Good morning, and welcome to the Annaly Capital Management’s Fourth Quarter 2021 Conference Call. All participants will be in listen-only mode. . After today’s presentation, there will be an opportunity to ask questions. . Please note, this event is being recorded. I would now like to turn the conference over to Sean Kensil, Director of Investor Relations. Please go ahead.

Good morning, and welcome to the fourth quarter 2021 earnings call for Annaly Capital Management. Any forward-looking statements made during today's call are subject to certain risks and uncertainties, including with respect to COVID-19 impacts, 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 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 only accurate 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 posts important information for investors on the company's website, www.annaly.com. Content referenced in today's call can be found in our fourth quarter 2021 investor presentation and fourth quarter 2021 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 and update investor presentations and similar materials on a regular basis. Participants on this morning's call include David Finkelstein, President and Chief Executive Officer; Serena Wolfe, Chief Financial Officer; Ilker Ertas, Chief Investment Officer; Mike Fania, Head of Residential Credit and other members of management. And with that, I'll turn the call over to David.

Thank you, Sean. Good morning, everyone, and thank you for joining us for our fourth quarter earnings call. Today, I'll provide an overview of the current macro environment, briefly discuss our performance during the quarter and full year 2021 and close with our outlook for the year ahead. Ilker will then provide more detailed commentary on our investment portfolio, while Serena will discuss our financial results. And as noted, our other business heads are also here to provide additional color during Q&A. Now beginning with the macro landscape, we saw increasingly challenging market conditions in the fourth quarter and into 2022 as the robust performance of the U.S. economy has made it evident that a withdrawal of pandemic stimulus is imminent. Strong consumption and investment activity helped the U.S. economy grow 5.7% in real terms in 2021, marking the best annual growth in nearly 40 years. Meanwhile, the labor market has seen a rapid recovery as employers added 6.4 million jobs last year and the unemployment rate fell to 3.9%. Both measures suggest that the labor market has recovered significantly since the onset of the pandemic. Stimulus measures fueled this rapid recovery, which has also spurred inflation to generational highs as seen in December when the consumer price index reached 7% year-over-year. Although much of this increase in prices was initially seen as temporary, ongoing elevated price gains across various categories of goods and services raise the risk that inflation could persist for some time. Accordingly, current macroeconomic conditions have led to a meaningful shift by the Fed, which now views less accommodative monetary policy is the primary way to ensure parts of its mandate, full employment and stable prices are being met. In addition to an accelerated taper, Fed has begun to signal a larger number of hikes than…

Thank you for the kind words, David. As you discussed, the fourth quarter was challenging for Agency MBS due to a combination of factors. The Fed initiated and then accelerated the taper, which in conjunction with risk of sentiment caused by the virus variant and geopolitical risks led to significant curve flattening and an uptick in interest rate volatility. Mortgage investors, notably banks turned their attention to 2022 without Fed support and decreased the pace of their purchases. MBS underperformance was broad-based across the coupons spec with supply weighing on to , while higher coupons struggled into the curve flattening. Although our portfolio was not immune to these sectors, we had been proactively reducing our MBS based exposure throughout 2021. In fourth quarter, we reduced our agency holdings by roughly $5 billion, primarily through TBA sales, bringing the total 2021 portfolio reduction to $10 billion. Through this resizing, our portfolio construct remains well positioned across the coupon stack. In lower coupons, we continue to favor TBAs, which maximize our liquidity profile and despite the initiation of the taper, dollar roll financing remains special in the context of 30 basis points to 40 basis points. Meanwhile, our specified portfolio is based up in coupon, up in quality and is roughly 4 years season, which should provide resilient cash flows as we shift out of the financing environment and into one debt favors extension protection. In terms of our interest rate exposure, the adjusted hedges towards the front end of the yield curve by selling additional short-term treasury futures, which increased our hedge ratio to 95% of our liabilities. We have also added short-term SOFR swaps, which are an efficient hedge to our repo-funding levels. Our conservative portfolio is integral to managing high volatility market environments like the one we experienced recently.…

