Good day and welcome to the Q1 2017 Annaly Capital Management Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Jessica LaScala of Investor Relations. Please go ahead.

Good morning and welcome to the first quarter 2017 earnings call for Annaly Capital Management Inc. 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 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. Please also note this event is being recorded. Participants on this morning’s call include Kevin Keyes, Chief Executive Officer and President; David Finkelstein, Chief Investment Officer; Mike Quinn, Head of Annaly Commercial Real Estate Group; Glenn Votek, Chief Financial Officer; and Tim Coffey, Chief Credit Officer. I will now turn the conference over to Kevin Keyes.

Good morning, everyone. When my role transitioned as CEO in the summer of 2015, one of my first priorities was to expand and enhance our relationships in dialog with our institutional and retail investors, research analysts in the broader investment community overall. Since that time, we have embarked on a comprehensive marketing campaign holding over 200 investor meetings, including communications with over 90% of our largest institutional shareholders. Today, we are beginning to realize the benefits of our outreach. However, despite our outperformance in the improved market conditions of our diversified model, a wide relative valuation divide remains when comparing Annaly’s operating and financial metrics against not only the mortgage REIT industry, but more importantly versus the broader market and other yield oriented companies in the equity market. Since mid-2015, Annaly has achieved a total return of 60% far outperforming all yield-oriented equity strategies and far exceeding the returns of the S&P 500 by 200% and the Bloomberg Mortgage REIT Index by over 70%. During our numerous investor meetings, three common issues are consistently a part of almost every discussion. First, what I am called the persistent paranoia around Fed policy in the economy; second, questions around the resiliency of the mortgage REIT model, especially during times of volatility; and third, issues relating to the supply demand imbalance in the sector. We have gained clarity and insight into the answers to all three of these questions with our views in performance leading the way and thus evaluations have listed in the sector, especially over the last few months. To simplify the response to the first question, the market consensus is now aligned with our views, views which we have expressed for a while, but although rates maybe moving higher, the Fed’s moves will be gradual and slow in a fragile…

Thank you, Kevin. The first quarter provided the considerably more favorable investment environment than that which we experienced at the end of last year. While agency MBS spreads widen modestly, volatility diminished somewhat and prepayments were subdued Credit markets experienced an acceleration of the spread tightening that followed the November election as fundamentals remain on solid footing and we saw further strengthening in the technical landscape for credit assets that persist today. As a result of these factors we were able to deliver another solid quarter in which we generated a modest earnings improvement as well as growth in book value. As Kevin discussed relative values in the broader market, I would like to address valuations across the markets that we operate in as well as our views on the current environment. Continued economic strength and renewed optimism surrounding physical policy have created a tailwind for risk assets that has generated significant appreciation in credit sensitive sectors. At the same time monitory policy makers have been successful in raising short-term rates in each of last two quarters and have signaled their intension to begin balance sheet normalization either later this year or early in 2018. As a consequence of this eventuality, agency MBS have not participated in the spread rally that is impacted virtually all other fixed income sectors, creating an attractive valuation disparity between agency MBS and credit. Agency option adjusted spreads are at their widest levels in 3 years, while credit spreads are at the tightest levels post crisis across many sectors and credit curves continue to flatten. For example current coupon 30 year agency MBS have widened on an OAS basis over the past two quarters, while high yield and second loss CRT spreads are 100 basis points tighter and CMBS BBB minus spreads have rallied nearly…

