Good morning, and welcome to the Annaly Capital Management Quarterly Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [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 Third 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 and our most recent annual and quarterly SEC filings. Actual events or 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 hereof. 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 post information for investors on the Company’s website at www.annaly.com. Content referenced in today’s call can be found in our third quarter 2019 investor presentations and third quarter 2019 financial supplement both found under the Presentations section of our website. Annaly intends to use our web page as a means of disclosing material non-public information for complying with the Company’s disclosure obligations under Regulation FD and to post an update investor presentations and similar materials on a regular basis. Annaly encourages investors, analysts, the media and other interested parties to monitor the Company’s website in addition to following Annaly press releases, SEC filings, public conference calls, presentations, webcasts and other information it posts from time-to-time on its website. Please 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 and other members of management. And with that, I’ll turn the call over to Kevin Keyes.

Thank you, Purvi. Good morning, everyone, and welcome to our call. As we enter the final two months of this decade and approach the 2020s, I want to reiterate, update and provide commentary on some of the critical themes we highlighted at the start of this year. To recap on our fourth quarter 2018 earnings call in February, we stated that there was "An obvious combination of economic, fiscal, political and macro pressures that will contribute to a shift toward more accommodative monetary policy and we’ve been able to project for a long time." On our call in May I then remarked, "There has been return of flashing red lights across markets with the flattening yield curve and compressed credit spreads, resulting in little differentiation of risk." The volatile summer followed and on our second quarter call in July, I commented "Deteriorating economic data, weak inflation ratings and the unresolved global trade outlook signaling a growing possibility of an apparent earnings recession in corporate America." This provoked the Fed to embark on its first rate cut later that day. Fast forward to today, following a challenging third quarter for which my prior commentary has served to preview, we can now say that the market environment has certainly improved for Annaly for numerous reasons. I’ll give you the top five. First lower funding costs going lower still. Number two, better outlook for asset yields. Number three, the New York Fed’s recent commitment and actions to stabilize the repo market. Number four, the expected slowing of pre-payments by quarter end. And number five, improving repo LIBOR spread as an additional tailwind. Because of this increased visibility, we reaffirm the quarter dividend of $0.25. Against this backdrop of more favorable market conditions and enhanced visibility and policy there are five significant and expanding…

Thank you, Kevin. While the market environment at the onset of the third quarter was relatively calm, an increase in trade tensions in the prospect of a further slowdown in the global economy resulted in volatility picking up meaningfully in August. Longer-term interest rates rallied sharply to levels close to their all time lows, which led to considerable flattening of the yield curve in Agency MBS, exhibited one of their worst months of relative performance in the post-crisis period on a rising concerns over prepayments and hedging costs. Although, September brought some relief as rates retrace partially and spreads were modestly, we did in the quarter with materially lower rates and wider Agency spreads. Amidst this challenging environment, we were able to generate a positive economic return of 1.4% and we ended the quarter at 7.7 turns of leverage. Turning to portfolio activity and beginning with the Agency sector, performance was highly directional with interest rates. Prepayments increased driven by a combination of lower mortgage rates in summer seasonals. And while our portfolio has considerable protection, we were not immune to higher speeds as portfolio of pre-payments increased to just over 14 CPR, but did remain somewhat contained relative to the pre-payment increase in the broader MBS universe. We took a relatively conservative trading approach during the quarter, as we opted to protect book value by reducing assets into volatility and managing leverage coincident with our stock buyback program that we commenced in August. Also on the asset side, we modestly gravitated down in coupon, specifically in TVA’s. Our activity was more focused on the hedging side as we shifted roughly 10% of our swap position to the front-end of the yield curve, which we began prior to the curve flattening and the adjustment also helped to reduce our weighted…

