Annaly Capital Management Q4 2024 Earnings Call Transcript

Quartr
Provided by Quartr
January 30, 2025
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Operator

Good morning, everyone, and welcome to the Q4 20 24 Annaly Capital Management Earnings Conference Call. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask questions. Please also note today's event is being recorded. And at this time, I'd like to turn the floor over to Sean Pennzil, Director of Investor Relations.

Operator

Sir, please go ahead.

Sean Kensil
Sean Kensil
Director of Investor Relations at Annaly Capital Management

Good morning, and welcome to the Q4 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.

Sean Kensil
Sean Kensil
Director of Investor Relations at Annaly Capital Management

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 Q4 2024 Investor Presentation and Q4 2024 Supplemental Information, those found under the Presentations section of our website. Please also note this event is being recorded.

Sean Kensil
Sean Kensil
Director of Investor Relations at Annaly Capital Management

Participants on this morning's call include David Finkelstein, Chief Executive Officer and Co Chief Investment Officer Serena Wolf, Chief Financial Officer Mike Fania, Co Chief Investment Officer and Head of Residential Credit Srinivasan, Head of Agency and Ken Adler, Head of Mortgage Servicing Rights. And with that, I'll turn the call over to David.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Thank you, Sean. Good morning and thank you all for joining us on our Q4 earnings call. Today, I'll briefly review the macro and market environment along with our performance during the Q4 and the full year, and then I'll provide an update on each of our three businesses and then with our outlook for 2025. And Serena will then discuss our financials, after which we will open the call up to Q and A. Now, starting with the macro landscape, the U.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

S. Economy continued to perform well in the 4th quarter, recording strong growth on the back of healthy consumption. The labor market strengthened in November December, reducing concerns of more meaningful slowdown. Given the health of the economy and the consumers' continued willingness to spend, inflation remained elevated in Q4, though the most recent December data did show signs of improvement. During the quarter, interest rates moved contrary to market expectations from September when the onset of the Federal Reserve cuts was seen as supportive of rates markets.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

The yield curve subsequently bear steepened in Q4 with 10 year treasury yields rising nearly 80 basis points as the stronger economic growth and inflation data combined with increased attention to the long term budget outlook led to a meaningful rise in term premium. An additional factor contributing to higher yields was the shift in tone from the Fed during the quarter as officials argued that after 100 basis points cuts, Fed funds rate is now less restrictive than during the summer and further downward adjustments will depend on incoming data and progress towards lower inflation. In line with treasury yields, primary mortgage rates increased to nearly 7%, which reversed some of the pickup in housing demand when mortgage rates touched as low as 6% in late Q3. Available for sale housing supply continues to slowly increase with current levels of inventory now only 25% lower than pre pandemic averages. But despite these factors, home prices on a national level continue to increase modestly.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Against this backdrop, our portfolio generated an economic return of 1.3% for the 4th quarter with all three businesses contributing positive returns. In Annaly's full year 20 24 economic return of 11.9 percent underscores the strength and diversity of our housing finance portfolio in light of volatile fixed income markets. Economic leverage decreased to 5.5 turns on the quarter, driven by increased capital deployment within our lower levered credit and MSR businesses, including positioning the portfolio for $385,000,000 in market value of MSR that is anticipated to settle in Q1. Despite our lower economic leverage, earnings available for distribution rose $0.06 to $0.72 on the quarter, led by lower financing costs given the commencement of the Fed cutting cycle, as well as steepening of the yield curve. And lastly, we raised over $400,000,000 of accretive common equity through our ATM in Q4, bringing the total capital raised in 2024 to $1,600,000,000 Now turning to our investment strategies and beginning with agency, the portfolio ended the year at roughly $71,000,000,000 in market value with $7,400,000,000 of dedicated equity, representing 59% of the firm's capital.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

We continue to migrate up in coupon in the quarter by primarily rotating into 6s 6.5s, modestly increasing our weighted average coupon to 5%. Our allocation to TBAs remain minimal given elevated implied role financing rates that prevailed in Q4 and a preference for better convexity with specified pools. Now, Agency MBS began the quarter on weaker footing with spreads widening in late October as markets experienced higher rates and increased volatility leading up to the election. Spreads reversed course post election and tightened as agency MBS participated in positive risk sentiment displayed across fixed income and equities. MBS spreads on average ended the quarter a couple of basis points wider, but performance varied significantly across the coupon stack.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