Thank you, Ilker, and good morning, everyone. Today, I'll provide brief financial highlights for the quarter and as of December 31, 2021, and discuss select year-to-date metrics. Consistent with prior quarters, while our earnings release disclosures GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP EAD and related key performance metrics, which exclude PAA. As discussed earlier, the last quarter of the year exhibited challenging market conditions resulting from a risk off sentiment over the Omicron variant and anticipation around the initiation of the Fed tapering. Notwithstanding this more difficult economic return environment, we have again delivered solid earnings and ample coverage, approximately 125% of our dividend. To set the stage with some summary information. Our book value per share was $7.97 for Q4, and we generated earnings available for distribution per share of $0.28. Book value decreased $0.42 for the quarter primarily due to lower other comprehensive income of $680 million or $0.47 per share on higher rates and spread widening and the related declining valuations on our agency positions as well as the common and preferred dividend declarations of $349 million or $0.24 per share, partially offset by GAAP net income of $418 million or $0.29 per share. Our multifaceted hedging strategy continued to support the book value, albeit in a more muted fashion this quarter due to the aforementioned spread widening with swaps, futures and MSR valuations contributing $0.16 per share the book value during the quarter. Combining our book value performance with our fourth quarter dividend of $0.22, our quarterly and tangible economic returns were negative 2.4%. Subsequent to quarter end, as Ilker and David both mentioned earlier, we continue to see significant spread widening impacting the valuation of our assets, which is partially offset by the benefit of our MSR investments and…

. The first question is from Rick Shane of JPMorgan.

Ilker congratulations. Look, I just have one sort of conceptual question. Historically, when we looked at the space, environments like we're in now, where there is a very clear expectation of rates moving higher, the actual risk to the industry where people really get carried out is when rates unexpectedly trend lower. And again, I realize this is a tail risk in the current environment, but it's also an important consideration. And I'm just curious, as you're positioning the portfolio, how do you defend against that tail risk?

Yes, Rick, great question. And you're absolutely correct that, that would be a risk should rates move lower. When we look at the forwards, we do see out the horizon, 5 year, 5 year, for example, in the range of around 210 or thereabouts, and we actually do is a little on the low side. So our bias is a little bit towards higher rates. And we've certainly seen them, and you can see it in our hedge ratio and how we're hedged across the curve. But yes, you're right, there is that risk that rates for some reason or another whether it's geopolitical or something unexpected do end up rallying. And as a consequence, even though our hedge ratio is 95%, there is some duration in the portfolio that we maintain for that eventuality, which is right now roughly around 0.5 year. Again, it's not our base case that rates rally from here. We think the forwards are priced relatively well with the possibility of slightly higher rates should the market rally. I think we've managed through that just fine. And it would probably also suggest that a lot of the expected actions on the part of the Fed may be delayed, which might create a little bit of a tailwind for us from the standpoint of earnings as well as even balance sheet runoff out the horizon. So there's a silver lining in that eventuality as well. But we do keep a little bit of duration in the portfolio for that tail risk.

Got it. And look, I realize it is sort of out of the blue question, but it's literally almost 20 years to the day where we saw some mortgage REITs carried out in that scenario, there was a clear expectation of rates heading higher and you got the opposite and it caused immense destruction in the space.

Yes. Exactly. Exactly. Thank you for the question, Rick.

The next question is from Doug Harter of Credit Suisse.

Can you talk about how the Agency MBS portfolio paired with MSRs has performed versus your kind of traditional swap hedges kind of in the fourth quarter in January, just kind of as that is growing as a percentage of your equity allocation.

Yes, it's benefit, obviously, like agency like if the hedging is constructed carefully, definitely like MSR part hedges the current coupon exposure. But as I said, hedges need to be constructed carefully because when you are long agents -- when you are long MSR hedge with mortgages, your curve you have a really big curve steepening. So that part needs to be hedged but hedge carefully that benefited and will benefit.

