Good day, and welcome to the Annaly Capital Management Fourth Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note today's event is being recorded. I would now like to turn the conference over to Sean Kensil, Director of Investor Relations. Please go ahead, sir.

Good morning, and welcome to the fourth quarter 2022 earnings call for Annaly Capital Management. 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 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. Content referenced in today's call can be found in our fourth quarter 2022 Investor Presentation and fourth quarter 2022 Financial Supplement, both found under the Presentation section of our website. Please also note this event is being recorded. Participants on this morning’s call include David Finkelstein, Chief Executive Officer and Chief Investment Officer; Serena Wolfe, Chief Financial Officer; Mike Fania, Deputy Chief Investment Officer and Head of Residential Credit; and Ken Adler, Head of Mortgage Servicing Rights. 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 fourth quarter earnings call. Today, I'll provide an update on the market and how it impacted our performance, then discuss the macro landscape, our portfolio activity this past quarter and conclude with our outlook for each business as we begin the new year. Serena will then discuss our financial performance, and we are also joined by our other business leaders to provide additional context during Q&A. Starting with the market backdrop, risk assets ended 2022 on a more constructive note, driven by improved inflation data and a moderation in the size of Federal Reserve rate hikes. Given the cumulative hikes delivered thus far, inflation and wage growth are slowing and the decline in volatility has improved investor sentiment and led to fund flows into fixed income. Mortgage and credit spreads tightened from the peak spreads exhibited in October with November representing the best month of excess returns in the history of the Bloomberg MBS Index. The strong finish to 2022 helped drive our 8.7% economic return for the quarter and our economic leverage decreased from 7.1x to 6.3x quarter-over-quarter, attributable to a modest decline in portfolio size as well as book value appreciation. Turning to the macro environment. Following the 25 basis point hike last week, the Fed expects to hike a couple of more times and hold interest rates at elevated levels, subject to inflation and labor market developments. This scenario should make for a more stable environment for fixed income in 2023, with certain risks out the horizon remain. But one, the failure to result the debt ceiling has the potential to cause disruption in markets. And moreover, although inflation is cooled in recent months, these readings offer little information about the medium-term run…

Thank you, David. Today, I will provide brief financial highlights for the quarter ended December 31, 2022, and discuss select year-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. Our book value per share was $20.79 for Q4, which increased by $0.85 per share for the quarter, primarily due to basis timing amidst slower rate volatility. Strong gains on Agency investments of approximately $1.61 per share, contributed significantly to the book value appreciation for the quarter. These gains were partially offset by losses in our derivative positions of roughly $0.60 per share and lower valuations on residential and other investments of approximately $0.14, primarily related to our MSR portfolio. After combining our book value performance with our fourth quarter dividend of $0.88, our quarterly economic return was 8.7% compared to negative 11.7% in Q3. We generated earnings available for distribution of $0.89 per share for the fourth quarter. The $0.17 reduction in AID compared to last quarter is attributable to the continued rise in repo expense and lower TBA dollar roll income due to less specialness. Partially offsetting these factors, however, was the approximately $146 million increase in swap income quarter-over-quarter and a further rotation into higher-yielding Agency MBS. Given the continued increase in financing costs, runoff of swaps and the mismatch between economics and earnings related to futures. All things equal, we currently expect further pressure on EAD in the near-term. Average yields ex PAA were 58 basis points higher than the prior quarter at 2.82% due to the previously mentioned acquisition of high-yielding assets and a further decline in amortization. The factors that impacted EAD are also illustrated in NIM for the quarter with the…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Bose George with KBW. Please go ahead.

Hey everyone, good morning. Could I get an update on book value quarter-to-date?

Sure, Bose. Good morning. So as of weeks in book was up roughly 8% to 9% post payrolls, we've come off just a touch and as of last night up, roughly 7%.

Okay. Great. Thanks a lot.

You bet.

And then talk about normalized leverage. Is the current level of leverage kind of where you're comfortable unless or until things change?

It is for this capital allocation. It's going to be dependent upon how we allocate our capital, but with 67% agency. The other one-third allocated between resi and MSR. We feel good about the level of leverage. We do have the capacity to take it up given our liquidity, but we're very comfortable with it right here, Bose.

Okay. Great. Thanks.

You bet, Bose.

Thank you. And our next question today comes from Doug Harter at Credit Suisse. Please go ahead.

