ANNALY-CAPITAL-MANAGEMENT Earningcall Transcript Of Q2 of 2024

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.

And with that, I'll turn the call over to David. 

David L. Finkelstein -- Chief Executive Officer and Chief Investment Officer

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 the quarter that saw a fair amount

of  volatility.  While  interest  rates  rose  modestly  quarter  over  quarter,  the  10-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  and  a  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.

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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.  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. 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  continued  to  rotate  up  in  coupon  to  take  advantage  of  wider  spreads  offered  by  production

coupons, increasing our holdings of 5.5 and higher by $4 billion. And year to date, the average net

coupon on our agency portfolio has increased by 30 basis points to 4.87%. And consistent with prior

quarters, we favored high-quality prepayment-protected collateral with durable cash flows. 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.

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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.

For  example,  a  portion  of  the  6.1  trillion  in  money  market  assets  should  gravitate  toward

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.

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 to 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,

and year to date, we've already locked and settled more loans than the entirety of 2023.

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And  our  current  pipeline  continues  to  exhibit  strong  credit  characteristics,  including  a  754  average

FICO  and  a  68%  CLTV.  The  OBX  platform  has  remained  a  market-leading  sponsor  of

securitizations as we priced five 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. And also

to note, we continue to see 12% to 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. Our MSR holdings increased

$135 million quarter over quarter, driven by purchase and settlements, as well as a modest increase

in  the  value  of  the  portfolio  given  the  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 and serious delinquencies are inside of 40 basis points.

And increased competitiveness surrounding deposits is driving elevated float income and all leading

to  prospective  hedge  returns  remaining  in  the  12%  to  14%  range  currently.  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. And 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.  And  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.

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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 in monetary policy. And this should steepen the yield curve, reduce volatility,

and ultimately, in our view, lead to agency outperformance. And 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.  And  now  with  that,  I'll  hand  it  over  to  Serena  to

discuss our financials.

Serena Wolfe -- Chief Financial Officer

Thank you, David. Today I will provide brief financial highlights for the second quarter ended June

30th,  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  30th,  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 to Q2. Looking back to the beginning of 2024,

including  $1.30  dividends  declared  year  to  date,  we  have  generated  an  economic  return  of  5.7%.

Rate volatility and modestly higher Treasury 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 $0.4 per share to $0.68.

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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 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. 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.

And  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 seven days compared to Q1 at 36 days for the

second quarter.

During Q2, we furthered our strategy of providing financing optionality for our Onslow Bay platform,

closing  additional  warehouse  capacity  of  $250  million  and  expanding  our  non-market  market

sublimits. As of June 30th, 2024, we had $4.2 billion of MSR and home 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  remained  undrawn  and  can  be  quickly  converted  to  cash  subject  to  contractual

advance 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. Our efficiency

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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?

Questions & Answers: