Annaly Capital Management Inc.

Good morning and welcome to the Q2 2022 Annalee Capital Management 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 touchtone phone. If you would like to withdraw your question, please press star 10-2. At this time, I would like to turn the conference over to Sean Kensal, Investor Relations. Please go ahead, sir.

Good morning, and welcome to the second 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 effects. 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 contents 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 second quarter 2022 investor presentation and second quarter 2022 financial supplement, both found under the presentation section of our website. annually 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 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 Ertas, 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 for a second quarter earnings call. Today, I'll review the macroeconomic and housing market backdrop, our performance during the quarter, and then provide an update on our broader strategic direction as we begin the second half of the year. Ilker will then discuss our portfolio activity in more detail, followed by Serena, who will go over our financial results for the quarter. Starting with the macro landscape, as all are aware, the first half of 2022 has been an exceptionally challenging investment environment. Very high inflation, geopolitical uncertainty, and the fastest pace of monetary policy tightening in recent history led to broad-based deterioration across asset classes. Despite forecasts for inflation to peak this spring, Headline CPI climbed through the quarter, reached 9.1% year-over-year in June. Meanwhile, tight labor markets supported healthy consumption, making it increasingly clear economic activity was too strong for inflation to slow meaningfully. In response, the Federal Reserve hiked 125 basis points in the second quarter and another 75 basis points just yesterday. The hawkish Fed markets pricing an additional 100 basis points of rate hikes for 2022 in June relative to March led to the largest quarterly tightening of financial conditions since the onset of the financial crisis. Economic activity now appears to be slowing, which can best be seen by the decline in activity in interest rate sensitive sectors such as housing. Given the importance of the housing market to our business, I want to spend a moment on the outlook for single-family housing. Home prices have continued to rise sharply, appreciating over 10% the first five months of the year, according to the Case-Shiller Index. Housing activity, however, has slowed recently, as the highest mortgage rate since 2008 and 40% cumulative home price appreciation since the start of the pandemic has weighed on both consumer and builder sentiments. Affordability for prospective homeowners has been significantly reduced with mortgage payments 50% higher year over year on a national average. This is curbing consumers' ability to purchase homes and in turn is reducing demand for mortgages. This correction will be welcome for the agency MBS market as it reduces elevated net supply, which has been the main headwind for the sector in the recent past. Our expectation is that housing will exhibit negative momentum in the second half of the year, with the deceleration of home prices and declining month-over-month HPA becoming a realistic possibility, particularly on a regional level. However, a systematic shortage of one to four single-family homes relative to future demand, low leverage as measured by outstanding mortgage debt to equity, lean builder inventories, Historically tight underwriting standards and the majority of mortgage borrowers locked into a low fixed rate mortgage suggest a moderation and slight decline in home prices is more likely than a protracted decline. Now shifting to the broader market outlook, risk to the rates market are more balanced now as concerns over an economic downturn are on the rise. The Fed has demonstrated its commitment to curb inflation, and markets are now anticipating elevated inflation to decline, particularly if we experience an economic slowdown. As a consequence, we expect investors to allocate more capital to fixed income in this environment, which should result in a welcome decline in volatility going forward. Combination of lower volatility and reduced supply would provide a positive backdrop for agency MBS where spreads remain historically high. While our MSR and residential credit businesses have benefited from rising HPA, we maintain a constructive outlook given the underlying composition of our portfolios and the support from the long-term supply demand imbalance in the housing market. Turning to our performance, we experienced a negative economic return of 9.6% in the second quarter in light of this difficult environment. Economic leverage increased slightly to end the quarter at 6.6 turns. And despite our decline in book value, we generated strong earnings available for distribution of 30 cents for the quarter. However, as we have signaled in prior quarters, we expect earnings to moderate going forward, as Serena will cover in more detail. Now I'd like to provide an update on our strategic initiatives. We completed the previously announced sale of our middle market lending portfolio during the quarter as planned. And to reiterate our rationale for the transaction, the sale provided an opportunity to monetize a less liquid non-core business at an attractive valuation and redeploy capital into our core businesses. As I discussed on last quarter's call, the sale of the MML portfolio culminates our natural evolution to becoming a dedicated housing finance REIT. With our sharpened focus, we have the capacity and flexibility to expand our operational capabilities and leadership across the residential credit and MSR landscape, and we have made significant strides over the past year, which I'll turn to now. Notwithstanding the broader market volatility and disruptions to the mortgage finance sector this year, our residential credit and MSR platforms have built upon their strategic capabilities and gained market share, all while maintaining an intentional focus on credit and risk management. Within residential credit, we remain a programmatic securitization issuer with Onslow Bay representing the largest non-bank issuer of prime jumbo and expanded credit MBS in the first half of 2022. We've securitized $4.8 billion across 12 transactions year to date, generating $525 million of credit investments. Our issuance has benefited from increased originator partnerships and continued momentum in our residential whole loan correspondent channel. Our 2022 non-QM lock commitments are approximately 50% above our 2021 total lock volume. In Annalise balance sheet, commitment to the market, permanent capital are differentiating factors that reinforce our position as an industry leader and a reliable source of capital to the originator community. Our mortgage servicing rights portfolio has grown significantly with Onslaught Bay establishing itself as the fourth largest purchaser of MSR year-to-date and a top 20 owner of GSE mortgage servicing rights. We've prudently built the infrastructure necessary to scale as we continue to enhance our operations through the addition of key hires and new partnerships. While the business has grown 15% of capital in the span of a year, we've been disciplined with respect to our purchasing activity in order to responsibly build our MSR assets vis-a-vis our broader portfolio. Also to note, we closed our first MSR credit facility subsequent to quarter end. However, consistent with our prior guidance, we plan to employ only modest leverage on MSR, and the facility serves primarily as a tool to manage liquidity. Over the long term, we expect our allocation of residential credit and MSR to approach 50% of our capital based on prevailing returns and where we are in the cycle. Accordingly, agency is at the higher end where we see its long run capital allocation, which we are very comfortable with given the current relative attractiveness of the agency sector. But ultimately, we are confident that increasing our exposure to lower levered, less liquid assets with a premium return will help improve the durability and quality of our economic returns. While this year has been difficult throughout financial markets, we are encouraged by the robust growth within these businesses and the long-term potential as we fully scale our housing finance capabilities. Now finally, before I turn it over to Ilker, I want to highlight that we published our third corporate responsibility report last month. The 2021 report demonstrates our continued focus on setting and measuring progress on our ESG goals, as well as our commitment to providing best-in-class disclosure and increased transparency. And we continuously strive to advance these efforts each year. In the latest report, for example, we included incremental disclosures that outline climate-related risks and opportunities across our business. We're proud of the progress we've made to further integrate ESG priorities throughout our company that has undoubtedly helped to create lasting value for all of our stakeholders. And now with that, I'll hand it over to Ilger to provide a more detailed overview of our portfolio activity for the quarter and outlook for each sector.