Good afternoon, everyone, and welcome to RBC Capital Markets Financial Institutions Conference. My name is Kenneth Lee, and I'm a Senior Equity Analyst covering the mortgage REIT sector. Welcome to our industry panel, Mortgage Finance Investment Outlook. I am very pleased to be joined by my panelists today. We have here to my right, David Finkelstein, CEO and CIO of Annaly Capital Management. David joined Annaly in 2013. Prior to that, he served as the Primary Strategist and Policy Advisor for the MBS Purchase Program at the Federal Reserve Bank of New York. Then to his right is Bill Greenberg, President and CEO of Two Harbors Investment Corporation. Bill previously served as the CIO at Two Harbors and joined the company in 2012. Welcome, everyone. Thanks, Ken. Thank you. Before we dive in, perhaps you could start off with a brief overview of your respective companies. I'll start off with you first, David. Sure. Thank you, Ken. And it's a pleasure to be here, and thank you for the invitation. Again, David Finkelstein, CEO and CIO of Annaly Capital. We are obviously a mortgage REIT, the largest of the REITs. We've been a public company for a little over 26 years now. We have about $11.25 billion of permanent capital split between common equity and preferred equity. That capital is allocated across three separate portfolio strategies. Agency MBS is the core of our portfolio. It encompasses about 62% of our capital, and that's the mothership and the liquidity engine of the overall company and portfolio. Second largest business is residential credit, which is largely a whole loan acquisition to securitization strategy where we retain subordinate securities off of securitizations that we bring to market on a very programmatic basis. And then the third portfolio strategy we have is mortgage servicing rights, which occupies about 18% of our capital. It's about a $2.7 billion portfolio of agency Fannie and Freddie MSRs that help hedge our agency portfolio and add incremental yield to the portfolio. We have been focused solely on housing finance for the past few years. But prior to that, we've had a commercial business, which we sold in 2021. We've also had a corporate lending business, which we divested just two years ago. And on a go-forward basis, our strategy is to be exclusively in housing finance but across virtually all aspects of housing finance. Yeah, thanks, Ken. And again, thanks for having us here today. Two Harbors was founded in 2012, really in the wake of the Great Financial Crisis, to participate in the dislocation of prices in both the agency and non-agency market that was occurring at the time. Throughout the years, we've also been involved in various different asset classes, including commercial real estate and mortgage credit and single-family rentals and things like that. But really, in the post-COVID world, after 2020, we decided to refocus our efforts and our investments to two main business lines. One is an agency mortgage-backed securities portfolio, and one is an agency mortgage servicing rights portfolio. In some ways, our portfolio is almost a mirror image of Dave's here. We have around 62% of our capital allocated to agency mortgage servicing rights on a hedged basis, and the remainder around 32% allocated to agency RMBS. We also feel like we're going to continue to be along the housing finance dimensions. But one very important differentiation between our companies is that we have recently acquired RoundPoint Mortgage Servicing. We did that at the end of September to bring the servicing of our portfolio in-house. And we did that for several reasons. One, to achieve economies of scale from being able to achieve more of the cash flows associated with the asset than we were able to in a subservicing model, to achieve cost savings from duplication of roles, and generally to participate more fully in the housing finance space across different dimensions and so forth. And so we're really excited about that. We think there's a lot of opportunity for us to grow our business and to add incremental revenue through that channel. Great. Well, we're going to keep this discussion relatively interactive. I expect a lot of back and forth between these two panelists as well. We will periodically open it up to the floor for any kind of questions, so keep those handy. Before I start off, let me just read a quick disclaimer. Any forward-looking statements made during today's event are subject to certain risks and uncertainties, which are outlined in the Risk Factors section in Annaly and Two Harbors' most recent SEC filings. Actual events and results may differ materially from these forward-looking statements. Both companies encourage you to read the forward-looking statements disclaimer in their quarterly and annual filings. In addition, comments made during this call may contain time-sensitive information that is accurate only as of today's date. The companies do not undertake or specifically disclaim any obligation to update or revise this information. The companies may discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP and non-GAAP measures is included in each company's most recent filings. With that out of the way, let's start off at a broad level here. Given your business models and conceptually, I like to think of mortgage REITs as leveraged bond