Filed by Annaly Capital Management, Inc.
pursuant to Rule 425 under the Securities Act of 1933
and deemed filed pursuant to Rule
14d-2
under the Securities Exchange Act of 1934
Subject Company: MTGE Investment Corp.
Commission File No.:
001-35260
On May 3, 2018, Annaly Capital Management, Inc. (Annaly) hosted a conference call to provide
supplemental information regarding Annalys pending acquisition of MTGE Investment Corp. (MTGE) pursuant to the Agreement and Plan of Merger, dated as of May 2, 2018, by and among Annaly, MTGE and Mountain Merger Sub
Corporation. A copy of the transcript from this call follows.
Annaly Capital Management Q1 Earning Conference Call
May 3, 2018
C: Jessica LaScala; Annaly Capital
Management; IR
C: Kevin Keyes; Annaly Capital Management; Chairman, CEO and President
C: David Finkelstein; Annaly Capital Management; CIO
C: Glenn
Votek; Annaly Capital Management; CFO
P: Doug Harter; Credit Suisse
P: Bose George; KBW
P: Rick Shane; JP Morgan
P: Ken Bruce; Bank of America Merrill Lynch
Operator
Good day everyone and welcome to the Q1 2018 Annaly Capital Management Earnings Conference Call. All participants will be in listen-only mode. Should
you need assistance, please signal a conference specialist by pressing the star key, followed by zero. After todays presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone
phone. To withdraw your question, please press star then two. And please note that todays event is being recorded. I would now like to turn the conference over to Jessica LaScala. Please go ahead.
Jessica LaScala Head of Investor Relations
Good
morning and welcome to the First Quarter 2018 Earnings Call for Annaly Capital Management, Inc.
Any forward-looking statements made during todays
call are subject to risks and uncertainties, which are outlined in the Risk Factors section in our most recent annual and quarterly SEC filings. These risks and uncertainties include but are not limited to the ability of the parties to consummate
the proposed transaction on a timely basis (or at all) and the satisfaction of the conditions precedent to consummation of the proposed transaction. Actual events and results may differ materially from these forward-looking statements. We encourage
you to read the forward-looking statements 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 of the earnings call. 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.
Also note that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase any
shares, nor is it a substitute for the exchange offer materials that Annaly and its merger subsidiary have filed with the SEC.
Annaly and its merger
subsidiary will file a tender offer statement on schedule TO. Annaly will file a registration statement on form
S-4,
and MTGE will file a solicitation/recommendation statement on schedule
14D-9
with the SEC with respect to the exchange offer.
The exchange offer materials, including an offer to exchange, a
related letter of transmittal and certain other exchange offer documents, and the solicitation/recommendation statement will contain important information.
MTGE shareholders are urged to read these documents carefully when they become available because they will contain important information that holders of MTGE
Securities should consider before making any decision regarding exchanging their securities.
The offer to exchange, the related letter of transmittal and
certain other exchange offer documents, as well as the solicitation/recommendation statement, will be made available to all holders of MTGE common stock at no expense to them.
The exchange offer materials and the solicitation/recommendation statement will be made available for free at the SECs website at www.sec.gov.
Participants on this mornings call include: Kevin Keyes, Chairman, Chief Executive Officer and President; David Finkelstein, Chief Investment Officer;
Glenn Votek, Chief Financial Officer; Tim Coffey, Chief Credit Officer, Timothy Gallagher, Head of Commercial Real Estate and Michael Quinn, Head of Commercial Investments. Please also note this event is being recorded.
Ill now turn the conference over to Kevin Keyes.
Kevin Keyes Chairman, Chief Executive Officer and President
Thanks, Jessica. Good morning, everyone, and welcome to the call.
I would like to begin with a brief summary of Annalys acquisition of MTGE Investment Corp, which we jointly announced last evening.
First, Id like to thank everyone who has been involved in this transaction, my team, our advisors and the Annaly and MTGE Boards of Directors. These
deals obviously take a lot of hard work, and I personally very much appreciate the collaboration and the effort needed to successfully complete this deal. The strategic nature of this transaction is a unique combination adding to our franchise value
and is in the near and long term best interests of our shareholders.
There are numerous ways in which all shareholders benefit from this transaction. To
summarize Ill review my Top 5: First the asset and business diversification it offers; Second - the deal is accretive and the structure provides further upside; Third - the strategic synergies and cost savings to be realized; Fourth -
the increased scale and liquidity of the combined company, and #5 the inherent value creation that consolidation brings to both Annaly and the mREIT industry.
On the first point, through this combination, Annalys evolution continues as we further expand our ability
to invest in multiple areas across all four of our business segments. As it relates to MTGEs portfolio, the assets are highly complementary and add meaningfully to our existing agency and
non-agency
portfolios. Additionally, MTGEs countercyclical healthcare real estate assets will increase the number of our available investment classes to 37, approximately 3x as many as when our diversification strategy was initiated. The healthcare real
estate properties also provide stable, long-term, triple net lease cash flows to our Company. Pro forma for the transaction, Annaly will have 27% of its capital allocated to interest rate insulating, lower levered, floating rate credit assets.
