ANNALY CAPITAL MANAGEMENT INC

Fixed income markets benefited from two positive trends in the third quarter (“Q3 2024”). The Federal Reserve (the “Fed”) commenced a cycle of lowering the Federal Funds Target Rate to less restrictive levels, while the U.S. economy generally maintained its strong pace of growth. Officials lowered the Federal Funds Target Rate by 50 basis points at the September Federal Open Market Committee (“FOMC”) meeting, lowering short-term interest rates for the first time since the July 2023 FOMC meeting. Fed officials signaled that they intend to ease monetary policy over time as current policy remains restrictive, with the pace and extent of easing dependent on incoming economic data. The Fed's cutting cycle will be geared at lowering interest rates to levels that promote a healthy, stable labor market while keeping inflation near its 2% target. Short-term interest rate markets currently price this “neutral rate” at 3.25%, though estimates have varied somewhat in recent weeks.

The change in monetary policy was driven by the labor market, as reduced demand for workers and slower hiring have moved labor supply and demand roughly in balance for the first time in the past three years. For much of the post-pandemic experience, strong demand for labor had exceeded available supply, leading to higher wage growth and the potential for a negative feedback loop between rising prices and rising wages. According to the minutes of the September FOMC meeting, Fed officials judged that risks of such a feedback loop appear to have declined. Inflation continues to normalize with personal consumption expenditures excluding food and energy (“core PCE”) likely to run only slightly above 2% annualized in Q3 2024.

The market's pricing of additional rate cuts has led to a steeper yield curve, increasing the attractiveness of fixed income assets more broadly and Agency MBS in particular. In addition, interest rate volatility has continued to decline to the lowest levels since the March 2023 regional banking crisis, though it remains meaningfully above pre-pandemic historical average levels. These developments have been supportive of our diversified business model, as seen in the strong performance delivered in the quarter. We generated an economic return of 4.9% in Q3 2024 and our earnings available for distribution (“EAD”) exceeded our common dividend. We achieved these results with continued robust earnings power of our portfolio even with lower economic leverage, which decreased modestly during the quarter to 5.7x.

Our strong performance and the supportive backdrop for our investment strategies allowed us to raise over $1.1 billion of accretive common equity over the quarter through our at-the-market sales program. The environment to deploy capital remains attractive as the market value of all three of our business lines increased quarter over quarter.

With respect to our portfolio activity during the quarter, in light of the capital raised, our Agency MBS investments grew by over $4 billion notional value with the remaining increase in market value attributable to price appreciation. Despite the positive fixed income market backdrop, Agency MBS performance was bifurcated across coupons. Lower coupons benefited from strong money manager demand, while the decline in mortgage rates raised concerns regarding prepayment behavior in higher coupons, leading such coupons to underperform their respective interest rate hedges. Given this relative performance, we increased our allocation to 5.0% coupons and higher given their attractiveness relative to intermediate and lower coupons. This represents an extension of our methodical migration up the coupon stack over the last two years with a diligent focus on high-quality pool selection. For example, 6.0% coupons and higher represent roughly a quarter of our portfolio, though the majority of these higher coupon holdings are held in specified pool form that offer significant protections from higher prepayment speeds.

Our outlook for the Agency MBS sector remains favorable. Notably, the supply and demand technical factors, often a headwind over the past few years, have continued to improve as net supply is trending lower, likely reaching levels somewhat below 2023 totals. Meanwhile, fixed income flows have helped improve money manager demand for this year, which is currently running at nearly double the estimated pace from last year. In addition, appetite from banks and overseas investors should increase as the Fed’s normalization of interest rates, leading the spread between MBS yields and deposit rates to increase and currency hedging costs to decline.

We maintained conservative interest rate exposure throughout the quarter, while benefiting from a position geared towards the steepening of the yield curve that ultimately took place during the quarter. As interest rate levels declined throughout Q3 2024, we proactively managed our rate exposure, shifting hedges across the yield curve as mortgage durations contracted. Going forward, we expect continued interest rate volatility driven by the upcoming elections, geopolitical risks and the trajectory of fiscal deficits, which present uncertainty around the terminal level of interest rates.

Meanwhile our Residential Credit portfolio increased approximately $535 million in Q3 2024 to $6.5 billion in economic market value and $2.3 billion of dedicated capital, representing 18% of the firm’s equity. Growth continued to be driven by our correspondent platform with our residential whole loan and retained Onslow Bay (“OBX”) securitization portfolio.

Capitalizing on firm credit spreads, which moved in roughly a 10 basis point range during the quarter, we closed six securitizations totaling $3.2 billion in unpaid principal balance. Since the beginning of 2024, we have now priced 18 securitizations totaling $9.4 billion, establishing Onslow Bay as the largest non-bank securitization sponsor in the residential credit market and second largest overall. The quarter once again produced record volumes across both locks and fundings at $4.4 billion and $2.9 billion, respectively. Our diligent focus on underwriting sound credit risk and proactive asset management has led to OBX Non-QM securitizations having the lowest delinquencies across the top 10 largest issuers in the market. The Residential Credit business remains well-positioned given the optionality of our growing correspondent channel and our ability to manufacture high-yielding assets across various spread environments.

We continued to grow our holdings of mortgage servicing rights (“MSR”) to $2.8 billion in market value as we committed to purchase a bulk transaction comprising $125 million in market value, which is expected to settle before year-end 2024. The mark on the portfolio decreased slightly in the quarter given a relatively sharp 80 basis point decline in the mortgage rate, highlighting the durability of a portfolio whose average refinancing incentive is 300 basis points below current mortgage rates. Fundamental performance of the portfolio remained strong as the 3-month annualized prepayment speed of the portfolio was 3.9%, serious delinquencies were minimal at 45 basis points, deposit income remains elevated given the shape of the yield curve, and increased competition in the subservicing market has benefited financial participants like us.

On the strategic front as it relates to MSR, our long history of formulating value-add partnerships was again on display this quarter as we announced a sub-servicing partnership with Rocket Mortgage (“Rocket”) in early October. Our size and the stability of our capital helped develop this relationship and we are pleased to be Rocket’s first Agency MSR subservicing client. Rocket is expected to begin servicing loans for us as early as December, and this partnership should allow us to benefit from Rocket’s recapture abilities and we expect it to increase our competitiveness in purchasing new MSR. Similar to our existing sub-servicing agreement, our Rocket agreement allows us to effectively participate in the gain on sale of a loan refinanced by our recapture partners, helping to preserve and protect our portfolio.

Earnings available for distribution and economic leverage are non-GAAP financial measures. Refer to "Non-GAAP Financial Measures" for additional information, including a reconciliation to its most directly comparable GAAP results.