Thanks David. We have had a good start to the year with solid first quarter financial results as evidenced by improvement in earnings quality and increased book value. Beginning with our GAAP results, we reported net income of $440 million or $0.41 a share versus Q4 net income of $1.8 billion or $1.79 a share. Two factors drove this sequential change. First of all, net gains on interest rate swaps were $1.2 billion lower this quarter reflecting a more modest increase in rates in the period compared to the higher rates that rose in Q4. Additionally, premium amortization expense increased by approximately $220 million. As mentioned on last quarter’s call based upon SEC interpreted guidance on the use of non-GAAP financial measures, the fourth quarter was our final period to record core earnings metrics that exclude the premium amortization adjustment or PAA. Beginning this quarter, core earnings and related core metrics include the PAA. However, given its value in analyzing this company’s financial performance, we will continue to separately disclose PAA and its impact on other key metrics. This will allow you to calculate the core earnings metrics as previously defined as well as permitting you to compare to both historical measures as well as that of industry peers. And of course, non-GAAP measures should not be viewed in isolation and are not a substitute for financial measures computed in accordance with GAAP. So, with that, our core earnings were $318 million for the quarter or $0.29 a share that included a PAA cost of approximately $18 million at $0.02 a share. The comparable fourth quarter core earnings were $0.53 a share. It included a PAA benefit of about $239 million or $0.23 a share. Some key factors contributing to this quarter’s results were high coupon income, including higher interest…

Thank you. [Operator Instructions] The first question comes from Bose George with KBW.

Hey, thanks. Good morning. First one on the agency ARM holdings, it looks like that was down a couple of billion and then can you just talk about relative value there in versus other agencies?

Sure, Bose. This is David. So, as the quarter progressed and banks started to look at higher interest rates and they often are attractive to ARMs given their cash flows. As a consequence, there was a lot of demand for that sector and they actually tightened pretty significantly trading at very negative Z spreads and so we took the opportunity to sell about $1.3 billion I want to say of ARMs and then the rest came through run-off. Subsequent to that, it did cheapen back up and so right now we are sort of in a holding pattern. We don’t anticipate selling right now.

Okay, thanks. And then actually just on the prepays, do you think prepays have largely troughed just can you give us your outlook for prepays?

Yes, certainly. So, the portfolio paid 11.5 CPR in the first quarter. And that was actually somewhat inflated by pull-through that occurred at the end of the year, which was reflected in January speeds. And so we don’t anticipate prepays to increase that much this quarter. The portfolio last month paid at 11.5 CPR as well. This month we give speeds tonight. We expect them to be largely unchanged with possible increase next month. So, for the quarter, we don’t expect much of an increase and as we get into the later part of summer, we could see higher speeds and it depends on what the rate environment does, but at these rate levels, we don’t expect a significant increase in spite of the seasonals that are coming forward.

Okay, thanks. Actually just one more, just in terms of incremental levered ROEs on the agency MBS, where is that sort of coming at it?

Yes, currently it’s roughly just north of 12% which is the highest we have seen. We are pretty conservative about how we look at agency leverage relative to others and some are saying mid-teens are in upwards of mid-teens, but we think it’s just about 12%.

Okay, great. Thanks.

Sure.

The next question comes from Rick Shane with JPMorgan.

Hey, guys. Thanks for taking my question this morning. First of all, I want to say I appreciate this somewhat passionate tone this morning from Kevin. And I think that there is a lot going on here. And one of the other observations I would make is that I think if we think about Annaly over a very long horizon, this has always been a very strategically driven company sort of big changes to the business model as opposed to more tactical. And what we are hearing today is in terms of how you are handling the portfolio is much more tactical level decisions and I am curious if this is a change in tone or actually a change in how you are approaching the market and I am also wondering that the diversity or the diversification of the model allows you to be more tactical, because you are not so concentrated in any particular segment?

Rick, well, thanks for the compliments, I think I am not the only passionate person around here. I think we have a big group of passionate people driving this company. Look, I think you have been tracking the history of this company probably longer than most. So, I think you can appreciate the evolution. I could answer that question and take another 30 minutes to do it, but I think the short version or the Reader’s Digest version, I would just tell you is that I would like to think we are both continuing to be strategic big picture wise and tactical, I think it’s a combination. I think the latter part of your commentary, I think is the driving factor here. We have built this platform with four complementary businesses that now have 30 different investment options. And I just think in a market like this, the mortgage REIT of history is history. I think there are so many opportunities that are complementary for our shareholders. We built this platform over past couple of years really consolidating all our strategies on to one balance sheet. And at the end of the day, I hear commentary about people talking about nimble strategies or scalable strategies. To me, it’s all about liquidity and diversity. There is no optimal – the optimal metric is liquidity. Whether you are a $1 billion or $500 million or $5 billion, the biggest thing that we have that no one else has is liquidity. Then the second thing we have that no one else has is the diversified options. So I think you and I have talked before and we have talked to the market before about risk management and the nature of this model. And when you have a shared capital model where you have…