5.5s and higher outperformed, while intermediate coupons, the primary outperformers in the 3rd quarter, widened by half a point. Accordingly, our portfolio benefited in Q4 from our ongoing up in coupon allocation as approximately 50% of our holdings are at 5.5s and higher. Now, as it relates to our hedging strategy, the portfolio's duration extension was proactively managed by increasing hedges at the long end of the yield curve, predominantly through treasury futures. The hedge position remains skewed toward the long end where we anticipate a greater risk of yields moving higher, while the front end appears to be more anchored at current levels. As interest rate volatility has remained elevated, we plan to maintain a conservative hedge profile while preserving a mix of swap and treasury hedges across various points on the yield curve, leveraging the advantages of a diversified and liquid hedge portfolio.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

And it's worth noting that Agency MBS proved much more resilient during the 4th quarter than other recent periods of similar increases in rates, and this dynamic was driven by lower supply and increased demand for MBS as the reduction in financing rates improved MBS carry. And the combination of better technicals coupled with an ongoing cutting cycle should support a narrower range of MBS spreads going forward, which remain attractive. Now, moving to residential credit, the portfolio ended the year at $7,000,000,000 in economic market value with $2,700,000,000 of dedicated equity, representing 22% of the firm's capital. The portfolio grew approximately $500,000,000 quarter over quarter as we continue to prioritize our organic strategy, increasing our whole loan and retained OBX assets by $730,000,000 while decreasing our allocation of third party securities given relatively tight credit spreads. Market conditions for securitization sponsors remained favorable in Q4 as we recorded our tightest AAA spread of the year and our last deal with 2024 at 115 basis points over treasuries.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

We closed on 4 securitizations totaling $2,300,000,000 in Q4, bringing our cumulative issuance on the year to 21 transactions totaling $11,000,000,000 which created $1,100,000,000 of proprietary assets for Annaly in 2024. Our securitization volume continues to be driven by growth in our conduit as we settled $3,900,000,000 through the channel, a 32% increase quarter over quarter. And strong momentum within our lock volumes also continued as we processed $5,400,000,000 of locks on the quarter, a 24% increase over Q3. On the year, we closed $11,700,000,000 of residential whole loans through the correspondent channel with total loan acquisitions of 13,000,000,000. Our locked pipeline remained robust at year end as we had 2,300,000,000 of high credit loans in the pipeline with a weighted average FICO of 7.57 and a CLTV at 68%.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

As our whole loan production continues to increase, credit discipline remains top priority as evidenced by the OBX Shelf continuing to report the lowest delinquencies out of the top 10 largest non QM issuers. Onslow Bay's positioning in the market as an industry leading non agency correspondent and one of the largest most liquid residential credit securitization sponsors should allow us to continue to manufacture high quality assets with double digit ROEs despite tighter credit spreads. Now, turning to the MSR business, our portfolio ended the 4th quarter at 3,300,000,000 in market value including unsettled commitments, which is a roughly 25% increase year over year. MSR ended the year representing 19% of the firm's capital with 2,500,000,000 of dedicated equity. During the quarter, we committed to purchase nearly $425,000,000 in market value with a $28,000,000,000 principal balance and a weighted average coupon of 3.67%.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

We onboarded $58,000,000,000 UPB of MSR throughout the year, ending 2024 as the 3rd largest buyer of conforming MSR in the market. While supply declined by nearly 40% in Q4, we anticipate that MSR bulk activity will stay elevated relative to historical levels as the origination market remains challenged with high mortgage rates, tepid origination volumes and compressed gain on sale margins. The valuation on our MSR portfolio increased 3% to a 5.78 multiple on the quarter, resulting from the rise in mortgage rates, a steeper yield curve and modestly tighter spreads. Fundamental performance within the MSR portfolio continues to outperform our expectations with actual realized prepayment speeds and delinquencies lower than initially modeled, while the competition for deposits and resulting flow income has been higher than anticipated. Portfolio paid 3.7 CPR in the quarter with current serious delinquencies approximately 50 basis points.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

