Annaly Capital Management, Inc. (NYSE:NLY) Q4 2023 Earnings Call Transcript
Annaly Capital Management, Inc. (NYSE:NLY) Q4 2023 Earnings Call Transcript February 8, 2024
Annaly Capital Management, Inc. isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, and welcome to the Fourth Quarter 2023 Annaly Capital Management Earnings Conference. Please note that, today’s event is being recorded. I would now like to turn the conference over to Mr. Sean Kensil, Director and Investor Relations. Please go ahead, sir.
Sean Kensil: Good morning, and welcome to the Fourth Quarter 2023 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. Content referenced in today's call can be found in our Fourth Quarter 2023 Investor Presentation and Fourth Quarter 2023 Supplemental Information, both found under the Presentations 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. And with that, I'll turn the call over to David.
David L. Finkelstein: Thank you, Sean. Good morning, everyone, and thanks for joining us today. I'll begin with a brief review of the fourth quarter market environment and our portfolio performance, then discuss the current macro landscape, followed by an update on our businesses and our outlook for 2024. And Serena, will then discuss our financials before opening up the call for Q&A. Now as all are aware, fixed income markets exhibited considerable volatility in the fourth quarter, as evidenced by the 10-year treasury trading in a 120 basis point range peaking at 5% mid-October before rallying throughout November and December. The second half of the quarter proved beneficial to mortgage assets as implied volatility declined, the yield curve modestly steepened and agency spreads tightened meaningfully.
We were well-positioned to take advantage of this environment, delivering a 10.1% economic return for the quarter and we out earned our dividend with earnings available for distribution of $0.68 per share. And we achieved these results with lower economic leverage, which declined to 5.7 turns at the end of the quarter. And as we reflect on 2023, we're pleased to have generated a 6% economic return in a year characterized by numerous unforeseen risk events. We believe that our performance on the year demonstrates the value of our diversified housing finance model and our disciplined portfolio and risk management. Now turning to the macro environment, the primary driver of the strong demand for fixed income since November can largely be attributed to a shift in the Federal Reserve's communications.
Moving away from the higher for longer narrative, Fed officials began to express comfort around the decline in inflation, suggesting that risks around the monetary policy outlook are more balanced. A normalization of policy is likely to begin in 2024 as long as inflation continues to moderate. And while not declaring victory just yet, as evidenced by Chair Powell's recent statements, policymakers are keen to ensure that a soft landing can actually occur. Powell also highlighted that future balance sheet discussions will occur in the upcoming March meeting, noting policy rates and the potential tapering the balance sheet as independent tools. And while existing financing conditions remain ample, we're encouraged that the Fed appears to be signaling a conservative approach with regard to its balance sheet and liquidity in the financial system.
Now a second factor leading to the decline in yields in the fourth quarter is this change in debt issuance dynamics as the treasury chose to issue incremental supply in the front-end of the yield curve, taking advantage of the record amount of cash in money market funds while exerting less pressure on longer term yields. Now the broader domestic economy remains strong with Q4 GDP at 3.3% the unemployment rate at 3.7% and consumer still exhibiting spending strength. Inflation meanwhile has moderated meaningfully in absent a shock, core PCE should benefit from base effects to bring year-over-year measures towards 2.5% in the coming months. Now looking at the housing sector, home prices outperform the market's expectations over the last couple of years, despite mortgage rates reaching 20-year highs.
[HBA] (ph) has continued to benefit from existing homeowners experiencing lock in effect, resulting in low available for sale inventory as borrowers who struck below current market mortgage rates are unwilling to move or trade up. Housing activity remains subdued, although we have seen modest signs of an uptick in demand following the recent decline in mortgage rates. In all told, we're constructive on the housing sector should the labor market and the consumer remain resilient and in-line with the soft landing scenario. Now shifting to our portfolio and beginning with the Agency sector, much of our agency reduction occurred at the very outset of the quarter, which left us well prepared for the spread widening and volatility of the market experienced as October progressed.
And as volatility subsided and spreads normalized, we rotated out of lower coupons and TBAs and in the higher coupon specified pools. We remain disciplined in our selection of specified pool stories favoring high-quality prepaid protected securities, which represented the vast majority of our higher coupon purchases. In addition, we opportunistically grew our Agency CMBS holdings by $1.2 billion as the sector did lag the move tighter in Agency MBS locking in attractive spreads and increasing the portfolio size $3.2 billion in market value. Fixed rate Agency CMBS is a complementary asset to our agency portfolio as it provides a high-yielding stable cash flow with minimal convexity exposure. Now our agency strategy overall represented 62% of our dedicated equity at quarter-end down from 64% the quarter prior as, we further reallocated out of agency in favor resi credit and MSR late in the quarter.
