Annaly Capital Management Inc (NLY) 2018 Q1 法說會逐字稿

Good day, everyone, and welcome to the Q1 2018 Annaly Capital Management Earnings Conference Call. (Operator Instructions) And please note that today's event is being recorded.

I would now like to turn the conference over to Jessica Scala. Please go ahead.

Good morning, and welcome to the First Quarter 2018 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. These risks and uncertainties include, but are not limited to, the ability of the parties to consummate the proposed transaction on a timely basis, or at all, and the satisfaction of the conditions precedent to consummation of the proposed transaction. 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 the 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.

Also note that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase any shares nor is it a substitute for the exchange offer materials that Annaly and its merger subsidiary have filed with the SEC. Annaly and its merger subsidiary will file a tender offer statement on Schedule TO. Annaly will file a registration statement on Form S-4, and MTGE will file a Solicitation/Recommendation Statement on Schedule 14D-9 with the SEC with respect to the exchange offer.

The exchange offer materials, including an Offer to Exchange a related Letter of Transmittal and certain other exchange offer documents, and the Solicitation/Recommendation Statement will contain important information. MTGE's shareholders are urged to read these documents carefully when they become available, because they will contain important information that holders of MTGE securities should consider before making any decision regarding exchanging their security. The Offer to Exchange, the related Letter of Transmittal and certain other exchange offer documents as well as the Solicitation/Recommendation Statement will be made available to all holders of MTGE common stock at no expense to them. The exchange offer materials and the Solicitation/Recommendation Statement will be made available for free at the SEC's website, at www.sec.gov.

Participants on this morning's call include Kevin Keyes, Chairman, Chief Executive Officer and President; David Finkelstein, Chief Investment Officer; Glenn Votek, Chief Financial Officer; Tim Coffey, Chief Credit Officer; Timothy Gallagher, Head of Commercial Real Estate; and Michael Quinn, Head of Commercial Real Estate Investments.

Please note this event is being recorded.

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

Thanks, Jessica. Good morning, everyone, and welcome to the call. I would like to begin with a brief summary of Annaly's acquisition of MTGE Investment Corp., which we jointly announced last evening.

First, I'd like to thank everyone who has been involved in this transaction, my team, our advisers and the Annaly and MTGE Boards of Directors. These deals, obviously, take a lot of hard work, and I personally very much appreciate the collaboration and the effort needed to successfully complete this deal.

The strategic nature of this transaction is a unique combination, adding to our franchise value and is in the near- and long-term best interest of our shareholders. There are numerous reasons which all shareholders benefit from this transaction. To summarize, I will review my top 5: first, the asset and business diversification it offers; second, the deal is accretive, and the structure provides further upside; third, the strategic synergies and cost savings to be realized; fourth, the increased scale and liquidity of the combined company; and number five, the inherent value creation that consolidation brings to both Annaly and the mortgage REIT sector overall.

On the first point, through this combination, Annaly's evolution continues as we further expand our ability to invest in multiple areas across all 4 of our business segments. As it relates to MTGE's portfolio, the assets are highly complementary and add meaningfully to our existing Agency and non-Agency portfolios. Additionally, MTGE's countercyclical health care real estate assets will increase the number of our available investment classes to 37, approximately 3 times as many as when our diversification strategy was initiated. The health care real estate properties also provide stable, long-term, triple net lease cash flows to our company. Pro forma for the transaction, Annaly will have 27% of its capital allocated to interest rate-insulating, lower-levered floating rate credit assets.

Secondly, Annaly's shareholders can expect this deal to be accretive to core earnings, neutral to book value, deliver double-digit cash-on-cash returns while not materially impacting Annaly's current leverage and liquidity profile. The 50% cash and 50% stock transaction structure provides MTGE's shareholders the ability to capture an immediate premium to their existing ownership positions, while the equity component of the transaction enables them to share in the potential upside of this strategic combination.

Reason number three: Shareholders would benefit from significant and tangible cost efficiencies generated by Annaly's scalable operating model, achieved both through a base management fee that is 30% lower than MTGE shareholders' existing fee and the elimination of redundant G&A expenses once the merger is completed.

