Annaly Capital Management Q2 2024 Earnings Report

Annaly Capital Management EPS Results

• Actual EPS: $0.68
• Consensus EPS: $0.66
• Beat/Miss: Beat by +$0.02
• One Year Ago EPS: $0.72

Annaly Capital Management Revenue Results

• Actual Revenue: $1.18 billion
• Expected Revenue: $318.00 million
• Beat/Miss: Beat by +$859.33 million
• YoY Revenue Growth: N/A

Annaly Capital Management Announcement Details

• Quarter: Q2 2024
• Date: 7/24/2024
• Time: After Market Closes
• Conference Call Date: Thursday, July 25, 2024
• Conference Call Time: 9:00AM ET

Annaly Capital Management (NYSE:NLY), Inc. is a publicly traded real estate investment trust (REIT) that specializes in generating income through investment in mortgage-related assets. The company’s core business activities include the acquisition, financing, and management of a diversified portfolio of agency and non-agency residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), and other real estate debt instruments. Annaly seeks to profit from the spread between the interest earned on its mortgage investments and its cost of funds, as well as from capital gains realized through active portfolio management.

Founded in 1997 and headquartered in New York City, Annaly has grown to become one of the largest mortgage REITs in the United States. The company went public in 1997 and trades on the New York Stock Exchange under the ticker symbol NLY. Over the years, Annaly has expanded its investment strategies to include credit opportunities and other yield-oriented products, seeking to navigate a variety of interest rate environments and credit market conditions.

Annaly’s investment portfolio is structured around several distinct business segments, including Agency, Credit, and Other Real Estate Investments. The Agency segment focuses on securities issued or guaranteed by U.S. government-sponsored enterprises, offering high liquidity and low credit risk. The Credit segment targets non-agency residential and commercial mortgage assets, while the Other Real Estate Investments segment may include net lease properties and selected opportunistic debt investments. Through this diversified approach, Annaly aims to optimize risk-adjusted returns for its shareholders.

Leadership at Annaly is headed by Michael A. Farrell, who serves as Chairman and Chief Executive Officer, overseeing the firm’s strategic direction and capital management activities. The company’s executive team brings extensive experience in finance, real estate, and risk management. Annaly primarily serves the institutional investment community but also provides access to mortgage market income for retail investors through its listed shares and subsidiary funds.

Annaly Capital Management Q2 2024 Earnings Call Transcript

Key Takeaways

• Delivered a roughly 1% Q2 economic return and 5.7% H1 return, with earnings available for distribution exceeding dividends by $0.03 on prudent leverage of 5.8 turns.
• Anticipating Fed rate cuts in H2 driving a steeper yield curve, reduced volatility and increased demand for Agency MBS supporting outperformance.
• Grew agency portfolio by ~$1.6 B notional in Q2, rotated into higher coupons (average net coupon +30 bps to 4.87%), with focused hedging to manage rate and prepayment risk amid attractive spreads.
• Residential credit portfolio at $5.9 B saw record growth in the Onslow Bay channel—locking $4.1 B in loans (22% QoQ) and settling $2.8 B—driven by strong credit metrics.
• Expanded MSR portfolio to $2.8 B in market value (22% of capital), with muted prepayments, sub-40 bps serious delinquencies, prospective returns of 12–14%, and enhanced flow/recapture partnerships.

Presentation

[Operator]

Good morning, and welcome to the Annaly Capital Management Second Quarter 2024 Earnings 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 your question, please press Star then two. Please note this event is being recorded. I would now like to turn the call over to Sean Kensil, Director, Investor Relations. Please go ahead.

[Sean Kensil, Director of Investor Relations at Annaly Capital Management]

Good morning, and welcome to the second quarter 2024 earnings call for Annaly 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.

