Good morning and welcome to the Annaly Capital Management Q2 2017 Earnings Conference Call. All participants will be in a 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 with Investor Relations. Please go ahead.

Good morning and welcome to the second 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 the event is being recorded. Participants on this morning’s call include Kevin Keyes, Chief Executive Officer and President; David Finkelstein, Chief Investment Officer; Michael 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. On our first quarter's earnings call, I summarized three of the basic questions the market had been asking us in our 250 investor meetings over the past two years, including number one, what is the fed going to do; number two, how resilient is your model; and number three, does the supply demand imbalance exist in an industry with too many small monoline companies trying to compete. At the time, I commented that we were gaining clarity and more insight into the answers to all three of these questions and that the market had begun to seemingly agree with our views. Now, as we’ve traveled through this past second quarter and into the third, I'm more convinced the market has not only begun to see the light at the end of the tunnel on these particular issues, but as importantly, investors have begun to better differentiate among certain industry competitors in the world of equity based yield. So well aware of these evolving realizations, Annaly was prepared and then moved opportunistically by executing back to back public offerings, raising 1.5 billion of accretive growth capital within a week. With these transactions, we successfully completed the fourth largest overnight common stock offering in the US market this year and the largest non-rated preferred offering ever. Also, using a portion of the proceeds from the newly issued 6.95% Series F preferred, we announced the redemption of our Series A preferred, efficiently reducing overall cost on that layer of our capital structure. The tremendous market reception and demand from both of these offerings is a clear endorsement of our views, investment opportunities and our unique platform overall. To summarize, there are five fundamental themes that support our rationale for the recent capital raises and also substantiate our positioning and outlook…

Thank you, Kevin. This past quarter, we experienced a relatively stable market environment as interest rates decreased modestly, agency spreads were slightly wider and credit spreads exhibited a continuation of the tightening trend that characterized the post-election period and into 2017/ Year to date, we have generated a 5.6% economic return, which equates to just over 11% on an annualized basis as book value was up marginally on the year and we've consistently delivered our $0.30 dividend. With respect to portfolio activity, we did add to our agency portfolio, given favorable valuations. These additions were almost exclusively in 30-year MBS, both on an outright basis as well as versus 15 years. Our ARM’s holdings decreased slightly, primarily due to paydowns that we did not reinvest in the sector, given the flatter yield curve and an acceleration in prepayment speeds, heading into the summer months. On the liability side of the balance sheet, additional interest rate hedges were added to accommodate asset purchases and we also supplemented our hedge position with swaptions as lower implied volatility reduced the cost of swaptions to slightly lows. While our MSR Holdings declined slightly over the quarter, as Kevin mentioned, we do intend to replace a portion of the runoff of that portfolio through our JV with our sovereign wealth fund partner coupled with our newly established relationship with Bayview Asset Management. Turning to residential credit, although we did shrink our portfolio modestly, given ever tighter spreads in the sector, we were able to add roughly 100 million in whole loans this past quarter, which continues to be a growth area for us and our loan portfolio now totals approximately 800 million. Portfolio reductions primarily came through taking gains on a portion of our CRT Holdings given historically tight spreads. For example, the mezzanine tranche…

Thanks, David. Beginning with our GAAP results, we reported net income of 14.6 million, which net of preferred dividends, was a loss of $0.01 per common share. This compares to Q1 net income of 440 million or $0.41 a share. Primary factors driving the quarterly change included lower marks on interest rate swaps, representing sequential change of about 325 million on lower forward rates and higher premium amortization of approximately 15 million due to higher estimated CPRs. We posted 333 million of core earnings, excluding PAA, or $0.30 a share. The PAA for the quarter was a cost of approximately $0.07. And this compares to the first quarter core earnings, excluding PAA, which were relatively flat at 336 million or $0.31 a share with a PAA cost of $0.02. Some key factors contributing to the comparative quarterly results were modestly lower coupon income on lower average agency balances which were partially offset by higher income generated by both commercial and residential loan portfolios and higher dollar roll income that combined represented an increase of about $0.01. Conversely, interest expenses was up on higher repo rates, partially offset by lower net swaps expense and together represented higher economic interest cost also of about $0.01. Our projected long term CPR at period end increased to 10.6% from last quarter’s 10%, which resulted in GAAP premium amortization of $251 million, which included the PAA cost of 73 million and compares against last quarter's premium amortization of 204 million, including the PAA cost in that quarter of 18 million. Consistent with the stability of our performance, our financial metrics remain solid. Core ROE, excluding PAA, was just over 10.5% and our comparable net interest margin was 153 basis points, both relatively flat versus Q1 as well as being within a pretty tight range over…

[Operator Instructions] Our first question will come from Rick Shane with J.P. Morgan. Please go ahead.