And with a weighted average note rate of 3.2%, our portfolio's cash flows should remain durable. While we continue to find lower coupon MSR more attractive in the current environment, the expansion of our flow business and our leading recapture relationships provide us the optionality to invest across both current coupon as well as low note rate MSR. Now to conclude with our outlook, we believe each of our three strategies is well positioned heading into the New Year. Agency MBS continues to exhibit attractive spreads on both an absolute and relative basis to competing asset classes, further supported by a better balanced supply and demand picture and improved carry. Our residential credit business is a clear market leader with strong momentum for continued growth after another year record loan production and securitization volume, and we expect the NonQM origination market to grow in 2025 with Onslow Bay well positioned to further expand our market share capabilities.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Within MSR, our deep capital base, low leverage and partnerships with originators and servicers all support further growth of the portfolio. And we expect the NLE platform to continue to outperform in the current operating environment as our diversified strategies, conservative leverage and ample liquidity are key differentiators. And now lastly, before I turn it over to Serena, I wanted to congratulate Mike Fania on being named Co Chief Investment Officer. Over the past 2 years as Deputy CIO, Mike has played a critical role in our portfolio management committee, which oversees all three of our investment strategies. I look forward to continuing to work closely with Mike and our other investment leaders to manage our portfolios and further our leadership across all aspects of housing finance.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

And now with that, I'll hand it over to Serena to talk about the financials.

Serena Wolfe
Serena Wolfe
CFO at Annaly Capital Management

Thank you, David. Today, I will provide brief financial highlights for the Q4 and select full year measures for the period ended December 31, 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 December 31, 2024, our book value per share decreased 2% from $19.54 in the prior quarter to $19.15 After accounting for our dividend of $0.65 we achieved an economic return of 1.3% for Q4, and we were pleased to generate an economic return of 11.9% for the full year 2024. Our portfolio strategy delivered sound results despite higher interest rate volatility and a rate sell off.

Serena Wolfe
Serena Wolfe
CFO at Annaly Capital Management

For the quarter, we incurred losses on our Agency MBS portfolio of $4.14 per share and on our resi credit portfolio of $0.26 per share. However, our hedge position gains of $3.74 as well as $0.21 in gains from our MSR portfolio nearly offset agency and resi declines. Earnings available for distribution per share increased significantly to $0.72 and exceeded our dividend for the quarter due to lower borrowing costs as our average repo rate decreased 57 basis points to 4.93%. Additionally, coupon income increased on higher average agency investment balances and our continued rotation up in coupons. The ReadyCredit business contributed additional income due to the platform's continued growth as the debt securitized $2,300,000,000 in assets sourced through the Enzo Bay correspondent channel during the quarter.

Serena Wolfe
Serena Wolfe
CFO at Annaly Capital Management

Lower net interest income on SWAF partially offset these increases, which declined due to lower average net rates given the decrease in SOFA during the quarter. Average asset yields ex PAA increased modestly 1 basis point to 5.26 percent in Q4. However, the 57 basis point decline in average repo rates that I mentioned earlier, partially offset by lower swap income and higher securitized debt expense from the 4 securitizations that closed during the quarter, helped fuel a 14 basis point decline in our economic cost of finance. Based on these factors and as we had messaged in Q3 and our recent Investor Day, we saw improvement in both NIM and NIS. Our net interest spread, ex PAA, improved by 15 basis points to 1.47 percent and our net interest margin, ex PAA, improved by 19 basis points to 1.71%.

Serena Wolfe
Serena Wolfe
CFO at Annaly Capital Management

Our financing strategy continues to be guided by strong market demand for our agency and non agency security portfolios. Accordingly, we have maintained a consistent repo strategy, positioning the book around Fed meeting dates as term premium in the agency repo market remains somewhat elevated. As a result, our Q4 reported weighted average repo days were 32 days, down 2 days compared to Q3. Moreover, we have maintained our disciplined approach to diversifying our funding options in our credit businesses. During Q4, we added $300,000,000 $150,000,000 in warehouse capacity for MSR and residential credit respectively, which brings our total warehouse capacity across both businesses to $5,200,000,000 with a utilization rate of 41% as of December 31.

Serena Wolfe
Serena Wolfe
CFO at Annaly Capital Management

Post quarter end, we upsized an existing MSR warehouse facility by $250,000,000 adding to our substantial availability. Annaly's financial strength is further evident in our unencumbered assets, which ended the Q4 at $5,800,000,000 including cash and unencumbered agency MBS of $3,900,000,000 In addition, we have approximately $1,100,000,000 in fair value of MSR that has been pledged to committed warehouse facilities, but remains undrawn and can be quickly converted to cash, subject to market advance rates. Together, we have approximately $6,900,000,000 in assets available for financing, down approximately $500,000,000 compared to the 3rd quarter, though up approximately $700,000,000 year over year. Finally, turning to expenses, our efficiency ratios improved during the quarter due to flat G and A costs and higher average equity balances. This resulted in our OpEx to equity ratio decreasing 9 basis points to 1.39% for the quarter.