Thanks. Just a little bit more about the dividend. Obviously, book value has been incredibly volatile and just how you kind of think about kind of setting and targeting that 11% to 12% yield on book in an environment like this where book is moving around?

Sure. Good morning, Doug. And look, it's a function of where asset yields are and the leverage we apply. And just to run through it, in the agency market, current mark-to-market levered returns range between 13% to 15%, depending on what collateral we're buying in residential credit, looking at OBX securitization and retained holdings with very modest leverage. We're talking 12% to 15%. And then in the MSR market, unlevered returns around 10%. And so we get to an average yield in the market today of around, call it, 14%, 13% to 14% across the assets and 135 to 145 basis points to run the business, which we think is incredibly efficient, brings you down to that level of 11% to 12% roughly. And Serena, you want to add something?

Yes. And Doug, we've always been really clear that our dividend policy is to set a dividend that is consistent with our historical yields, but also something that we can consistently achieve. And so we do, as David mentioned in his remarks, that we believe that what we've referred to as a very sustainable level, given new money returns that David, just walk through.

Great. And then just one follow-up on the returns you just mentioned, David. I guess, are those the returns that you see at your current leverage? And is there flexibility or risk or opportunity to kind of move leverage up or down over time? And obviously, how that impacts returns?

Sure. There is. So there is flexibility to move it up or down, but that is using the agency market, roughly 8 turns of leverage which is approximately where we're currently levered in the agency portfolio. And just to break it down a little bit in terms of what we're buying. Generally, we're buying production coupons, and we're somewhat barbelled between really low pay up, but what we think to be good quality pools, for example, new production, retail bank service pools with low WACs coming to pay up of just a few ticks, and that's going to get you on a levered basis, a little over 15%, but we're obviously considerate of the possibility of a rally in the sensitivity of production coupons to prepay in a rally. And so we are kind of barbelling that with higher-quality pools. For example, high loan balance collateral and [indiscernible] coupon comes at a cost of about two points roughly, and the levered return on that is around 13%. So you take the average and you get to 14%. In resi, and Mike's done obviously a number of securitizations over the recent past and the retained bonds with around 1.5 turns of leverage and up to that low to mid-teens type returns. In MSR, we currently apply very, very minimal leverage to the portfolio simply a liquidity source. But the fact of the matter is we do have the capacity to lever that portfolio. And when you look at the composition of our MSR and the loan rate, given how deep out of the money it is, that's very different than production coupon MSR from a variability of cash flow standpoint as rates move. The fact of the matter is if rates can move a meaningful amount, you're not going to change the cash flows on that MSR that much. And so all else equal, you're not going to see a lot of price volatility we expect. And so as a consequence, you do have the ability to apply leverage to that, but we currently don't. Does that help?

Really helpful. Thanks, David.

You bet, Doug.

And our next question today comes from Trevor Cranston with JMP Securities. Please go ahead.

Hey, thanks. A question on the MSR market. It seems like there's the potential for a fairly large amount of MSRs to maybe come to market over the next few months. Can you talk about like how you think that will impact the MSR market and valuations overall? And if you think there's going to potentially be an opportunity to deploy a significant amount of capital into bulk MSRs? Thanks.

Sure. I'll start it off, and good morning, Trevor, and then I'll hand it off to Ken. So yes, there is – as I mentioned in my prepared remarks, we do expect a fair amount of supply to come to market. Last year was obviously quite a heavy year, and we took advantage of it. But the supply will continue in terms of how it can impact the market and pricing. We do think there's a lot of capital that is ready, including ourselves. But if you look at our mark for Q4, we did mark our MSR down modestly, and that was a function of that pending supply. Ken, do you want to elaborate?

Yes. I mean just – thank you very much. Last year was record supply for the industry and the flow’s were somewhat balanced, as you can see where much of it went, including ourselves. And 2023 is certainly shaping up to be a higher amount of supply than 2022, and we're evaluating several opportunities, and we're opportunistically going to participate in those. So yes, we're ready. And as Dave mentioned, that was the reason for the mark up.

Exactly. And also why we remain relatively quiet last quarter. It's currently 15% of our capital, which is lower than we like, but we're going to remain patient and wait for the opportunities to come to us.

Yes. Just one last thing. I mean, this markdown, I mean, it's just a pure technical. The cash flows are higher in quality and certainty than they've ever been because of the [indiscernible] of the collateral. So you're certainly looking as a great opportunity.

Great. Okay. That makes sense. Thank you.

You bet, Trevor.