Yes, Doug, I'll just say that the component of the portfolio of MSR paired with TBAs outperformed the equivalent component of the portfolio of swaps entering TBAs since then. And to your point about capital allocation, we were 5% of capital at the end of the quarter with acquisitions thus far or commitments thus far. In Q1, it brings us up to about 7%. We set a steady state. We'd like to see it around 10%. And we could overweight that or underway that depending on what the environment looks like. But thus far, 2022 is shaping up to be a vibrant environment in terms of MSR transactions. I think there's been thus far, we've seen about $1.5 billion in market value transacted priced thus far this year, and we've acquired about 20% of that.

I guess on that, can you just talk a little bit about who the sellers are and who makes kind of an attractive partner to you for kind of the continued subservicing and good risk characteristics to those.

Sure. Most of the sellers are nonbank originators as we predicted earlier on, and that's materializing, and we are seeing some residual portfolios who bought them for negative duration purposes are selling but a bigger chunk of the sale. And going forward, we expect the greeting of the sales will come from nonbank originators.

Yes, Doug, that was the thesis as we built the operations in-house is that would ultimately be a liquidity need from folks like us with deep reservoir capital to finance MSR on the part of our nonbank originators and what we expect, it is playing out or has played out, and we expect it to continue to.

The next question is from Kenneth Lee of RBC Capital Markets.

Just wondering, at a higher level, could you talk about in terms of adopting a more offensive approach towards investment opportunities. Are there any specific market conditions or macro backdrop factors that you're looking for before you start getting a little bit more offensive there.

Yes, sure. Thanks, Ken. So look, what we've talked about in the past and Ilker talks about every day is when we look for to add agency to the portfolio is the quality of earnings. Now obviously, we're at the lowest leverage point we've been since 2014. And so we certainly have the capacity to add mortgages and what's necessary is to make sure that the quality of earnings associated with Agency MBS is deemed to be high. And that's -- there's 2 components to that. First, with respect to the agency market, is the spread on the agency asset as well as the predictability of the cash flows. Now when we look at the widening that's occurred over the last number of months, spreads are ample in our view and look reasonably attractive. In terms of the cash flow and predictability of the cash flow, the convexity profile of the agency market and our portfolio certainly has improved meaningfully since the beginning of the year. In fact, the negative comeback of the portfolio is down about 30% to 35% with the rate move and at current dollar prices. So from both a spread and a cash flow perspective, mortgages look pretty good. The other element that we have to consider when it comes to quality of earnings is expected volatility, and that has to do with the macro environment and how much it will cost to hedge Agency MBS and that is still yet a little bit uncertain. We got to get more clarity from the Fed with respect to the pace of rate hikes as well as at what point we're going to see balance sheet runoff and what's that really going to look like. And so from a quality of earnings standpoint, the criteria is nearly met or met from an Agency spread and cash flow standpoint, we're still waiting for the macro environment to get a little bit more clear. Does that help?

Yes. Very helpful, very helpful. And then one follow-up, if I may. Wondering if you could just talk about thoughts around how a potential flattening of the yield curve could impact Annaly?

Yes. So always a good question. And I think it's -- our concern over a flattening of the yield curve is, I think, exemplified in the hedging that was done in the fourth quarter and even early into the first quarter. We do have a bias now towards a flattening with respect to our hedges. At 95% hedge ratio, we feel like that's very strong, and we've actually increased it to over 100% since the beginning of the quarter. Part of that is attributable to the fact that we have some swaps rolling off in the second quarter that we wanted to get ahead in, but it's also a little bit defensive. And so from the standpoint of the yield curve and protecting that, we feel like we're in good shape from a hedging standpoint. Now in terms of earnings, those front-end swaps and those front-end hedges will offset higher repo expenses, and that's the design of those hedges. So a flat yield curve is never a great environment for mortgages, but we've hedged it as well as you can I think.

The next question is from Bose George of KBW.

Can you just discuss current returns both on TBAs and pools. And then just talk about what you're expecting for specialness into the back half of the year.