Serena Wolfe
Serena Wolfe
CFO at Annaly Capital Management

And on a full year basis, our OpEx to equity ratio remains in line with historical levels at 1.44%. Now 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. And our first question today comes from Bose George from KBW. Please go ahead with your question.

Bose George
Managing Director at Keefe, Bruyette & Woods (KBW)

Hey, everyone. Good morning. Actually, I wanted to first ask about the stronger earnings power this quarter. That $0.72 EAD looks like it equates to around 15% net ROE. Would you characterize this level of EAD as in line with the current normalized economic return of your portfolio?

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Generally, Bose, over the course of the quarter, we didn't really see much of a change in spreads and you could see agency at 15% to 17% and probably at the higher end of that. And with expenses, which are now lower given the equity raise, that's reasonably contextual. And in terms of run rate, we don't have longer term guidance. But for the Q1, we feel like earnings with all we know today will be contextual with where we're at in Q4.

Bose George
Managing Director at Keefe, Bruyette & Woods (KBW)

Okay, great. And then just in terms of an update on the dividend, just given the run rate of earnings, I guess it's fair to say the dividend looks well covered?

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Yes, I think we feel that for 20.25 the dividend certainly feels safe and it's obviously a conversation we have every quarter with our Board. And as we evaluate the dividend, we always look for durability, so we don't take those decisions lightly and we go through a thorough evaluation. We feel good about where things are at. And our outlook is optimistic that we'll be able to maintain this run rate.

Operator

Our next question comes from Rick Shane from JP Morgan. Please go ahead with your question.

Richard Shane
Richard Shane
Stock Analyst at JP Morgan

Good morning. Thanks for taking my question. Look, obviously, investment in MSR is a really important part of the strategy. And one of the things that you've noted over the last couple of quarters is a migration from sort of low coupon to higher sort of on the run MSR. The competitive dynamics in that space are changing pretty significantly as you've got a lot of originators focused on recapture.

Richard Shane
Richard Shane
Stock Analyst at JP Morgan

We're now looking potentially at expectations for lower origination volumes in '25 versus what we were looking for even 3 or 4 months ago. Curious how that's impacting the competitive landscape and if that sort of shifts your view at all in terms of that opportunity in the short term?

Ken Adler
Ken Adler
Head of Mortgage Servicing Rights & Portfolio Analytics at Annaly Capital Management

Hey, thanks for the question. This is Ken. Look, we're actually super excited about the opportunity because as there is lower volume, there's also lower profitability within the mortgage industry. So, these lenders are less able to retain MSR. So, while there might be less MSR created industry wide, there is also less industry that is retained by those lenders originating it.

Ken Adler
Ken Adler
Head of Mortgage Servicing Rights & Portfolio Analytics at Annaly Capital Management

So, they really are in need to kind of monetize that MSR very quickly as those loans are originated in a way that hasn't been the case in the last few years. So, we're kind of super excited to set up for that opportunity. And as we continually mentioned, we are the strategic partner to the lending world. So, yes, we're out there growing our network of partners that will need this sort of execution.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Yes.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

And Rick, I'll just add. That's how we set up the business, to be a capital partner for the origination community. And while both volumes, as I mentioned, have slowed down, there is still ample amounts of MSR on originator balance sheets, and we're here to provide liquidity.

Richard Shane
Richard Shane
Stock Analyst at JP Morgan

Got it. So, guys, that's a really helpful answer. And in some ways not in some ways, but you guys answered that question from a supply perspective and it's really great context and it's a good reminder. I guess what I would say is that totally makes sense, but also it does feel like the demand side has picked up a lot as well. Is that is the supply opportunity offsetting that demand increase?

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Yes. Look, the assets performed well. So, there's a lot of capital that's there is capital that's flowed in the space. The advantage we have is we're just a reliable source of partner a reliable source of capital and we are this great partner. So, it's really it's not just bond trading, it's really establishing this network of relationships and kind of being there on a regular basis.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

So, we do notice most of the lenders are operationally constrained and they really do limit themselves to 1, 2 or 3 partners. And we just show very well given how much capital we have and how kind of reliable we can be as an execution.

Operator

And our next question comes from Jason Stewart from Janney Montgomery Scott. Please go ahead with your question.

