Good morning, and welcome to the Annaly Capital Management Quarterly Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Purvi Kamdar, Head of Investor Relations. Please go ahead.

Thank you. Good morning, and welcome to the second quarter 2019 earnings call for Annaly Capital Management Inc. Any forward-looking statements made during today’s call are subject to certain 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. As a reminder, Annaly routinely posts important information for investors on the Company’s website at www.annaly.com. Content referenced in today’s call can be found in our second quarter 2019 investor presentation and second quarter 2019 financial supplement, both found under the presentation section of our website. Annaly intends to use our webpage as a means of disclosing material, non-public information, for complying with the Company’s disclosure obligations under Regulation FD and to post and update investor presentations and similar materials on a regular basis. Annaly encourages investors, analysts, the media and others interested parties to monitor the Company’s website in addition to following Annaly’s press releases, SEC filings, public conference calls, presentations, webcasts and other information it posts from time to time on its website. Please also note this event is being recorded. 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; Mike Fania, Head of Annaly’s Residential Credit; and Tim Gallagher, Head of Annaly’s Commercial Real Estate. And with that, I’ll turn the conference over to Kevin Keyes.

Thanks Purvi. Good morning everyone and welcome to our second quarter earnings call. Yesterday officially marked the end of the Federal Reserve’s hiking cycle, which began back in late 2015, the same time I started my tenure as Chief Executive Officer of Annaly. I spoke as incoming CEO on our second quarter earnings call exactly four years ago. At that time the market was exhibiting extreme paranoia as the beginning of the Fed hiking cycle approached. To recall, I highlighted three ways Annaly planned on positioning ourselves for the Fed’s upcoming lift off in rates. Number one, aggressive build out of our investment teams and corporate infrastructure. Number two, the prioritization of specific internal and external growth strategies including joint ventures and acquisitions. And number three, I set the course for the initiation of our diversified shared capital business plan. The strategy we laid out has been largely successful and arguably one of the most difficult operating environments in quite a while, marked by the Fed hiking interest rates nine times over the past four years. Summarizing our efforts since 2015, Annaly has delivered a total return of over 60% to our shareholders, outperforming agency peers by 40% and the broader yield sectors by almost 20%. We have also grown our market cap by over 50%, paid out $5.1 billion in dividends, acquired two less efficient mortgage REITs for $2.4 billion and formed over 20 exclusive investment and strategic partnerships. And finally, members of this management team have voluntarily purchased nearly $20 million of stock in the open market since 2015, while not selling a single share ever. Annaly’s performance over the recent hiking cycle is an endorsement of our shared capital model and human capital advantage we’ve built at our firm. Now as we enter a new phase of…

Thank you, Kevin. As all are aware, Fed drove price action across U.S. fixed income markets in the second quarter. Interest rates rallied 40 basis points to 50 basis points in turn modestly steepening the yield curve while risk assets perform reasonably well on the quarter. Agency MBS lagged, however, as a consequence of higher volatility as well as the reintroduction of refinancing risk into the agency market at current lower rate levels. Agency performance did adversely impact our book value in Q2. However, it is worth noting that just over half of this deterioration has reversed thus far in the third quarter. Our portfolio leverage increased to 7.6 times due to both additional assets added to the agency portfolio in light of water spreads as well as the decline in equity value. Turning to portfolio activity and beginning with the agency sector, our additions were focused in specified pools, while we also reallocated a portion of our TBA holdings into pools. Specified pools continued outperformed TBAs in the second quarter that we do feel that pool pricing is justified given both the interest rate environment as well as continued deterioration of the deliverable float that is characterize in the TBA market this year. While our portfolio is well protected from higher prepayments as 80% of our assets exhibit prepayment protection, we do expect peak in the third quarter given both the lagging effect of lower mortgage rates as well as seasonal factors. We continue to believe that the investments we have made over the last few years in both people and technology to significantly elevate our prepayment expertise are a differentiator. In today’s market, we are balancing the convexity risks with our pay up exposure and therefore focused our additions in the quarter in cohorts, we feel have an…

