Annaly Capital Management Inc.

Good day, and welcome to the third quarter 2021 Annalee Capital Management 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 touchtone phone. And 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 Mr. Sean Kinsel. Please go ahead.

Good morning and welcome to the third quarter 2021 earnings call for Annaleigh 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, Annalie routinely posts important information for investors on the company's website, www.annalie.com. Content referenced in today's call can be found in our third quarter 2021 investor presentation and third 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. Annalie encourages investors, analysts, the media, and other interested parties to monitor the company's website. In addition to following Annalie'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, Ilker Ertas, Head of Securitized Products, Tim Coffey, Chief Credit Officer, and Mike Fagna, 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 third quarter earnings call. Today, I'll provide an overview of the broader market environment, including our thoughts on the Federal Reserve's reduction in asset purchases, briefly touch on our performance during the quarter, and highlight some of our recent achievements in positioning across our businesses. Ilker will provide more detailed commentary on our agency and residential credit portfolios, and Serena will discuss our financial results. And as Sean noted, our other business heads are also here this morning to provide additional context during Q&A. Now, first, with respect to the macro landscape, the COVID Delta wave and related factors have led to a moderation in the economic recovery. Labor market gains have slowed relative to the strong pace at the beginning of the summer. Production bottlenecks and global supply chain disruptions have caused delays that raise prices on products in high demand. And while inflation has been boosted by higher goods and energy prices, record home price appreciation has started to filter into inflation's shelter component, suggesting that price pressures may persist for longer than previously anticipated. Meanwhile, interest rates experienced meaningful intra-quarter volatility given the shifting narrative on the economic recovery and inflation. Early in the quarter, rates rallied as markets sought direction on the magnitude of the impact of the Delta variant. And later in the quarter, as a relative reduction in COVID case counts led to a return to economic optimism, rates sold off and the curve steepened to end the quarter. Now, the greater near-term focus in the macro landscape, however, is the imminent reduction in the Fed's pace of asset purchases. Following the September FOMC meeting, we now have a clearer picture as to what the taper will likely look like. The Fed is expected to reduce Treasury and agency MBS purchases by roughly $10 billion and $5 billion per month, respectively, beginning as early as November. This pace would result in the Fed halting balance sheet expansion in the summer of 2022, though we expect reinvestment and portfolio runoff to persist well beyond the end of the taper, consistent with the QE3 experience. Most notably, the Fed's transparent communications have helped to limit the market impact to both interest rates and agency MBS spreads ahead of the official taper announcement. While the Fed has attempted to decouple the taper and eventual rate hikes, elevated inflation readings and more hawkish central bank messaging globally have accelerated investors' expectations of a rate hike. With markets currently pricing as many as two hikes in 2022, we remain vigilant in managing analyst duration exposure, both in the front end and the long end, as Ilker will expand later on. Now reflecting briefly on the agency MBS supply and demand outlook in light of the taper announcement, private market participants will need to absorb an increased amount of mortgages in 2022. Elevated net issuance remains an uncertainty in the supply-demand outlook, but we currently estimate supply to the private market next year will be similar to levels seen in recent years pre-pandemic. And several factors are supportive of more limited widening in spreads before buyers emerge. Banks are flush with deposits and see little loan demand, suggesting a strong appetite for securities is likely to continue, particularly at potential wider spread levels. and money managers remain underweight mortgages but will likely increase their relative allocation if mortgage spreads become more attractive. Ample liquidity, best seen in the $1.6 trillion pledged to the Fed's reverse repo facility at quarter end, and readily available financing remain the main factors underlying the current accommodative financial conditions. The repo market remains highly liquid and has allowed us to decrease our cost of funds to another record low. In line with efforts earlier in the year, we continue to broaden our financing through increased use of credit facilities by funding high-quality credit securities for longer terms. These actions help to enhance Analeigh's liquidity profile at extremely attractive spread and haircut levels, as Serena will discuss in more detail. Now, turning to Annalise performance in the third quarter, our portfolio generated a positive economic return of 2.9%, reflecting a two-cent gain on book value and earnings available for distribution of 28 cents. We achieved these returns and made continued conservative portfolio positioning, maintaining economic