Annaly Capital Management Inc.

Good morning and welcome to the Annually Capital Management's fourth quarter 2021 conference call. All participants will be in 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. To withdraw from the question queue, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Sean Kensal, Director of Investor Relations. Please go ahead.

Good morning, and welcome to the fourth quarter 2021 earnings call for Annalee 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 only accurate 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 fourth quarter 2021 investor presentation and fourth quarter 2021 financial supplement, both found under the presentation section of our website. Annalee intends to use our webpage as a means of disclosing material and 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. Participants on this morning's call include David Finkelstein, President and Chief Executive Officer, Serena Wolf, Chief Financial Officer, Ilka Ertas, Chief Investment Officer, Mike Fania, Head of Residential Credit, and other members of management. And with that, I'll turn the call over to David.

Thank you, Sean. Good morning, everyone, and thank you for joining us for our fourth quarter earnings call. Today, I'll provide an overview of the current macro environment, briefly discuss our performance during the quarter and full year 2021, and close with our outlook for the year ahead. Ilker will then provide more detailed commentary on our investment portfolio, while Serena will discuss our financial results. And as noted, our other business heads are also here to provide additional color during Q&A. Now, beginning with the macro landscape, we saw increasingly challenging market conditions in the fourth quarter and into 2022 as the robust performance of the U.S. economy has made it evident that a withdrawal of pandemic-era stimulus is imminent. Strong consumption and investment activity helped the U.S. economy grow 5.7% in real terms in 2021, marking the best annual growth in nearly 40 years. Meanwhile, the labor market has seen a rapid recovery, as employers added 6.4 million jobs last year and the unemployment rate fell to 3.9%. Both measures suggest that the labor market has recovered significantly since the onset of the pandemic. Stimulus measures fueled this rapid recovery, which has also spurred inflation to generational highs, as seen in December, when the consumer price index reached 7% year over year. Although much of this increase in prices was initially seen as temporary, ongoing elevated price gains across various categories of goods and services raised the risk that inflation could persist for some time. Accordingly, current macroeconomic conditions have led to a meaningful shift by the Fed, which now views less accommodative monetary policy as the primary way to ensure parts of its mandate. Full employment and stable prices are being met. In addition to an accelerated taper, the Fed has begun to signal a larger number of hikes than previously expected. Front end rate markets are pricing roughly five 25 basis point rate hikes this year beginning in March, up from just two one quarter ago. Given the uncertainties around the economy, the Fed is likely to direct market pricing and hike in line with it rather than provide forward guidance well ahead of time. The Fed has also begun to discuss shrinking its balance sheet, and we expect the Fed will let assets run off at a pace faster than the prior taper of $50 billion per month. Now, this notable shift in policy expectations and higher volatility have led to a tightening of financial conditions and an underperformance of assets most closely tied to monetary policy, best seen through the spread widening in agency MBS in recent weeks. Turning to Annalee's portfolio, Agency MBS underperformed given weaker demand following the initiation of Fed taper and a flattening of the yield curve. In anticipation of wider spreads, we managed the portfolio to decrease leverage and optimize our asset allocation, with total assets decreasing by approximately $5 billion to $89 billion and a quarter. As a result, economic leverage declined slightly from 5.8 to 5.7 times. And we were certainly not immune to the spread volatility as we experienced an economic return of negative 2.4%. However, we generated earnings available for distribution of 28 cents unchanged from the prior quarter and exceeding our dividend by 6 cents per share. With respect to capital allocation, in line with recent quarters, we increased the allocation to our credit businesses by approximately 200 basis points to 32% in the fourth quarter. as prospective returns continued to favor credit. Looking back on the full year, our credit allocation increased approximately 10 percentage points from December 2020, even with the successful sale of our commercial real estate business, which underscores the favorable fundamentals and strong execution from our resi credit and middle market lending businesses. I'll touch more on our outlook shortly, but notably, both market and business-specific tailwinds remain favorable for our credit businesses. Now, 2021 was a transformative year for Annalee, marked by the sale of our CRE business, the launch of our mortgage servicing rights platform, and the expansion of our residential credit business. The collective impact of these initiatives has increased our presence throughout residential housing finance and allow us to allocate capital effectively where returns are most attractive, a key differentiator for Annalee. Now I'd like to briefly touch on notable milestones in our businesses and how they have better equipped Analeigh to be nimble in the midst of volatility. First, our MSR business had a solid year with assets increasing over $500 million throughout 2021 to $645 million. We successfully established our MSR platform last year through the addition of key hires, procurement of strategic partnerships, and build out of the operations and infrastructure necessary to scale the business efficiently. As a result of these efforts, we've proven to be a key player in the market, ending the year as the fifth largest bulk buyer of MSR. And with over 200 million of MSR commitments already through the end of January, we're continuing to see progress towards fully scaling the platform, and we expect to see increased market activity given diminished originator profitability. Our residential credit platform, which grew nearly 90% last year, remains diversified with the ability to deploy capital efficiently in either whole loans or securitized markets. The generation of assets for Annalie's balance sheet while controlling strategy, diligence, and servicing outcomes remains paramount to our investment approach. Business activity was enhanced by the launch of our whole loan correspondent channel, which expanded our sourcing capabilities through the addition of new strategic partners and product offerings. We've also benefited from new bulk partnerships established outside of our correspondent channel. And altogether, these efforts helped drive the group's record $4.5 billion in whole loan purchases last year, which exceeded the amount of originations in both the prior two years combined. Further, Onslow Bay remains a programmatic issuer of securitizations, pricing 13 whole loan transactions, totaling $5.3 billion since the beginning of 2021, with OBX being the fourth largest non-bank issuer of Prime Jumbo and expanded Prime MBS over the past two years. And with housing fundamentals expected to stay strong, residential credit should remain a key driver of our overall portfolio growth in the year ahead, as we build on our origination and securitization momentum. Now, shifting to our 2022 outlook, our portfolio is well prepared for volatility, which we anticipated would materialize as the Fed normalizes monetary policy. First, we have thoughtfully reduced our economic leverage a turn and a half since the onset of COVID to 5.7 times, the lowest it's been since 2014. Our defensive leverage profile is further supported by our low capital structure leverage with 88% of our equity in common stock and minimal asset level structural leverage as highly liquid agency MBS make up the vast majority of our portfolio. Second, we have substantial liquidity with $9.3 billion of unencumbered assets, up $500 million year over year. And this liquidity is complemented by our wide array of financing options, including our own broker dealer. Finally, we are conservatively hedged to mitigate interest rate risk with a year-end hedge ratio of 95%. We expect to remain close to fully hedged over the near term. With ample liquidity and historically low leverage, we are well positioned to take a more offensive posture if and when the opportunity presents itself. While agency returns are increasingly attractive, as Ilker will elaborate on, We believe there will be better tactical opportunities out the horizon and will be patient given uncertainty around the market and the Fed. But should assets continue to widen past current levels, which we deem close to fair value, we stand ready to add fundamentally desirable assets. Finally, before handing it off to Ilker to discuss our portfolio in greater detail, I wanted to congratulate him on recently being named our Chief Investment Officer. I've worked with Ilker at three different institutions for the better part of the past 20 years, and I cannot think of an individual more knowledgeable about mortgages and prepayments or better suited to help us drive success for Anneli into the future.