Thanks David. Our earnings release discloses both GAAP and non-GAAP financial results. I’ll be focusing this morning primarily on our non-GAAP metrics while excluding PAA. So beginning with the GAAP results, the decline in rates during the quarter lead to mark-to-market losses on our swaps portfolio which contributed to a reported GAAP loss of $1.24 per share. Offsetting mark-to-market gains in our agency portfolio which run for equity reducible loss on a comprehensive basis at $0.09 per share. We generated core earnings at $391 million or $0.25 a share compared to $433 million or $0.29 in the prior quarter. A few factors impacted our core results this quarter beginning with interest income. Return on PAA adjusted basis was up 13% or $119 million driven by the increase in agency investments that David had just mentioned and discussed. Additional factors impacting the improvement in interest income were slightly higher average asset yield which was up about three basis points sequentially partially offset by a $13 million increase in PAA’s adjusted premium amortization. A higher amortization expense was due to projected CPR is increasing a 14.5% from 11.6% in Q1 with the magnitude of the change, also contributing towards a greater premium amortization adjustment for the quarter. And the improved interest income was offset by increased interest expense attributable to higher repo balances. But most meaningful factor in the quarter was the persistent dislocation between repo funding costs and LIBOR that we had foreshadowed on our last call. While repo rates were relatively unchanged for the quarter, LIBOR based resets on the received legs of our swaps declined about 20 basis points which contributed to $15 million decline in income generated to the interest component of our swaps. This is the key factor causing both core earnings and net interest margin declines.…

This will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Eric Hagen of KBW. Eric, please proceed. Eric, your line is live. Please proceed.

Hello, am I coming through?

Hi Eric.

Hi. I'm not sure what happened there. Good morning. I just wanted to get your thoughts on the relative value as you see it right now between specified pools, and TBAs, or generics and the types of specified pools that you like. And as a follow-up to that, your presentation notes that the total premium in the portfolio is more than a third of total shareholder equity. So I'm just curious how you guys think about the longer term prepayment risk at Annaly? And how that factors into the percentage of overall capital that you have devoted to Agency MBS over time? Thanks.

Sure Eric, this is David. To start with your question on our allocation between pools, TBAs and within the specified sector, as I said in my prepared comments, specified pools have obviously done quite well, it's obviously a function of the interest rate environment, but again, it is also driven by deterioration in the TBA deliverable, which has occurred pretty continuously over – about the past year. What we've seen in the TBA market is that coupon swaps are relatively flat. So it's advantageous for originators to deliver higher loan rate coupons or mortgages into lower coupons, more profitable, number one. Number two, as the GSEs have gravitated toward this UMBS model, they haven't really been able to compete with one another, given the similarity or the essential, identical securities that are created. So they have been more aggressive with originators on buying IO from them, which also has incentivized those originators to deliver higher loan rate loans into coupons. And in addition, originators have differentiated themselves based on their aggressiveness in terms of refinancing. There's a lot of originators out there that are very aggressive about getting their borrowers to refinance. And so the deliverable isn’t that much worse from that standpoint. So it's not so much a function of the richness in specified pools, but also driven by what the deliverable looks like. Now within specified pools, we are certainly cognizant of pay ups, and we are very sensitive to that. And so our focus has been largely over the last quarter on lower pay up pools, differentiating between gross WAC and servicer, and paying small premium to get what we think is good relative value compared to TBAs and not elevating that overall pay up exposure too much. That's where we've been focused, but we do hold considerable amount of very high quality specified pools. We're not of the mindset that we're going to transition out of those in the lower pay up pools, because we need that protection. But the marginal dollars spent on relatively lower pay up pools. Now in terms of your question about premium, coupon premium relative to equity, certainly it's a concern obviously given the fact that we are in a lower rate environment and we do have a lot of premium in our portfolio. But we also have to understand that the portfolio is very well hedged from a duration standpoint and quite dynamically hedged, both in up rate and down rate scenarios. And so we actively manage that exposure. And obviously if the market sells off, pay ups will diminish, but we actively manage it and we're certainly aware of exposure relative to equity.

Eric well I’ll just add three points to that in terms of the premium. Looking forward, well my commentary is about the credit valuations versus our Agency business. And in the past quarter or so we’ve chosen to redirect into Agency because of just the obvious value arbitrage there. So that’s the positioning. Going forward, our liquidity position gives us extreme flexibility roughly $1 billion, $1.5 billion a month of cash flow to redirect our capital allocation, is more flexibility. And it certainly dwarfs any company in our sector. The second point is we're a third less levered. So we have additional, incremental financing capabilities that we do want to shift our capital. And lastly, regarding the arbitrage, I mean, it really has never been as dramatic in terms of a valuation differential Agency versus our three other credit businesses. My overall commentary is the Fed is signaling, other central banks are signaling that we're at a position now where a high debt growth has impacted combined with the slowing of the economy and a lot more uncertainty has impacted corporate earnings and valuations are too high in most of the other sectors. So we're waiting for that impact again to fundamentally hit the market. And then we would anticipate just shifting into better valuations in the credit, frankly. So the portfolio is an accordion, it's always going to be dynamic. And I just view this opportunity sitting here today with more visibility on the central bank and not enough focus on the fundamentals of valuation across the asset classes. And once there as the market begins to focus, I think, you'll see us take advantage of that and redirect our capital and the portfolio will adjust accordingly.

