Good morning and welcome to the Annaly Capital Management Third Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] At this time, I would like to turn the conference over to Sean Kensil, Director of Investor Relations. Please go ahead.

Good morning and welcome to the third quarter 2022 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 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 posts important information for investors on the company’s website, www.annaly.com. Content referenced in today’s call can be found in our third quarter 2022 investor presentation and third quarter 2022 financial supplement, both found under the Presentations 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. Please note this event is being recorded. Participants on this morning’s call include David Finkelstein, President and Chief Executive Officer; Serena Wolfe, Chief Financial Officer; Ilker Ertas, Chief Investment Officer; Ken Adler, Head of Mortgage Servicing Rights; and Mike Fania, Head of Residential Credit. And with that, I will turn the call over to David.

Thank you, Sean. Good morning and thank you all for joining us on our third quarter earnings call. Today, I will provide an update on the macroeconomic landscape, our financial results this quarter, and our positioning heading into year end. Ilker and Serena will then discuss our portfolio activity and financial performance. Now, beginning with the macro backdrop in what continues to be a historically challenging year, the third quarter brought about a further sell-off in the bond market and mortgage spreads widened to crisis era levels. Persistently high inflation readings, rapid and sustained Federal Reserve rate hikes, tightening financial conditions, elevated volatility, geopolitical turmoil, and rising financial stability risks have weighed heavily on markets that have put this in historical perspective, the total return for the Bloomberg U.S. aggregate bond market index was negative 14.6% in the first three quarters of 2022, far worse than the negative 2.9% in 1994, the previous worst year in the history of the index. And in light of the continuation of this difficult environment, Annaly experienced a negative economic return of 11.7% for the quarter. Now, the Federal Reserve has signaled that it is determined to continue tightening monetary policy until inflation approaches its target, a commitment that has been echoed by virtually all fed speakers since Chair Powell’s Jackson Hole speech at the end of August. This has caused a meaningful repricing of the rate path with markets currently expecting the hiking cycle to end at a Fed Funds rate of nearly 5% compared to expectations of just 3.5% at the end of June has led to a sharp sell-off in interest rates and exceptionally high levels of volatility. A consequence of volatility has been extremely weak investor demand for fixed income products, particularly for agency MBS. In fact, the third quarter…

Thank you, David. As you discussed [indiscernible] in the first half of the quarter, interest rate volatility resumed its much higher, risk sentiment turned negative, and agency MBS sharply underperformed interest rate hedges, with spreads widening 25 to 30 basis points. Meanwhile, non-agency spreads also saw considerable volatility throughout the quarter, but ended Q3 roughly unchanged and MSR reservations remained relatively stable. Starting with agency portfolio activity, our holdings grew by roughly $3 billion in market value as we patiently deployed the equity raise during the quarter purchasing meaningful of fewer assets than implied by constant leverage on new capital. We continued to rotate the portfolio of in coupon significantly reducing our holdings of 3 and below, while adding to our positions in [indiscernible], which benefit from lower sensitivity to spread movements and better carry. Our purchases were predominantly imposed and we reduced our TBA holdings by $3.5 billion. During the quarter, specified pools outperformed TBA as investors gravitated toward the better convexity of specified collateral given the elevated volatility. Additionally, with TBA rose softening, pools provide incremental credit across nearly all coupons. Lastly, with the mortgage universe firmly out of the money from a refi perspective, seasonal cash flows are in strong demand. The embedded HPA should provide expansion protection benefiting our portfolio, which is on average over 3-year season. In terms of prepays, our portfolio pays 9.8 CPR in Q3 has slowed down from 14.9 CPR in the prior quarter, primarily driven by high rates. We expect slow prepaid environment to persist over the near-term as seasonal turnover declines and cash-out refinances diminished due to elevated rates and declining HPAs. In our hedge portfolio, we maintained the defensive posture consistent with prior quarters. We added over $5.5 billion notional primarily longer dated swaps to match the expansion of…