Sure. So current returns improved quite a bit. In pools, you are talking about like a very low doubles at this point, conservatively hedged. On TBAs with still the special rolls, you are expecting like 2.5% type returns, again, conservatively. In terms of specialness of the rolls, it will be highly coupon dependent. For example, like with this recent sell-off, market just skipped the 3% origination. So it moved from 2.5% to 3.5%. So we think that growth, depending on the coupon, will continue to be special, not as special as last year, but there will be pockets of specialness, and we have intention to take advantage of those.

Okay. Great. And then the return on the MSR hedged with Agency MBS. How does that differ from the return just on your -- the rest of the portfolio?

In terms of the return, absolute return, it's not that much different, marginally higher. But again, it's more stable. Like as David was mentioning, quality of the cash flows, if you are pairing mortgages with MSR, quality of the cash flows will be better. But in terms of overall return, especially if we are not levering MSR too much, it will not be that different. And we are again applying too much leverage to the MSR portfolio.

The next question is from Eric Hagen of BTIG.

I think a couple for me. Going back to the hedge portfolio and the short duration swaps. I think I can appreciate wanting to manage to a core earnings figure, but with 5 or 6 Fed hikes already priced into the yield curve, I think the fair value of those swaps should already reflect that. So just going forward, I mean, are there any rebalancing efforts that you take towards that short-duration swap portfolio? And then it's really nice to see you guys to active as issuers of securitization. I would love to hear your view on how you think liquidity conditions develop for securitized assets as the Fed withdraws liquidity.

Yes. So I'll start off and then Ilker and Mike can jump in on the securitization. So look, yes, the market has well priced Fed expectations. We have -- as of this morning, there's 6 hikes priced in for 2022, and we get to 2 more out the horizon. And when you look at what the market's pricing versus what the Fed is priced. The market saying, we get to -- we peak at 2% when you look at OIS this morning at the end of next year. The Fed is saying they're going to get to 2.5% in the long run. So there still remains somewhat of a debate, even though the market over the very recent past has moved closer to the Fed. At some point, we would -- if we think the front end is too cheap, we will absolutely lift it, and I'll bring you back to a point at a similar time, the last time the Fed was entering into a policy normalization period, which was 2014, we had a considerable amount of front-end swaps, and we listed $27 billion in front-end hedges. We're not there yet, but we will be proactive if we do think the front end is too cheap. And to the extent the market gets too far. So yes, we'll manage that actively. And on the securitization question, Fania, you can jump in.

Thanks, Eric. This is Mike. I think in terms of securitization, you've seen some of the numbers that we put out in terms of how active that we've been. And a lot of that is that the capital markets have been conducive to securitizing. So since the beginning of 2021, we've done 13 deals, $5.3 billion in issuance. We've created about $450 million of OBX securities through that. But I think most importantly for us, if you look at year-end, about 80%, 82% of our whole loan portfolio was financed through securitization. If you fast forward to today, about 87% was financed. So we've locked in -- and about 90% of that is fixed rate. So we've locked in a very low 2% cost of funds on our whole loan portfolio. So I think we've been able to be very opportunistic in terms of accessing the capital markets. I think on a go forward, we just went through a year in which there was $210 billion of issuance in the non-agency market. You had to go back to 2019 to have anywhere near that level, and that was about $140 billion. So the market, I think, has done a fairly good job of digesting the technicals of increased supply over the past 1.5 years, 2 years. I think on a go forward, we've built up the investor base for AAA non-Agency investors. But in a market like this, there will be a lot of volatility. AAA spreads on non-QM are probably out 50 basis points since the end of Q3. But I think for us, we remain committed to term financing our portfolio, and we will be opportunistic in doing so. But I think we've done a fairly good job of locking in financing on close to 90% of that portfolio.

The next question is from Brock Vandervliet of UBS.

Just following up on that one regarding non-agency. And clearly, housing -- anything housing related has been a great place to be with the freight train of home price appreciation and up until now, very low rates. There is a school of thought that once mortgages tap around 4%, you're finally going to see some real housing pressure in terms of potentially lowering reducing the purchase market activity. Do you subscribe to that? How are you feeling about the housing market and especially non-QM in the context of higher rates?