Secondly, Annalys shareholders can expect this deal to be accretive to core earnings, neutral to book value, deliver double digit
cash-on-cash
returns while not materially impacting Annalys current leverage and liquidity profile. The 50% cash/50% stock transaction structure provides MTGE
shareholders the ability to capture an immediate premium to their existing ownership positions, while the equity component of the transaction enables them to share in the potential upside of the strategic combination.
Reason #3: Shareholders will benefit from significant and tangible cost efficiencies generated by Annalys scalable operating model, achieved both
through a base management fee that is 30% lower than MTGE shareholders existing fee and the elimination of redundant G&A expenses once the merger is completed.
The 4
th
reason is in regard to scale and liquidity - this transaction grows our pro forma capital base to
nearly $14.5 billion and increases our market capitalization to 25 times the median mREIT. And now with over $7.7 billion of unencumbered assets, and our diversified financing sources, our internal and external growth strategies are fueled
with unmatched liquidity to maintain our ability to be opportunistic across our interest rate and credit businesses.
And finally this acquisition
further establishes Annaly as a disciplined, market leading consolidator. The deal represents Annalys 3rd transformative acquisition over the past few years with a combined value of $3.3bn which equates to the total size of the smallest
14 mREITs in the sector. So yes, the industry still remains extremely fragmented.
Our leadership and belief in the need for consolidation is driven by
our view that the mREIT industry has similar ingredients of other industry sectors in certain cycles of the past and present: The cycle goes like this: First, there is obvious oversupply and unsustainable growth, followed by underperformance
(usually coupled with volatility), which leads to the resultant required rationalization, in order to have the chance for renewed outperformance.
A closely related sector which has already undergone this transformation over a longer period of time through consolidation is the Equity REIT industry. In
the late 1990s, the Equity REIT sector expanded far and wide among real property asset classes as suffering banks, insurance companies and private funds spun out their real estate holdings into the more capital efficient
REIT structure. From 1997 until 2006 the sector flourished, with the total market capitalization of the Equity REIT industry more than tripling from $130 billion to $410 billion. An
oversupply of IPOs and secondary issuance coupled with the onset of more challenging market conditions, led to sudden and dramatic underperformance at the end of that decade. A broad consolidation wave ensued, with over $138bn of M&A
transactions taking place in 2006 and 2007 alone, removing approximately 33% of the total market cap of the sector. Since then, the Equity REIT industry has continued to mature, rationalize and healthily grow with the average industry player now
over 3x times larger than the decade before. The higher quality, larger market leaders have especially outperformed, driving consistent industry growth that now amounts to a size of approximately $835bn today.
The parallels and comparisons of the evolution of the Equity REIT industry to our sector are obvious to me. Following the financial crisis and spurred by
historically accommodative monetary policy, the mortgage REIT sector also ballooned in size, creating a growing supply/demand imbalance from the deluge of capital raised. From 2009 until the 2013 Taper Tantrum, over half of the 40 companies in the
sector went public and the market cap of the mREIT sector nearly tripled the same multiple of growth as the Equity REIT sector but in half the time with almost $40 billion of equity capital raised. The Taper, coupled with the new
Fed regime in early 2014, led to heightened market volatility and an abrupt pause in capital raising, leaving a large number of
sub-scale,
monoline operators not able to reach critical mass to operate
efficiently and whose performance then began to suffer.
In April 2016, Annaly initiated the 1
st
wave
of consolidation with our $1.5 billion acquisition of Hatteras. In the wake of our transformative transaction, and with an increased scrutiny on smaller less efficient companies, there have been 15 M&A deals and strategic processes
announced in the mortgage REIT sector over the past two years for a total value of approximately $13 billion nearly 25% of the sectors market cap. Over the same period, while the number of mortgage REITs decreased byroughly20% from
this consolidation, performance and valuations recovered and the average mREIT market capitalization grew by over 50%. Our ability to initiate industry altering change has brought unique value to our shareholders and helped the sector recover
following the Taper. We have been a catalyst to help drive industry evolution while outperforming the sector and increasing our market share demonstrably since the Hatteras transaction.
In the past few months, as valuations have now reverted to below historical averages and volatility has returned to the market the second wave of
mortgage REIT consolidation is now upon us. We first demonstrated our resolve by buying a Company in the first quarter of 2016 when credit spreads were at their widest point since the Crisis, and now again, amidst the renewed market volatility we
witnessed in the first quarter of this year, we are acquiring MTGE. And as Ive consistently stated, given the numerous remaining small competitors, the sector is still in need of further rationalization.