Thank you, Ilker. Today, I will provide brief financial highlights for the quarter ended September 30, 2022 and discuss select quarter-to-date metrics. Consistent with prior quarters while our earnings release discloses GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP EAD and related key performance metrics which exclude PAA. Additionally, our per share metrics are adjusted for our 1-for-4 reverse stock split effective in September 2022. Our book value per share was $19.94 for Q3, which decreased by $3.65 per share for the quarter, primarily due to higher rates, spread widening and the continued declining valuations on our agency portfolio, along with lower credit valuations, albeit more modest declines in comparison to the agency book. Our swap in futures position supported book value providing a partial offset to the agency declines mentioned above contributing $6.93 per share to the book value during the quarter and our MSR position added $0.09. As noted in our Q2 earnings call, while our futures book does not offset higher repo rates in the EAD, the derivatives are fully reflected in economic return. And in Q3, they serve their function with futures alone having contributed 60% of the hedge benefit to our book value. After combining our book value performance with our third quarter dividend of $0.88, our quarterly economic return was negative 11.7%. We generated earnings available for distribution of $1.06 per share. EAD continued to outpace our dividend, though we experienced the beginning of the moderation in EAD that we have discussed on our recent earnings calls, with EAD per share reduced by $0.16 compared to last quarter. The lower EAD for the quarter is primarily related to the continued rise in repo rates causing repo expense to more than triple during the quarter as well as lower expected TBA…

[Operator Instructions] Our first question will come from Bose George of KBW. Please go ahead.

Hey, everyone. Good morning. Can I start just asking about mark-to-market book values so far this quarter?

Sure, Bose. Good morning. So, obviously, the turbulence continued into October notwithstanding the fact that we did pick up a few percentage points this week. But nonetheless, as of last night, book was off 6% to 7% at roughly 18.60?

Okay, great. Thank you. And then your current dividend implies a net ROE of around I guess, 17.5ish and is that an attainable economic return on your portfolio? And then just in your comments, you noted the EAD next quarter will be more in line with the dividend, but when you think about the dividend, should we really be focusing more on the economic return versus the EAD just given your treasury futures?

Sure, Bose. And to your point, we discussed this with you last quarter actually economic return or economic earnings is how we think about it. And just to review Serena’s comments as she mentioned, we do expect to earn the dividend this quarter, earnings available for distribution, is moderating. And also to Serena’s point, swap income is becoming an increasing portion of that EAD as short rates are increasing and futures do impact or benefit the economic income or economic return, but don’t flow through EAD. So there is some non-economic factors that may bring EAD down. But nonetheless, to the point of moderation, there are real economic factors that are influencing earnings. For example, as we sit here today, leverage will likely be lower. Financing costs are going up and some swaps are rolling off. So, we do have to take those into consideration. And with respect to the actual earnings yield, as you mentioned, we are right around 18% on quarter end book, it’s above the peer set as it has been really since the onset of COVID and its above where we have been historically. And we will obviously take a look at that as the market evolves and make a determination as to what the appropriate yield should be. And as we have said, consistently, we expect to maintain a competitive yield with the peer set, but also sustainable and in line with our historical average payout ratio. So to give you a summary, we feel good about Q4 we will see how rates evolve over the next number of months. And always look at the dividend in conjunction with a Board and come up with the appropriate payout ratio.

Okay, great. Thanks.

You bet Bose.

The next question comes from Doug Harter of Credit Suisse. Please go ahead.

Thanks. Can you talk about kind of how you’re thinking about leverage balancing, kind of near-term volatility versus kind of the wide level of spreads and kind of what you might be looking for in order to either take up or take down leverage from here?

