Annaly Capital Management Inc.

Good day and welcome to the Analeigh Capital Management second quarter 2021 earnings conference call. Today, all participants will be in a listen-only mode. Should you need assistance during today's call, please signal for 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 that today's event is being recorded. At this time, I would like to turn the conference over to Sean Kensel, Vice President, Investor Relations. Please go ahead, sir.

Good morning, and welcome to the second 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 factor 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, 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 second quarter 2021 investor presentation and second 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 the Annalise 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, Ilker Erta, Head of Securitized Products, Tim Coffey, Chief Credit Officer, and Mike Fania, Head of Residential Credit. And with that, I'll turn the call over to David.

Thank you, Sean. Good morning, everyone, and thanks for joining us for our second quarter earnings call. Today, I'll provide an overview of the macro environment and current market dynamics, briefly discuss our performance and capital allocation trends during the quarter, and lastly, I'll highlight our progress on the various strategic initiatives that I outlined on last quarter's call. Ilker will provide a more detailed commentary on our agency and residential credit portfolio activity, and Serena will review our financial results. Finally, as Sean noted, we are joined by our other business leaders today who can provide additional context during Q&A as needed. Now, economic momentum accelerated in the second quarter as COVID-driven restrictions were lifted and the U.S. economy reopened. Strong consumption was closely followed by rising prices as several goods, most notably cars and services, were in short supply relative to surging consumer demand. These price pressures are expected to cool from June levels, where core CPI rose 4.5% year over year, yet it remains unclear as to how entrenched higher prices will be going forward. In a surprise to many, longer-term interest rates deviated from these positive economic fundamentals and rallied nearly 30 basis points during the quarter. Rate markets seem to suggest that peak growth momentum is behind us, a narrative that has been fueled in recent weeks by a resurgence in COVID cases, as well as the growing realization that elevated valuations require a sustained low interest rate environment. The other meaningful economic event during the quarter was the subtle shift in communication from the Fed at the June FOMC meeting. In light of the high inflation readings, the Fed signaled rate hikes might occur as early as 2023. Additionally, the momentum in growth and continued progress in labor markets led the committee to begin discussions around tapering their asset purchases. This pulled forward expectations for a tightening in monetary policy and implies a taper announcement could occur in the coming months. Although there is plenty of attention on the potential taper timeline and options right now, the Fed will be deliberate and transparent around any announcement as it wants to continue to minimize any potential market disruptions. Returning to our portfolio, we experienced a negative economic return of 4% in the second quarter amidst a challenging operating environment for agency MBS. Rising volatility and persistent elevated prepayment speeds drove much of the deterioration in agency, as Ilker will discuss in more detail. We continue to prudently manage the portfolio, reducing leverage and hedging incremental moves in interest rates while allocating capital towards credit investments with more attractive risk-adjusted returns. Consequently, our total portfolio decreased by approximately $7 billion to $93 billion, contributing to a reduction in economic leverage from 6.1 to 5.8 times and an increase in unencumbered assets from $8.9 billion to $9.6 billion quarter over quarter. In light of relatively tight asset spreads and the end of easy monetary policy in sight, we expect to continue to maintain our leverage profile at the lower end of the range that we've historically operated in. Despite the decline in our portfolio, we were able to generate earnings available for distribution exceeding our dividend by $0.08. Although earnings have been in the proximity of 30 cents for the past several quarters, we view this effectively to represent the high watermark and anticipate earnings will likely moderate going forward. On the financing front, we continue to take advantage of the historically attractive funding markets with sustained record low financing costs, which Serena will expand upon. Further, we amended terms and credit facilities for our residential credit and middle market lending businesses increasing capacity, and extending the term on facilities. Notably, we decreased pricing for financing on non-QM loans by nearly 50 basis points during the quarter. We also expanded collateral eligibility to meet the evolving needs of the residential credit business, including newly offered products such as agency eligible and non-agency second homes. Capital allocation continued to shift in favor of credit, increasing modestly from 27% to 29% during the quarter, despite our exit from the commercial real estate business. Our residential credit business experienced another active quarter as we took advantage of opportunities in shorter spread duration securities, as well as the non-QM loan market, which was bolstered