Annaly Capital Management Inc.

Good morning and welcome to the Analy Capital Management Second Quarter 2020 Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Porvi Kamdar. Please go ahead.

Thank you. Good morning and welcome to the second quarter 2020 earnings call for Analy 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 findings. Actual events and results may differ materially from these forward booking 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 relief. As a reminder, Annaleigh routinely posts important information for investors on the company's website at www.annaleigh.com. Content referenced in today's call can be found in our second quarter 2020 investor presentation and second quarter 2020 financial supplement, both found under the presentation section of our website. Analy intends to use their webpage as a means of disclosing material, non-public information, for complying with the company's disclosure obligations under Regulation SDE, and to post and update investor presentations and similar materials on a regular basis. Analy encourages investors, analysts, the media, and other interested parties to monitor the company's website in addition to following Analy's press releases, SEC filings, public conference calls, presentations, webcasts, and other information it posts from time to time on its website. Please note, today's event is being recorded. Participants on today's call include David Finkelstein, Chief Executive Officer and Chief Investment Officer, Serena Wolfe, Chief Financial Officer, Mike Fania, Head of Residential Credit, Tim Gallagher, Head of Commercial Real Estate, Tim Coffey, Chief Credit Officer, and Ilker Ertas, Head of Securitized Products. And with that, I'll turn the call over to David.

Thank you, Porvi, and good morning, everyone, and thanks for joining us on our second quarter earnings call. Today, I'd like to highlight a number of current corporate initiatives, provide an update on the market and discuss portfolio activity across our four businesses during the quarter, and finally, provide our outlook for the balance of the year, and then I'll hand it off to Serena to discuss the financials. Of note, while last quarter each of our credit leaders provided an in-depth look at their respective markets and portfolios, To be efficient, I'll provide those updates today, but as Corby noted, each of our business heads are here as well to join in Q&A. Now to begin with, I wanted to touch on a few strategic and corporate actions we've taken as of late. At quarter end, we closed our previously announced internalization transaction, which marks a significant step in the series of measures Annaly has implemented as an industry leader from a governance standpoint. As an internally managed REIT, we look forward to demonstrating increased transparency and alignment with our shareholders who will benefit from our ability to be more nimble in the way we do business in order to generate long-term value. We also announced two leadership changes. Steve Campbell was appointed as Chief Operating Officer and Glenn Botech will retire from his role as Senior Advisor at the end of August while remaining a director on our board. As COO, Steve will expand on the work he has been doing as head of business operations and work closely with the executive team to help oversee Annaly's overall operations and risk management functions. Len has been an invaluable part of our leadership team and we thank him for his numerous contributions over the years and look forward to his continuing service on our board. Additionally, during the second quarter, we utilized our share buyback program and have now repurchased $175 million in common stock here to date. This underscores our belief that the stock is undervalued relative to our book value and affirms our support of the value of our stock through the various capital allocation tools we have on hand. These initiatives are a testament to our focus on driving shareholder value, ensuring that the firm as a whole, our structure, as well as our portfolio, is positioned to continue outperforming as our second quarter results demonstrate. Following one of the most challenging and unforeseen operating environments in ANALY's history, we were pleased with our performance during the second quarter. We delivered an economic return of nearly 15% and achieved core earnings well in excess of our right size dividend. Our measured approach to weathering the crisis served us well, and we feel very good about our positioning as the recovery progresses, as I'll get into in more detail. The economic slowdown brought on by the pandemic has obviously created considerable uncertainty and this is a different kind of recession than that which we have experienced in the past given the unprecedented speed and magnitude of the downturn. Social distancing and mandated shutdowns have damaged certain sectors of the economy and the corresponding impact on the labor market has been substantial. There have been some signs that the worst of the economic distress may be behind us, although the recent surge in cases in some areas of the U.S. demonstrates the fragile nature of the recovery. Nevertheless, financial conditions have improved considerably. The market dysfunction that occurred amid the initial COVID outbreak in the U.S. has dissipated, and we have seen significant improvement in liquidity and asset pricing. This is in large part due to the ongoing decisive actions taken by the Federal Reserve which have been successful in restoring markets and easing credit strains. Liquidity tools have sufficiently supported funding markets. The credit facilities have opened channels to credit for businesses, households, and local governments. The temporary adjustments to regulations have somewhat encouraged bank lending. And most impactful to Analy's portfolio, the asset purchases have supported the smooth functioning of treasury and agency markets. Now turning specifically to the agency market, the Fed's purchase in upwards of 850 billion MBS in just over four months has dramatically altered the supply and demand picture for the sector. After a pace of purchases at the height of the volatility that reached nearly 50 billion per day to help stabilize the sector, the Fed has transitioned to a steady run rate of 40 billion per month net of portfolio runoff, which on a gross basis equates to roughly 40% current agency issuance. That is largely taking delivery of the most negatively convex MBS, which has resulted in a shift of the TBA deliverable across production coupons to more newly originated pools. And as a result, nominal carry on production coupon TBAs has improved dramatically, thereby adding to returns for TBA holders. Given this dynamic, we increased our TBA position in the quarter and gravitated further down in coupons. Lower coupon holdings are predominantly in TBAs, and higher coupons are concentrated in specified pools in light of the meaningful elevation in prepayment speeds in this environment. While our portfolio speeds did experience an increase on the quarter, prepays on our overall portfolio were notably lower than the GSE universe, which paid roughly 8 CPR faster, despite the higher average coupon of our portfolio relative to the universe. With respect to our hedges, we added to our swap portfolio. Primarily in the front end, the short-term swaps with pay rates close to 0% provide an attractive hedge to our financing. This reduced our pay rate as well as shortened the maturity of our swap portfolio. We further reduced the LIBOR footprint of our hedge portfolio with our swap book now 80% in OIS, and we reinitiated our Treasury futures short position that was unwound in the first quarter. We also continue to take advantage of the attractive low levels of volatility to hedge the tail risk of the sharp rise in rates in the long end of the yield curve. And as such, we replaced much of our legacy swaption position with additional out-of-the-money payer swaptions. Shifting to residential credit, the sector saw significantly more activity as market dynamics began to improve following the crisis. The housing market remains strong given long-term positive fundamentals, which we believe will help the ultimate recovery. We're experiencing a meaningful imbalance between supply and demand as the cyclically low number of housing units meets continued strong household formations. And anecdotal evidence suggests that pandemic disruptions have had limited impact on the home buying and refinancing processes. Non-agency securities across Legacy, CRT, Jumbo 2.0, and Non-QM have seen substantial recovery. Improvement signals that the market currently believes that the majority of forbearance cases, which have stabilized over the past couple of months, will ultimately be resolved. However, non-agency lending has been somewhat slow to redevelop. as credit standards have tightened relative to pre-pandemic underwriting and mortgage originators tend to be focused more on agency originations in light of fewer frictions in a wide primary secondary spread. A residential portfolio was roughly unchanged quarter over quarter at 2.6 billion as modest purchases and mark to market increases largely offset sales and portfolio runoff. Securitization markets started to show signs of life in mid-May and we issued nearly $500 million of expanded prime securities earlier this month subsequent to quarter end. Aggregate issuance under our OBX shelf has now reached $4.5 billion across 11 transactions since 2018. As I mentioned last quarter, we expect to see more growth in this segment as markets continue to normalize and we are encouraged by the steady pace of securitization activity to support our asset generation strategy. In the commercial sector, we're slowly beginning to see activity pick up, but volumes do remain somewhat muted. June, however, did bring about an increase in new refinancing requests with some new acquisition activity at post-COVID purchase prices. And simultaneously, we have seen a significant number of warehouse providers begin to close new loans, although pricing levels have been reset higher. Across sectors within commercial, the operating fundamentals remain challenged in hospitality. as the average national occupancy rate hovers around 40%. And in retail, the prolonged shutdown and increasing number of retailer bankruptcies is continuing to weigh on that sector. On a more positive note, multifamily remains strong throughout the quarter as the latest data indicates over 90% of renters made a full or partial rent payment as of June. And in the office sector, although new leasing has slowed significantly, Office REITs have reported strong rent collections