Thanks, David. Beginning with the GAAP results, we reported a GAAP loss of $0.54 per share driven by hedge portfolio losses, which improved sequentially and offsetting mark-to-market gains in our Agency portfolio which run through equity resulted in comprehensive income of $0.11 per share. Book value declined modestly to $9.21 a share and we generated core earnings ex-PAA of $342 million or $0.21 a share. There are a number of factors that contributed to our results this quarter, beginning with interest income. While coupon income increased $0.04 on higher average earning assets, higher pre-payment speeds resulted in approximately $0.06 of additional PAA adjusted premium amortization. Higher amortization expense was due to projected CPRs increasing quarter-over-quarter, as David that just noted a moment ago. Additionally, drop income declined $0.01 sequentially and higher average repo balances added another $0.01 to interest expense. Our operating efficiency metrics improved on declines of both management fees and other G&A. The dislocation between repo funding costs and LIBOR that we’ve discussed in prior calls remained the factor once again this quarter, while our average repo funding cost declined 13 basis points, LIBOR-based reset on the receive leg of our swaps declined on an average basis by about 25 basis points. This dynamic also impacted NIM and net interest spread as lower rates, coupled with the higher premium amortization, as I just mentioned, drove asset yields lower to a greater extent than the decline in our funding cost which have lagged Fed reduction in rates. Looking forward, we expect CPRs to peak in early Q4 and anticipate lower funding costs and wider agency spreads to more than offset this impact, contributing to NIM and net interest spread improvements of 10 basis points to 15 basis points. Turning to the balance sheet, assets declined roughly $3 billion, primarily…

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Rick Shane with JPMorgan.

Hey, guys. Thanks for taking my questions this morning. Look, if you head into Q4 and into 2020 you make a compelling case that margins are going to improve that this is a trough in earnings and we definitely see that in the trends as well. I am curious when you think about this, not on a pure return basis, but on a risk-adjusted return basis, and I know that’s more qualitative in terms of thinking about risk, but when you think about things on a risk-adjusted basis, how do you feel about the operating environment?

Hey Rick, I think our comments are meant to be constructive and positive, but measured. First of all, I think the way I would answer that in a Reader’s Digest version on a risk-adjusted basis and it’s a very good way is to how we look at our capital allocation models across four businesses. I think it’s fair to say, we anticipated what was going to happen and happened and I think going forward pursuant to our commentary, risks are lower and returns could be higher, predominantly in the Agency business. I think in the credit businesses, what we’ve demonstrated is, we’ve done about $4 billion of credit in the last couple of years across the businesses. On a risk-adjusted basis that I think has been demonstrably better than the market, albeit, it’s not necessarily reflected in the numbers yet, because there hasn’t been a credit contraction or credit hiccup or sell-off. So all that being said, we are bit different because we have these four businesses that are complementary and combined. So credit, I think to David’s point still is quite tight, but we’re finding 12%, 13% returns at 2 times leverage, which is very attractive even versus Agency business, which has become a lot more favorable. So I think going into the four quarter, the reason we’re maintaining the dividend and the reason why we are constructive on the outlook is that we see the portfolio’s long-term earnings potential, not just stabilizing, but returning really to the levels that we anticipated earlier this year. And I think the bogey for us, the attractive kind of call option for us is what happens in credit, because I think we’ve basically been firing on two of our four cylinders here. And if there is a corruption or if there is a disconnect in any of the credit businesses, we’re capable of capitalizing like nobody else. So and that’s on top of again the Agency business that we think is a lot more attractive today certainly than it was over the summer.

Got it. And in that spirit look, if you look at the leverage – the economic leverage on a headline basis, it’s ticked up a turn year-over-year, but if you – in the idea of sort of risk adjusted, if you look at the allocation to equity to credit going down, I would argue that there is actually less risk in terms of the increased leverage than the number would suggest. Headed into this sort of environment in Q4 and into 2020, are you comfortable taking leverage up given the current allocation to credit?

Hi, Rick, this is David. So to your point about leverage ticking up as a consequence of shift further towards Agency, that is correct. Agency is obviously more levered. So as we make that shift, you’ll see more leverage in the portfolio as you have. Another point to note over the past year is to my comments in my script, the Fed has shifted to a more accommodative approach, not just in terms of short rates, but also very recently as we’ve seen their intervention in the repo market and Agency being a balance sheet intensive product does give us more comfort with respect to having a higher levered portfolio. Now going forward, we think we can generate the returns that we feel is practically prudent with the current level of leverage, but should things change or should we shift our capital allocation back towards credit if things cheapened and they may go down or if there is an opportunity that we really think Agency leverage could go up or leverage go up by increasing our Agency exposure we would do so, but we’re not there right now.