portfolios. The macro backdrop is always going to be an important consideration. Could you talk about the challenges you saw last year, and what's your outlook on the macro environment, the rates, and Fed policy? And Dave, perhaps we could start with you. Sure. That'll take about 45 of the 30 minutes we've allotted here today. But I'll give you a brief summary of what happened in 2023 as it relates to how the macro economy and the market evolved. So essentially, we came into '23 thinking it was going to be a much calmer year than 2022, given the significant rate selloff that we experienced during 2022. And it started off to be the case. In January, it was a very good environment for risk assets and the bond market rally. Then all of a sudden, you got a very strong set of data, beginning with payrolls at the beginning of the year for January of 2023, and then a further reacceleration in inflation. And we're heading into tomorrow, where the Fed chair testifies to Congress in his semiannual testimony. And if you recall last year, in that exact same set of discussions, he was talking about hiking rates 50 basis points in March of last year. Well, then the next day, Silicon Valley Bank starts to tumble, and all of a sudden, it's a 150 basis point rally in the two-year note and a complete flight to quality. And then past that episode, we have the debt ceiling dilemma, which took quite a while to get resolved. And that just added more volatility to the market. And then when you think things are calming down, you get the August Treasury refunding announcement, and then all of a sudden, more hawkish Fed, better data, and a 10-year note at 5% in October. And so to make a long story short, as it relates to rates and volatility, it was not a year for the faint of heart. We were hoping for a calmer year. We didn't get it, as it concerned the rates market. That made it a very difficult environment for Agency investments, which I think weighed on the sector quite a bit throughout the year. Silver linings, however, as it related to credit, for example, Residential Credit was really buoyed by really, really durable housing as well as a strong economy. Credit spreads tightened throughout the year. Also, near and dear to both Bill and my hearts is on the prepayment equation, speeds were much slower than we would have anticipated. In an out-of-the-money environment, we would have thought turnover would have been at least a little bit higher. But it was very low. As a consequence, both of our MSR portfolios, I think, did quite well. It was a difficult time for the rates market and agency MBS. But MSR and resi certainly did well, which kind of gave us a lot of comfort. And so far as returns, we're not great. But we're in the upper single digits on an economic return basis, which we're happy with. And that leaves us where we're at currently, which is a much better outlook than we had last year, I think. We did have 6.5 cuts priced in heading into the year. And we've moderated that back to 3.5, roughly, for the year. And there hasn't been really much damage at all. Agency spreads are a little bit wider. But volatility is much better than it was last year. And ultimately, the Fed will begin cutting rates. The bar to hike is very high, I think. You could see the Fed on hold for a little bit longer. But ultimately, rates will be lower. The Fed will begin to taper its quantitative tightening program. We will be in a better place. Currently, you have ample spreads across agency. You have relatively elevated interest rates, which creates a reasonably good environment. We're reasonably optimistic. There are certainly risks. There's the uncertainty around the timing of Fed cuts. There is still the possibility of reacceleration in inflation. Volatility has not left the market. Just looking around the world, there's plenty of risks out there. We're certainly cautious. But nonetheless, we expect a much better environment in 2024 than we had either of the last two years. When you were talking about volatility, my first thought was, it's early yet, right? We talk about these measures all the time. And Dave and I will sometimes look at implied volatility and realized volatility and so forth. But one of the things I always try to do is think about things in really simple terms, right? In our last earnings report, we showed a little graph of the number of days in 2023 that showed interest rates moving more than 10 basis points. And in 2023, it was 53 days. So fully, 20% of all trading sessions moved more than 10 basis points a day, which is unprecedented. The last time that happened was, of course, the Great Financial Crisis in 2008, right? And so as I say, I think we're on the pace so far in 2024 is not that far behind that pace so far, right? And so we're all hopeful that that will be true. But I'm not sure. I think I'm probably also maybe a little less sure than you, Dave, about the path of future Fed cuts. Obviously, I think if the Fed does cut, the steepening of the yield curve might bring back some net interest margin into the sector, maybe allow the banks to participate more fully, which would certainly be good for spreads and get more participation across the sector. But I think the risks are fairly balanced in terms of spread tightening, spread widening. Sometimes, as I think about it, more