The fourth reason is in regard to scale and liquidity. This transaction grows our pro forma capital base to nearly $14.5 billion and increases our market capitalization to 25x the median mortgage REIT. Now with over $7.7 billion of unencumbered assets, along with our diversified financing sources, our internal and external growth strategies are fueled with unmatched liquidity to maintain our ability to be opportunistic across our interest rate and credit businesses.

And finally, this acquisition further establishes Annaly as a disciplined market-leading consolidator. The deal represents Annaly's third transformative acquisition over the past few years with a combined total value of $3.3 billion. This value equates to the total size of the 14 smallest mortgage REITs in the sector today. So, yes, the industry still remains extremely fragmented.

Our leadership and belief in the need for consolidation is driven by our view that the mortgage REIT industry has similar ingredients of other industry sectors in certain cycles of the past and present. The cycle goes like this: first, there is obvious oversupply and unsustainable growth; followed by underperformance, usually coupled with volatility, which leads to the resultant required rationalization in order to have the chance for renewed outperformance.

A closely related sector, which has already undergone this transformation over a longer period of time through consolidation, is the equity REIT industry. In the late 1990s, the equity REIT sector expanded far and wide among real property asset classes as suffering banks, insurance companies and private spun -- funds spun out the real estate holdings into the more capital-efficient REIT structure. From 1997 until 2006, the sector flourished, with the total market cap of the equity REIT industry more than tripling, from $130 billion to $410 billion. An oversupply of IPOs and secondary issuance, coupled with the onset of a more challenging market environment, led to sudden and dramatic underperformance at the end of that decade. A broad consolidation wave ensued, with over $138 billion of M&A transactions taking place in 2006 and 2007 alone, removing approximately 33% of the total market cap of this sector at the time. Since then, the equity REIT industry has continued to mature, rationalize and healthily grow, with the average industry player now over 3x larger than the decade before. The higher-quality, larger-market leaders have especially outperformed, driving consistent industry growth that now amounts to a size of approximately $835 billion today.

The parallels in comparisons of the evolution of the equity REIT industry to our sector are obvious to me. Following the financial crisis and spurred by historically accommodative monetary policy, the mortgage REIT sector also ballooned in size, creating a growing supply-demand imbalance from the deluge of capital raised. From 2009 until the 2013 taper tantrum, over half of the 40 companies in the sector went public, and the market cap of the mortgage REIT sector nearly tripled, the same multiple of growth as the equity REIT sector but in half the time, with almost $40 billion of equity capital raised. The taper tantrum, coupled with the new Fed regime in early 2014, led to heightened market volatility and an abrupt pause in capital raising, leaving a large number of subscale monoline operators not able to reach critical mass to operate efficiently and whose performance then began to suffer.

In April of 2016, Annaly initiated the first wave of consolidation, with our $1.5 billion acquisition of Hatteras. In the wake of our transformative transaction and with an increased scrutiny on smaller, less-efficient companies, there have now been 15 M&A deals and strategic processes announced in the mortgage REIT sector over the past 2 years, for a total value of approximately $13 billion, nearly 25% of this sector's market cap.

Over the same period, while the number of mortgage REITs decreased by roughly 20% from this consolidation, performance evaluations recovered, and the average mortgage REIT market capitalization grew by over 50%.

Our ability to initiate industry-altering change has brought unique value to our shareholders and helped the industry recover in the past few years. We have been a catalyst to help drive industry evolution while outperforming the sector and increasing our market share demonstrably since the Hatteras transaction.

Now, in the past few months, as evaluations have reverted to below historical averages, and volatility has returned to the market, the second wave of mortgage REIT consolidation is now upon us. We first demonstrated our resolve of buying a company in the first quarter of 2016 when credit spreads were at their widest points since the crisis. And now again, amidst the renewed market volatility we witnessed in the first quarter of this year, we are acquiring MTGE. And as I've consistently stated, given the numerous remaining small competitors, the sector is still in need of further rationalization.

The mortgage REIT sector is not alone, though. We are seeing similar dynamics driving the need for consolidation in certain other industries in the broader marketplace. At $1.1 trillion, the first quarter of 2018 had M&A volume that was up 46% year-over-year, marking the most active first quarter ever. M&A activity is currently being driven by strategic buyers looking for diversification and complementary products or markets, given the more challenging and volatile investment environment. It's also interesting to note that over 2/3 of this record first quarter M&A volume is made up of the market's yield sectors, including real estate, natural resources, telecom and media, and financial institutions.