Rick, what I would just also offer and it ties to your first question, risk-adjusted returns, what we also – what we really look at is core ROE per unit of leverage. And if you look at our – if you just take a look at our numbers, if you analyze our core earnings year-to-date per unit of leverage, we have a higher return than the sector by far by using less leverage. So that’s the output of this model is designed to produce better or higher returns with lower leverage. And to me that’s part of your risk-adjusted equation and overtime, really the last five years, we’ve been – if you look at that measure, historically, our core ROE per unit leverage is about 30%, 35% higher return with 30% or 35% lower leverage. So there is – that’s the big part of how we balance out where we put our capital.

Got it. Hey Kevin and David, thank you very much.

Thanks, Rick.

Our next question comes from Kenneth Lee with RBC Capital Markets.

Hi, thanks for taking my question. Just a follow-up on the equity capital allocation. You mentioned in the prepared remarks, that allocation towards credit assets is closer to the lower end of the range right now and Agency is closer to the higher end, but just wondering, looking forward to the near-term, given the current investment opportunities and the macro environment. How do you see that evolving, could we see material shifts more out towards credit if pricing changes, I just want to get a little bit more thought about that?

Yes. Ken, it’s really – it’s pretty basic, right now on a relative value basis, risk-adjusted basis, Agency is cheaper than credit. So that’s where you see our portfolio reflecting that in terms of our capital allocation being higher towards Agency than it has been in the past few years. It will shift when credit gets relatively cheaper relative to Agency. So that’s a – on the part of our model, which is shared capital and by definition, risk management, is that we don’t put – we don’t have to put our money to work in everything or in any one thing, so we measured every day, every week. When credit is weaker or weekends or we find a deal in credit that is on a risk-adjusted basis more attractive than Agency, then we will steer our money that way. The way I always answer the question also is what does it take for, if there is a correction on a reset in credit, what would our mix look like and the efficient frontier for this company given the efficiency of our operations is that we could be 50/50 credit-agency in terms of capital allocation without really having to invest in the infrastructure here. When I said in my comments, we paid it forward. We’ve set this Company up to grow in many different ways, and especially in credit, when we do see that retraction in the spreads.

That’s very helpful.

Yes. And I would just say to the point about being at the lower end of the credit spectrum and capital allocation in efficient frontier. We do have to strike the balance between smoothing both volatility and earnings. I mean we are a late cycle in credit, the spreads are relatively tight. We do have enough organic origination through our three businesses that certainly maintain our credit exposure in quality assets, but we’re not price takers in credit by any means. We’ll do what we do and to the extent there is an opportunity to add through cheaper spreads, we will, but we’re not chasing anything.

Got it, very helpful. And just one follow-up, if I may. I’m wondering, I want to get some of your thoughts around your capital position and specifically, available capacity for making investments going forward? Thanks.

You’re saying with respect to the increasing leverage, or making larger capital investments with our liquidity?

Yes, I guess, either potential to – potentially increased leverage or utilize, other like for example, the unencumbered assets, just wanted to see the interplay between them and how do you view, how much you could actually use to deploy capital in potential investment opportunities?

So Ken, the headline answer to that is yes, yes, and yes. I mean we have, I would argue to this model, not just more. There is three things, more options to invest in the four businesses. Number two, more financing availability and options for the four businesses. And number three, our liquidity and capacity towards most in the sector. So the reason we’re not kind of fully amped up across the businesses in terms of leverage is that it’s been a – so the point on the other question about risk-adjusted returns, it’s been a higher risk market across the board. Now what we see going forward is lower risk in Agency on a relative basis and we’re picking our spots and credit. But our liquidity really is our mode, it’s our advantage and frankly, the sources of that liquidity, we have 10 different ways we finance our businesses non-recourse, which nobody else has. And that’s the reason we built this platform, the way we did. So going forward, you’re going to see the lag effects catch up for us. Meaning, our weighted average cost of funds will continue to go down in the fourth quarter and beyond. So the cost of financing is going up and yet, we still haven’t drawn down on a lot of our capacity in any one of the businesses. So we’re – we think we’re paying you pretty good cash-on-cash return to weight for a capital appreciation event or the next bigger event in terms of an acquisition or portfolio lift or some other strategic direction that we are – that’s why we are – that’s why we maintain the liquidity position that we do.

Great, very helpful. Thank you very much.

Thanks, Ken.

Our next question comes from Matthew Howlett with Nomura.

Everyone, thanks for taking my question. Just to reiterate, did you say 10 to 15 basis point improvement in 4Q in the margin?

Yes, we did.

