Annaly Capital Management Inc.

Good morning and welcome to the first quarter 2022 Anna Lee Capital Management Earnings Conference Call. Today, all participants will be in a listen-only mode. Should you need any 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 your question, you may press star then one on your telephone keypad. To withdraw your question, please press star, then two. Please note that today's event is being recorded. Now, I would like to turn the conference over to Sean Kensal, Director, Investor Relations. Please go ahead, sir.

Good morning, and welcome to the first quarter 2022 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 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 first quarter 2022 investor presentation and first quarter 2022 financial supplement, both found under the presentation section of our website. Annalie 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. Please also note this event is being recorded. Participants on this morning's call include David Finkelstein, President and Chief Executive Officer, Serena Wolf, Chief Financial Officer, Ilker Ertoff, Chief Investment 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 on our first quarter earnings call. Today, I'll review the macro backdrop and how it impacted our performance during the quarter, and then I'd like to discuss the sale of our middle market lending portfolio and the transaction's implications for our capital allocation and our broader strategic direction. Ilker will then provide more detailed commentary on our portfolio activity And then Serena will go over our financial results. Although growth slowed in the first quarter relative to last year, the U.S. economy remains robust. The strength in inflation in the labor market has demonstrated that the Federal Reserve needs to remove monetary policy accommodation much faster than previously anticipated. This led to a sharp repricing of fixed income assets, with the aggregate U.S. bond market index facing the worst quarterly performance since 1980. Consistent with the broader market, Annalise Portfolio was vulnerable to the exceptional volatility in this environment, despite our efforts to defensively position our portfolio, experiencing an economic return of negative 12%, with a reduction in total portfolio size of roughly $5 billion, to end the quarter at $84.4 billion in total assets. Returning to the macro landscape, inflation continued to rise during the first quarter, with headline CPI reaching 8.5% in March, driven by a sharp rise in commodity prices. Now, even outside of commodities and food, inflation pressures remain elevated and broad-based, as seen, for example, in the Federal Reserve Bank of Dallas' estimate that only 10% of PCE components are currently witnessing annualized inflation below 2%. The labor market, however, has arguably been the bigger driver of the Fed's hawkish shift. The employment picture has recovered significantly, with the unemployment rate falling 1.1% over six months to 3.6% in March. Consequently, the demand for labor remains extremely strong, creating the risk that employers will have to pay even higher wages to attract workers, which could trigger a wage price spiral. The combination of these two developments, high inflation and tight labor markets, have demonstrated the need for much more aggressive monetary policy tightening, As Fed officials have signaled expeditious rate hikes in coming months, overnight index swaps suggest the Fed will deliver a total of 250 basis points of hikes in 2022, compared to expectations of just three 25 basis point increases back in January. And 100 basis points of hikes are likely to come in the second quarter alone. Now, this repricing of Fed expectations led to a meaningful sell-off in Treasury rates, where two-year yields rose 160 basis points during the quarter, marking the most severe quarterly sell-off in nearly 40 years. The long end of the yield curve fared somewhat better, with 10-year notes rising just over 80 basis points, leading to a substantial yield curve flattening during the quarter. Given the rate sell-off, as well as concerning geopolitical developments that include the Russian invasion of Ukraine, Interest rate volatility, particularly in short and medium term tenors, rose to the highest realized levels since the financial crisis. And as Ilker will discuss in further detail, the volatile rate environment weighed heavily on mortgages, with production coupon nominal spreads widening 40 basis points on the quarter. Agency MBS spreads are now attractive, and we are comfortable maintaining our current agency portfolio at prevailing spread levels. but we remain considerate of heightened interest rate volatility as well as the supply outlook in light of imminent Fed portfolio runoff. Now, specifically with respect to the Fed's balance sheet, the March FOMC meeting minutes provided the market with a general framework for the second iteration of quantitative tightening. For one, runoff will be significantly faster, with the Fed planning to retire up to $95 billion in assets per month, nearly twice the aggregate cap seen during the 2017-19 period. In addition, caps will be phased in more quickly than last time. We currently expect an announcement at the May FOMC meeting next week and fully ramped declines starting three months later. Runoff is likely to last for multiple years as current Federal Reserve security holdings have resulted in excess liquidity within the financial system best seen in the $1.8 trillion of cash pledged to the Fed's reverse repo facility. Using current