Annaly Capital Management Inc.

Good day, and welcome to the Q1 2021 Annually Capital Management Earnings Conference Call and Webcast. All participants will be in a listen-only mode. If you need assistance, please shoot your 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 the touchtone 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 call over to Mr. Sean Kensel, Vice President, Investor Relations. Mr. Kensel, the floor is yours, sir.

Good morning, and welcome to the first quarter 2021 earnings call for Annali 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 filing. 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 filing. 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, Annaleigh routinely posts important information for investors on the company's website, www.annaleigh.com. Content referenced in today's call can be found in our first quarter 2021 investor presentation and first quarter 2021 financial supplement, both found under the presentation section of our website. Annaleigh 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. Annaleigh encourages investors, analysts, the media, and other interested parties to monitor the company's website in addition to following Annaleigh's press releases, SEC filings, public conference calls, presentations, webcasts, and other information it posts from time to time on its 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 Wolf, Chief Financial Officer, Elgar Erta, Head of Securitized Products, Tim Coffey, Chief Credit Officer, Mike Fania, Head of Residential Credit, and other members of management. And with that, I'll turn the call over to David.

Good morning, everyone, and thank you for joining us today. Back on our first quarter 2020 earnings call, I discussed the conceptual three-phase process for how our portfolio strategy would evolve coming out of COVID. To review briefly, the first phase was about preserving capital and shoring up liquidity, which we did successfully as the crisis unfolded, positioning us with the healthiest liquidity and capital position this company has exhibited in years. Phase two, which characterized the majority of last year, was about deploying capital in the agency sector, which I referred to as the shelter in the storm, while making opportunistic investments within credit, while the Fed and fiscal intervention provided strong support for both our assets and liabilities. We then outlined a phase three, which involved more transformative and strategic reallocation of capital to best position the company in a new environment. We were prepared to utilize our liquidity to benefit from the dislocations across markets and sharpen our strategic focus. Today, I will provide an update on our progress on this third phase, which reflects our macro views and the vision for the company going forward. Following changes to the senior leadership team, including my appointment as CEO last March, was an opportune time to reevaluate certain businesses and revisit our expense structure, while also aggressively building out the necessary infrastructure and personnel to broaden our operational capabilities within residential housing finance. Now, before I go too far down that path, I'll begin with a commentary on the rates market as the price action this past quarter was notable. First quarter was marked by a meaningful sell-off in interest rates as the 10-year note rose over 80 basis points, signifying one of the largest quarterly sell-offs in the past five years. This sharp repricing was driven by a meaningful boost in economic growth expectations, best seen in the Federal Reserve's economic forecast for 2021 GDP growth. While FOMC members had forecasted a strong 4.2% growth this year at the December meeting, they revised their projections up to 6.5% by the March meeting. If realized, annual growth would be the strongest in nearly 40 years as the significant progress made on vaccinations appears to be paving the path out of the pandemic. And at the same time, substantial government stimulus and very healthy consumer balance sheets are also boosting the U.S. economy. Longer-dated rates also reflect the anticipation of higher inflation. Base effects and consumers' willingness to pay elevated prices, given the receipt of stimulus checks, are noticeably lifting prices. Inflation is likely to temporarily rise above the Fed's 2 percent target in the near term, but it remains uncertain as to whether persistent higher inflation will take hold until we see meaningfully higher wages for consumers. In addition, all the factors that have been associated with lower inflation over the past three decades, changing demographics, automation, and increased globalization, to name a few, remain in place, which does reduce the risk of a continued sharp sell-off. That being said, volatility in rates markets suggests that investors are not yet efficient in pricing the economic response to consumer enthusiasm. Volatility should therefore remain somewhat higher as investors learn how much inflation will rise, how much fiscal support the government will offer, and how rapidly the US exits the pandemic. However, any turbulence should be dampened by a Federal Reserve that continues to signal patience when it comes to its monetary policy decisions, despite the strong improvement in the outlook in recent months. Further down the road, the Fed will face difficulties extricating its sizable monetary policy footprint from markets, necessitating any withdrawal to be gradual and well-communicated. While we still see strong tailwinds for agency MBS, which Ilker will expand upon following my commentary, the forecasted strong economy and the interest rate landscape tilts the relative value equation modestly in favor of certain pockets of credit. Our capital allocation to credit rose