spreads have been sort of fairly range-bound this year a little bit. But I feel like it's not like a big bulge of a distribution in the middle of things being here, and we're about to take this side. I feel it's more bimodal, depending on what's going to happen, whether inflation, either acceleration or Fed cutting or something like that. And I think the outcomes are potentially pretty divergent there. And so we're keeping our portfolio risk sort of neutral in recognition of what we think are sort of more balanced risks. And we've been happy with the servicing asset, as Dave says. Speeds have been lower than most market participants expected. I think that's a reflection of having a mortgage market, which is 350 basis points out of the money that we've never seen before. And we've never seen the effect of lock-in at that level before. And so I think that's the reason. And again, we had a slide in our last earnings deck that in our portfolio, with a gross WAC of less than 3.5, which is currently paying whatever, 3 or 4 CPR, right? If rates were to rally 200 basis points, we projected speeds to go all the way up to about 10, right? So we're still miles and miles away from the refinancing event. And so I think that gives us a lot of confidence going into 2024. Gotcha. And for the next one, I'll have you start this one off, Bill. And I think you touched upon this very briefly in your previous remarks. In terms of your investment outlook for agencies, what's the outlook given the current rates outlook as well? What's the potential implications for other market participants? And once again, you touched upon this briefly for banks, for asset managers. And what could this mean for agency spreads? Well, look, I did just say a lot of that in my previous answer. I think a lot of market participants are looking, dare I say hoping, for the Fed to cut, right, which may, I think it may be expected to bring more participants back into the market. I'm just as well happy to have things just sit here, right? I think the risks are reasonably balanced for wider and tighter spreads. But I think one of the downsides of having spreads tightened here, mortgage spreads tightened, while we'll get book value appreciation, is that the future return outlook will decline from there, right? So if I could write my own script, I would write the script of, let's just stay here for a long time and have volatility go down, be able to extract more of the spread that's available in both our asset classes, and enjoy that spread rather than hoping for Fed cutting and spread tightening. And then for the next one here, and this is a question that we get from time to time from investors, flattening yield curve, how does it impact your respective business models and earnings power? And perhaps we could start with you again, Bill. I just answered three in a row. The short answer is not at all, right? Maybe that's a little bit of an oversimplification somewhat. But it's more true than not, for sure. We hedge the entire yield curve of the assets, right? And so if you have a leveraged strategy, if you own a mortgage which yields 6%, right, and you're levering it and paying 6%, right, then you might think that, oh, well, there's no money to be earned there. Or God forbid, the funding rate is higher than that, in which case you would earn a negative amount. But that's not all we do. We hedge the interest rate exposure of our assets. And so if we are in a mortgage portfolio, if you're paying fixed at 4%, say, a long-end interest rate, and you're receiving floating, which is 6%, then you've locked in that spread, the difference between the 6% and the 4%. And that's what we are. And I dare say that's what most mortgage REITs are these days, is we're spread investors. And no one that I know is borrowing short and investing long. And so the shape of the yield curve, by and large, doesn't matter. There's some second-order effects that we can talk about. The bank participation in the mortgage sector is one of them. Those guys do borrow short and invest long, right? So they do want the yield curve to steepen. And that will bring out more investors therefore. But for people like us, we're just really focused on the spread. Well done. Let's just pause here briefly and see if there's any questions from the floor before we proceed. At one point, I'll note, just to follow up on that, we're now approaching the one-year anniversary of Silicon Valley Bank and the other failed banks. It's a critical point as it relates to leveraged maturity transformation and the difference between mortgage REITs and banks. We are like a component of the bank business model, the portfolio associated with it. But there's distinct differences between our business model and what a bank does. And Bill obviously brought the most considerable point, which is we actually hedge the duration exposure associated with our portfolios. And so we don't end up in a situation where we have deep underwater assets without offsetting hedges. And we end up stuck as zombie institutions. The second point to note is our financing is institutional short-term financing. But it's very durable. We're not relying on deposits that can be very flighty and very psychologically motivated. We have very longstanding relationships with all of our counterparties. And they don't hesitate