Recently published sell-side research has substantiated the argument that, over the long term, shareholders benefit from acquirers capitalizing on challenging market backdrops. Transactions announced in periods of high volatility have historically outperformed deals announced in less-volatile periods by a factor of 2x.

The ultimate winners in any fragmented industry in need of consolidation are those who have the platform, capital, liquidity, appropriate cost structure and expertise to be opportunistic. These key attributes allow Annaly to be more nimble when it comes to proactively seeking, evaluating and acting on these opportunities, and our shareholders continue to benefit from this discipline. We have established ourselves as an industry leader through our proven ability to take advantage of our unique internal and external growth strategies we have developed over time.

Now I'll turn it over to David to go through our investment activity in the first quarter and the additional benefits of the merger across our portfolio in more detail.

Thank you, Kevin. The first quarter saw a meaningful rise in interest rates, which was fueled by a positive domestic growth outlook, a Federal Reserve signaling for a continued steady pace of interest rate hikes and rising levels of public debt.

A further challenge to managing mortgage portfolios came from a widening in Agency MBS spreads, coincident with the rate sell-off and flattening of the yield curve. Meanwhile, credit spreads saw a modest widening, which occurred largely amid the increased volatility in equity markets, but spreads still remain at post-crisis tight levels.

Prior to discussing the onboarding of the MTGE portfolio, I do want to provide details on the first quarter, and I will begin with the Agency portfolio. Our efforts in Agency were largely focused on managing leverage and duration in light of interest rate and spread volatility throughout the quarter. We reduced our TBA position and significantly increased our interest rate hedges to a hedge ratio of 94%. Consequently, we ended the quarter with slightly lower economic leverage and a meaningfully reduced sensitivity to interest rate fluctuations. We achieved this despite the reduction in equity as well as the MBS duration extension associated with higher interest rates.

Specifically, with respect to our hedge composition, we substituted out of our Eurodollar futures and replaced those hedges with shorter-dated interest rate swaps, which explains our higher swap balance, and combined with the restrikes that we completed in the fourth quarter, lowered the overall pay rate on our swaps portfolio.

The spike in LIBOR this year has had a beneficial impact on our liabilities considering that repo rates attract overnight index swaps more closely than LIBOR. This has led to a receive rate on our swap portfolio well in excess of the financing rate on our repo portfolio.

LIBOR remains elevated, but the forwards do imply a normalization of the relationship between OIS and LIBOR as the year progresses. Nonetheless, we anticipate this dislocation to remain a tailwind over the very near term.

Turning to residential credit. The modest growth in our portfolio was concentrated in the whole loan sector as we funded over $180 million of loans in the first quarter. In February, we executed call rights on 2 of our legacy securitizations, giving us access to $218 million of seasoned, prime whole loans. With these loans, along with an additional $122 million of loans held on balance sheet, we securitized into a rated RMBS transaction. Through this securitization, we sold $279 million of AAAs at LIBOR plus 65 at a 90% advance rate, and Annaly attained -- retained approximately $60 million of credit investments in interest-only certificates with an expected unlevered yield of high single digits to low double digits.

While we had the option to finance these loans through our FHLB membership, we opted to capitalize on the strong securitization market, as evidenced by the robust new issued pipeline year-to-date. Executing our inaugural residential securitization establishes Annaly as an issuer in the space, broadens our financing options for the sector and provides us with additional flexibility in growing our whole loan portfolio.

Our middle market lending platform continues to be a growth engine for our credit businesses as we net added $140 million in assets last quarter, bringing the total portfolio to roughly $1.2 billion. While we maintained nearly 60% of the portfolio with first lien loans, we are seeing an increase in second lien opportunities that align with our strategy of selecting companies in highly defensive industries that have an ability to rapidly delever, which gives us second lien pricing at first lien-like leverage.

Our commercial real estate business grew very modestly this past quarter given our cautious stance on commercial credit and valuations. However, we did increase our CMBX holdings from $125 million to nearly $300 million as synthetic exposure remains inexpensive relative to cash CMBS as well as direct lending.

Now with respect to the MTGE portfolio, as Kevin discussed, the Agency and residential credit assets did well with our current strategy, and we expect a seamless onboarding given our ability to value the assets and integrate those positions into our existing portfolio.