[Sean Kensil, Director of Investor Relations at Annaly Capital Management]

Content referenced in today's call can be found in our second quarter 2024 Investor Presentation and second quarter 2024 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 Wolfe, Chief Financial Officer, Mike Fania, Deputy Chief Investment Officer and Head of Residential Credit, V.S. Srinivasan, Head of Agency, and Ken Adler, Head of Mortgage Servicing Rights. With that, I'll turn the call over to David.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Thank you, Sean. Good morning, and thank you all for joining us for our second quarter earnings call. I have four areas to discuss today before handing it off to Serena to discuss the financials. First, I'll briefly highlight our performance during the quarter, then review the macro and market environment, followed by an update on each of our three businesses, and I'll finish with our outlook for the second half of the year. Now, to begin with, we were pleased with our performance during a quarter that saw a fair amount of volatility.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

While interest rates rose modestly quarter-over-quarter, the ten-year Treasury yield traversed a 50 basis point range as economic data in April meaningfully reduced the magnitude of 2024 rate cuts priced into the market, whereas in June, employment and inflation data brought accommodative policy in the near-term focus for the market and certainly the Fed. Now, in this environment, we delivered a roughly 1% economic return for the second quarter and a 5.7% return for the first half of the year. Earnings Available for Distribution exceeded our dividend by $0.03, demonstrating our ability to consistently earn strong returns with prudent leverage, which stood at 5.8 turns at the end of the quarter. Now, to expand further on the macro landscape, activity continues to slow gradually as tight monetary policy weighs on most parts of the U.S. economy.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

While core service inflation has been more muted following their brisk pace in Q1, recent data suggests that shelter inflation, the most stubborn component of inflation, is finally beginning to meaningfully soften. Meanwhile, the employment picture has moved into better balance as demand for labor has slowed and the pace of hiring is more in line with historical averages. Now, these developments point to rising conviction that the Federal Reserve will begin to lower interest rates in the second half of the year, and this should be followed by additional cuts, depending on the pace of further labor market softening, as the Fed's employment mandate gains more prominence over the inflation mandate. Now, moving to our portfolio and our investment strategies, and beginning with Agency, we actively managed the portfolio during the quarter as current coupon nominal spreads widened by roughly 10 basis points, driven predominantly by elevated rate volatility.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Early in the quarter, as mentioned on our last call, we tactically reduced our Agency holdings as we navigated higher rates and wider spreads. We gradually added that exposure back over the remainder of the quarter as our outlook and relative value considerations improved, growing our Agency portfolio by approximately $1.6 billion notional on the quarter. We continue to rotate up in coupon to take advantage of wider spreads offered by production coupons, increasing our holdings of 5.5s and higher by over $4 billion. Year to date, the average net coupon on our Agency portfolio has increased by 30 basis points to 4.87%. Consistent with prior quarters, we favored high quality, prepayment-protected collateral with durable cash flows.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

And in an environment where the TBA deliverable is expected to further deteriorate, premium specified pools best position us for strong performance in the coming quarters. Now, as it relates to our hedges, the notional value increased relatively in line with Agency Asset Growth, and we're likely to maintain the portfolio's conservative rate exposure as longer term Treasuries continue to face technical headwinds from elevated federal budget deficits, not to mention potential volatility surrounding the upcoming November elections... MBS spread volatility declined in the second quarter, with the technical picture showing signs of improvement. The market has experienced strong inflows into fixed income funds and modest bank buying, while net issuance has run slightly below expectations. And we expect demand for Agency MBS to increase once the Fed initiates its cutting cycle.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

For example, a portion of the $6.1 trillion in money market assets should gravitate towards longer duration fixed income. In addition, Agency MBS is highly attractive relative to other fixed income alternatives, particularly corporates, as MBS nominal spreads are well above historical averages, while competing assets are trading at the tighter end of their historical averages. Now turning to residential credit. Our portfolio ended the quarter at $5.9 billion in economic market value and $2.2 billion in equity, representing 20% of the firm's capital. The modest decline in the resi portfolio was driven by our sale of third-party securities to take advantage of relatively tight credit spreads while increasing our exposure to Agency MBS.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Residential credit assets were largely range-bound throughout the quarter, with investment-grade non-QM securities trading in a 10 basis point range and the CRT market tightening 10-20 basis points. The fundamentals of the residential credit market remain constructive, although we are closely monitoring the increasing regional disparities in housing and the strength of the consumer, given softening labor markets. Mortgage delinquencies, however, remain in near record low levels. Our Onslow Bay correspondent channel experienced record growth in Q2, as we locked $4.1 billion of expanded prime loans and settled $2.8 billion, representing a 22% increase quarter-over-quarter. Year to date, we've already locked and settled more loans than the entirety of 2023. Our current pipeline continues to exhibit strong credit characteristics, including a 754 average FICO and a 68% CLTV.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