Okay. And then I mean does that when you look at further is that something that’s sustainable. And when you look at sort of new purchase yields and you can finance them at. How should we think about the stability? You did a good job really aligning, what the headwinds were in the third quarter and they should normalize in fourth quarter, is that – you think things will stabilize on that or could they get better, or could they get worse? And I know, you don’t have a perfect level, but I just want to hear your thoughts?

Yes, I mean obviously we don’t have a crystal ball as far as what’s going to happen overtime, but we are very confident in what we’re seeing in terms of trends with respect to our funding cost and the benefit will have on both NIM as well as net interest rate.

Great, okay. And then, Kevin, I just want to follow-up on your positioning and a lot of – you’ve probably seen a lot of REITs moved into this operating model, I know you said you’re not price takers here in this market. When you look at buying an originator or becoming more of an regional. How do you see things playing out and you’re looking at everything here?

It’s a good question. Annaly looks at everything and we have, I think thankfully, we see a lot of the mortgages, because of the ecosystem of these businesses, right. In terms of origination, we do – we see everybody, we have great relationships, right now we’ve chosen to maintain our joint venture and partnerships that I described in my prepared comments. And look, we do the math and the math is definitive for us that we can produce X billion of assets from an origination partnership at 20% to 25% of the costs, meaning 75% cheaper, because we’re are not – we don’t have the people, the systems, the infrastructure needed to run a conduit to originator and have all the bricks and mortar around it. So, the math says that we are accessing these assets 75%, 80% more cheaply than those that are producing it on their own. So that’s beneficial for incremental returns here. And as we see that business grow and it’s been one of our higher growth businesses and we will continue to be to my comments. The point here is, I want to grow, not necessarily just in size, but I have seen return on invested capital. So incremental business that push through our residential platform should be higher margin business for us, the more we do. So we’re getting to that scale, we’re at that threshold now where those returns, albeit, all things being equal in the market, those returns should even get better. Now that being said, if there is a partnership or a platform that we would like to lock up in terms of proprietary relationships and have an investment to do that, by all means, we’re open to do that because we – that’s another way to – just to take a lot of flow, and secure more tangible definitive flow on top of what we have. But what we have is producing some really good growth as you’ve seen.

Well, I’ll certainly say I see you’re buying back stock and recognizing the value in the platform. Long-term, does it makes sense, I mean given those businesses combined, I know you’d like to sort of reference the shared capital model. Or do they need at some point to be sort segregated given the high returns and some of the premiums that are applied to other peers?

Yes. The some of the parts, we think we’re undervalued today, but long-term, I think especially in these markets where I don’t think you get paid to take excessive risk or get paid to do quarterly trades or things could go sideways on you quite quickly. So we think the sum of the parts here – the value for our shareholders, is really safety, and these businesses together churning out the complementary cash flows that they churn out, it’s more seats for them all to be collectively together. Now, as these have grow and it’s more efficient and lot of liquidity and everything else – every business benefits from each other. Look if there comes a time and I mentioned it, I think couple of quarters ago, if the some of the parts becomes more obvious, and there is an arbitrage ability for us to take advantage of some are, whether we sell assets or spin off a business or carve out of company, we’re prepared to do that. All these businesses are run and accounted for independently under one very tight umbrella. So it’s a call – another call option in owning our shares is that potential. But I don’t see anything coming down the road, because we are frankly focused on efficient growth with returns on invested capital, which are higher as one company versus one of these companies was on a stand-alone basis.

Good. Thanks for the comments, Kevin.

Thank you.

Our next question comes from Eric Hagen with KBW.

Hey guys. Thanks, good morning. I had a question on the originator as well and I think you answered that really well. I’ll just add that it’s been exciting to watch you guys issue some securitizations and get those deals done so congrats. Just a couple of housekeeping items, I guess, I think this is for you, Glen, is there a sensitivity that you can give us to the level of premium amortization that corresponds to a change in your CPR assumption in either direction?

Yes, it’s a really complicated set of calculations in terms of how the whole PAA adjustment works. I think the simple way of looking at it is to look at what the prior quarter’s projection was and how that compares against a future. In other words, we’re trying to reset it back to that prior period. I can tell you that based on where we see pre-payment trends currently, we would expect on a PAA adjusted basis amortization expense to be roughly equivalent next quarter as far as what we see – or what we had experienced in Q3.

Okay. That’s helpful. And then where in the coupon stack are you guys reinvesting run off in the Agency portfolio and on the dollar roll side, I see that you guys have a net long position in TBAs around $11 billion. But are you short any roles? That’s the question. Thanks.