Also of note, the additional Agency leverage through the cash component of the acquisition is an advantageous replacement for a portion of the roughly $7 billion Agency assets we reduced our portfolio by in the first quarter.

Regarding the health care portfolio, although these assets are unique to our current strategy, we do have specific expertise in the sector within both our commercial and middle market lending businesses that has been instrumental in evaluating those assets. And we are enthusiastic about the introduction of the health care portfolio into our current diversification strategy. Furthermore, the combined efforts of our commercial and MML platforms will be instrumental in optimizing the value of those assets.

Given the cash stock mix, we do expect overall leverage to increase very modestly, nearly 0.2 turns, but this is within our target range, and we are comfortable with the additional Agency exposure at current spread levels.

Now lastly, regarding our views going forward, we are considerate of the prospect of rates rising further driven by the same dynamics that led rates to rise in Q1, thus, we expect to make greater interest rate protection over the near term than we would typically operate at current rate levels. That said, several factors, including the relative attractiveness of U.S. yields and a fading storyline of synchronized global growth, suggest there to be a plausible ceiling on rates, which we will reach should the sell-off continue at a pace similar to Q1.

In credit, securitized products, both non-Agency and commercial, present somewhat of a challenge for levered investors given that asset spreads have tightened significantly more than the compression in financing spreads. Our broader diversification strategy, however, enables us to focus on areas where we have a distinct advantage, such as residential whole loans and middle-market lending, both of which we expect to grow over the near term. We are seeing more opportunities in the commercial space, but we will remain disciplined in light of asset valuations and focus on credit fundamentals as we seek value in that sector.

Now with that, I will hand it over to Glenn to discuss the financials.

Thank you, David. Beginning with our GAAP results. First quarter GAAP net income was $1.3 billion or $1.12 per share compared to approximately $750 million or $0.62 per share for Q4. Primary factors driving results was unrealized gains and interest rate swaps, which improved by approximately $490 million for the quarter.

Additionally, net interest income increased over $85 million on a combination of higher coupon income and lower premium amortization expense as CPR slowed.

Core earnings, excluding PAA, were relatively flat to last quarter at $385 million or $0.30 per share.

Among the highlights for the quarter: higher Agency MBS average balances produced an increase in coupon income, which was partially offset by higher PAA adjusted amortization. Additionally, our resi loan and MML portfolio has contributed to an increase in interest income, while dollar roll income was relatively flat.

Interest expense increased, driven by both higher repo balances and higher rates, the average rate rising to 164 basis points from last quarter's 141 basis points. A significant portion of the increased funding costs was mitigated by a reduction in interest costs related to our swap hedges, which were impacted by the factors that David enumerated. As a result, the hedge portfolio at period end is now in a net receive position, which will benefit us in future quarters.

The hedge book limited to rising our overall funding cost to 7 basis points, which also limited the impact on both our net interest spread as well as our net interest margins.

Our financial metrics remained solid. In addition to net interest margin and net interest spread, core ROE, ex PAA, was unchanged, with a healthy 10.7%. And our operating efficiency metrics remained at favorable levels, consistent with the scale benefits of our operating platform.

Turning to the balance sheet. While average interest-earning assets were up slightly during the quarter, our portfolio assets ended the period down approximately $1.9 billion, with that decline largely coming from the Agency portfolio. Additionally, the TBA notional position ended the period down about $7 billion.

Middle market lending portfolio grew once again this quarter at about $141 million to 14%, and we also saw resi loan portfolio likewise having some growth in the quarter.

From a capital allocation standpoint, the credit portfolios represent a 26% of allocated capital, up from 24% prior quarter. Balance sheet leverage was up modestly to 6.1x, while economic leverage declined to 6.5x.

And book value declined to $10.53 per share from $11.34 at year-end.

During the quarter, we further enhanced the depth of diversification and economics of our funding and capital sources. Beginning with repo, we took advantage of the rates market and termed-out portions of the repo book, with the weighted average maturity extended by about 14 days, ending the quarter at 72 days. We also continued to have success growing our counterparties, both at the Annaly and broker-dealer level.

And David mentioned the securitization that was executed in the quarter, which further diversifies our funding for the resi whole loan business beyond FHLB, establishing another source of attractive funding for that business.