The OBX platform has remained a market-leading sponsor of securitizations as we priced 5 non-QM transactions in the second quarter and have now priced 13 securitizations, totaling $6.7 billion on the year. OBX represented 25% of the non-QM issuance in the market and approximately 10% of gross non-Agency issuance for the first half of 2024. Also to note, we continue to see 12%-15% prospective returns on the retention of OBX assets. Now, shifting to the MSR business, our portfolio ended the second quarter with $2.8 billion in market value and $2.5 billion of equity, representing 22% of the firm's capital.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Our MSR holdings increased to $135 million quarter-over-quarter, driven by purchase and settlements, as well as a modest increase in the value of the portfolio, given a 20 basis point increase in mortgage rates. Although our transactional activity slowed in Q2, the portfolio is nearly 30% higher year-over-year, as Annaly remains firmly entrenched as a top 10 non-bank holder of servicing rights. The fundamental performance of the portfolio continues to outperform our expectations as prepayment speeds remain muted despite peak seasonals, as serious delinquencies are inside of 40 basis points. An increased competitiveness surrounding deposits is driving elevated float income and all leading to prospective hedge returns remaining in the 12%-14% range currently.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Now, with respect to supply, the record amount of bulk offerings over the last two years appears to be normalizing, as originators are better positioned with access to capital markets and their gain on sale margins improving. While we will continue evaluating bulk MSR opportunities as a result of the changing market dynamics, we have focused on enhancing our flow and recapture capabilities to acquire newly originated MSR from our network of partners. We remain well positioned to grow our MSR business, given our structure and partnerships, and we believe we have constructed one of the most durable and high-quality portfolios within the MSR sector. Now lastly, with respect to our outlook, we're encouraged by the return potential across each of our three investment strategies, and we're optimistic as the market prepares to enter a more accommodative phase of monetary policy.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

This should steepen the yield curve, reduce volatility, and ultimately, in our view, lead to Agency outperformance. While we expect to continue to grow our residential credit and MSR businesses opportunistically, we feel our current capital allocation and portfolio construction is positioned to generate sustainable returns in an environment that should be favorable to fixed income investors. Now, with that, I'll hand it over to Serena to discuss our financials.

[Serena Wolfe, CFO at Annaly Capital Management]

Thank you, David. Today, I will provide brief financial highlights for the second quarter ended June 30, 2024. Consistent with prior quarters, while our earnings release discloses GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP EAD and related key performance metrics, which exclude PAA. As of June 30, 2024, our book value per share decreased from the prior quarter to $19.25. Despite the asset spread widening and interest rate volatility during the quarter, we generated a 0.9% economic return, including our dividend of $0.65 for Q2.

[Serena Wolfe, CFO at Annaly Capital Management]

Looking back to the beginning of 2024, including $1.30 in dividends declared year to date, we have generated an economic return of 5.7%. Rate volatility and modestly higher reasury rates resulted in a decrease of $0.96 per share on our Agency MBS portfolio, with positive contributions of $0.16 and $0.31 per share coming from our resi MSR portfolios and hedges, respectively. Earnings Available for Distribution increased in the second quarter by $0.04 per share to $0.68. Higher coupon income related to the continued rotation up in coupon on the Agency portfolio, and $2.8 billion in assets settled via the Onslow Bay-based correspondent channel contributed to the increase in EAD. Consequently, average asset yield, ex PAA, increased 27 basis points from the first quarter to 5.14% in Q2.