Sure. So thanks, Bob. I appreciate your question. I think in terms of higher rates, we've seen the mortgage rate go from a 3.20 mortgage rate at the end of Q3 to about 4% walking in here today. If you look at just an aggregate $350,000 loan size, that mortgage payment is up about $150 given that 75 basis points, 80 basis point increase in mortgage rates. So that's about a 10% increase in terms of the payment. Coupled with home price appreciation being up 18%, 19%, one of the tailwinds that we see within the resi market is potential affordability concerns. I think you have to go back to 2010 to kind of where we're at. However, the QM market, the expanded prime market, about 65% of that market and of our purchases has come from the purchase market. So I think into its sell-out into mortgage rates, what we've seen significant interest from nonbank originators that normally would not have interest in terms of moving towards non-QM and expanded prime given their desire to clean some of that purchase business. So that market is not -- it's not immune to higher rates. However, given that it is a high percentage of cash out and purchase business, we do feel that it will have strength going forward in terms of originations.

Okay. Got it. And just flipping over to the MSR business also clearly seeing plenty of pressure among the non-bank originators, the ramp-up in this business was -- looks very well timed. Can you give us a sense, you mentioned the $1.5 billion I believe in flow, where do you think that could go the remainder of the year? And kind of part 2, what sort of price dislocation are you seeing in these transactions?

Yes, Brock. So it's difficult to predict how much volume there could be this year, but we think it will be elevated relative to years past. And the nonbank origination community has taken up an increasingly greater share of overall origination and these are operating companies, not portfolio companies. And when you look at the profitability of origination right now to get to a cash flow positive point, you do -- it does require selling the MSR. So a lot of it will be determined by origination. Origination will be much lower this year than it was last year, probably half on a gross basis but there's also a lot of stock in the hands of nonbank originators. And a lot of it isn't hedged, and they've done quite well with the sell-off. And so there's some monetization. There's new origination, which will be lower than it was last year, obviously and they'll, in our view, be enough flow to satiate demand. And the buyers have been reasonably competitive. Multiples are -- they're elevated, but the OASs are certainly attractive. The barriers to entry in the sector are quite high, which gives us comfort that we're going to be able to acquire as much MSR as we need to acquire, and we feel like it's advisable for relative value. So we feel like it will be a healthy environment for us for this year.

The next question is from Kevin Barker of Piper Sandler.

So most of my questions have been answered, but I wanted to check in just given the MSR market, I appreciate all the comments you've already given. But are you -- what are the gross yields you're seeing on new MSRs today just given the amount of liquidity that's being allocated to MSRs with rates moving higher. Are you seeing an increasing amount of competition for that asset class, even though nonbanks are increasingly putting more MSR in the market?

In terms of yields, let's say, unhedged, unlevered yields are high single, so which is pretty attractive. In terms of our competition for buying the assets, yes, we are seeing like -- still a residual of the money that has been raised and they have been like bidding into that. But there was also big wire base of buying for the recapture for it so to feed their origination business. So we expect that part of the buyer base will be done. But so far, it's a very healthy environment out of low is coming and buyers are taking a little bit wider spread, so which will be more than welcome. But so far, everything is healthy. S

Next question is from Kevin Heal of Argus Research.

With regards to the MSR portfolio, can you give indication of the WACC at year-end and also what you estimate the WACC, given the additional purchases of $210 million in early Jan.

Sure. Obviously, like we have been buying very low gross with MSR. So our overall growth rate on this entire thing is like below 3%. So as you know, the current mortgage rate is 4% right now, it's well out of the money. The new MSR purchases, so obviously, it's coming from the flow side, it will be around 4% growth rate. But there is plenty of old MSR sitting in the originators books that David mentioned around like low 3s growth rate that we will be competitive in. But our current growth rate on the overall book is like less than 3%, which is like very attractive cash flows right now.

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

Thank you. Thank you, everybody, for joining us, and let's talk next quarter after we wind down this pandemic and everybody stays safe in the meantime.

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