And following our $425 million offering of 6.5% preferred stock early in the quarter, which was a record-low coupon among unrated issuances, we called $412 million of higher cost preferreds, which contributed to what is now an aggregate 56 basis point reduction in the cost of our preferred capital.

And a final thought on the MTGE transaction to add to the remarks provided by both Kevin and David. The transaction allows us to take further advantage of our operating platform as we expect to generate annualized run rate cost savings of over $15 million, a major component of that coming from the reduced management fee. And the consideration structure, including Annaly stock, allows both companies' shareholders to participate in the future value of Annaly.

And with that, William, we're ready to open it up for questions.

(Operator Instructions) And it looks like our first questioner today would be Doug Harter with Crédit Suisse.

Kevin, on the acquisition, the prior 2 acquisitions you made were at discounts to book. And while I hear the other benefits you have of the acquisition, can you just talk about kind of why kind of at this price versus the discounts on the other 2 deals?

Sure. I'll give you the short Reader's Digest version, and we can go into as much detail as you like, Doug. First, the way we value these companies, the public companies, anyway, externally, and anything we value internally, we look at more than 1 metric, as you might imagine. But in terms of your question, book value relative to the previous 2 deals, I would say the short answer is that this portfolio, frankly, reflects the least risk versus the other 2. A large percentage of the assets are obviously Agency and resi credit, of which not only is it fairly transparent in terms of those relative valuations, but, frankly, we -- I think we're probably one of the best in the world at understanding not just the current valuation but, frankly, the potential valuation, given where we are in the cycle. So the multiple reflects really a pristine -- relatively pristine portfolio on the Agency and resi credit side. And then the ultimate call option here are the other assets predominantly made up and represented by the health care portfolio. So, in CreXus, that was a different time and a different cycle, that company was smaller and more of a liquidity trap with a different type of origination model. So that discount made sense tied to the assets in the portfolio at the time. And with Hatteras, that company not only was predominantly made up of floating rate arms, but it had an operating entity within it that was highly costly to run, which not only impacted their valuation; it impacted their liquidity. So all these deals are relative, and I think where we ended up striking the price here, I think, is a very good balance of -- we definitely didn't -- we definitely have potential upside with the portfolio across the board. And the transaction structure was structured accordingly for that, for the shareholders. So you get the premium, and you get the upside. But basically, this valuation and where it came out was really tied to the transparency of the asset in the -- assets in the portfolio. The other thing, the additional vague here is folding into our company and our operating platform, we're going to run this thing 3x more efficient than it was as a stand-alone company, which is always our goal, to plug and play and make it accretive, not just on earnings but make it accretive tied to additional cost savings.

Kevin, and then on the health care assets, is that something that you will look to continue to originate? Or just kind of hold the existing assets?

We're analyzing it now. What I think is unique about this is we're one of the few companies that have the internal expertise to not just manage these assets, but to figure out the strategy of a health care portfolio. So we're going to -- we're assessing it. I think it's a platform that we think we -- on a relative value basis is a good entry point. I think one of the -- one time we do -- anytime you do these types of deals, people kind of are skeptical about our "diversification." But the fact that we're able to onboard that type of portfolio should exemplify to people that we have businesses within our businesses. We have expertise within the commercial real estate group, a group within a group that has managed these portfolios historically, both on the equity side and the debt financing side. So this is a real diversification play, and we're not guessing about how to manage them. We're just early stage in terms of how we're going to think about growing it.

And our next questioner today will be Bose George with KBW.

Actually, in terms of the deal, once we include the cash component of the deal, will your leverage go up? Or are you just going to rotate cash from other investments to finance the deal?

Bose, this is David. As I said in my prepared comments, leverage should go up about 0.2 turns, but, again, that's perfectly well within our comfort range. So we ended the quarter at 6.5x. Right now, I would say we should end around 6.75, but we'll oscillate around that, and things could change.

And the structure was meant to come up with the optimal pro forma capitalization, and it's even, frankly, more conservative on a leverage basis than at the time of Hatteras, where I believe on that deal, our leverage went up about 0.5 turns. So we back end to where it we want it to be. We didn't end up where we didn't want to be.

Okay. That makes sense. And then, actually, switching to the LIBOR-OIS spread, can you just quantify the benefit as long as that kind of remains where it is, what the benefit to your spread is?