Got it, that's helpful color. Thank you.

Thanks Eric.

Yes, thanks. And then it looks like about half year swap portfolio is rolling over in the next, call it 18 months. And that's on a blended average basis that you give us the weighted average maturity. I'm curious what percentage rollover just by year end? And maybe you do or don't have strong views on Fed policy and whether the forward curve is appropriately priced or not. But, where along the yield curve do you think it makes the most sense to add new hedges?

Yes two good questions. Look with respect to our short term hedges, we constantly maintain that and as we do get close to roll-off, we'll push hedges out. I think we have 34 billion or thereabouts in the lower or shorter duration bucket. And we'll certainly maintain that. Now with respect to new hedges that's a function of our overall rate outlook, not just over the very near term, but really well out the horizon. So if you look at the swaps curve right now, twos, tens is priced around relatively flat, it's about four, five basis points. One year forward, it's roughly 26 basis points. So that says that a year from now the market is priced twos, tens to be 26 basis points. Now our view is we are very sensitive to the uncertainty surrounding Fed policies. And I think communication that we've seen is obviously necessitated that. And certainly volatility we experienced yesterday, for example, during the press conference we had a 12 basis points to 14 basis point trading range for the two-year note, which is just an example of how much uncertainty there is with respect to Fed policy. But when we look far out the horizon, we do feel like we are in an easing cycle. The curve should be a little bit steeper than what the forwards are implying. 26 basis points a year from now is probably a little light in our view. And so the marginal hedge is pushed a little bit further out the curve and it's not a strong view because we do feel like we're pretty spread across the curve, but marginally we do feel like longer term hedges are better bet. And consistent with your prior question in terms of pay up exposure in specified pools which are longer duration, having longer term hedges does help manage the potential for a drift higher in rates and some dissipation in those pay ups as well.

Got it. Thank you so much. Thanks for the comments.

You bet.

Our next question comes from Matthew Howlett of Nomura. Matthew, please proceed.

Thanks for taking my question. Just what explains the reduction in the interest rate sensitivity quarter-over-quarter with the increase in leverage that happen?

Shorter duration of the assets, our asset duration is around three-and-a-quarter years. Our hedge duration is a little bit longer, closer to four years. So in spite of the 74% hedge ratio, we do have the same or slightly better protection, or actually better protection than when you look at the rate shocks last quarter. And with respect to spread shocks, that's the same factor driving that. Shorter duration, we have more leverage, but because the assets are shorter, they're less sensitive to spread changes.

Got it. And then just quickly, do you know – is there any repo rolled over today? Just curious if you give any real time quotes on repo rates?

Sure. Overnight we set it around 230. With the decrease in the Fed funds rate yesterday it's a little bit elevated relative to where it should be all else equal. We would expect it to be about five basis points inside of that level. But we do feel like ultimately as things settle, you will get better repo rates on an overnight basis and a near term basis relative to LIBOR.

Got it. And then just one last question is, Kevin, you about some point reallocating to credit. I mean, how do I look at the sort of trajectory in the next couple of quarters? You said carry might improve on the Agency side. So would do we expect that portfolio to – can it grow leverage to can it grow higher? And at some point if credit spreads do normalize, you go into – you sell some Agency MBS and you're moving into credit. And how do you – what sort of the cadence, the next few quarters of leverage trends and then, allocation?