Jason Stewart
Director & Equity Research Analyst at Janney Montgomery Scott

Thanks for taking the question. On GSE reform in the expanded credit market, maybe you can give us some thoughts on how you see that progressing and what opportunities you see emerging as we go down that path?

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Yes, it's a good question. There's obviously been a lot of talk about the GSEs as of late, Jason. And look, our view is that the hurdles for meaningful transformation of the GSEs are quite high. There is still the matter of the liquidation preference whereby treasuries of $334,000,000,000 which we don't see being going away, certainly and so far as it's owed to the taxpayer. In addition, you do have an ROE constraint amongst the GSEs.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

It's hard with capital requirements that are prescribed for the GSEs to raise capital at current ROEs. And also there is a considerable amount of industry pushback with respect to the model and what could happen. And it's not just the industry, it's a lot of policymakers as well. I think the way we look at the GSEs is it's an incredibly effective mechanism to provide housing finance. If you think about it, private capital takes rate convexity and credit risk.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

The GSEs and originators do a very effective job of intermediating that risk. And the government provides catastrophic risk, which works very well. Government just prices that risk much more calmly than private markets. So we're certainly hopeful that that's well recognized and we're having every conversation you could have to make sure that everybody understands the criticality of the GSEs and the association with the government, but we're watching it closely and we're eyes wide open. With respect to opportunities in credit and that is the silver lining with respect to changes with this administration.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

At a minimum, we do feel like the footprint of the GSEs will be somewhat reduced going forward. And if you think about it, roughly 20% of what the GSEs guarantee is what's considered non core. So for example, loans on second homes, investor properties, higher loan balance loans and cash out refis, you could see higher LLPAs on those types of products, which opens the door for private capital. And Mike and his business is perfectly set up to provide that liquidity. And if you think about the growth of the residential securitization market, I think it was $140,000,000,000 last year and there continues to be strong demand for residential credit.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

And I think the market would welcome a reduction in the footprint because private capital is right here.

Jason Stewart
Director & Equity Research Analyst at Janney Montgomery Scott

Great. That's helpful. And Mike, congratulations

Jason Stewart
Director & Equity Research Analyst at Janney Montgomery Scott

on the new role well deserved.

Jason Stewart
Director & Equity Research Analyst at Janney Montgomery Scott

And then just quick follow-up in case I missed it, I didn't hear a book value update. If it was given, I apologize.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

No, we didn't actually. So heading into the week as of weekend, we are up just a fraction of 1% pre dividend accrual with the dividend, call it a little over a percent and there has been improved a little bit of improvement this week. So as of last night, all in a little over 2%. Thank you, Jason.

Operator

Our next question comes from Doug Harter from UBS. Please go ahead with your question.

Douglas Harter
Douglas Harter
Equity Research Analyst at UBS Group

Thanks. Hoping you could talk about the outlook you have for 2 year businesses and kind of how you think about the cost of volatility in that and kind of in that construct kind of how you're thinking about the outlook for volatility this year?

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Sure. I missed the first part of your question. You just said the outlook for returns. Yes. So, look,

Douglas Harter
Douglas Harter
Equity Research Analyst at UBS Group

returns Yes. The return ranges that you give, whether that includes kind of your return ranges that you give whether that includes kind of your estimate of the cost of

Douglas Harter
Douglas Harter
Equity Research Analyst at UBS Group

volatility or if that could be a drag on those returns?

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Well, with respect to agency, what I will say is volatility does erode those returns to some extent. That is the nominal return on agency MBS. And our objective is to manage the portfolio in a way that extracts the vast majority of that nominal spread and minimize our hedging costs, which I think we have done a very effective job. But to the extent volatility materializes, then there is always a cost associated with that. In resi and MSR, given residential credit is there is negative convexity in a lot of the securities, but it's not meaningful.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

So I wouldn't characterize it as material at all. And then our MSR portfolio is certainly subject to some level of volatility. But when you consider the note rate at 3.2%, that volatility is quite minimal associated with that. So to sum it up, yes, if volatility picks up agency, you don't extract that entire amount of return, but I think we have done as good a job at any of managing the hedge position and dynamically hedging the portfolio to get the most of that return. And then part of the benefit of having a diversified model is you can rely on resi and our MSR portfolio to buffer a lot of that and it enables us because really you are only talking about 60% of your portfolio roughly of your capital being subjected to that volatility, it enables us to sit on our hands a little bit more when a market is oscillating and not have to be as reactive.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

And I think if you look at the last couple of years of our returns that really shows up in the economic return, 12% last year, 6% the prior year, we are pretty happy with how it's performed.