Sure. So we did take down leverage, somewhat modestly, as we started, the quarter, where we sit today is around six and three quarter turns, and we feel good about it, agency MBS, as well as other sectors we invest in is historically cheap. But also volatility is historically high. And the technical factors associated with agency specifically in terms of Fed runoff and where flows are coming from have also been somewhat negative. So what we’re looking for in terms of how we’re managing the portfolio is that decline in volatility and money to flow into fixed income, and particularly agency MBS. So we’re comfortable with the current leverage ratios – leverage level. Currently, it is elevated to where we’ve been, but at the end of the day, assets are cheap, and we do expect there to be a decline in volatility and with spreads at historically wide levels. We’re certainly comfortable with where we’re at now.

I guess in that construct, with knowing that there is volatility, I mean, why not kind of lean into that leverage kind of creep higher, and sort of take a longer term view and absorb near-term volatility.

So, let’s talk about the last 6 weeks and what we’ve gone through with the market and just to frame out how we’re thinking about things. And, candidly, Doug, there has been virtually no good news over the past 6 weeks for fixed income investors beginning with the Jackson Hole speech in late August where that was probably one of the most hawkish speeches we’ve seen from the Fed in quite some time. And then subsequent to that, we move into September, we get a strong payrolls number. Then CPI ticks up from 5.9 to 6.3, again, not good news. We go into the September Fed meeting where the plots exceeded what the market was pricing with the foreign AAA’s rate at the end of the 2022. Projected as well as, reinforcing that hawkish tone. Then we get into late September, and we have the UK gilt debacle, which led to 140 basis points sell off and guilt over the course of about 5 days, which is for a very developed market, like the UK is stunning. And then the Ministry of Finance intervention and then we move into October was September payrolls showing very strong results 3.5% unemployment rate. As, as well as 5%, year-over-year wage gains, and then following that September CPI at 6.6%, which is obviously, core CPI, which is obviously quite high. And all of this explains I think why we had a trough to peak sell off across U.S. yields of about 120 basis points and 35 basis points wider MBS spread. So, we have to be respectful of all of that. Now, we are sitting here at the quarter end with $4.3 billion in cash and agency MBS unencumbered, but we feel like we want to maintain our liquidity until we get out of this and we get some better news. We do expect things to turn, obviously, the economy, we have seen signs of slowing, but remains resilient with a strong labor market and underlying inflation, which we haven’t seen turn yet. And so we need to really see a term before we would incrementally add to our portfolio. Does that help?

Very helpful. Thank you, David.

You bet.

Next question comes from Rick Shane of JPMorgan. Please go ahead.

Good morning everyone and thanks for taking my question. So, I am very intrigued by the hedge mix on Page 11. And I find it particularly interesting in the context of what we have seen for mortgage rates. And we have had this incredible event, which is that between December 21, and today, we basically reset the channel markers in terms of mortgage rates from a low to a high and those extremes were the lowest and highest in more than 20 years. You have seen your hedge ratio shift or your hedge composition shift fairly significantly. As we approach potentially a peak in terms of mortgage rates, how would we expect this to shift? I am particularly concerned about the swap ratio and adding a lot of duration there in an environment where you might actually start to see speed to pick up at some point in the future?

Sure. So, I am assuming you are asking like, are we hedging too much, are we like, putting like up too many hedges? That seems to be my understanding?

No. I think yes. But I think the real question is, from our point of view, not being as sophisticated at this as you are, how do you mitigate that risk of being over hedged if rates do start to shift? And is that what we are seeing in terms of this mix shift on the hedge portfolio?

Sure. If you look at reasonably the performance of mortgages, you will see a correlation with the rates and the correlation is that hedge rates are low, mortgages underperform. So, we expect this short-term negative correlation to persist. This is opposite of what it used to be in the long run. Usually risk-off days or market rally days, but we are in an environment which David really described like very nicely in the previous question, that we are in a very different environment, that risk-off environments are like market setup and ones. This explains a little bit of our high regulations. But I see your point and we have been looking into that. And the point when we realize that correlation is turning off, we will do the appropriate actions. But to reiterate, we do not take interest rate positions right now. We are trying to fully hedge. And we are cognizant that correlation is on the other side of the system. Does that help?