from 22% to 27% this past quarter, primarily driven by $1.4 billion of gross residential credit investments. I'll also note that the nominal increase in the percentage was in part due to capital optimization decisions for certain credit products made possible by our excess liquidity cushions. Now turning to our strategic activity in the quarter, we announced the sale of our commercial real estate business to Slate Asset Management for a purchase price of $2.33 billion. And we feel the transaction achieves great execution for our shareholders and is a validation of the quality of the portfolio that has been on balance sheets since 2013 and the experience of our team. The rationale for the transaction is best illustrated by briefly revisiting history. Turning back to the environment when we acquired Crexis, bringing commercial assets onto our balance sheet, the Fed was a few months into QE3 and agency MBS looked rich on a risk adjusted basis relative to credit, given the first order impacts of the MBS bond buying program. Moreover, we were still in the somewhat early stages of the economic cycle and could therefore pick up 200 to 300 basis points of excess spread and senior transitional light loans with strong visibility of business plans and top markets. That relationship has sharply reversed over time as the commercial market has seen strong investor interest and record levels of capital raised, which subsequently eroded the compatibility of the commercial platform with our core agency strategy. We had embarked upon an evaluation of the optimal size and structure of the commercial business pre-COVID. But the pandemic required CRE participants to confront the fundamental structural changes in the industry that we expect to occur over time. With the unprecedented support injected in the economy, we had certainty the recovery would prevail. And when the data began to turn, we were well prepared and confident that a sale of our commercial platform would provide the strongest outcome for the company and our shareholders. After a comprehensive exploration and a process to find firms that would represent strong fits for the business going forward, we identified a potential buyer to acquire the platform, including its assets and the majority of the people. In addition to the fixed economics to the buyer, we will maintain a favorable carry profile on the assets until close, mitigating our reinvestment risk. With respect to use of proceeds, while agency may serve as a placeholder for capital returned, considerate of spreads, over time we will rotate the capital across our other investment strategies as opportunities arise. Given the customary closing conditions and regulatory approvals, we're still multiple months away from receiving the capital back from sale, which will be approximately $650 million. The transaction will give us additional capacity to further expand our leadership and operational capabilities across all aspects of the residential mortgage finance market, which has been the cornerstone of Annalie's strategy since our founding. The current environment reaffirms the strength of the housing sector, and we continue to be excited about the growing synergies between our agency and residential credit businesses. Now, the first area in which we're expanding our capabilities is the MSR sector. Previously, we owned MSR via a servicer that we acquired in connection with our Hatteras acquisition and later sold. But our portfolio has been in runoff mode for the past year, and therefore, we've employed a multifaceted approach to investing in the asset class today. We have committed third-party partnerships that we've developed as part of our build-out to own and oversee servicing of MSR in-house, and we have made several key hires with decades of industry experience to lead this effort. Additionally, we've witnessed significant progress with licensing our Onslow Bay subsidiary, established a satellite office, and have begun to grow our portfolio again. We are a complimentary strategic partner to originators because of the breadth of products we can acquire from them and the certainty of our capital as a takeout. This has become particularly useful as the primary secondary spread has contracted, reducing originator profitability, and leading to increased secondary MSR volumes. MSR is highly additive to our prospective returns as a positive yielding hedge to our core agency strategy, while also modestly reducing our agency basis exposure. However, as we have said in the past, in the absence of a severe pricing dislocation, we do not see capital allocated to the sector much above 10% on a run rate basis, given the implied structural leverage and liquidity of the asset. Our view is that MSR is a very attractive ingredient in the portfolio, but the measurements and the recipe require precision in light of potential volatility and risks. Now, additionally, we continue to add to our third party and in-house sourcing capabilities on the residential credit front, which drove the over $450 million of whole loan purchases we saw in the quarter, and our pipeline continues to grow. We also continue to believe that a diversified platform beyond residential is a key differentiator for us, including the optionality embedded in our alternative strategies like our middle market lending platform. Through that business, which has been on balance sheets since 2010, we generate leading returns with cycle agnostic investments. And we'll also retain a $500 million commercial mortgage-backed securities portfolio, which we expect to grow over time depending on pricing and our outlook. And now with that, I'll turn it over to the investment teams to go over our markets and portfolio activity, beginning with Ilker to go through the agency sector and hedging activity.