Douglas Harter
Douglas Harter
Equity Research Analyst at UBS Group

And I guess just then how do you think about the outlook for volatility this year?

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

There's a couple of components to that question. First of all is rate volatility and then the second is spread volatility. As it relates to rate volatility, some of that is uncertain. But what we have seen as of late has been somewhat encouraging in terms of vol. We think we are in somewhat of a range bound market, the long end of the yield curve is going to stay elevated for reasons that everybody understands with respect to deficits and debt.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

It's a little bit fragile, but with real yields, it's a 10 year part of the curve north of 2%, we feel like it's reasonably well priced. And then the front end with the 2 year note at 4.20 just sitting right below where short term rates are, we feel like it's somewhat anchored. We do think the curve could steepen a little bit more, but generally we think the outlook for rate volatility is better today than it has been in the past couple of years. And as it relates to spread volatility, and that's something that's a really important point as it relates to the agency business, what we've seen over the recent past is much lower spread volatility in the agency market. The agency market is healing well from volatility in 20222023, and we've gone from 4 basis points a day of spread volatility to to today it's less than a basis point, which is quite encouraging.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

So we feel like spread volatility is contained and it gives us a lot of comfort in investing in the agency market. And a lot of that has to do with the fact that the market and the agency market is just in much better balance today from a technical standpoint. You have much broader participation, banks are back involved, money managers are taking in a lot of AUM, REITs are growing a little bit and supply is relatively light, that's still running off the portfolio, but that's reasonably predictable. So we feel like the market is in good balance and when spreads widen, we see demand come in. So we feel generally good about it.

Douglas Harter
Douglas Harter
Equity Research Analyst at UBS Group

Great. Appreciate it. Thank you.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Thank you, Doug.

Operator

Our next question comes from Matthew Ertner from Jones Trading. Please go ahead with your question.

Matthew Erdner
Director at Jones Trading

Hey, good morning guys. Thanks for taking the question. So turning to non agency, with the expected growth to kind of be 20% year over year there, how do you guys keep and grow your market share with increased competition in the space? And then kind of as a follow-up to that, with 2nd liens and HELOCs, how big of a player do you guys want to be when it comes to those kind of products?

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

Sure. Thanks, Matt. This is Mike. I appreciate the question. I think in terms of our current market share and where we're at, we did $13,000,000,000 of loans that we closed on throughout 2024.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

If you look at our correspondent channel, it was $11,700,000,000 And we think total origination is probably call it $75,000,000,000 to $80,000,000,000 A lot of the industry publications, they undercount non QM and DSCR origination.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

But we

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

think that we have a fairly consistent market share. I would say that we've addressed this on previous calls in terms of the competitive landscape. I think what we provide our correspondence is a certainty of execution and stable capital, right. So we're in the market since April of 2021 with a stable rate sheet, consistent pricing and that's from the stability of our capital. A lot of our peers, it's private equity, There's periods of times where they have to fundraise, they have to back out their pricing and they're not providing that certainty of execution.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

So I think the infrastructure that we put together, the architecture that we put in place, it's led us to have a competitive advantage virtually across the majority of the market. I'd also say that we are providing a white glove service. We have a fully staffed scenario desk. We respond to exceptions. We make common sense exceptions.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

And our speed to funding we think is an industry standard. So I think we are in a good position to keep our market share, potentially grow our market share. When we look at what is growing within the non QM and DFCR market, a lot of it is the large non banks. The large non banks have kind of doubled down their efforts on the product. They like the margins that they are getting within NonQM.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

The margins are higher than the agency business. And our share with these large non banks, it is higher than our peers. They don't necessarily want to have 5, 6, 7 investors. They usually only have 2 to 3 investors. And given the stability of our capital and our pricing, we're one of those investors.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

So I think we're as well positioned as what we could be. Turning to HELOCs and closed end second liens, we do believe that we're going to have a HELOC transaction in Q1. We have over $200,000,000 of drawn balances on HELOCs that is close funded. So that's something that we are looking and we're going to evaluate market conditions on. Closed end second is incredibly competitive market.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

I would say that the pricing that we see within that market leads us to believe where the prepay speeds, the longer term prepay speeds, I think we're fading some of the market pricing and the market assumptions. But we price both of those products through our correspondent channel. We are getting some supply, but I'll say 92%, 93% of what we're ultimately getting through the correspondent is 1st lien NonQM DSR, and that's going to continue to be the case in the near future.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Thanks, Matt.

