, the dislocation and uncertainty around the CMBS market with respect to risk retention changing. It seems to spell greater opportunity. How do you think you play there? Do you play as a lender? Or might you play as a partner with a sponsor holding the subordinate tranche?

The basic answer is regulation across the Board, permanent capital vehicles like ours are set up to take advantage of it. In terms of how this risk retention, new line in the sand shakes out, I think we are more focused on partnering with real estate owners and really single asset or multi-asset type deals. And really, providing the financing that the banks no longer, can no longer provide so it's -- ours is more of a transaction-based business.

I think when I mentioned in my comments about non-conflicted financer, financier, here, is private equity; we are a nice partner for them. We're more like Switzerland if private equity firm A, B, or C wants to take a position in a building in the equity box, they'd much rather have us in room as a lender than one of their own competitors. So my comments are really related to the core business we have here which is lending to real estate, not necessarily the CMBS flow market.

Yes, and this is Mike. I would just add that, we're not going to be leaders in determining what the ultimate structures look like. We're going to react to see what the market is going to do to pricing and it's my view right now that, given all this regulation, it's going to be more expensive for borrowers in the future than it is today and I think that benefits us. So that's a very simplistic view. In terms of a very complex thing that's going on right now.

But I don't think it benefits us to be a leader in this space. I don't think there's any reason to be out in front of it. And my view is that there'll be more volume in the future at better pricing.

And competitively we don't like to talk too much about it.

Okay. All right. Fair enough. And then a quick one for David. Clearly, your Agency book dynamics have changed materially with the Hatteras ARM portfolio. How comfortable are you with that? The weighting that you currently have in ARMs it's obviously much bigger than the new origination market share in ARMs. Steeper yield curves helped but how are you feeling about that weighting?

Thanks, Brock. That's a good point you bring up about new origination. One of the tailwinds for the ARMs sector are the technicals associated with issuance and the fact that there's not a lot of supply expected in the sector. So from that standpoint we're comfortable with the positioning in terms of pricing and support from a technical standpoint.

Fundamentally, we obviously have seen significant amount of steepening in the curve over the recent past. We've gone from a low 75 basis points between (inaudible) [intense] to now a spot on 100 which is supportive of that sector for obvious reasons. One of the things we did do as we onboarded Hatteras was we reduced modestly our 15 year position to accommodate the onboarding of those shorter cash flows.

And as it stands currently, we think ARMs look cheap to 15 years so as a substitute for those front cash flows, we're perfectly comfortable maintaining them and we like the profile going forward. As I've said, we're through the summer seasonals. We've seen a lot of fast speeds in that portfolio and we feel like it's going to perform better and all of the factors that I just mentioned are supportive of that going forward, not just today's price.

Great. Thank you for taking my questions.

Thanks, Brock.

Douglas Harter, Credit Suisse.

Kevin, when you take a look at the portfolio, where do you think you are in terms of diversification? If you were to look forward a year from now, is the Agency allocation smaller and the other pieces bigger? I guess how do you think about that?

That's a fundamental question we've been facing ever since we put all these strategies on balance sheet, one balance sheet. I would say a couple of things. First, we ended up where we are right now is about where we wanted to be because we've reached to my comments on book value, durability, and earnings stability, the credit roughly $3 billion of equity capital in the credit businesses and frankly under levered right now. So we put some leverage on but we still have capacity for more return if we choose to finance it more fully.

We're at this balance right now at about 25%-ish that we really think is the fulcrum to providing that incremental earnings stability to keep cranking through this volatility in the rates market. So, we are where we are as a goal to really optimize the current return and relative risk of the portfolio.

Going forward, we don't have to add a body or a computer to get the 50% credit. But we are only going to swing to more of the credit side of the business, again, back to relative value, given our incentives here, only aligned to producing a durable return. So -- and a liquid return. I'll let David comment as well.

I think the other thing we remind people of is in this market where credit is pretty tight, pretty expensive and there are more risks today than there have been when we have been growing the portfolio, it really comes down to, in my mind, especially at this time of the year and this type of market is liquidity, and if we are making a credit that in terms of a single asset or a single type of financing opportunity, that credit return has to exhibit a pretty healthy premium to the Agency return.