[Serena Wolfe, CFO at Annaly Capital Management]

Higher coupon income was partially offset by an increase of 12 basis points in our economic cost of funds. Taken together, our net interest spread, ex PAA, increased by 15 basis points, reaching 1.24% in the second quarter. Net interest margin, ex PAA, also rose 15 basis points quarter over quarter to 1.58%. While repo rates remained stable, even declining 2 basis points in Q2, securitized debt expense increased in Q2 due to the high volume of securitizations we completed in the first six months of 2024. Additionally, our swap benefit declined modestly due to a large position maturing during the quarter, representing our final scheduled swap maturity for this year. As we continued executing our repo strategy, our weighted average repo days declined 7 days compared to Q1, at 36 days for the second quarter.

[Serena Wolfe, CFO at Annaly Capital Management]

During Q2, we furthered our strategy of providing financing optionality for our Onslow Bay-based platform, closing additional warehouse capacity of $250 million and expanding our non-mark-to-market sub-limits. As of June 30, 2024, we had $4.2 billion of MSR and whole loan warehouse capacity at a 39% utilization rate, leaving substantial availability. Annaly's unencumbered assets increased to $5.4 billion in the second quarter, including cash and unencumbered Agency MBS of $3.5 billion. We also had approximately $900 million in fair value of MSR pledged to committed warehouse facilities, which remain undrawn and can be quickly converted to cash, subject to contractual event rates. Together, we had approximately $6.3 billion in assets available for financing, up $45 million compared to last quarter, notwithstanding the slight increase in our leverage profile.

[Serena Wolfe, CFO at Annaly Capital Management]

Our efficiency ratios worsened during Q2 due to the timing of certain expenses. However, we expect expenses to normalize and full-year OPEX to equity ratios to align with historical levels. That concludes our prepared remarks. We will now open the line for questions. Thank you, operator.

[Operator]

We will now begin the question and answer session. To ask a question, you may press star, then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Bose George with KBW. Please go ahead.

[Bose George, Managing Director at KBW]

Hey, everyone. Good morning. Actually, can I start just with getting an update on quarter to date book value?

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Sure, Bose. Good morning. As of Tuesday's close, we were up roughly 2% with the dividend accrual and, a little over 1% net of the dividend.

[Bose George, Managing Director at KBW]

Okay, great. Thank you. And then just in terms of the hedges, so you were replacing the maturing swaps with Treasury futures this quarter. Can you, you know, just talk about the advantages, you know, of that?

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Yeah, sure. So there's multiple advantages. We were certainly concerned with rate volatility and particularly spread volatility. So, reducing the exposure to swaps was somewhat warranted, particularly later in the quarter. And there is differences with respect to initial margin and liquidity associated with swaps. It's not a material change. One of the catalysts for the change was also putting on a little bit of a curve trade, a steepener, given what our view was with respect to the expectation for a little bit of yield curve steepening, which we saw this quarter. Certainly, as we're about 20 basis points steeper, 2s10s. And generally just for liquidity and IM benefit, as well as creating the right balance.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Another point to note as it relates to our swaps, Bose, is that our swap position is in a very good place. We have had a lot of runoff over the past couple of years, including this past quarter and Q1, and we're in a place where we do not have any more swap runoff at that low pay rate for the rest of this year. And so we feel pretty good about our swap position here. And when you look at the relative tightness of swap spreads, you know, I think ten-year swap spreads are around negative 45.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

It's a good hedge, so we're going to be a little bit overweight swaps, because the levered return relative to swaps versus other hedges is pretty attractive right now, notwithstanding the concerns over balance sheet as it relates to swap spreads.

[Bose George, Managing Director at KBW]

Okay, makes sense. Thanks a lot.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Thank you, Bose.

[Operator]

The next question is from Doug Harter with UBS. Please go ahead.

[Doug Harter, Equity Research Analyst at UBS]

Thanks. David, you talked about, you know, kind of having a slightly different strategy on acquiring new MSR. Can you just talk about the risk profile of new MSR and the relative attractiveness of adding those to what's, you know, a very attractive existing portfolio?

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Sure, Doug, I'm going to hand it over to Ken to help you with that.

[Ken Adler, Head of Mortgage Servicing Rights at Annaly Capital Management]

Yeah, sure. I mean, new MSR just has materially more prepayment exposure to it. So it relies on a different hedging strategy than the legacy MSR, with a much lower note rate and more stable cash flow. However, the new MSR also provides opportunity for recapture that that's not present in the legacy MSR. So that's an additional revenue opportunity as well.