Operator

Our next question comes from Eric Hagen from BTIG. Please go ahead with your question.

Eric Hagen
Managing Director at BTIG

Hi, thanks. Good morning. Maybe just building off some of these previous questions. I mean, do you have perspectives on the level of mortgage spreads and how you're managing leverage from the context that we have at this near term outlook for a huge supply of treasury issuance, right? And that having any impact on where along the yield curve you might add incremental hedges going forward?

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Yes. So look, as I said, we have been very happy with how range bound spreads have been. There is room for tightening, but that will be driven by ball coming down if it is to do so and also a pickup in bank demand as deposits grow. So generally, we think spreads are fair to inexpensive right here. There is some room for tightening, but we don't expect a lot.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

As it relates to treasury supply and hedges, look, we are keeping our hedges at the long end of the yield curve consistent. There is fragility out there and we expect $2,000,000,000,000 or thereabouts in net treasury issuance and that has to be absorbed. The market is term premium has increased a lot in the treasury market and the market is well priced for it, but there could be an increase in rates and we're going to maintain discipline as it relates to the hedge profile.

Eric Hagen
Managing Director at BTIG

So with Annaly being the largest mortgage REIT in this space, I mean, do you guys use your stock valuation as sort of a proxy or a benchmark of any kind for like the level of MBS demand? And like how do you treat the opportunity to maybe grow from here when you think about the macro drivers for MBS and where the sources of demand might come from and how you kind of retrace that back to your own stock valuation?

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Look, we think our valuation is a function of a number of factors. First of all, the economic return that we generate, our EAD, which we've obviously just exhibited acceleration in, our low leverage and the health and liquidity of our balance sheet and the stability of the model. So that's the key to valuation of the Company, all of which I think we hit on all cylinders. As it relates to being a proxy for the broader MBS market, look, it's a massive market, dollars 7 odd,000,000,000,000 market and you have many large players and we happen to be one of them. So it's the collective demand from all sources of capital, whether it be REITs, banks, money managers.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

I think it's the movement of all of those participants that drive the valuation. And right now, it feels as though demand is widespread, but spreads are elevated and they're going to stay elevated, we think for the foreseeable future with some again room for some tightening. And the back half of your question, I'm sorry, Eric.

Operator

Eric. Our next question comes from Harsh Harmani from Green Street. Please go ahead with your question.

Harsh Hemnani
Equity Research Analyst at Green Street Advisors, LLC

Thank you. So we spoke a little bit about the competitive landscape in residential credit. Maybe one more thing that I wanted to touch on there is, what's your outlook on sort of the difference between whole loan spreads and the spreads on private label securitization? So, you mentioned that securitizations have tightened quite a bit, especially at the end of last year. But at the same time, we've sort of seen competition on the whole loan side come in, not just from private equity firms, but also insurance companies and asset managers.

Harsh Hemnani
Equity Research Analyst at Green Street Advisors, LLC

So that's the demand side on that front. But it seems like there might also be some more private label whole loan supply because of lower footprint on the GSEs. So when you sort of put that all together, what's your outlook on the difference between the whole loan spreads where you acquire these and where you can securitize these?

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

Sure, Harsh. Thanks for the question. I would say that the whole loan market is incredibly efficient in terms of when securitization spreads tighten as what we have seen. Whole loan spreads also will subsequently tighten. So we have issued 20 securitizations since the beginning of 2024.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

The spreads at which we have issued those AAA securities, it's been incredibly stable. It's been 115 basis points over on our last deal of 2024 to 145 basis points. So we've issued within a 30 basis point range. But when you do see that execution move up and down, you do see corresponding changes to your whole loan spreads. I think that the majority of the competition that we face is still private equity, it is other REITs, it's asset managers.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

We think that 60% to 65% of the production of NonQM and DSCR ultimately goes to entities like ourselves. So given the stability that we've seen within spreads, it's allowed us to grow the platform. There is a lot of commentary on insurance companies. This has been the commentary that we've heard over the past number of years. The reality is, yes, they are an active participant, but in terms of their size and their scale, we don't think that they drive the market.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

So if you look at the end of 2023, insurance companies and this is S and L filings, it's all public, insurance companies had $88,000,000,000 of residential whole loans on their balance sheet. If you look at Q2 of 2024, so through the first half of twenty twenty four, the number was $93,000,000,000 So the insurance companies only net increased their residential holdings by $5,000,000,000 over that 6 month period. And that also includes jumbo loans, non QM DSCR loans and RPL loans. So certainly, they are a competitor. In terms of how they buy, they don't really buy through correspondent.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

They're not willing to put out the infrastructure and the architecture that we have. We now have 2 60 plus correspondents. So we certainly need to be reactive to market conditions and we understand where they come out in terms of where they're buying. But I think we feel very good in terms of where we're positioned. We also do sell loans and insurance companies are one of the takeouts in terms of our capital markets distribution.