Yes, I mean, I think you hit on kind of all the levers that we have. We don't necessarily have to sell agencies to allocate more credit. But that is certainly available to us again, given the liquidity agency strategies and the relative valuation are that we could take advantage of. I think the biggest thing for our credit businesses is our pipelines are basically two to three times more full today than they were this time last year just because of the businesses have matured, and they're more seasoned in terms of our origination capabilities and our partnerships. So we have the ability to invest more into credit, frankly we'll do more when it cheapens up. It's as simple as that. The second thing is our credit businesses are virtually they're way under levered, relative to the market. So in terms of earnings power on incremental credit, if we decide to increase the leverage there, and by definition we shrink the Agency book, then the financing of the company frankly becomes more efficient and the returns, which is the goal of this whole thing, this whole model, more levered, higher quality of earnings, more balanced towards credit. But we just can't, we don't want to overstep, given my prepared commentary on what's not reflected in the markets. These credit buckets are relatively very expensive certainly in two of three – two of our three businesses. But at the end of the day, I think, as you've heard us talk before Matt we are pretty much set up for, I feel like we're in the calm before the storm again. And similar to other time periods, like first quarter of 2016, 2018 when we made another acquisition, we're kind of waiting in the wings, we're paying you 10% to 11%…

Right, it makes a lot of sense. And it's nice that you have – I hear you on the strategy and I like the buyback. I guess I'll have to throw in the question. You said that the buyback hasn't quite reached your return hurdles, what point does it, because of all – all the things you mentioned, all these intrinsic value in these other businesses that’s not being recognized.

You can look at historically when we repurchase shares is we’re the first company to put a buyback up in 2012 and we've purchased shares, repurchased shares along the way in 2016. In the first quarter we repurchased about 200 million shares worth, and then a couple of weeks later we bought Hatteras., because of the relative value are between repurchasing stock or buying someone else's stock. In terms of me translating or giving you preview of when or if we buy stock, it's really down to relative value across our 37 options. And if it's more accretive for our shareholders to do it, we'll do it. But right now we have, like I said, pipelines and liquidity that are generating higher cash-on-cash returns than if we were to soon than if we were to shrink the company.

Right. Thank you.

Thank you.

[Operator Instructions] Our next question comes from Rick Shane of JP Morgan. Rick, please proceed.

Hey guys, thanks for taking my questions this morning. Look, I think, what we're hearing is, when we look at the Annaly wheel of choices, a strategic push towards the Agency bucket. David, I think I also heard you say that in the near term the tactic is to be up in volatility, but that might be lower levered returns, in that bucket. You guys show a 10% to 12% range, in the Agency opportunity. Where do you see that playing out as you sort of go through this transitory period of dampening volatility by potentially giving up a little bit of return?

Yes. So to separate Agency from credit, first of all, that 10% to 12%, I would say that over the near term, the third quarter the return is a little closer to 10%, but when we look at the forwards, out the fourth quarter and beyond, that's really when the return on Agency starts to look more attractive. So the range is appropriate but near-term it's a little bit lower over this quarter and elevates after that. In terms of substituting credit for Agency in low returns that I didn't mention, Agency is the liquidity engine in the portfolio. And as Kevin talked about that's where the dominant activity is certainly. But we have reduced our allocation in credit over the past few quarters. And when we look at the portfolio on a broad basis and capital allocation, what risk adjusted returns look like out the horizon, we do feel like we're at the lower end of the range on credit, just given the diversification benefits. And so to the extent we want to maintain the credit exposure, and not simply gravitate more towards Agency. In light of tighter spreads, re-investing is going to necessitate sacrificing some return. But again, where we're at in the business cycle, we're not going to chase yield, we're going to move up in quality except a slightly lower return as we re-invest, run runoff from those businesses, and it will compliment the Agency portfolio, just given the lack of correlation. And then on a total risk adjusted return, we'll have a better outcome as our view.

That's great. It's actually a perfect segue into the second part of my question, which is that when I look at some of your allocations, for example, when I'm looking at your commercial real estate allocation, it strikes to me that one opportunity is for you guys to particularly on the security side, really move up the stack and it seems consistent with your outlook on credit. Should we expect to see, for example, more super senior CLOs more AAA CMBS in that portfolio going forward?

Yes. And Rick, I'm going to hand it over to Tim Gallagher, who heads our Commercial Business and he can help you.

Yes. Hey Rick, it's Tim Gallagher. I think you're spot on with that. We have been doing some of it already and to the degree that spreads continue to tight and assets continue to persist at rich levels. We will look to grow up the capital structure in CMBS, CMBX more liquid products in areas where we feel like we can make the returns that we need to make on a better risk adjusted basis.

All right. Hey Tim and I apologize to my peers for asking one last question, but any exposure to the – what change rules in New York in the portfolio?

No, we don't have any material exposure to that.

Great, thank you guys.

Thanks.

This now 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 joining the call today and for your support of Annaly. We look forward to speaking to you all again next quarter. Thank you.

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