Kevin, you made a really intriguing comment, I think you, it was an echo from last quarter where you basically said that you're potentially embarking on one of the greatest growth opportunities in the history of the company. I'm curious about that in terms of how you think that accrues to shareholder benefit? Do you think that there is actually as you grow additional opportunity for scale and efficiency in ROE enhancement or is this basically going to be an opportunity for more shareholders to get the same return?

Good question, Rick. I’m not just saying that is a good question. I would say both and I think I have to get that comment, it's a strong comment, but I said it for a reason, given where we are at this threshold in my opinion and I think I would say a couple of things. First, these capital raisings that we just completed, I really believe there it's an endorsement for our platform and I really believe it's the market reflecting back to us and to you the relative value here and I think at the end of the day, the reason we raise money and this is the near term and I'll get to the longer term, but the reason we raise money is it has this R [ph] between agency MBS valuations and credit, has never been, hasn’t been this obvious in a long time. So when we can put money to work in highly liquid government backed securities with double digit returns versus credit valuations today that have contracted, I mean, the numbers are daunting. The reason we didn't -- the reason we raised money is because it's so obvious to us. Credit within resi for instance is 40% tighter on a spread basis this time -- you know from year end of ’16. And in commercial real estate, it's about a third tighter in the last six months. So, and we have those options, a lot of us don’t. So I think the reason I say that we have a big opportunity now is the relative value proposition is very obvious. Secondly, going beyond that, in terms of our scalability and returns, I think, look, we're going to be able to pivot back and forth like nobody else and we've already scaled those other credit businesses. So we don't have to spend any incremental money to grow them. So by definition, if the values are there, inherently, we should be able to produce frankly very compelling ROEs, improving ROEs as we scale. So when we go out and raise money, we're enhancing not just our liquidity, we're enhancing our optionality. So, and that’s the longer term. The last thing I would say, this is all against the backdrop of a market, which is what I talked about on the last call and I think you and I went back and forth on it, just our relative valuation. I don't look at the mortgage REIT sector. I look at us versus these other yield players and we have the lowest valuation and the lowest beta, while we have the highest margin, highest dividend and the highest liquidity of any yield -- of most yield companies. So in a market that I think at some point is going to go risk off here, because of the credit valuations, I think we're just well positioned in the longer term, especially now that the Fed is moving out than most other platforms.

Look, I would -- based on the types of conversations we're having, I would definitely agree that the institutional interest has picked up substantially, I mean starting to recognize some of the factors that you're describing and the other issue is that, when we look at companies reducing capital or growing their balance sheets, often, it is because it has a supply impact, supply of capital impact on the overall market, but given reduced demand from the Fed and frankly the size of your market, it doesn't seem to be that this will be as disruptive.

Yeah, I mean we are in a highly liquid market with a really good risk adjusted returns. And then if others could raise a billion five they go do it but they can't.

The next question will come from Bose George with KBW. Please go ahead.

I just want to follow up on Rick's question, it terms of supply, relative to the size of the agency REIT market which I think is little over 400 billion of agency MBS, potential supply is obviously very significant but could come out of the FEDs. And do you have thoughts about where that supply ends up, how much of that could end up with the mortgage REITs versus other market participants.

Bose, we’ve run these scenarios constantly in terms of the redistribution of these assets. And look what I would say couple of things. First, the timing of it is not, no one knows for sure, but it is more clear, so that's the first thing. I think that’s when I talk about clarity and more visibility. Secondly in terms of how much our sector can take on. I look at that as kind of the timing as a longer term prospect. I think the economics around that redistribution I think are hard to you know anticipate, but all things being equal, if we could raise on accretive basis more capital to be a permanent capital model to take down those assets versus other models, hedge funds or private equity or banks. I just think we are a very transparent elegant solution for that redistribution. And I think in talking to the regulators and speaking to government officials in Treasury and beyond, I think we're just viewed as a very transparent vehicle that is paying out 90% of its earnings as an SEC reporter, New York Stock Exchange, Board of Directors. I think the REIT model overall is one of the best vehicles to take on the supply. The last thing in terms of calibrating amount or dollar amount I mean, this second and beyond this sector, but if you just focus on this sector it should grow it has a big opportunity here. I think as long as people are taking excessive risk and that really revolves around leverage. The equity REIT market back in the 90s went from 5 billion and it's almost 1 trillion now in the redistribution of commercial property. Now we're not going to get to 1 trillion in our sector, but we can go from - we can double 400 billion with prudent capital raises and prudent risk management. And I think that's when I talk about our growth opportunity as a company. I think if we have prudent actors taking on the supply, we can be a beneficiary along with everyone else that's going to trying to do the same.

As you sort of touched on this already in your comments, but is there from an Annaly specific perspective, do you see sort of limits in terms of your balance sheet growth? I mean is there, are there times when there is a lot more capital coming to do it in some other vehicle or could Annaly beat 50% larger to be.