And Rick, this is David. I would just also add that as markets change, we are going to reassess the portfolio and markets have changed quite a bit. Often times, dislocations materialize when there isn’t a broad move in the market or we happen to have a view that’s inconsistent, I would say reducing leverage early on was a function of the fact that Fed started talking about reducing the balance sheet. And we thought it was more conservative approach and then we took a look at valuations into this quarter and simply added back. We think it was a good decision. The agency portfolio as we parse the data did add to our book value appreciation. Resi credit was a dominant driver. But when you look at our performance relative to other fixed rate agency REITs, we had an increase in book value and some of that was driven by the agency portfolio. And so we think it was a sound decision. And also I wanted – I do want to say with respect to tactical versus long-term when we make decisions, it’s always about the cash flows over the life of both the assets and liabilities. We would look at things not just over the near-term, but over quarters and years out and that always drives the way we would think about the longer term positioning of the portfolio. But to the extent we have the resources and we have invested quite a bit in the trading teams here, we are going to take advantage of near-term opportunities as they present themselves.

Got it. One follow-up question and one comment. Kevin, you talked about the $7.5 billion of unencumbered assets, one question we have received a number of times over the last month related to Annaly is what is your appetite given the current multiple for additional equity capital and I think I know the answer, but I want to hear it?

Well, I will start. You want me to hit that softball. We are not – we have no need or desire requirement for capital, which is why I put that in my statement in terms of our liquidity. I would say just a couple of things to that, because I can’t resist. I just think the market needs to pay attention especially in our sector just like other sectors and start to differentiate what’s going on beyond the headlines, right. And I think I would ask the market to dig in a little bit and the most recent capital raises, I would argue are something that I used to do this for a living for 20 years before I showed up here. They are not advisable. The most recent examples, there is – it’s not just capital raising, it’s the combination of the decision making and what’s happened. There are scenarios where a company loses in the past couple of quarter even with the stock prices appreciating. The scenario is you lose, I don’t know 10%, 12%, 15% of book value in a couple of quarters. You cut your dividend couple of times to over the last three quarters. Management sells stock during that time period and then you come back to the market and ask institutions to buy new issue that dilutes your current shareholders after all that. To me that is opposite of how you manage capital. So I have spoken before about other things. This is the most recent example. We have talked about stock buybacks. I won’t talk about buybacks, there was $40 billion issued in 3 years and $4 billion bought back and we did $1 billion of the buyback and no issue. There has been a talk about the FHLB and there has been business models built around that. Well, 22 companies added and then 17 companies lost it. Right on that line, management is selling stock, 80% of the companies, there is management selling in the middle of this run up. So I just think I got it, I just don’t want to be compared in our industry necessarily. I want to stand apart from it and I think that’s what we are trying to do. And then capital raising is just one part of the equation. I really think it’s to your point on strategy and tactics. In strategy, we did the biggest acquisition in history a year ago. And tactically we have invested in the intellectual capital around here in the last 3 years to be more tactical, to complement our strategy. So no we are not raising capital, unfortunately as I have anticipated it doesn’t surprise me that this company is kind of raised their eyes above the water level, north of book value, you have seen 15 different deals come in the form of converts, preps, common deals, ATMs, all different types of flavors of dilution, shareholder dilution, we are just not going to do that.

I apologize to my peers for asking such long question on a busy day. I will let you go. Thank you, guys.

Thanks.

The next question comes from Doug Harter with Credit Suisse.

Hi, this is actually Sam Choe filling in for Doug. I mean, you guys answered most of my questions, but I mean in terms of the relative attractiveness of the four business lines, I mean I was wondering if you could provide some color on how the return profiles are kind of going to trend during the coming year, I know you kind of touched on this in the prior questions, but just wanted more color on this?