when it comes to maintaining our financing lines in times of volatility. And so it's something we feel very good about. And then the third point I'll say is that we're not marked to market. And we're very transparent. You see just about every component of our portfolios every single quarter. And they're all marked to market. And you see our book value. There's no held-to-maturity, so. You said you're not marked to market, but you are. You said that. We are. Sorry. Yeah, we are marked to market. So you know exactly what the portfolios are worth. The point you made about the deposits is a great one, actually, right? I love that one, that we might not know the duration of our assets very well. But we know the duration of our liabilities, right, perfectly well. Whereas what we saw last year was that the duration of the bank deposit liability is highly unknown. Exactly, exactly. That's actually a really good point. Yeah. By the way, again, going back to SVB and then the lessons learned and so forth, those guys seem to have the assets that they owned weren't bad assets, right, low coupon mortgage and so forth. They were fine assets. They just made a hedging error or didn't hedge or something like that, which made people like us sort of scratch our heads a little bit, like, what the heck happened over there? Because the way that we all manage our portfolios, that wouldn't have ever happened. That's a good point. For each of you, you have meaningful mortgage servicing rights or MSR portfolios. And I think each of you talked about it briefly. Could you talk about your respective MSR strategies and the attractiveness of the MSR asset in the current environment? And sort of what's the growth outlook here? And perhaps I'll start with you, Dave. Sure. And to note, Bill and our strategies are very different. So we characterize ourselves as a financial participant, purely a financial participant in the MSR market. What we want to do is take our capital and provide liquidity to the non-bank mortgage originator community such that they can do what they do, which is originate loans. And we can provide the liquidity to take their MSR. We're not a competitor. We don't have an origination arm. We're not looking for a customer acquisition or anything like that. We want the yield on the asset and the hedge benefits to the overall portfolio. So that's sort of the philosophy behind our strategy in MSR. And as a consequence, we do have deep relationships with the largest of the non-bank originators. We provide them certainty of execution. And it works out quite well for everybody. In terms of our portfolio strategy, and Bill talked about his composition of his portfolio, it's not that dissimilar from ours. There's a considerable amount of legacy low-note rate MSR in the market that was originated in 2020- 2021. The average mortgage rate, conforming mortgage rate in the market, is still below 4%, even though we've been well above 6% for the last almost two years. All of this asset in the market is in the process or has been in the process, or a lot of it, being transferred from the non-banks to more financial participants like both of us. And that's worked out quite well. It's been a very symbiotic relationship, particularly as the origination model has suffered. And the non-banks have needed to monetize their MSR, which they made a lot of money on in the sell-off. It's a great portfolio asset for folks like us. We really like the low-note rate, deep out of the money underlying collateral because of the benign cash flow variability. It has turned out to be a sector that has outperformed, I think, both of our expectations with respect to the stability and slow pace of prepayments. We would have thought here that there'd be enough housing turnover in the current environment, is out of the money as these mortgages are, that you'd have 1-2 CPR faster speeds. Every 1 CPR slower is worth about 100 basis points in OAS or thereabouts. So as we've gone through the passage of time here over the last year and studied the behavior of borrowers and the lock-in effect, the MSR asset has performed quite well. As a matter of fact, our portfolio paid it roughly 3 CPR for the last quarter, which is extraordinarily low. Granted, it's the slow seasonals. But it's a great asset. And so our strategy still involves buying low-note rate, out of the money MSR because it's just a great cash flow vehicle for us. We do buy current coupon on a flow basis. But we're not nearly as attracted to that as the discount MSR. I always like to say, again, with turnover speeds being 3 CPR, the main drivers of turnover are usually considered to be death and divorce. I always think that people of a certain age can compromise a lot with their spouse in order to maintain a 3% mortgage. Of course, even conventional loans are actually assumable upon the death of a borrower by the estate. That's not well known. Ginnie Maes are famously assumable. Even conventional loans can be and so forth. Our strategy has certainly started out, at least, very similar to Dave's. We've been a financial investor in MSR since 2013. We have said for many years, we'd like the hedging characteristics of the MSR asset relative to the MBS assets. And just as our portfolio grew and we achieved greater and greater scale, we decided that we could benefit by taking