Annaly Capital Management Inc.

Good day and welcome to the fourth quarter 2023 Annalee Capital Management Earnings Conference. Please note that today's event is being recorded. I would now like to turn the conference over to Mr. Sean Kinsel, Director and Investor Relations. Please go ahead, sir.

Good morning and welcome to the fourth quarter 2023 Earnings Call for Annalee Capital Management. Any forward-looking statements made during today's call are subject to certain risks and uncertainties, 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. Content referenced in today's call can be found in our fourth quarter 2023 investor presentation and fourth quarter 2023 supplemental information, both found under the presentation section of our 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, Mike Fania, Deputy Chief Investment Officer and Head of Residential Credit, V.S. Sreenivasan, Head of Agency, and Ken Adler, Head of Mortgage Service and Rights. And with that, I'll turn the call over to David.

Thank you, Sean. Good morning, everyone, and thanks for joining us today. I'll begin with a brief review of the fourth quarter market environment and our portfolio performance, then discuss the current macro landscape, followed by an update on our businesses and our outlook for 2024. Serena will then discuss our financials before opening up the call for Q&A. Now, as all are aware, fixed income markets exhibited considerable volatility in the fourth quarter, as evidenced by the 10-year Treasury trading in 120 basis point range, peaking at 5% in mid-October, before rallying throughout November and December. The second half of the quarter proved beneficial to mortgage assets, as implied volatility declined, the yield curve modestly steepened, and agency spreads tightened meaningfully. We were well positioned to take advantage of this environment, delivering a 10.1% economic return for the quarter, and we out-earned our dividend with earnings available for distribution of 68 cents per share. And we achieved these results with lower economic leverage, which declined to 5.7 turns at the end of the quarter. And as we reflect on 2023, we're pleased to have generated a 6% economic return in a year characterized by numerous unforeseen risk events. We believe that our performance on the year demonstrates the value of our diversified housing finance model and our disciplined portfolio and risk management. Now, turning to the macro environment, the primary driver of the strong demand for fixed income since November can largely be attributed to a shift in the Federal Reserve's communications. Moving away from the hire for longer narrative, Fed officials began to express comfort around the decline in inflation, suggesting that risks around the monetary policy outlook are more balanced. A normalization of policy is likely to begin in 2024, as long as inflation continues to moderate. And while not declaring victory just yet, as evidenced by Chair Powell's recent statements, policymakers are keen to ensure that a soft landing can actually occur. Powell also highlighted that future balance sheet discussions will occur in the upcoming March meeting, noting policy rates and the potential tapering of the balance sheet as independent tools. And while existing financing conditions remain ample, we're encouraged that the Fed appears to be signaling a conservative approach with regard to its balance sheet and liquidity in the financial system. Now, a second factor leading to the decline in yields in the fourth quarter is the change in debt issuance dynamics as the Treasury chose to issue incremental supply in the front end of the yield curve, taking advantage of the record amount of cash in money market funds while exerting less pressure on longer-term yields. Now, the broader domestic economy remains strong with Q4 GDP at 3.3%, the unemployment rate at 3.7%, and consumers still exhibiting spending strength. Inflation, meanwhile, has moderated meaningfully, and absent a shock, core PCEs should benefit from base effects to bring year-over-year measures towards 2.5% in the coming months. Now, looking at the housing sector, home prices outperformed the market's expectations over the last couple of years, despite mortgage rates reaching 20-year highs. HBA has continued to benefit from existing homeowners experiencing lock-in effect, resulting in low available for sale inventory, as borrowers who struck below current market mortgage rates are unwilling to move or trade up. Housing activity remains subdued, although we have seen modest signs of an uptick in demand following the recent decline in mortgage rates. And all told, we're constructive on the housing sector should the labor market and the consumer remain resilient and in line with the soft landing scenario. Now, shifting to our portfolio and beginning with the agency sector, much of our agency reduction occurred at the very outset of the quarter, which left us well prepared for the spread widening and volatility the market experienced as October progressed. And as volatility subsided and spreads normalized, we rotated out of lower coupons and TBAs and into higher coupon specified pools. We remained disciplined in our selection of specified pool stories, favoring high-quality prepaid protected securities, which represented the vast majority of our higher coupon purchases. In addition, we opportunistically grew our agency CMBS holdings by $1.2 billion as the sector did lag the move tighter in agency MBS, locking in attractive spreads and increasing the portfolio size to $3.2 billion in market value. Fixed-rate agency CMBS is a complementary asset to our agency portfolio as it provides a high-yielding, stable cash flow with minimal convexity exposure. Now, our agency strategy overall represented 62% of our dedicated equity at quarter end, down from 64% the quarter prior as we further reallocated out of agency in favor of resi credit and MSR late in the quarter. As it relates to our hedges, our