runoff parameters, the Fed would have to shrink its balance sheet for roughly 18 months before reserves equivalent to these excess cash balances are extinguished. And also to note, although markets continue to discuss the potential for MBS sales, Fed official communication has indicated runoff will be, quote, predictable and running in the background. suggesting that sales will be on the back burner for the next several quarters. While accelerating runoff, MBS sales from the Fed's portfolio would further deteriorate and elevate its supply outlook, risk excessive tightening of financial conditions, and could be difficult to implement effectively. Now, with that said, let's turn to our recent strategic activity. We are pleased to have announced the sale of our middle market lending portfolio to ARIES this past Monday, The $2.4 billion transaction, inclusive of our on-balance sheet portfolio, as well as assets managed for third parties, follows the completion of a highly competitive process that is expected to be accretive to book value and validates the quality of our differentiated corporate credit portfolio. While the middle market lending portfolio has been a source of complimentary returns, it was an opportunistic time to pursue a transaction given the relative valuation ascribed to middle market assets in the current environment. As broader fixed income markets have come under pressure, middle market lending was one of the few areas of the market that commanded a premium while attracting a significant amount of new capital. Accordingly, the sale provided an efficient way to monetize a less liquid non-core business and an attractive valuation and redeploy over a billion dollars in capital into cheaper assets in our core strategies. We expect to close the deal by the end of the second quarter following customary closing conditions. and we believe ARIES is a clear strategic fit for the assets going forward. Finally, turning to our long-term strategy, the MML sale furthers our natural progression towards becoming a dedicated housing finance REIT. Combined with the sale of our commercial real estate business last year, the transaction moves annually closer to the vision we laid out when I stepped into the role of CEO two years ago. As a relative value investor, our permanent capital base allows us to increase our exposure to lower levered, less liquid assets with a premium return, which serves to enhance the durability and quality of our earnings. Accordingly, we expect to expand our capital allocation and non-agency mortgage finance over the long term and solidify our role as a market leader within the MSR and non-agency residential credit sectors. Annaleigh is well positioned to leverage operational synergies across these businesses, which we expect to provide a unique advantage in these high barriers to entry, more operationally intensive businesses. Regarding our MSR business specifically, we expect it will grow to represent a greater steady state capital allocation than the approximately 10% guideline we have discussed in the past. Following the removal of MML's assets from our capital allocation framework, we will be able to devote more capital to MSR while still maintaining our high liquidity and risk management standards. The increased emphasis on MSR is further informed by both the attractiveness of the asset class within our portfolio, as well as the more rapid pace of establishment of our platform in the market. We've grown the asset base by more than five times over the past year and ended the quarter as a top 10 secondary market purchaser of MSR. And as noted on previous calls, the sector remains highly active due to consistent disposition of MSR by the originator community, given reduced profitability, a trend we see likely to persist. Coupled with wider spreads, we expect MSR to remain a vehicle for growth that should improve our overall returns and book value stability over the long term. Additionally, we expect to build on momentum within our residential credit group, which recently surpassed over $1 billion in closed loans through our correspondent channel. With the opportunity to further scale both our securities and whole loan portfolio, we are poised to take advantage of substantial opportunity across residential credit, where private capital is primed to play an even greater role. While the sector grows to post-global financial crisis highs, Annalie continues to broaden its presence, as demonstrated by Onslow Bay becoming the second largest non-bank issuer of Prime Jumbo and expanded credit MBS. As we further increase our products, partnerships, and resources, we're well prepared to capitalize on organic as well as external growth opportunities throughout the marketplace. Now, ultimately, following our MML disposition, Annalia is positioned for its next phase of growth with a scaled and diversified portfolio backed by three distinct but complementary businesses. The power of Annalie's capital allocation framework lies in our ability to calibrate our investments based on where we are in the cycle, as seen through the relative growth of our agency and residential credit assets in recent years. Looking ahead, I'm excited for Annalie's future as we continue to develop our housing finance capabilities, propelled by strong tailwinds within MSR and residential credit, while taking advantage of a more attractive reinvestment landscape for our core agency business. And now with that, I'll hand it over to Ilker to provide a more detailed overview of our portfolio activity for the quarter and outlook for each sector.