As it relates to our hedges, our balance liability position help protect us from the elevated rate volatility experienced during the first half of the quarter. One adjustment we did make tactically, however, was we rotated from treasury futures into [SOPR] (ph) swaps at the very front-end of the yield curve, given the particularly tight level of swap spreads experienced in the year-end. And overall, we remain conservatively positioned as it relates to our rate exposure as seen through our 106% hedge ratio and rate shock tables. However, given the changing policy landscape, we may reach a point where we begin to feel more comfortable adding duration of the portfolio in the near future. And as we begin 2024 with the Fed's pivot to a more neutral monetary policy, the distribution of future rate pass has narrowed, which has resulted in a decline in implied volatility.
We'll likely see rate cuts materialize as we approach mid-year, which historically have been a catalyst for inflows in fixed income funds. And furthermore, an earlier end to QT should help stabilize deposits, which along with incremental regulatory clarity should support bank demand. In coincident with these improving technical factors, [MBSR] (ph) and historically attractive spreads, particularly relative to fixed income alternatives, while convexity and prepayment risk in the market remains relatively low. Now turning to the residential credit market, the non-Agency sector participated in the broader fixed income risk on sentiment to end the year with AAA Non-QM spreads 20 basis points tighter and below investment grade CRT 60 basis points tighter quarter-over-quarter.
Our resi portfolio ended the year $5.7 billion in market value, up 14% year-over-year and currently comprises 20% of the firm's capital. The growth in the portfolio can be attributed to our organic whole loan acquisition and Onslow based securitization strategy. In the OBX retained portfolio and whole loan position now account for roughly half of the total resi portfolio assets. Residential whole loan acquisitions continue to be strong in Q4 as we settled $1.8 billion in loans, of which $1.6 billion was sourced directly through our correspondent channel. Lock volume was robust in the fourth quarter at $2.7 billion a 13% increase quarter-over-quarter despite winter seasonals. In our quarter-end, correspondent pipeline was $1.6 billion with strong credit characteristics as demonstrated by 748 FICO and 70% [CLTV] (ph).
And since the beginning of the fourth quarter, we've securitized seven OBX transactions for $2.8 billion inclusive of three transactions price subsequent to quarter-end. And these securitizations generated $290 million of assets at projected mid-teens returns utilizing modest recourse leverage. Onslow Bay continues to be a leader in the residential credit market as we remain the largest non-bank securitizer and second largest overall over the past two years. In addition, we have the lowest delinquency rates across the 10 largest Non-QM issuers. And also to note, we were just able to sell the tightest new issue AAA bond executed in 2024 year-to-date. And our correspondent channel remains our preferred investment option within residential credit, allowing us to organically manufacture assets, while maintaining control over pricing, our partners, diligence, credit and volume.
Now shifting to MSR, our portfolio increased by 18% or $400 million in market value in the fourth quarter through the purchase of three bulk packages in addition to modest flow acquisitions. In our MSR portfolio inclusive of forward settling trades increased nearly 50% throughout 2023 to end December at $2.7 billion in market value, making Onslow Bay a top 10 non-bank owner of servicing rights. The MSR market had an active Q4 with bulk transactions of modestly quarter-over-quarter, capping a record 2023 that saw over $800 billion in principal balance trade. Annaly was able to capitalize on this significant supply and we were the fifth largest buyer in the market, on-boarding $42 billion in principal balance throughout the year. In consistent with our previous commentary, we continue to favor low note rate, high credit quality collateral and given the lack of refinance incentive, the portfolio is exhibiting highly stable cash flows and historically low prepayment speeds.
The MSR portfolio had a three months CPR of 2.9% as of December, approximately 40% lower than the MBS universe. And with our unique position in the MSR market as a preferred partner to originators in light of our scale and certainty of capital, we've been able to establish new relationships and expand our footprint. In particular, we've started to add flow sourcing partnerships, which we have begun selectively purchasing seen through this past quarter. And while low no rate collateral still our preferred segment of the MSR market, we expect these flow relationships to add a source of more predictable supply. Now looking ahead, we anticipate the MSR market to be active this year, though sales may moderate from 2023's elevated levels. And we continue to be well-positioned to add MSR with ample warehouse capacity, minimal leverage and a desire to continue to allocate capital to the strategy.