Liquidity right now we've never been as liquid -- we haven't been this liquid in, I don't know, six to eight quarters, because of what's going on in the market. So if we're going to make a credit investment or a credit financing, it has to represent more of a premium in my mind today than it has when we been growing it. If that gives you a sense for how we calibrate things.

Doug, this is David. I'll just add on to Kevin's comments, I think if you asked us this, if we talked about this a quarter or so ago, we would have thought credit broadly looked more attractive, but obviously we seen a fair amount of tightening in the sector as well as agencies but credits done quite well. And currently its price per carry not so much for spread tightening and appreciation to add to Kevin's comments and the Agency market has tightened, it's by no means cheap at all.

There are favorable tailwinds for both sectors, Agency MBS as supported by strong demand, as I said from both domestic investors as well as overseas, given the global yield landscape. Prepayments are expected to be better going forward with slightly higher rates. We have a more accommodative [bed] than we had a number of months ago with -- as evidenced by recent language both at the [FOC] statement level as well as the dot plots and even in recent speeches.

And we do feel like they do have a strong desire to limit volatility over the coming quarters which is very supportive for the Agency sector. So, while spreads are tighter, than they were in agencies last quarter, we feel like they're justified and we're comfortable investing.

Another point to note is regarding leverage, with the Hatteras acquisition, we brought leverage up to 6.7 times, we're currently at 6.1 times. That reduction in leverage was largely a function of the performance of the portfolio, but we will wait to see what the next couple of months brings about with respect to all of these risk events but if this curve looks like it's going to stay reasonably well sloped and the environment looks good, we won't be hesitant to add to the Agency portfolio. But we're certainly cautious here over the next couple of months.

And on the credit side, housing fundamentals certainly looks strong, HPA is up 5%, delinquencies are the lowest point since 2006, inventories are low. There's $2 million in existing home sales in inventory, versus $4 million in 2007 and the consumer is strong. So the fundamentals there look perfectly reasonable and as Mike mentioned on the commercial side, at least with respect to what we are engaged in, in that sector, we like the fundamentals.

And so the market is priced appropriately here. Spread tightening is warranted, but we are cautious and we'll make investments in a competitive fashion looking at all four businesses and whichever pocket offers the best return. We're at a point in the portfolio in terms of diversification where there is real competition and we can select the best assets.

Just following up on some of the things you said, on the one hand you said the Fed is looking to dampen volatility but you guys are holding more liquidity for sort of fears of volatility. How do you square those comments?

It's about, Doug, it's about the near-term. If you look at what we have coming over the next couple of months and again, our leverage was brought down by the market. But if you look at over the near-term, obviously the election presents a huge binary event possibly for the market and we have a lot of global central bank policies at inflection points with the ECB, whether or not -- or how they're going to extended their QE, what's going on with Japan and their monetary policy which has a lot of observers a little bit confused as to what the actual strategy is.

And then the Fed, in terms of -- we expect the rate hike in December and that's largely priced in the market but there's still a little bit of information that is yet to come out through that event. And if you think back to last year, when the Fed raised rates in December, there was a fair amount of volatility as a consequence of that and coincident with that, and we expect over the near-term there to be some shake-ups in the market that we think will create opportunities as I had mentioned in my initial comments.

Doug, I would just say what happened in the last year, beginning of this year, I wouldn't mind seeing it happen again. And in terms of our ability to move opportunistically when things widen out or other companies are hurting.

Got it. That makes sense. Thank you for the clarification.

Thank you.

Rick Shane, JPMorgan.

Hey, guys. Thanks again for taking my questions this morning. When we look at what's happened with Annaly over the last five years, you've basically gone from what I would describe as a relative return vehicle concentrated in a single asset class, to an absolute return vehicle across, as you guys point out, a very diverse set of investment choices.

I'm curious now, we're looking at it, and again, there are lots of different ways to calculate it for you, but we're probably looking at ROEs on a core basis right now in the high single digits. I'm curious, in the current environment, where you think that can go given the strategy? And, Kevin, objectively, what you think the long term goal is there, especially as you have been able to stabilize book value?

It's a fundamental question, Rick. And I think it's easy to go on and on and on trying to answer that. Relative return of versus absolute return; I'd say we're a hybrid of that. We're looking for absolute returns that are risk-adjusted but are relative to our other strategies.