We could be a lot larger and I think that that’s the attraction here. We can get a lot larger and to Rick's question, we can scale and produce incremental returns. So 50% larger, I would love to be 50% larger and have a more natural valuation environment for credit. So, in a perfect world, the credit markets kind of readjust here just in my view in terms of valuations and we can have growth, more growth among those businesses, bring down our leverage, while maintaining or increasing our returns and adding to the durability of our earnings. That's been I think the - I mean I think I’ve talked about this before, the plan here for the past few years is to position ourselves to look like that.

And then actually just one on the broader market. Obviously volatility has been very low, just wanted to get your thoughts about how the outlook there on volatility, what worries you about that changing.

I'll do a macro comic, we’ve done a lot of work on this Bose, tied to our valuation and then I’ll ask David to comment as well. I mean I just look at, we have a heat map of the yield world and the S&P and other indices and sectors in terms of valuation. And I think what I'm going to start talking about now is our beta relative to these other sectors. And I think we're obviously in this benign marketplace with the VIX at its lows and the complacency index at an all-time high and there is a trillion dollars going into agnostic investment vehicles and sitting on some of the highest equity valuations in history and on and on and on. We're a vehicle that is more liquid, highest margin, high yield and a very cheap multiple and frankly worse more of a safe haven now on a relative basis than we have been in history of the company. So when you talk about volatility, we want volatility to come back to the market because that's where we can take advantage of it with our liquidity. But as you wait for that volatility or you're worried about that volatility even if it's not reflected in the VIX or other indices, you have to look at the beta of these other sectors and these other companies. They are trading with more volatility on a daily or weekly basis underlying these very high valuations. So if you want you know if you're looking for something in your investment bucket with low beta and high yield and low value that’s kind of where we sit in, especially now given my comments earlier about where credit is valued and where the equity market is valued and where most other asset classes are valued.

Hi Bose, this is David, just drilling down a little bit, I think with respect to the portfolio, we're always concerned about uncertainty and unforeseen events and that's the reason why we hedged the vast majority of our duration risk and we continue to do so. That being said, we've never had a Fed as transparent with respect to their intentions as we do today. And it is our view that they have done so, been as transparent as they are because they do want to engineer low volatility environment as they normalize the balance sheet. And so the way we look at it the last two quarters has been pretty indicative of that. We've had a relatively range bound market, it's been very good for agency MBS. And as you know the largest risk to agency MBS is that you are short volatility. So for the same amount of leverage you're actually getting a lower risk trade for the time being if you believe that this low volatility will persist. Now we still need to see a little bit more evidence to ensure that to give us more comfort that it will persist, but all indications are now and certainly the market is pricing it this way that we will be in a low ball environment for the foreseeable future.

The next question will be from Douglas Harter with Credit Suisse. Please go ahead.

Sort of touching on that last point, can you talk about how you view kind of that the trade-offs between return and sort of tightening duration gaps in this environment?

Sure Doug, this is David. So, the three risk that we take our agency basis, duration and credit, and we look at those risks. To generate a return what risks should we takes or is it prudent to take to generate the return. And in the current environment, we think as Kevin said and I discussed, agency basis risk is the most attractive risk. We do carry duration on the portfolio, you do get paid for taking duration risk, but it's not as attractive currently or as agency basis risk. With our recent purchases, we've hedged the vast majority of that duration much like we have in the past. We feel like we're conservatively positioned with respect to portfolio duration. We've added some optionality to the hedges. We’ll continue to do so if we think it's attractively priced and we'll also be very active dynamically edging the portfolio should rates move. So we take a conservative approach as we always have. As I think the fourth quarter of last year indicated with respect to the cushioning that our hedges provided then in our performance during that episode of volatility and we’ll continue to do so.

The next question comes from Brock Vandervliet with UBS. Please go ahead.

David, I guess this one is more for you based on what you know at the moment in terms of the taper. Can you kind of update us on your thoughts on how you think that's going to transpire more in terms of how long the taper takes place not exactly when it starts but how long that runs? Does the Fed run down their agency holdings completely or stop short of that.