Sure. Eric, with respect to where in the coupon stack, we do have a tilt toward higher coupons, but that being said, I’d say that we still do think that in spite of elevated pay ups loan balance paper is still very attractive. You know the way we look at TBAs versus pools is. TBAs are benchmark and they are relatively cheap benchmark and pay ups have obviously increased quite a bit, but they’ve reached to achieve benchmark. So when you look at pools on a cash flow basis and the spread relative to financing and hedging costs, reasonably well protected pools are still certainly attractive to us and we are certainly maintaining our exposure in higher quality pools, but we’re also sensitive to the value associated with lower pay of pools. For example, you can distinguish between servicer and how much third-party origination in gross WACC. And you actually can get real value relative to that very cheap benchmark with the pay ups are somewhat low. So your question about TBA and the roles. In the third quarter, we did not have short positions, as has been discussed, higher coupon rolls did trade negative. Our view was that higher coupons rolls were also relatively cheap and their performance, TBA performance, in the third quarter on a curve adjusted basis was relatively strong. So we think that was a good decision not to be short TBAs in the third quarter. However, since higher coupons have performed reasonably well since August, we have exited to some short TBA positions in higher coupons, given the fact the we always do persist in a negative drop. So we do have a small amount of short positions in TBAs.

Got it. That’s helpful and then just to kind of pin you down on the coupon question, just run off is going into 3s and 3.5s and mostly 3s, I mean just give us a sense for…

Some 3s and 3.5s. I would say, but we have 70% of the coupon exposures in force 4s and 4.5, so we’re not reallocating there.

Got it. Thank you very much.

You bet.

[Operator Instructions] Our next question comes from Douglas Harter with Credit Suisse.

Thanks. I was hoping you could help me understand kind of the big drivers of kind of the earnings volatility over the last 10 quarters, kind of almost four years of kind of stable earnings and kind of what changed so much over the past few quarters to introduce more volatility into earnings?

Sure. This is David. I’d say there is a couple of factors heading into the spring and summer, we did have some swap run-off of some lower fixed rate payers that did run off in the second quarter, which caused earnings to go down somewhat in the second quarter. And in the third quarter it was predominantly attributable [indiscernible] associated with pre-payments. But that being said, when you consider the third quarter versus the fourth quarter, I think it’s notable that we got essentially 80% of one Fed cut in the third quarter. If we look at the fourth quarter, we’ve now have three cuts from July September and October to where the weighted average is two and two-thirds rate cuts for the fourth quarter, and so we do think that will be the predominant tailwind that will equate the third quarter to a trough.

Great. And then I guess just looking forward, kind of – as we get through the fourth quarter and you get those rate cut benefits. I guess just how do you view your earnings stability going forward. Are we likely to go back to kind of the prior four years of stable earnings or do we think we’re in a period that this volatility in earnings is going to continue?

Look, our outlook right now is a lot more constructive, Doug. And when you look at our stability, right, the last four years, our core earnings variability has been 24% versus the sector – and REIT sector’s core earnings variability was a 111%. So, which is five times more volatile. You know the yield factor that I always quote. In terms of the broader market for companies and other industries that produce income, their variability is about 60% or three times more volatile than us. So we have proven over time that we’re more stable and there is no reason to believe in our outlook that we can’t maintain that stability with this model, to David’s point and Glen’s points, protecting book value sometimes you sacrifice earnings in order to maintain the portfolio and the earnings potential going forward, and that’s what we’ve done. And the outlook, I think on a risk-adjusted basis to start the Q&A. I think we feel a lot better, albeit we never feel good about anything as we’re defensive yield stock. So look, this model more than any other is built for stability and not again for our quarterly trade or a short-term outlook. That’s why I talk about the next decade. And we about the big macro influences and GSE reform. Thanks retreating and PE, PE meeting Switzerland in terms of lending to them. So you, I think we’ve not only made it through the trough of one quarter of earnings. I think we’re looking forward to frankly more volatility in different parts of the market that we’re prepared to take advantage of than others aren’t. And then, that’s when we can start firing on all cylinders and that’s what we’re looking for.

Thank you.

Thanks, Doug.

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

I’d like to thank everyone for their interest in Annaly and for joining the call and we will speak to next quarter. Thanks everyone.

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