our servicing in-house. And so that certainly has put us in quite a different category than the pure financial investors. And we think that, as I said, that we can achieve economies of scale and generate other sorts of revenue streams from owning your own servicer in addition to enjoying the benefits of the MSR cash flows. Our portfolio is similar to Dave's, almost exclusively made of these low coupon note rates. In order to hedge our portfolio, one of the things that I always say about servicing is that when interest rates go down, which they inevitably will one day, right, prepayment expectations will go up. The value of servicing will go down. All of that's known and is not a surprise, right? We can hedge that decline in MSR prices and values by buying financial instruments, right? But the one thing that we can't hedge by financial instruments is faster than expected prepayment speeds. I said a moment ago that if interest rates fall 200 basis points, I expect our speeds to go from 4-10, right? And if that happens, that's fine. But if speeds go to 20 instead of 10, then your financial hedges won't work. And you'll lose money. The only thing I know in the world that hedges faster than expected prepayment speeds is an origination business. And so we've been dragged into that business, like it or not, in order to protect our portfolio against that eventuality. And so we have hired a guy who has lots of experience building direct-to-consumer origination channels with the idea of just recapture or portfolio defense on our portfolio. So we just want to protect our 900,000 guys from faster than expected speeds. And given the nature of our note rate and where mortgage rates are today, we feel like we have the time to build the platform that we want to make sure it's right side up in terms of costs, that it doesn't have any legacy risk, and so forth. And so that's one of the things that we're doing, really, just as a hedge. Great. Now let's talk about capital allocation more broadly. Annaly, there's a combination of agencies, residential credit, MSRs. For Two Harbors, there's been a notable shift towards MSRs. How do each of you think about capital allocation in terms of best positioning you for your near-term outlooks? Dave, I'll start with you again. Sure, sure. So again, three verticals between agency, resi, and MSR. We have said publicly that the ultimate objective is to get our agency portfolio down to 50% of capital. Right now, it's at 62%. We have achieved considerable benefits associated with the diversification that we've obtained. And it shows up on our economic returns, I think, particularly for 2023 and even relative to agency REITs in 2022. So we've been happy with where we've gone. And we expect to continue to allocate incrementally more capital to both residential credit and MSRs. However, there are limits to which we'll reduce our agency portfolio for a couple of reasons. Number one, it is the liquidity engine of the company, as I mentioned. It leaves us with a considerable amount of latitude to be able to do meaningful things in the event opportunities arise in times of volatility to write big checks because of that Agency liquidity, whether it's through M&A or even asset portfolio opportunities or things like that. We really value that liquidity. Another point to note is that when you do have an Agency portfolio and as much capital allocated to it that leaves a residual amount of unencumbered cash in agency MBS, which can be pledged to just about anything, you can use the Agency portfolio as a bit of a bank to save on your financing costs in both Residential Credit and MSR. So for example, we run our resi credit and MSR portfolios with less leverage, much less leverage than peers do in each of those businesses. For example, resi credit at the end of the year was 1.5 turns of leverage. MSR was about 0.4 turns. The reason being is because we have this ample liquidity in our agency portfolio where those businesses can effectively borrow at SOFR as opposed to, in MSR lines, SOFR + 275 or 250, something like that. So there's a real arb there associated with that agency book. And it enhances the returns of each resi credit and MSR because we have the appropriate balance. But nevertheless, we're going to continue to reduce our agency exposure. But there's limits to it. When we talk about liquidity arising from the agency book, there's really two kinds of liquidity. The other one is the liquidity of the asset, which very likely can raise T+ 1 liquidity whenever you want. But the bank aspect of the thing really is arising from the fact that the haircut on agency RMBS is low. No one would ever, in their right mind, leverage that much. So you have all this extra cash sitting around to act as your bank like that. We think about it in the same way. So while we have 62% of our capital allocated to MSR, and we think that can go somewhat higher, it can't go to 100% for the exact same reason that Dave has, that the MBS part of the portfolio, right, is the reservoir of liquidity for us. Gotcha. Well, we are out of time at this point. So I'd like to wrap up here. And once again, I'd like to take this opportunity to thank both of our panelists, Dave and Bill, for joining us. I really enjoyed our discussion. Thanks again. Thanks very much. Thanks, guys. Thanks a lot, Ken.