First of all welcome back, Brock, nice to hear you. So with respect to the Fed when it begins and how it evolves. It is going to start in September, they've laid out the schedule, they’ll start with reducing purchases by 4 billion a month going to 8 billion, 12 billion and up to 20 billion. So that will leave the Fed in the market buying reinvesting a portion of their run off in agency MBS for some time. We think our forecast tell us that based on paydowns, using the forward and what the schedule they’ve laid out, it will be is that they will be buying as much as 10 billion per month through the middle of next year and then buy about the end of the third quarter when the caps are fully in place and with if you believe the forward and what repayments will be, then they’ll likely be out of the market within about a year and a quarter to a year and a half. So it should be a relatively smooth transition. When they ended [indiscernible] the beginning of 2010, they had a taper program that that was reasonably efficient and private market picked up a lot of the slack and the same thing occurred with the taper of new purchases. This is even more I think transparent. It will lead to some opportunities in the PVA market with bank given their reduced presence. It should also create trading opportunities for us as they do withdrawal. So, overall it will a year and a quarter, year and a half before they’re fully out. Longer term it's difficult to say whether or not they're going to reinvest when they get to the steady state size of the portfolio, where they need to have assets to match liabilities, whether they're going to continue to reinvest in agency MBS or run off or go into treasury bills or how that's going to evolve. The [indiscernible] came out the other day expecting that they would reinvest in the bills. Our hope is that they remain a presence in the mortgage market to provide support to the mortgage rate and to housing. And I think that if you look at how they've behaved in the past, they did change their reinvestment strategy after QE1 to go back into agency MBS because they did want to be a positive force in the housing market. So our hope is that they do remain over the long term and we'll have support and opportunities as well.

I would just have Brock, I think we're not pre-occupied with whether it's a year, year and a half, two years. I think the macro environment and the comments I made about the economy and growth and everything else I think they could be stalled, it can probably, they can probably weight back in. There is uncertainty. I think David mentioned that and we're acknowledging that. But I think overall we're set up for it. Now, we're in the most liquid position we've been in I would say ever because of we’re not just going into these waves blindly. But I'm thankful we have a team here that has a heck of a lot of experience not around the hedges but actually inside the rooms of how these decisions get made.

And just as a quick follow up, technically obviously this is incredibly well flagged, are agency spreads kind of already where you expect them to be or do you think they're going to be technical factors once they start moving in terms of flows going from a player that doesn't hedge the Fed to private participants like yourselves that do, that could drive spreads, agency spreads wider or not a factor?

Hey Brock that’s a good question. So there's always going to be flow effects and bouts of widening and tightening. We’ll have to wait and see, agency spreads relative to credit have certainly underperformed as we've talked about quite a bit. And we feel like the market's prepared and the market's priced to where, you know, it fully understands the consequences of the Fed stepping back. We do anticipate that there will be some adjustments from time to time given liquidity considerations and the flow effects will have an impact. But overall we feel good about valuations here.

The next question comes from Mark DeVries with Barclays. Please go ahead.

You're obviously very successful raising a lot of stock this quarter both common and preferred, was hoping you could talk about the relative attractiveness of the two and also what percentage of your capital structure would be comfortable taking the preferred to?

Hi Mark, what was the first question, I'm sorry.

Oh just the relative appeal of common versus preferred here.

That is very basic, I mean we went into both these transactions obviously not exclusively, we measured and anticipated and sided them tied to our liquidity metrics, but really what we anticipated from the market in terms of demand. And at the end of the day, it's not an accident that they came out kind of 50/50 in terms of the size. We did not want to raise too much or be too aggressive in the first deal in terms of our common equity raise. I mean my experience in this part of the world is pretty deep. And the last thing we wanted to do is over flood the market with common have a deal that has trades poorly, don't attract the right type of long-term shareholders everything else because if you go to the market with too much supply as you know, Mark, these things unwind on you and that's happened to others in our sector, it is recently as this year. So we were very conservative with the first step in terms of sizing. We could have done more, but we chose not to. You can see that when we exercise the green shoe that by definition tells you that the transaction worked and worked very well. And you can see the aftermarket performance reflects that. So the first step was size the equity appropriately, knowing that you're coming back to the market with another type of security albeit targeting a different type of shareholder. But if that common deal doesn't work there's no deal that follows it. So the equity offering went quite well, very well. And the preferred deal was very interesting, we've been looking at that market and we've done obviously deals before. We did the largest non-rated preferred before a few years ago…

And sorry if I’ve missed this. Did you see any kind of material expansion in the institutional investors that participated in your common raise or you mainly selling shares to existing shareholders?

No. We had -- I have the stats in front of me, it was roughly 70% new buyers and 30% current So I think it's a function we've been speaking to the market and been active in our discussions with both current and new institutions. I'll go back, I didn’t answer your question on the pref. I mean look by my experience typically capital structures depending on the industry or the sector and the pref layer within that cap structure, right now we’re at 13%. We can easily flex a lot higher than that. I mean 20%, 25%. But that’s kind of industry standard is 20ish percent. So we have room. But the way I look at it is more about the overall capital structure not just one layer of it. But we are very pleased with the tightest coupon in the history of our sector at 695, I think and we weren't aggressive there either. We didn't push the market on price, we could have been tighter I would say. But we want to make sure that security worked.

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

Thanks again to everyone who joined the call and for the interest in support of Annaly. We will speak to next quarter.