Now to wrap up before handing off to Serena, I wanted to note that as always we're cognizant of the risks on the horizon and we remain prepared for additional market turbulence and vigilant as the operating environment evolves. That said, we're optimistic with respect to our outlook for each of our three businesses and we believe that our three complementary fully-scaled strategies should continue to provide Annaly shareholders superior risk adjusted returns, a strong earnings profile and stability across different interest rate and macro environments. And with substantial liquidity and prudent leverage, we remain ready to take advantage of opportunities where we believe capital will be most accretive. And now with that, I'll hand it over to Serena, to discuss the financials.
Serena Wolfe: Thank you, David. Today, I will provide brief financial highlights for the fourth quarter and select year-to-date metrics for the year ended December 31, 2023. 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 David mentioned earlier, 2023 was a year filled with substantial volatility and our team managed the markets admirably, finishing the year strong as demonstrated by our results for the quarter and full year. Our book value per share at year-end increased from the prior quarter to $19.44 and with our fourth quarter dividend of $0.65, we generated an economic return for the quarter of 10.1% and 6% for the year ended December 31, 2023.
In November and December, we experienced the inverse of the prior quarter with a sharp rally in rates and strong performance of mortgage related assets, which led to a net book value contribution of $6.74 per share from our Agency Residential Credit and MSR portfolios. These investment gains outpaced the losses on our hedging portfolio of roughly $5.56 per share. Earnings available for distribution increased compared to the third quarter by $0.02 per share to $0.68 for the fourth quarter. EAD benefited from a higher coupon on investments and lower repo expense due to lower average balances, despite higher average repo rates, partially offset by a lower net interest income on swaps and certain positions rolled off with favorable net receive rates.
David referenced our continued rotation up in coupon in Agency MBS. We also saw an increase in weighted average coupon for our residential credit investments. Altogether, this portfolio positioning continues to provide increased yields as average yields, ex-PAA, rose again quarter-over-quarter, 18 basis points higher than the prior quarter at 4.64%. Similarly, NIM followed the same trajectory as EAD for the quarter with a portfolio generating 158 basis points of NIM, ex-PAA, a 10 basis point increase from Q3. Net interest spread increased four basis points quarter-over-quarter at 122 basis points compared to 118 basis points in Q3 as Agency yields increased at a higher rate than repo rates net of swap interest. The total cost of funds continue to increase quarter-over-quarter, albeit at a reduced pace in comparison to prior periods, rising 14 basis points to 3.42% percent for the quarter.
Meanwhile our average repo rate for the quarter was 556 basis points compared to 544 basis points for the previous quarter. Despite this increase our total economic interest expense was only up marginally at $665 million compared to $652 million in the prior quarter, primarily due to the decrease in average repo balances from $66 billion to $62 billion. As noted above, our swaps impact on the cost of funds further normalized due to the maturity of specific contracts, resulting in the net interest component of interest rate swaps declining by $15 million which negatively impacted our cost of funds by approximately four basis points. Turning to details on financing, notwithstanding modest pressure we had noted in funding markets around quarter-end.
Funding markets remain ample and liquid. We continue to see strong demand for funding for our Agency and non-Agency security portfolios. And while we keep an eye on RRP volumes and treasury supply, we acknowledge that the Fed is very focused on liquidity and funding markets. Our repo strategy is consistent with prior quarters and our Q4 reported weighted average repo days were 44 days down from 52 days in Q3 due to the roll down of longer term trades completed in prior quarters. Our treasury team continued to source additional funding options for our credit businesses and had another busy quarter focusing on expanding warehouse capacity and achieving competitive financing terms for existing and new warehouse lenders. During the quarter, we upsized our committed MSR financing by $500 million and renewed a $400 million residential whole loan facility incorporating a non-mark-to-market sub-limit.
As of December 31, 2023, we have $3.6 billion of warehouse and a 38% utilization rate leaving substantial capacity. Market fundamentals for the quarter aided our liquidity profile with unencumbered assets of $5.2 billion compared to $4.7 billion in Q3, including cash and unencumbered agency assets of $3.8 billion an increase of $1 billion compared to the prior quarter. In addition we have approximately $1 billion in fair value of MSR that has been pledged to committed warehouse facilities that remain undrawn. Together we have roughly $6.2 billion in assets available for financing. Our disciplined approach to financing our credit businesses and prudent risk and cash management strategies have resulted in a very comfortable liquidity position to end the year.
And lastly, despite continued growth in our operating businesses during 2023, we efficiently managed our expenses resulting in an OpEx to equity ratio of 1.42% for the year, compared to 1.4% for the year ended December 31, 2022. That concludes our prepared remarks and we will now open the line for questions. Thank you, operator.
Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question will come from Bose George with KBW. Please go ahead.
Bose George: Hi, everyone, good morning. Just wanted to start with the question just about the sort of the best place for allocating new capital. You seem to lean into credit a little more just curious if we could see that continue in 2024?
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