[Doug Harter, Equity Research Analyst at UBS]

Can you just remind us, Ken, kind of where you are in terms of recapture, what agreements you have, and, you know, how confident you would be in your capabilities to execute?

[Ken Adler, Head of Mortgage Servicing Rights at Annaly Capital Management]

Absolutely. Look, we currently have four recapture partners. Each of these partners has different strategies, approaches, and creating recapture. And what we do is we compare the results between them and allocate our initiatives to the best performers and kind of refine these strategies over time. So we kind of have a portfolio approach to this, and we have the ability to be dynamic, given the use of multiple providers. We also have several strategic discussions with potential new partners that many are considered best in class, and they offer unique technology and differentiating strategies. So our approach and ability to partners with servicers and originators is what we're happy about.

[Doug Harter, Equity Research Analyst at UBS]

I guess, just to be clear on that, so when there is recapture, do you share in the full origination economics, or are you just getting the MSR back? You know, just wanna make sure I understand how those economics work.

[Ken Adler, Head of Mortgage Servicing Rights at Annaly Capital Management]

We effectively share in the gain on sale in a material way by taking that MSR back at a below-market price, and those prices are negotiated, and they're different depending on the provider, what the recapture rate is. So there's kind of an incentive fee structures with these providers. And, given how low origination margins are in the industry, the repurchase of the MSR back at a discount is effectively, you know, assuming that origination payment.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Yeah, and Doug, given how competitive origination and servicing is, we're able to extract the right value associated with our recapture relationships.

[Doug Harter, Equity Research Analyst at UBS]

Very helpful. Thank you, guys.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Thank you, Doug.

[Operator]

The next question is from Rick Shane with JPMorgan. Please go ahead.

[Rick Shane, Managing Director and Senior Equity Research Analyst at JPMorgan]

Hey, guys. Thanks for taking my question. I really needed to queue in before Doug, because that was the topic I wanted to explore as well. I am curious, you know, one of the things that is driving MSR pricing is that recapture opportunity. And I'm curious and again, you've talked about some of the efficiency from an economic perspective for you from a recapture perspective, but I am curious if you're seeing peers out there whose economics are really focused on the origination side, who are making pricing in that space less attractive for you. It's an interesting time to shift from bulk to flow.

[Ken Adler, Head of Mortgage Servicing Rights at Annaly Capital Management]

Yeah. Well, we are observing just, you know, as everybody is, when you observe the prices, the price spread between low note rate MSR and newly created higher note rate MSR, has never been less than I've seen. So, you are seeing increasing comfort with the ability to price in that recapture by the market overall. And, there's always a couple participants that stand out, but in general, yes, you know, the comfort with using big data, call center technology, seems. It has absolutely increased.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Yeah, and Rick, another point which you may be alluding to is that as it relates to our MSR portfolio, we're very protective of the borrower. And the last thing we want to do is use a sub-servicing relationship that is going to lead to, you know, over churning of our portfolio or anything that would damage our returns. And so, it's a high bar to partner with us when it comes to recapture and sub-servicing.

[Rick Shane, Managing Director and Senior Equity Research Analyst at JPMorgan]

Got it. That makes sense. Hey, a request. As you transition to more of a flow business and potentially the coupons start to shift a little bit, could you provide disclosure on the coupon in the way that you do for the MBS portfolio so we can see the distribution of coupons?

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Sure. That's certainly a consideration, but it is important to note that in the current portfolio, the vast, vast majority is, is very, very low rate. So, it's a pretty homogeneous bucket of, what are, you know, should be considered to be non-refinanceable, mortgages.

[Rick Shane, Managing Director and Senior Equity Research Analyst at JPMorgan]

Absolutely. Yeah, it, again, depending upon how fast that flow business grows, we could start-

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Yeah

[Rick Shane, Managing Director and Senior Equity Research Analyst at JPMorgan]

- to see the portfolio barbell a little bit, and just would love to understand that better.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

You bet, Rick.

[Rick Shane, Managing Director and Senior Equity Research Analyst at JPMorgan]

Perfect. Thanks, guys.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Thank you, Rick.