It does and it’s actually it puts language around some of the things that we are seeing that struggled or we have struggled to explain as well in terms of risk-on, risk-off as well. So, thank you.

Yes. It has been look – this episode has been an environment where risk-off is coming with a great sell off. So, that’s why it is particularly difficult for the financial players in the system that especially that you will hear a lot on the financial news, that 60-40 portfolio and all that kind of stuff. All they are really trying to describe is that this correlation break the other way around and that’s why it is very difficult.

Got it. Okay. Thank you.

Thanks Rick.

[Operator Instructions] And the next question comes from Trevor Cranston of JMP Securities. Please go ahead.

Yes. Thanks. Good morning. Question on the composition of the agency portfolio, you guys have obviously been moving up in coupon as the current coupon has increased substantially over the course of the year. Can you talk about sort of how much liquidity and float there is, say, like above 5% coupons today? And kind of on incrementally what the current coupon where it is, right now, kind of what coupons you would be sort of looking to move into within the agency portfolio? Thanks.

Yes. That’s a good point. The liquidity above 5s which are like 5.5s and 6s are very tend to say effect luck. The movements are so fast that we have been skipping coupons. But David and I have been doing this like over like 25 years. We have never seen that coupons skipping like this. Production coupons skip from 2.5 % to 5% like in very, very short period of time. And not even 5s are $96 price. There is not that much liquidity and apps. And above each of this the wrong word to say. There is not that much float in 5.5s and 6s above. So, that’s why like when we say often coupon, we usually mean 5s and we shifted most of our lower coupon exposure into 5s, and it’s like $96 price. And especially with the concern that Rick was raising in the previous question, we really like that price points $96 to $98 price point. And I think where we stand right now, that will probably be most of our focus going forward.

And Trevor, one more point about market liquidity. I think everybody has heard about some of the dislocations that have been exhibited in markets. And yes, liquidity is constrained, whether it’s treasuries or agency MBS or at the spectrum. But this is largely a function of volatility. And when volatility does subside, liquidity will certainly improve. But nonetheless, you have to be very gentle with your approach to managing fixed income portfolios in the current environment.

Okay, that makes sense. And then one question on the MSR, obviously, valuations continued to move higher this quarter. Can you talk sort of, theoretically, for low coupon, MSR, kind of where you view the cap in terms of valuation? And if there is a point somewhere soon where the duration of it could actually become positive?

Yes. I will start, Ilker can certainly add. We are certainly in the context of that cap. If you just look at the increase in valuation in the quarter, it’s only a 10th of a multiple. And we had roughly 100 basis point increase in rates across the curve. And the MSR CPR went down roughly 30%. So, you are starting to see that crest here in 10th. Ilker?

And your point, I mean look, the cash flows are fully extended. There is only slow the pools can pay, but the certainty of them paying slower continues as rates rise. So, on an option-adjusted basis, it gets more favorable. The other point is, when you own MSR, you manage lots of cash balances. So, as rates rise, you earn the service of the MSR earns more return on those cash balances. So, that negative duration, particularly in the front end of the curve continues. So, there is always going to be that negative duration.

Yes. That float effectively provides more room as short rates do rise obviously. And another point to note in terms of the construction of our MSR, we felt very good about what we owned. We have achieved a lot of growth over the past year. And the overall MSR is 400 basis points out of the money and the credit is quite good. So, with respect to how housing evolves, we think that asset is going to perform very well for us.

And to add to both David and Ken, the discount MSR is like it may not be aging interest rate risk anymore, but it is still hedging the turnover risk in the mortgage market. Turnover risk is the biggest risk if the volatility subsides in the mortgage market. We like where we stand on the discount MSR.

Okay. That’s good point. Thank you.

Thank you, Trevor.

This concludes our question-and-answer session. I would like to turn the conference back over to CEO, David Finkelstein for any closing remarks. End of Q&A:

Thank you, Andrea and thanks everybody for joining us this morning and good luck over the next number of months. And we will talk to you soon.

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