balanced liability position helped protect us from the elevated rate volatility experienced during the first half of the quarter. One adjustment we did make tactically, however, was we rotated from Treasury futures into SOFR swaps at the very front end of the yield curve, given the particularly tight level of swap spreads experienced in the year end. And overall, we remain conservatively positioned as it relates to our rate exposure as seen through our 106% hedge ratio and rate shock tables. However, given the changing policy landscape, we may reach a point where we'll begin to feel more comfortable adding duration to the portfolio in the near future. And as we begin 2024, With the Fed's pivot to a more neutral monetary policy, the distribution of future rate paths has narrowed, which has resulted in a decline in implied volatility. We'll likely see rate cuts materialize as we approach mid-year, which historically have been a catalyst for inflows in fixed income funds. And furthermore, an earlier end to QT should help stabilize deposits and which along with incremental regulatory clarity should support bank demand. In coincidence with these improving technical factors, MBS are in historically attractive spreads, particularly relative to fixed income alternatives, while convexity and prepayment risk in the market remains relatively low. Now, turning to the residential credit market, The non-agency sector participated in the broader fixed income risk on sentiment to end the year with AAA non-QM spreads 20 basis points tighter and below investment grade CRT 60 basis points tighter quarter over quarter. Our resi portfolio ended the year at $5.7 billion in market value of 14% year over year and currently comprises 20% of the firm's capital. The growth in the portfolio can be attributed to our organic whole loan acquisition and Onslow Bay securitization strategy. And the OBX retained portfolio and whole loan position now account for roughly half of the total RESI portfolio assets. Residential whole loan acquisitions continue to be strong in Q4 as we settled $1.8 billion in loans, of which $1.6 billion was sourced directly through our correspondent channel. Lock volume was robust in the fourth quarter at $2.7 billion, a 13% increase quarter over quarter despite winter seasonals. And our quarter end correspondent pipeline was $1.6 billion with strong credit characteristics as demonstrated by a 748 FICO and 70% CLTV. And since the beginning of the fourth quarter, we've securitized seven OBX transactions for $2.8 billion, inclusive of three transactions priced subsequent to quarter end. And these securitizations generated $290 million of assets at projected mid-teens returns utilizing modest recourse leverage. Onslow Bay continues to be a leader in the residential credit market as we remain the largest non-bank securitizer and second largest overall over the past two years. In addition, we have the lowest delinquency rates across the 10 largest non-QM issuers. And also to note, we were just able to sell the tightest new issue AAA bond executed in 2024 year to date. And our correspondent channel remains our preferred investment option within residential credit, allowing us to organically manufacture assets while maintaining control over pricing, our partners, diligence, credit, and volume. Now, shifting to MSR, our portfolio increased by 18% or $400 million in market value in the fourth quarter through the purchase of three bulk packages, in addition to modest flow acquisitions. And our MSR portfolio, inclusive of forward settling trades, increased nearly 50% throughout 2023 to end December at $2.7 billion in market value, making Onslow Bay a top 10 non-bank owner of servicing rights. The MSR market had an active Q4 with bulk transactions of modestly quarter over quarter, capping a record 2023 that saw over $800 billion in principal balance trade. Annalie was able to capitalize on this significant supply, and we were the fifth largest buyer in the market, onboarding $42 billion in principal balance throughout the year. Consistent with our previous commentary, we continue to favor low note rate, high credit quality collateral, And given the lack of refinance incentive, the portfolio is exhibiting highly stable cash flows and historically low prepayment speeds. The MSR portfolio had a three-month CPR of 2.9% as of December, approximately 40% lower than the MBS universe. And with our unique positioning in the MSR market as a preferred partner to originators in light of our scale and certainty of capital, we've been able to establish new relationships and expand our footprint. In particular, we've started to add flow sourcing partnerships, which we have begun selectively purchasing through this past quarter. And while low no-rate collateral is still our preferred segment of the MSR market, we expect these flow relationships to add a source of more predictable supply. Looking ahead, we anticipate the MSR market to be active this year, though sales may moderate from 2023's elevated levels. And we continue to be well positioned to add MSR with ample warehouse capacity, minimal leverage, and a desire to continue to allocate capital to the strategy. Now, to wrap up before handing off to Serena, I wanted to note that, as always, we're cognizant of the risks on the horizon, and we remain prepared for additional market turbulence and vigilant as the operating environment evolves. That said, we're optimistic with respect to our outlook for each of our three businesses, and we believe that our three complementary, fully skilled strategies should continue to provide Annalise shareholders superior risk-adjusted returns and a strong earnings profile, and stability across different interest rate and macro environments. And with substantial liquidity and prudent leverage, we remain ready to take advantage of opportunities where we believe capital will be most accretive. And now with that, I'll hand it over to Serena to discuss the financials.