Mike Fania
Mike Fania
Head Of Residential Credit at Annaly Capital Management

So we think that they're actually accretive and have had provides liquidity to the market.

Harsh Hemnani
Equity Research Analyst at Green Street Advisors, LLC

Okay, got it. That's helpful commentary. Thanks for that. And then maybe on the relative value of your 3 business strategies, it sounded like at the end of the Q3, you were maybe viewing agency MBS as more attractive relative to credit and MSRs, but the allocation over the quarter to agency MBS came down a little bit. Could you maybe touch on what's driving that decision through the quarter and how it might progress going forward?

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Yes. So we did allocate capital at year end to agency. Mike was going into the market right at the 1st day of the year with a resi transaction. So we held a lot of loans unencumbered on our balance sheet, which took some of the capital. And also to note, as we onboard MSR purchase last quarter, this quarter, you'll actually see all else equal, a further decrease in capital allocated to agency.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

There will be some leverage put on the MSR, but generally should be in the mid to upper 50s. But look, we would the marginal dollar would go to agency MBS. We did add a fair amount of agency in the Q3 with capital raised. And to the extent that we have run off or other forms of capital agencies where the marginal dollar goes for the reasons I mentioned earlier.

Operator

And our final question today comes from Trevor Cranston from Citizens JMP. Please go ahead with your question.

Trevor Cranston
Director, Mortgage Finance Equity Research at Citizens JMP

Another question on the MSR portfolio. Can you talk a little bit about the profile of bulk packages you guys are seeing in the market today, particularly in terms of like what kind of note rates you're seeing and how you'd expect that to look as more packages come out in 'twenty five relative to the super low note rate of the existing portfolio?

Ken Adler
Ken Adler
Head of Mortgage Servicing Rights & Portfolio Analytics at Annaly Capital Management

Thanks. Yes, sure. Hi, thanks for the question. This is Ken. The vast majority of bulk packages are lower note rate relative to current coupon.

Ken Adler
Ken Adler
Head of Mortgage Servicing Rights & Portfolio Analytics at Annaly Capital Management

And they're being sold because mortgage lenders need liquidity. And they prefer to sell to customers that are less likely to be active refinance candidates for them in the future. So, the low note rate MSR, it has actually a higher price because of the prepayment profile and it's also less valuable as a customer and a future revenue opportunity for mortgage lenders. So, that's really what folks look to sell first. And then, the overall theme that's going on is more lenders are holding less MSR overall.

Ken Adler
Ken Adler
Head of Mortgage Servicing Rights & Portfolio Analytics at Annaly Capital Management

So, when we do see higher note rate packages, they're often much smaller in size, because it's the last 1, 2 or 3 months origination. So, it's not quite flow, but we would use the term like mini bulk or something like that.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

And Trevor, another point to note is that the average note rate of the overall universe is still quite low and a lot of the MSR associated with that remains on the balance sheets of originators and banks and that is likely the type of note rate that would come out with some mix again of more current no rate MSR.

Operator

And at this time, we'll be concluding today's question and answer session. I'd like to turn the floor back over to David Finkelstein for any closing remarks.

David Finkelstein
David Finkelstein
Chief Executive Officer, And Chief Investment Officer at Annaly Capital Management

Thank you, Jamie, and thank you everybody for taking the time today and we will speak with you soon.

Operator

And ladies and gentlemen, with that, we'll conclude today's conference call and presentation. We do thank you for joining. You may now disconnect your lines.

Executives
    • Sean Kensil
      Sean Kensil
      Director of Investor Relations
    • David Finkelstein
      David Finkelstein
      Chief Executive Officer, And Chief Investment Officer
    • Serena Wolfe
      Serena Wolfe
      CFO
    • Ken Adler
      Ken Adler
      Head of Mortgage Servicing Rights & Portfolio Analytics
    • Mike Fania
      Mike Fania
      Head Of Residential Credit
Analysts
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Earnings Conference Call
Annaly Capital Management Q4 2024
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