above 90% throughout the back end of the second quarter. With respect to our CRE portfolio specifically, total assets at quarter end of $2.5 billion represented a slight decrease while economic interest remained essentially flat. The decline in portfolio size was driven by approximately $53 million in loan payoffs as well as security sales. On the financing side, our weighted average cost of borrowing decreased by roughly 60 basis points to 2.7%, driven largely by a reduction in LIBOR given Fed cuts. Overall, we feel good about the conservative positioning of the portfolio across sectors and the strength of our relationships with best-in-class sponsors and operating partners to mitigate any further disruption. Shifting to middle market lending. Activity has also picked up as of late as spreads have tightened and sponsors have refinanced transactions that have exhibited improving underlying leverage profiles. New Deal activity is primarily relegated to more broadly syndicated loans, however. For context, first lien executions on larger transactions have tightened 75 to 100 basis points over the past quarter, while traditional middle market has shown less movement in pricing. Unitranches and second lien loans within middle market are experiencing more notable price discovery than its larger market brethren, and we expect these gaps to remain as traditional middle market participants grapple with their portfolios. Consistent with our communication last quarter, we continue to speak actively with sponsors, borrowers, and agents to closely monitor performance. Despite the challenging environment, we are pleased with how the portfolio has performed during the period, ending the quarter essentially unchanged at $2.2 billion in assets. As we gain further clarity around the long-term implications of COVID, we are reassured by the stable and defensive nature of our portfolio and remain confident in its ability to withstand prolonged bouts of market volatility. We believe our focused industry-specific positioning within non-discretionary, defensive, and mission-critical names will generate the outperformance versus peers that will further differentiate our brand in the sector. In fact, some of our industry concentrations have materially benefited from the current environment. For example, government mandates at all levels have created an even greater dependency on technology, while also driving demand and behavior in ways that has made once boring annuity businesses into growth sectors. The portfolio construct has been protected against broader sectors that have witnessed demand destruction, and we maintain meaningful exposure where pockets of spend remain resilient. Now, with additional note with respect to our direct lending portfolios, we have taken what we believe to be a very conservative approach regarding reserves and CECL adjustments, which Serena will discuss in further detail. Finally, shifting to our outlook, as we think about our capital allocation out the horizon, we've been focused on preserving flexibility given uncertainty in the greater economy related to the COVID shutdown. We maintain the view that the agency sector represents the most attractive investment opportunity currently, while also providing strong liquidity. We have entered a more normalized environment with Fed actions serving as a key driver. MBS spreads have retraced much of the widening experienced in March. We do remain positive on the sector given ample funding availability at low rates, subdued rate volatility, and a complete reversal of an inferior technical backdrop that characterized the sector at the outset of this year. While our allocation agency may increase modestly, we do continue to evaluate opportunities to deploy capital across our three credit businesses. And we are beginning to develop a better lens into how each credit sector is evolving, and we expect to shift to a more offensive posture in the coming months as we gain more clarity on the economic and real estate landscape. We were certainly careful to take prudent steps during the early phase of the market recovery to ensure we are well positioned to capitalize on the opportunities that are sure to arise. And as part of our preparation, we have chosen to be conservative with our leverage as well as our dividend. Our goal has been to maintain optimal liquidity thresholds and to manage the portfolio within conservative risk parameters to produce the highest level of quality earnings in this market environment. Consequently, we reduced leverage during the quarter from 6.8 to 6.4 times and made the prudent decision to set our quarterly dividend at 22 cents. The dividend represents a 10.5% yield on our book value, which is in line with our historical average while being competitive relative to our peers and various fixed income benchmarks. As I mentioned, we out-earned the dividend by five cents this quarter and absent another market dislocation or other unforeseen developments, we expect Q3 core earnings to also exceed the dividend. Overall, we maintain a more constructive view of the operating environment and our ability to deliver compelling returns as each of our businesses' respective sectors begins to emerge from the initial volatility and disruption caused by the pandemic. and now with that I'll hand it over to Serena to discuss the financials.