by enhancements to our product sourcing capabilities that I'll discuss further shortly. Due to the more than $1 billion of purchases that were largely unlevered, capital allocation to the business increased six percentage points to 19%. Now shifting to middle market lending, we saw considerable portfolio activity during the quarter while maintaining our targeted investment approach, closing approximately $450 million in originations across six deals with an average commitment size of $75 million. Our ability to lead and underwrite deals in size, as demonstrated this past quarter, further differentiates our business, making us a preferred lender and partner to our private equity sponsors. Our syndication capabilities were also evidenced through seamless execution of one of our larger positions subsequent to quarter end. The portfolio continues to exhibit healthy performance, and we remain constructive on our outlook and positioning. Now the previously announced sale of our commercial real estate business remains on track to be completed by the end of the third quarter as planned. Subsequent to this past quarter end, the bulk of the platform, including a number of annually employees who supported the business, was successfully transitioned as part of the first closing of the transaction. A significant majority of the assets were settled during the first close and we have received nearly 85% of the capital thus far. On behalf of the entire Annalee team, I'd like to thank our departing colleagues for their numerous contributions and wish them continued success as they embark on this new chapter. Now, as I discussed on last quarter's call, our commercial real estate divestiture gives us additional capacity and strategic flexibility to further expand our leadership and operational capabilities across all aspects of the residential housing finance market. I would like to now provide an update on key milestones related to our top two initiatives, building our mortgage servicing rights business and portfolio, and expanding our residential credit platform. First, with respect to our MSR business, we have two avenues for investment in the sector. First, through a set of committed third-party partnerships, and second, by means of a build-out of our own capabilities to own and oversee servicing of MSR in-house through our Onslow Bay subsidiary. We continue to make key hires in this area with decades of industry expertise to lead the effort. We began this process over a year ago and have now built it to critical mass with over 400 million of exposure to MSR, nearly doubling our portfolio during the second quarter. As expected, diminished originator profitability in the first half of 2021 has led to elevated secondary MSR volumes from originators providing ample supply. We expect this dynamic to continue, and Analeigh is a synergistic partner to originators, given our deep capital base and ability to acquire a wide array of products. Ultimately, MSR is an efficient hedge to our core agency portfolio, given its negative duration and positive yield, and we believe it will significantly enhance the long-term sustainability of our returns. However, given the inherent structural leverage of MSR, we are not currently employing financing for the strategy and do not foresee our capital allocation to MSR to exceed 10%. As such, given the size and scale of our balance sheet, we expect to be able to sufficiently scale the MSR business and maintain a strong industry presence within these parameters. However, as we have noted previously, we expect to grow our portfolio responsibly, highly considerate of valuations. Now, expanding on residential credit, as I noted earlier, we deliberately increased our exposure to the sector during the quarter, and we remain positive on housing fundamentals given the monetary and fiscal stimulus and the undersupply of single-family homes in the US. Annalee has expanded its residential whole loan acquisition channels by initiating in-house aggregation through Onslow Bay's correspondent channel. Launched in April, this channel offers a broad and diversified program suite to purchase residential mortgage loans on a best efforts flow basis that adhere to our rigorous credit standards, and we continue to expand our network with new partners. Now, our big picture view is that the further development of these two initiatives combined with our best-in-class agency business and our size and liquidity increases our presence throughout the spectrum of residential housing finance and allows optionality to allocate capital where it is most attractive based on where we are in the cycle. And lastly, before turning it over to Ilker, I do want to highlight that we published our second corporate responsibility report earlier this month. The 2020 report, titled Leading with Purpose, demonstrates our continued focus on high-quality disclosure with respect to our ESG endeavors and provides an update on our ESG goals and commitments. With this year's report, we included additional SASB disclosures under the mortgage finance standards for our residential credit business, and made a new commitment to further assess climate change risks and opportunities through the consideration of the Task Force on Climate-Related Financial Disclosures. At Anneli, we are constantly striving to improve our corporate responsibility practices and to further integrate ESG considerations into our overall strategy to benefit all stakeholders. Now with that, I'll hand it over to Ilker to provide a detailed overview of our agency and residential credit portfolio activity and outlook for each sector.