[Operator]

The next question comes from Jason Stewart, with Janney Montgomery Scott. Please go ahead.

[Jason Stewart, Director and Equity Research Analyst at Janney Montgomery Scott LLC]

Good morning. Thanks for taking the question. One more on the MSR and servicing front. Do you have any thoughts ... I know it's early and likely to change, but thoughts on the CFPB's proposed servicing rule regarding foreclosures, how that might impact the valuation, competitive environment, et cetera?

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

... Yeah, that's a good question, Jason. So we certainly recognize the CFPB's efforts to revise mortgage servicing rules to benefit borrowers, and many of the proposed changes would result in more complex loss mitigation processes with potentially longer timelines to reach resolution. And you know, on the surface, if implemented as proposed, our sub-servicer oversight team would ensure that our sub-servicers are following all relevant laws and regulations, and we could expect sub-servicing costs to increase on the margin. But our portfolio, both on the resi credit side as well as the MSR side, is composed of very high-quality borrowers with significant equity in their homes. And our portfolios just is specifically Fannie and Freddie made up with very low delinquencies, as I mentioned, less than 40 basis points.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

And we have no Ginnie borrowers to speak of. We have a very small sleeve of Ginnie Mae from the legacy Pingora days. So we don't expect the cost to us to increase in any meaningful way, but it could lead to a little bit higher servicing costs overall.

[Jason Stewart, Director and Equity Research Analyst at Janney Montgomery Scott LLC]

Yeah, thanks. Yeah, I think it's important to note that differentiation there. So thanks for that color. And then going back to the up in coupon trade, you know, when you look at specified pools up in coupon, I think you noted you're looking at very, you know, call it high premium or quality pools there. When you combine that with the competitive environment for, you know, marginal refi activity, where is the most value, and how are you looking at hedging those to protect that value?

[Mike Fania, Deputy Chief Investment Officer and Head of Residential Credit at Annaly Capital Management]

So basically, our strategy has been that as we move up in coupon, we buy higher and higher quality pools. So, on 6.5s, we generally buy very high-quality pools, and on 6s it'll be a little bit less, and then 5.5s, it'll be a little bit less. The way we think about hedging is, we think of a specified pool as a combination of TBA duration plus a pay-up duration. So we kind of model how that pay-up duration is going to move in a rally and a sell-off, and we kind of measure that duration, and that's how we hedge the pay-up.

[Jason Stewart, Director and Equity Research Analyst at Janney Montgomery Scott LLC]

Okay, thanks for-

[Mike Fania, Deputy Chief Investment Officer and Head of Residential Credit at Annaly Capital Management]

The biggest advantage... Yeah, the biggest advantage is, the, these pools provide ample spread right now, and, because they are less negatively convex, we are not really giving up that much carry, in the near term. And in the long term, if and when rates do rally, they provide, very durable yields for an extended period of time.

[Jason Stewart, Director and Equity Research Analyst at Janney Montgomery Scott LLC]

Yeah, I guess, I guess my takeaway there was that the, the carry is gonna benefit you for several quarters, and you can potentially hedge away the negative convexity. But, you know, we might be getting too much in the weeds there, but that, that was just my thought.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Yeah, that's the right assessment, Jason.

[Jason Stewart, Director and Equity Research Analyst at Janney Montgomery Scott LLC]

Thanks.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Thank you, Jason.

[Operator]

This concludes the question and answer session. I would like to turn the conference back over to David Finkelstein for any closing remarks.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Actually, I do believe we have one more question in the queue.

[Operator]

I do see him, yes. Let me announce him. The next question is from Tim Chang with BTIG.