Sure. So right now, LIBOR-OIS is about 51 basis points, Bose. It's been as high as about 59. It's come off over the past couple of weeks. We think it's probably in upwards, currently, up 20 basis points outsized relative to where it will normalize roughly a year from now. But a lot of that normalization will come over the very near term. In fact, the forwards price LIBOR-OIS to converge by about 10 basis points just this quarter. So it's a small tailwind for us. But nonetheless, it will help this quarter. In terms of our overall swap expense, I think we were at $48 million for this quarter. With a positive spread now, we expect our swap expense to actually be a benefit to the tune of around $35 million to $40 million, based on the forwards this quarter, at the end of the quarter. And again, repo expenses are going up with the Fed hike, so that offsets that to some extent.

Okay. Great. And then, actually, just one more on book value. Can you just comment on how book value has trended quarter-to-date?

Sure. So as of month end on Monday, we were roughly unchanged on the quarter. The snapshot was $10.50 versus $10.53 at the quarter end.

And our next questioner today will be Rick Shane with JPMorgan.

I just want to talk about the swap strategy and the implications. Obviously, you increased the hedge ratio. You chose to do that, frankly, in a shorter duration than you have over the past couple of years. Was that just a function of pricing? Or should -- how should we be thinking about this?

Rick, this is David. So, the reason why it's shorter duration is because we replaced our Eurodollar futures, which are all relatively short duration. So those were roughly duration-matched. When we took off the euros, we simultaneously added swaps. And since those were short duration, the swaps matched those durations. But it didn't -- we didn't change our overall curve profile. In fact, currently, we're somewhat spread across the curve, I'd say, in terms of our hedges. We do think the front end is relatively inexpensive. But I would say that we're considerate of both Fed expectations as well as investor constraints at the long end of the curve that necessitates investment out the curve despite a relatively low longer-term rates, such as pensions, and so we're agnostic in terms of the curve and do not have a curve trade on it.

Got it. And I'm going to ask you a dumb equity guy question, but the Eurodollar position was a $17 billion position. The notional value of the swaps went up by about $30 billion. Is there something that's different in the convexity of those 2 instruments why you would increase the -- why, effectivity, it would be 2x in terms of the swap position?

No, Rick, they were a one-for-one match. There's not an economic difference or a material economic difference between Eurodollars and swaps. But why you see the increase in balance is as we talked about last quarter, is the increase in hedges associated with the rate sell-off and a great -- and a desire for greater interest rate protection.

And our next questioner today will be Ken Bruce with Bank of America Merrill Lynch.

I got a couple of different questions. I guess, first, on the acquisition and the diversification. Kevin, do you feel like, at this point, this is diversification for diversification's sake? Or are there specific capabilities or different asset classes that you're looking to add to the portfolio?

Do you mean are we -- I don't think we're confusing motion with progress, if that's your question. I think what we've done is we just -- I picture us as -- we're a company built for the future, and I don't want to get too hokey. But this -- we spent a lot of R&D within our strategies over time. And the resulting factors, did I expect to have 30 different -- 37 different options in the 4 businesses 3 years ago? No, we didn't target each and every one of them. We've recruited and hired people that are really good athletes that can do more than one thing, and that's how we've been able to scale, grow and diversify. So the product of our strategy diversification for diversification's sake, it's really been a function of having the most athletic talent in complementary businesses, both -- in both highly liquid sectors and in credit businesses that are more opaque and less competitive. So, it's really been a -- it's been a plan. It hasn't been like random. And I think at the end of the day, the takeaway or the easiest way to describe it and what the goal was, was really to have a plug-and-play strategy where you can be opportunistic when you have the most options, the most cards on your side of the table. So as we talked before, in difficult market environments over different cycles, it's nice to not have to be perfectly right every single time you're making an investment. And when you have more options, you have more room for error. So we won't say we're the smartest guy in the room, but we are the biggest, most liquid guy in the room with the most options. So by definition, we should be the most stable, and we should have more opportunities than anybody else. It's kind of that simple.