No problem Sam, I will start and then David can provide more detailed metrics. I think if you just look at the mix in the capital allocation for the last couple of quarters, I mean that kind of illustrates relative value in our opinion and the best risk adjusted return. So really in the order it’s in the order of resi credit in terms of our highest growth business right now. Middle-market lending, number two. The agency portfolio as the liquidity portfolio, but actually such as liquidity given these CPRs it sits really good cash flow as David mentioned at the highest rates of return we have seen in a while that is the defaults return. And then the commercial business, Mike Quinn is here, you can talk about it. But it’s really – it’s shrunk about 10% last quarter. That’s not because we don’t like commercial real estate and we don’t like the business, we like the business, we like the stability of cash flows and the lower levered floating returns. We just - when you stack up the four options, commercial real estate right now and it can change. Personal real estate right now is fourth in line. There lies the beauty of our model. We can pick and choose opportunities across the platform. We don’t have a gun to our head every 30 days forced to put money to work in a market that is highly valued. It’s – I made comments on the equity market valuations, well, every asset and every fixed income market is relatively expensive. But we have the convenience. And I think the foresight to build the platform, we are not taking excessive risk in anyone of these markets.

And Sam, I would just add that when we look at capital allocation having a core in credit in spite of the valuation discrepancies I spoke about having that core does lead to a more efficient portfolio overall from a risk adjusted return standpoint. So while agency does look to have the highest risk adjusted returns right now, we are anticipating and hoping that we are able to maintain the size of the credit positions and potentially grow those books. But we are not going to chase returns in the sector. We are going to rely on what we think are unique options for us including a middle market lending business as well as our residential credit platform where we can do things that others simply can’t do given our financing advantages.

Got it. Very helpful. Thank you.

Thanks.

The next question comes from Ken Bruce with Bank of America/Merrill Lynch.

Thanks. Good morning everyone. I guess firstly, some this has been fall in stock for a long time, I really think the changes that you have made over last few years has been positive and really do kind of play into safety and stability that you are talking about in terms of the business. So firstly congratulations on executing quite well. You’re welcome. I am also guilty of being persistently paranoid, so do apologize for that. Your comments about trying to differentiate Annaly not only in terms of performance, but ultimately in terms of the way that the market views the company and the valuation has been quite a bit an issue for a long time, I know Kevin you and I have had this discussion over the years is to what ultimately may kind of drive that, I guess I am interested in terms of as you think about the way that the market has evolved you got a lot more passive money that is in – that’s in the market, generally it’s pretty large, it’s almost 20% of ownership with Annaly, obviously it’s not very sensitive to the valuation that’s only senses the flows, the mortgage REITs not being part of the equity re-universes somewhat been orphaned in terms of having any kind of dedicated investor is, what do you think it takes for the market to start to think about Annaly not as just a mortgage REIT, something that is not just a yield producer, but ultimately we will kind of get that better valuation that you are aspiring to?

Well, I think that’s the similar question we think about everyday and my previous comments on our strategic view and the tactics surrounded. At the end of the day for our shareholders, we got to do our best to get recognition for the cash flow generation out of this place. So I guess I would say a couple of things. First, there is a reason, we have been out on the road and you have been sponsoring a number of trips for us Ken in the past year and a half. There is a reason we are doing it and we do it very efficiently. There is as much in 200 meetings, look we don’t have all the answers. So we are talking to our shareholders and talking to the smartest institutions in the world. I think we develop a better answer to the question long return. So that’s the first thing and I will get to the answer. Second thing is this platform – we have this time period really going – since 2014 to current, that’s really the teammates in place now and that’s when the diversification really started to kick in. So these cash flows are complementary on the credit side to the agency business and granted, agency’s 80% of the capital, but we could flex to 70%. We could flex it down to 70%, 60%, 50% of the capital if credit would ever – when credit ever becomes less expensive, so without adding a body or a computer as I have said before. So we have the flexibility with all those liquidity and diversity to grow the lower levered cash flows that complement the interest rates strategies. So the diversification gives us – now gives us, we didn’t have before prior to 2013. Now it gives…

Alright. Well, I have always been a little astonished by the lack of differentiation in the sector. So, I guess I apology for all the changes that you have made. I think they have all been very positive. Thanks for proving me wrong and thank you for your time this morning.