The biggest difference between us five years ago to today, I kind of referred to it in my comments. This platform was designed years ago to really take advantage of what wasn't happening five years ago after the crisis. It needed -- the market needed to come to us and it's come to us in terms of regulation. And it's come to us in terms of competitors that, frankly, we haven't built out what we've built out.

I actually looked back five years ago until today and what we really -- I view us as a yield manufacturer and not a mortgage REIT. And you and I have talked about that, just given the liquidity of our currency and the liquidity of our balance sheet. Our unencumbered assets are greater than the next guy's market capital alone. So five years ago, until today, we printed more dividends, about $8 billion of dividends, that's more than Simon Property or Public Storage or MetLife, Goldman Sachs, and American Express.

So, I view us as our job is to generate cash flow for our shareholders and let them sleep that night. Where we're set of right, is we're an asset manager for the future. I don't need to brand a new website or anything but I think we are set up with optionality where it's very difficult to take risk in one single asset type month after month after month. And a number of our competitors are doing exactly that. And they are financed 30 days as well, every 30 days.

So we want to term out our financing as we add it on and I think as we're doing that, we're adding to the more durable cash flows of the absolute returns of each business. But when you put it all together, high single digits in this environment is pretty good and I think there's incremental growth to that as we've showed with this Hatteras acquisition. So it's capital appreciation in addition to this -- these cash flows that I think can equate to double-digit returns and that's what we've done especially since this new team's been in play for the last three years.

Sorry for the long-winded answer but that was like a softball question. I had to hit it.

Look, it was definitely an open ended question and I historically think your old business, or your historical business was probably a low-teen [versus] a low double-digit ROE business but with a huge standard deviation around that. And I think, what objectively you're saying is, perhaps it's a tad lower than that but you've really taken out that standard deviation, that volatility.

Yes. And I think less leverage, longer-term cash flows complementing the liquidity of the Agency business, which is essentially our cash flow, $1 billion cash flow a month. There's not many models out there that are generating that to take advantage of volatility.

Got it. Thank you, guys.

Bose George, KBW.

Good morning. I actually just wanted to go back to the earlier discussion on commercial. It wasn't clear. Are you guys potentially interested in the BPs market that develops after resharing?

No. I think is the simple answer. There is a lot of smart guys at the investment banks, trying to figure out how to make money, continue to make money in that business. And my view is that whatever option they come up with, whether it's the vertical participation or the horizontal participation in new deals, either one of two things is going to happen. There's going to be less capital available for new deals or the price is going to be higher. And in my view, both of those things benefit Annaly, right?

And I think that's our simple approach to it right now. And I don't see us being a leader. If there are market opportunities in the future, we'll obviously evaluate those but we're not going to be a leader in that space.

Okay. That makes sense. And then, actually, switching -- the commentary earlier in the call suggested the MSR environment looks favorable. Can you discuss opportunities there, whether we could see you increase allocation?

Yes, hi, Bose, this is David. In terms of that portfolio and how we acquire these assets, as you are probably aware, we do acquire them on a flow basis through Fangoria Loan servicing. And that's been a steady amount of acquisitions since the acquisition of Hatteras.

As we onboarded not just the Hatteras assets but also this MSR business, we did do a lot to both improve the credit quality of the asset as well as the prepayment quality and we've been very happy with how that's developed over time. In terms of going forward in allocation to that sector, it's important to note that for Hatteras, this was, as they stated, a 20% of capital business, and it's for others that are still in the space, it's in the context of that as well. We do not believe that this is anywhere close to a 20% of capital type business. It is a volatile asset. It does on offer very attractive returns an obvious hedge benefits.

But for us it's supplements income and it complements our hedges and right now we're at about 4% of capital. It could very likely grow and we would expect it to grow but very modestly. And we have fortunately, we have some strong expertise in both the prepayment sector as well as an individual who previously managed an MSR portfolio before and we're very happy with the development of that portfolio and that business. So we're very comfortable with the asset but we don't see it growing astronomically or anywhere in the context of what some others think as a percentage of capital it could be.

Okay. Great. That's helpful. Thank you.

You bet.

This concludes our question-and-answer session. I would like to turn the conference back to Kevin Keyes, CEO, for closing remarks.

Thank you, everyone, for your interest and we will talk to you all soon. Thanks.

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