Annaly Capital Management Inc.

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 third 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 third quarter 2022 investor presentation and third quarter 2022 financial supplement, both found under the presentation section of our website. Annalee 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, Ildur Ertaf, Chief Investment Officer, Ken Adler, Head of Mortgage Servicing Rights, and Mike Thania, head of residential credit. And with that, I'll turn the call over to David.

Thank you, Sean. Good morning, and thank you all for joining us on our third quarter earnings call. Today, I'll provide an update on the macroeconomic landscape, our financial results this quarter, and our positioning heading into year end. Ilker and Serena will then discuss our portfolio activity and financial performance. Now, beginning with the macro backdrop in what continues to be a historically challenging year, the third quarter brought about a further sell-off in the bond market, and mortgage spreads widened to crisis-era levels. Persistently high inflation readings, rapid and sustained Federal Reserve rate hikes, tightening financial conditions, elevated volatility, geopolitical turmoil, and rising financial stability risks have weighed heavily on markets. Now, to put this in historical perspective, the total return for the Bloomberg U.S. Aggregate Bond Market Index was negative 14.6% in the first three quarters of 2022, far worse than the negative 2.9% in 1994, the previous worst year in the history of the index. And in light of the continuation of this difficult environment, Annalie experienced a negative economic return of 11.7% for the quarter. The Federal Reserve has signaled it is determined to continue tightening monetary policy until inflation approaches its target, a commitment that has been echoed by virtually all Fed speakers since Chair Powell's Jackson Hole speech at the end of August. This has caused a meaningful repricing of the rate path, with markets currently expecting the hiking cycle to end at a Fed funds rate of nearly 5% compared to expectations of just 3.5% at the end of June. It's led to a sharp sell-off in interest rates and exceptionally high levels of volatility. A consequence of volatility has been extremely weak investor demand for fixed income products, particularly for agency MBS. In fact, the third quarter represents only the third time in the past 10 years in which banks and mutual funds, two critical private sector holders of mortgage securities and loans, have reduced their agency MBS holdings simultaneously. In light of the sharp sell-off in rates and widening in MBS spreads, the Freddie Mac primary mortgage rate rose to 6.94% as of last Thursday, more than doubling in 2022, and contributing to the abrupt slowdown in housing market activity. Home price appreciation very likely peaked for the cycle and has begun to reverse course in many parts of the country. Given the mortgage affordability shock from high home prices and rapidly rising rates, we now expect the housing market to correct, potentially erasing the entire appreciation seen this year by early to mid 2023. Now, although prices could fall meaningfully from the recent highs, homeowners have built up substantial equity cushions, lending standards have been conservative, and given low rates on existing mortgages, homeowners are unlikely to default unless labor markets weaken considerably from here. And despite volatility in interest rate and mortgage markets, funding conditions continue to be healthy as agency MBS repo, residential credit, and MSR facilities remain readily available. Our financing rates have risen, certainly, but are commensurate with other benchmark short-term interest rates. While high volatility could drive an increase in repo haircuts, we've seen limited evidence of this thus far. The favorable financing conditions are driven by the high balances of investor cash and short-term interest rate products, best seen by the elevated bank reserve balances and reverse repo participation at the Federal Reserve. And notwithstanding Fed portfolio runoff reaching its steady state run rate of up to $95 billion per month, financing conditions should maintain support as cash remains ample. Now shifting to our portfolio, our focus is on prudently managing our liquidity, leverage, and risk profile in the current environment. We continue to position ourselves defensively given sustained volatility and have strong liquidity with more than $6 billion in unencumbered assets, including $4.3 billion in cash in agency MBS, which represents over 50% of our common equity as of quarter end. During the quarter, we maintained our economic leverage at 6.5 turns until mid-September, when the sharp market sell-off over the last two weeks of the quarter brought our leverage up roughly half a turn to end the quarter at 7.1 turns. While we're comfortable with our current portfolio positioning, we expect our leverage to trend modestly lower over the longer term, reflective of our target capital allocation. With respect to portfolio mix, we modestly grew each of the three strategies with our total assets increasing to 86.2 billion as we selectively deployed capital from common equity issuance on the quarter. While the majority of new capital was committed to agency, Our capital allocation to the sector decreased four percentage points to 67% as the agency portfolio absorbed the vast majority of the increase in leverage to end the quarter. Turning to residential credit, in light of deteriorating housing market fundamentals, portfolio growth was focused on opportunistic additions of securities that are less susceptible to home price declines. Though we believe our home loan portfolio is well positioned to withstand further weakness in the housing sector, we have tightened our already stringent credit standards, and we expect the pace of securitizations to moderate in the near term. Nevertheless, we remain the largest non-bank issuer of prime jumbo and expanded credit MBS this quarter. This has largely been a result of our whole loan correspondent channel, which recently achieved over 2 billion in aggregated loans since inception in April 2021. Now with respect to our mortgage servicing rights business, we have now fully scaled our platform, having more than tripled our portfolio size year over year. The MSR portfolio benefits from stable cash flows in the low prepayment environment and helps to hedge the risks of a further slowdown in housing activity. Although we were the second largest purchaser of MSR in 2022, as of the end of the quarter, we expect to be measured with respect to future growth, considerate of the sector's relative attractiveness, and our risk parameters. Now, overall, we anticipate market challenges will persist over the near term and will maintain our defensive posture until volatility subsides. While spreads across our investment strategies are historically attractive, again, we're focused on preserving liquidity and optionality against additional market turbulence. And when the outlook improves, we're well positioned to take advantage of opportunities across our three businesses. Now, lastly, before handing it off to Ilker, I wanted to take a moment to provide some perspective on where we sit today. We understand that 2022 has been an immensely challenging period in financial markets. We recently marked 25 years as a public company, and I was reminded of Annalie's resilience throughout numerous volatile market events, such as long-term capital in 1998, the 2008 financial crisis, the taper tantrum, and most recently, the financial market dislocation at the onset of COVID. Annalie has proven our ability to successfully navigate through these episodes of market turbulence, and we are confident that our business model will emerge from this current period stronger than ever. Now with that, Hilger will provide a more detailed overview of our portfolio activity for the quarter and outlook for each business.