Thanks, Ken.

The next question comes from Joel Houck with Wells Fargo.

Good morning, excuse me. Thank you. So on Slide 9, you show that the book value –realized volatility is a lot lower than agency and commercial and on par with hybrid, but on the efficient frontier slide on 13, you are showing the mostly I think these are price volatility returns are higher than the sub-sector which seems to imply that market is mis-pricing your relative realized volatility, it’s over pricing relative to the mortgage REIT universe, can you – do you see it that way and are you surprised I mean I am shocked that you are further out on a volatility curve than you as mortgage REITs on Slide 13?

Joel, this is David. So you are looking at Page 9, which is not addressing the stock specifically whereas the efficient frontier takes all the different asset classes and compares it to the stock returns as well as to the mortgage REIT sector. So, the point of that slide was simply to say that if you look at Annaly and you add that to a diversified universe of the best risk adjusted return combination of all the sectors in all markets, then you are going to end up with a more efficient portfolio. And that’s the point of that slide. So, you are talking about the stock versus dividend stability and book stability I believe.

Right. No, no, I get that, David. I mean, I am a CFA. What I am saying is that, you have better – you are claiming and I think it’s true, better fundamental performance right on Page 9, yet the market is not pricing it correctly. It’s saying that you are on – since 2014, on a monthly basis, your stock has been more volatile than the mortgage REIT universe, that’s disconnect to me. I am wondering can you – are you surprised at that? Is there some explanation that we wouldn’t be accounting for that discrepancy?

Yes, I think it’s a very basic explanation, Joel. We are the largest most liquid – one of the definitely the largest most liquid mortgage REIT, but we are one of the most largest, most liquid yield interest rate plays in the equity market overall. There is more hedge funds and more hedging going on in our stock tied to other investment classes or other investments than anyone else because of our liquidity. So, we have on a daily, weekly, monthly basis. We have a heck of a lot more renting going on in the stock, then sure long-only valued buyers in there. So, this past week is the perfect example. We are used as a hedge against what’s going on in not just the secondary markets overall, but what’s going on in the new issue market. So, there is more volatility tied to our stock over certain windows relative to others. Even though we are more liquid, you think we wouldn’t be as volatile, but just look at the past week when things go on in our sector we are used as a hedge.

Yes. And I agree just the notion that the most liquid stock will be typically in financial one on one, the less liquid security has more volatility. But let me ask a different question, so 2014 obviously that was I think on the heels of the Taper Tantrum, if you were able to parse out and exclude that period, which was a incredibly volatile environment for mortgage REITs. Would this chart not look even better for not only Annaly, but I presume the mortgage REIT universe together. In other words, it seems like it’s – the picture trying to paint here is probably better if you eliminate a 100-year flood event, i.e., the market reaction to the Taper, original Taper?

Joel, this is David. So, 2013, summer of ‘13 was the Taper Tantrum. 2014, we started the year that tender now yielded 3.03% I believe and it actually wasn’t quite a good year. We actually were very low levered at the time, but we added leverage early in the year. We ended up generating an 18% total return in that year in the rest of this sector. The rising tide with the rallying market in tightening spreads kind of lifted all boats. But the subsequent 2 years, I think we certainly differentiated ourselves as well. I think 2015 there was not a lot of return in the sector as there was lot of volatility. In 2016, to generate a 5.5% total economic return versus the peer group that really suffered in the fourth quarter led to that outperformance. So, I can’t say specifically removing 2014 from the equation whether that leads to sort of a steeper slope of that line of us versus the MREIT sector overall, I think on that efficient frontier. If you draw it or if you drew lines on the risk free rate, there are dots versus the MREIT sector. You do get a steeper slope, but I can’t say whether or not removing 2014 would further steep in us relative to the sector.

Okay. I appreciate you guys can in this. I will drop off and let others ask questions. Thank you very much for your responses.

Thanks, Joel.

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

Thanks everyone for participating. We hope to see most, if not all of you at our Shareholder Meeting on May 25 and we will speak to you all again next quarter. Thank you.

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