leverage at the low end of our historical range, and unchanged quarter over quarter at 5.8 times. Our liquidity remains at our highest levels with total unencumbered assets of $9.8 billion at quarter end. We continue to see relatively tight spreads and as a result are comfortable with our more cautious approach to managing the portfolio. Now that being said, should spreads become more attractive, our nimble positioning leaves us prepared to take a more offensive posture and increase leverage should it be justified. Now, over the quarter, mortgages performed in line with hedges in this environment as the sector benefited from clarity surrounding the upcoming taper and healthy demand from banks. We increased our agency portfolio by nearly $3 billion in Q3 as we invested a portion of the proceeds from our previously announced commercial real estate sale. Additions to our agency portfolio, which Ilker will cover in more detail, were primarily a placeholder as agency MBS remained fully valued, while credit sectors offer attractive pockets of opportunity, but deployment of capital is more episodic. With respect to capital allocation to end the third quarter, 30% of our capital was allocated to credit, up slightly from 29% in the prior quarter. in line with our view on the relative value equation vis-a-vis agency and our deliberate portfolio positioning ahead of the taper. Our residential credit business represents the majority of our credit allocation at 21% and had another strong quarter as the group continues to successfully execute on their strategy. With assets of $4.3 billion, the residential credit group is now larger than it was pre-COVID, and assets are up over 70% since year-end 2020. We maintain an optimistic outlook on the business, giving persistent, robust housing market fundamentals and long-term tailwinds, driving the need for private capital in the market. The Onslow-based securitization platform remains very active, completing nearly $2 billion of securitizations since the start of the third quarter and nearly $3 billion of securitizations year-to-date. We expect to maintain our securitization footprint, and we are continually adding to our partnerships to drive new sources of securitization collateral. Additionally, our correspondent network is adding new partners and analyzing large capital base and market expertise uniquely positioned Ansel Bay as an aggregator within the industry. And also as it relates to OBX, I wanted to briefly touch on the impact of the recent suspension of FHFA's cap on second homes and investor properties. While the decision will have an impact on the delivery of agency-eligible loans to our platform, it does not temper our bullish outlook for the sector. Annaleigh was an active issuer of agency-eligible investor loans before the cap was put in place, And notably, we issued three securitizations in 2019 and 2020, backed by $1.15 billion of collateral prior to the PSP amendment limiting delivery of investor loans to the GSEs in March of this year. As the FHFA has reversed the introduction of the caps, we expect Analeigh and private markets more broadly to be able to compete with GSE LLPA adjusted pricing again, assuming securitization execution remains attractive. Now regarding progress on our MSR business, we grew our holdings by more than 40% on the quarter with the portfolio representing $575 million in market value and 4% of dedicated capital. As we scale the business, we have solidified our position as a reliable partner in the MSR sector supplementing our bulk transactions with acquisitions through flow relationships. We've increased our MSR holdings by $470 million in 2021, and we anticipate responsibly growing the portfolio through our unique position as a non-competitive partner to originators that need liquidity and capital. Turning to our middle market lending business, we closed our inaugural private closed-end fund subsequent to quarter-end, with just north of $370 million of capital. The fund is approximately two times larger than the median size of first-time direct lending and private debt funds. It includes a mix of both U.S. and European investors comprised of public and corporate pensions, insurance companies, and asset managers. The fund has supported nearly $450 million of middle market loan investments to date with an attractive risk-adjusted return profile. Italy is co-investing 50-50 alongside each fund investment, bringing a strong alignment of interests. We believe the fund serves as a testament to the track record and expertise of our dedicated middle market lending team. allows for enhanced capital allocation flexibility to further scale the strategy and provides recurring fee revenue to the REIT. including the fund, the middle market lending strategy, managed $2.3 billion in funded assets at quarter end. Lastly, as the largest mortgage REIT with the capability to invest across all aspects of a mortgage loan, our strategic initiatives over the past year, including investing in MSR and balance sheet and expanding our residential credit business, have prepared us to be a leading source of capital in residential housing finance. Ultimately, the strength of Annalie's diversified model is enabled by our size and scale, and we remain confident in our ability to generate stable returns throughout various market environments and across economic cycles as we have done historically. And now with that, I'll turn it over to Ilker to provide a more detailed lens into our agency and residential credit portfolio activity and outlook.