And our next question today comes from Kenneth Lee at RBC Capital Markets. Please go ahead.

Hi, good morning. Thanks for taking my question. Just one on the potential dividend change. Is the assumption there that the underlying economic earnings over the near term is not going to change much. In other words, you're assuming that Annaly is not going to get a lot more aggressive in terms of investment or leverage over the near term even if the rate volatility, for example, were to settle down somewhere in the middle of the year? Thanks.

Well, we certainly could get more aggressive if the market is cooperative. But the way we look at it, again, is based on our current leverage and what returns are, Ken, and that's where we feel the market is offering returns for this business model.

Got you. Very helpful there. One follow-up. You touched upon this in the prepared remarks. Wondering if you just get your thoughts on what you think could be potential implications if the government does not resolve the debt ceiling? Thanks.

Yes. So look, it's very difficult to handicap the implications, Ken, it is something that we should pay attention to. On one hand, the market did rally in 2011. But look, it's a different world right now and you only have to look back to what occurred in September with the U.K. situation on the trust tax cuts, and you saw tenured guilds, for example, sell off 120 basis points based on somewhat of a lack of confidence. And it is somewhat of a precarious circumstance. In D.C. right now, I think we've all seen what's going on down there, and it's a little bit disconcerting. Our base case is that this gets resolved and it's not going to lead to certainly passing the X state without a resolution. But look, we have a contingent down in D.C. currently that is larger than it was in 2011 in Freedom Caucus and they're playing for a different outcome. It's more of a base outcome and even mainstream members of both parties are thinking about the broader country. But it's a little bit uncertain. We do think it's going to be resolved. But nevertheless, there's a lot of – there's a lot of outcomes that could occur. And so that's one of the reasons why we're being somewhat conservative.

Got it. Very helpful there. Thanks again.

You bet, Ken.

[Operator Instructions] Our next question comes from Vilas Abraham with UBS. Please go ahead.

Hi, everybody. Thanks for the question. Just a follow-up on the MSR conversation. So moving forward, would you look to grow that book by allocating more equity or increasing the leverage there? It just sounds like you have some capacity. How are you thinking about that?

Yes. We would expect more equity allocated to it, certainly with the option to apply a modest amount of leverage. As Serena talked about in our warehouse financing, we have an upwards of $1 billion worth of capacity. And so that will remain an option. But generally speaking, it's a liquidity arrow for us in the quiver, and we do expect to add more equity to the sector.

Okay. And then in terms of capital allocation between Agency MBS and resi credit right now, are you leaning one way or another?

Generally, we're a little bit more fond of Agency, our base case, notwithstanding some of the risks out of horizon is that volatility does continue to come down, which would favor Agency. And while housing has outperformed our expectations over the past six months modestly. There is a little bit of risk with the sector, particularly as we do get into the spring selling season, and we'll really see what kind of implications mortgage rates and other factors have on home prices. So we're a little bit cautious, but with Mike's residential securitization business and the acquisition of whole loans. That collateral, we're very comfortable adding particularly given his lending standards and the ability to control all aspects of the acquisition of a loan. So we'll add, but generally, we're marginally favorable towards agency right now.

Okay. That's helpful. And just lastly, on the nonsecuritization market, execution has gotten a lot better since Q4. Just any color that you can kind of add there on just what you're expecting? And are these level of spreads that you're seeing there sustainable and just what could move it one way or the other moving forward here? Thanks.

Sure, Vilas. This is Mike Fania. I would say, yes, I think a lot of what we saw in 2022 was gross issuance in non-QM. It was at $39 billion, $40 billion. It was a record for the sector. So consistent with risk off plus the technical landscape, it certainly pressured the non-QM market pressured non-QM spreads. I think what you’ve seen to start is that there is a high percentage of the market that seems to be pricing in a soft landing, and you're seeing that in terms of list on from probably late October, November, to where we sit today. And then from a technical landscape, supply will certainly be significantly lower than what it was last year. We think supply in non-QM maybe $25 billion to $30 billion this year. So with that, I think investors have realized that there is a scarcity of the asset class. And we've seen spreads now tighten to probably, call it, 150 over on the AAA, whereas the Ys, we were probably mid-high 200s. So we do think that it can be sustainable to the extent of the macro environment.

Great. Thank you.

You bet, Vilas. Thank you.

Thank you. And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Finkelstein for any closing remarks.

Well, thank you, everybody, and we look forward to talking to you again after the first quarter.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.