[Eric Hagen, Managing Director and BTIG Mortgage and Specialty Finance Analyst at BTIG LLC]

Eric Hagen. Sorry for punching in late. I think the question here is just, you know, if it looks like the Fed is gonna cut more aggressively, what's your perspective on how mortgage spreads will respond to that? Even what we're seeing just in the market over the last, you know, call it 24 hours. Thank you, guys.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Yeah, under that scenario, Eric, we would be optimistic on mortgage spreads. You'll see, you know, further steepening in the yield curve than the 50 basis points that's priced in over the next year between 2s and 10s. You know, the $6.1 trillion in money market funds, as those yields start to decline, will gravitate toward longer duration fixed income. As I mentioned, you'll potentially see bank demand come in, and it'll just be a better environment for agencies. You know, we've experienced this cycle after cycle. When the Fed cuts and the curve steepens, there is better demand for Agency MBS, and you would expect vol to come down. It should be a dampening environment, and we would expect strong performance from Agency, which is why we like this, the sector.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

We think that the appropriate amount of cuts are currently priced in. But, you know, when you look at the Fed's posture and the shift over the past number of months, it's gone from, you know, focus on the inflation mandate to more balance between the employment mandate and inflation. And there is a likelihood that given what's gone on in the labor market, is that the focus could shift to be more weighted towards the employment picture, and you could see more aggressive cuts than what's priced in, and that would be a perfectly good outcome for us.

[Eric Hagen, Managing Director and BTIG Mortgage and Specialty Finance Analyst at BTIG LLC]

Yep, that's good perspective. I appreciate that. Hey, so how are we thinking about the trade-off between maybe levering up with the MSR a little bit more and raising capital or even de-levering the Agency MBS portfolio to maybe balance out or buffer any, any of that, you know, prepayment risk?

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Yeah. Yeah, so I would say that incremental purchases of MSR would likely be levered. We have very, very low leverage on that portfolio. We've been fortunate, given our abundant liquidity, to be able to use the Agency portfolio as somewhat of a bank to finance it. And it's led to returns that are in excess of the 12%-14% we show in the materials, which assumes warehouse financing, and so we have the ability to leverage. Right now, we have the liquidity to not need to, but I would say to keep that capital allocation in the context of 20% or thereabouts, we probably would lever incremental purchases and maintain the liquidity of the overall portfolio. And look, as it relates to capital raise, capital raising, two conditions have to be met.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

It has to be accretive and benefit shareholders, and assets have to be available and at the right price. You know, there's a lot to get through, and to the extent it's you know the market is compelling us to do so, we'll certainly look at it, but we feel like we're in a good place, and we'll see how things evolve over the near term.

[Eric Hagen, Managing Director and BTIG Mortgage and Specialty Finance Analyst at BTIG LLC]

Yep.

[Mike Fania, Deputy Chief Investment Officer and Head of Residential Credit at Annaly Capital Management]

I'll just add that we have-

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

One more sec, Eric.

[Eric Hagen, Managing Director and BTIG Mortgage and Specialty Finance Analyst at BTIG LLC]

Go ahead.

[Mike Fania, Deputy Chief Investment Officer and Head of Residential Credit at Annaly Capital Management]

I just add that we have committed MSR line, so we can tap them anytime we want.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Exactly.

[Eric Hagen, Managing Director and BTIG Mortgage and Specialty Finance Analyst at BTIG LLC]

Yep, that's helpful. Hey, we appreciate you guys. Thank you. Thanks for squeezing me in.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Thank you, Eric. Have a good day.

[Operator]

This concludes the question and answer session. I'd like to turn the conference over to David Finkelstein for any closing remarks.

[David L. Finkelstein, CEO and Chief Investment Officer at Annaly Capital Management]

Thanks, Debbie, and thank you, everybody, for joining us today. Enjoy the rest of the summer, and we'll talk to you in the fall.

[Analyst]

Great job, guys.

[Operator]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

Participants

Executives

• David L. Finkelstein, CEO and Chief Investment Officer
• Ken Adler, Head of Mortgage Servicing Rights
• Mike Fania, Deputy Chief Investment Officer and Head of Residential Credit
• Sean Kensil, Director of Investor Relations
• Serena Wolfe, CFO

Analysts

• Bose George, Managing Director at KBW
• Doug Harter, Equity Research Analyst at UBS
• Eric Hagen, Managing Director and BTIG Mortgage and Specialty Finance Analyst at BTIG LLC
• Jason Stewart, Director and Equity Research Analyst at Janney Montgomery Scott LLC
• Rick Shane, Managing Director and Senior Equity Research Analyst at JPMorgan
• Analyst