Right. The reason I asked is, I guess, from my point of view, you've got a lot of the capabilities for investing in some of these different asset classes any way, and obviously, you could -- with those capabilities, you could replicate the portfolio. So I'm trying to kind of understand if you see this as a good financial transaction in the context of the assets, or if this is an exercise in terms of consolidating capital across the industry, which, from my point of view, ultimately, is what is going to occur. And for those managers that aren't successful enough to keep up with their peers, those are the ones that are going to fall by the wayside. So I guess, that's what I'm trying to understand, if this is a case of consolidation of capital.

I would say yes and yes, right? I think, we're built -- the way we can -- we're going to consolidate is because we're diversified. In other words, there are certain companies that if you're of 1 or 2 strategies or, in this case, 3, they were complementary, I mean, there's not many companies that match up that way. So diversification allows you to be more opportunistic. And this -- and the second part of it is, yes, I've said I think people kind of -- we laughed about it, I think, a couple of years ago when I first opened my mouth about consolidation when I -- when my role transitioned. And definitely in my opinion, the markets are always about a race for capital, and the strongest survive. And our sector just happens to be one where I'll take the high road, but it's been a sector with more smaller companies than any -- than most other industries. And I've also pointed to the BDC industry is another parallel. And the reason I bring up the equity REIT industry that you're familiar with, Ken, is obviously that's a more -- it's a more mature industry today, and it's close to $1 trillion in value in terms of market cap. But in the early '90s, no one even really knew how to spell REIT in the equity market. So I just -- not that we're going to be $1 trillion as an industry in 10 years. I just think the strongest survive, and it is a race for capital because investors are smart and capital is limited, and they're only going to invest their capital in the best companies. And I think that analogy directly applies to our industry and our strategy. And our goal is to not just to consolidate for the sake of consolidating. Our goal is to pick off the best opportunities, both internally and externally, that maintain and grow our capital base and keep this engine turning -- churning out stable earnings and cash flow. So it's yes and yes.

Yes. No, I appreciate that commentary. I guess, from the perspective of the market today, there's still a target-rich environment out there. My last question, as it relates to the increasing of the hedging strategy, I'm not trying to be critical here. I guess I'm trying to understand if, in fact, you're increasing hedging at the time that volatility is also increasing -- or is it an efficient way to essentially kind of position the portfolio? Or you're always chasing the market? Sorry for that type of question, because I know it's a little hypothetical, but if you could give us some sense as to how you think about that.

Ken, this is David. I would say it's perfectly consistent with the increased volatility. If you just look at this quarter, rates are 20 basis points higher. We obviously went through 3%, and I think the hedge position that we added is certainly a protected book this quarter. And you're just -- the fact of the matter is you're just not getting paid as much for taking interest rate risk given the volatility amid other factors like the flatness of the curve, and so it just makes more sense to have a better protected portfolio from a hedging standpoint. And we'll maintain that position until we feel like rates have gotten to a point where the market looks cheap or other factors through the diversification strategy enable us to take off hedges.

And I think the endpoint is tied to the first question, why are we diversified, and what's the goal of consolidation. And here, I think your question on just this quarter, the strategy, it's been consistent with David and the team. Over the past 3 or 4 years, I don't think we've been really chasing much of anything. We look at our -- I went back, and we study for these calls, but our book value performances has been quite good. I think we're about 300 basis points in better protection than the rest of the sector over the past 6 quarters, which involves some of the most volatile time periods. So we're building this model to protect capital in order to be opportunistic to grow it. You got to protect it if you're going to net-net grow it. But I think we look at over time, not just 1 quarter, and you know that whole speech. But I think we -- the strategy doesn't just hop off once the market shifts. I mean, we were -- we monetized a good portion of assets in the first quarter because the market was getting more volatile and, oh, by the way, it freed us up to do this acquisition much more efficiently, and our leverage barely had to move because we had positioned that way in front of it. So it's all tied together. But I think quarter-to-quarter thinking is not what we're really preoccupied with, where others probably are because they are financed month-to-month or quarter-to-quarter, and they have 30-day dividends and other short-term restrictive parameters that they have to keep to. We don't have to deal with that stuff.

And this will conclude our question-and-answer session. I would like to turn the conference back over to Kevin Keyes for any closing remarks.

Thanks, everyone, for dialing in and for your interest in Annaly Capital, and we will speak to you all next quarter.

And the conference has now concluded. Thank you for attending today's presentation, and you may now disconnect your lines.