The mREIT sector is not alone though, we are seeing similar dynamics driving the need for consolidation in certain other industries in the broader
marketplace. At $1.1 trillion, First Quarter 2018 M&A volume was up 46% year over year, marking the most active first quarter ever. M&A activity is currently being driven by strategic buyers looking for diversification and complementary
products or markets given the more challenging and volatile investment
environment. It is also interesting to note that over
two-thirds
of this record First Quarter M&A volume is made up of the markets yield sectors
including Real Estate, Natural Resources, Telecom and Media and Financial Institutions. Recently published sell-side research has substantiated the argument that, over the long term, shareholders benefit from acquirers capitalizing on challenging
market backdrops transactions announced in periods of high volatility have historically outperformed deals announced in less volatile periods by a factor of 2x.
The ultimate winners in any fragmented industry in need of consolidation are those who have the platform, capital, liquidity, appropriate cost structure and
expertise to be opportunistic. These key attributes allow Annaly to be more nimble when it comes to proactively seeking, evaluating and acting on these opportunities and our shareholders continue to benefit from this discipline. We have
established ourselves as an industry leader through our proven ability to take advantage of our unique internal and external growth strategies.
Now
Ill turn it over to David to go through our investment activity in the 1
st
quarter and the benefits of the merger across our portfolio in more detail.
David Finkelstein Chief Investment Officer
Thank
you Kevin. The first quarter saw a meaningful rise in interest rates, which was fueled by a positive domestic growth outlook, a Federal Reserve signaling for a continued steady pace of interest rate hikes, and rising levels of public debt. A
further challenge to managing mortgage portfolios came from a widening in Agency MBS spreads coincident with the rate selloff and flattening of the yield curve. Meanwhile, credit spreads saw a modest widening, which occurred largely amid the
increased volatility in equity markets, but spreads still remain at post crisis tight levels.
Prior to discussing the onboarding of the MTGE portfolio, I
do want to provide details on the first quarter, and Ill begin with the Agency portfolio. Our efforts in Agency were largely focused on managing leverage and duration in light of interest rate and spread volatility throughout the
quarter. We reduced our TBA position and significantly increased our interest rate hedges to a hedge ratio of 94%. Consequently, we ended the quarter with slightly lower economic leverage and a meaningfully reduced sensitivity to interest
rate fluctuations. We achieved this despite the reduction in equity as well as the MBS duration extension associated with higher interest rates. Specifically with respect to our hedge composition, we substituted out of our Eurodollar
futures, and replaced those hedges with shorter-dated interest rate swaps, which explains our higher swap balance, and combined with the restrikes that we completed in the fourth quarter, lowered the overall pay rate on our swaps
portfolio. Also of note, the spike in LIBOR this year has had a beneficial impact on our liabilities considering that repo rates have tracked overnight index swaps more closely than LIBOR, which has led to a receive rate on our swap portfolio
well in excess of the financing rate on our repo portfolio. LIBOR remains elevated, but the forwards do imply a normalization of the relationship between OIS and LIBOR as the year progresses, nonetheless we anticipate this dislocation to remain
a tailwind over the very near term.
Turning to residential credit, the modest growth in our portfolio was concentrated in the whole loan sector, as
we funded over $180mm of loans in the first quarter. In February, we executed call rights on two of our legacy securitizations, giving us access to $218mm of seasoned, prime whole loans. With these loans, along with an additional $122mm of
loans held on balance sheet, we securitized into a rated RMBS transaction. Through the securitization, we sold $279mm of AAAs at L+65 with a 90% advance rate and Annaly retained approximately $60mm of credit investments and Interest Only
(IO) certificates with an expected unlevered yield of high single digits to low double digits. While we had the option to finance these loans through our FHLB membership, we opted to capitalize on the strong securitization market, as evidenced
by the robust new issue pipeline year to date. Executing our inaugural residential securitization, establishes Annaly as an issuer in the space, broadens our financing options for the sector, and provides us with additional flexibility in
growing our whole loan portfolio.
Our Middle Market Lending platform continues to be a growth engine for our credit businesses, as we net added
$140 million in assets last quarter, bringing the total portfolio to roughly $1.2bn. While we maintain nearly 60% of the portfolio in first lien loans, we are seeing an increase in second lien opportunities that align with our
strategy of selecting companies in highly defensive industries that have an ability to rapidly
de-lever,
which gives us second lien pricing at first lien like leverage. Our commercial real estate business
grew very modestly this past quarter given our cautious stance on commercial credit and valuations, however, we did increase our CMBX holdings from $125 million to nearly $300 million, as synthetic exposure remains inexpensive relative to
cash CMBS as well as direct lending.
With respect to the MTGE portfolio, (as Kevin discussed) the Agency and residential credit assets fit well with our
current strategy, and we expect a seamless onboarding given our ability to value the assets and integrate those positions into our existing portfolio. Also of note, the additional agency leverage through the cash component of the acquisition is
a profitable replacement for a portion of the roughly $7 billion Agency assets we reduced our portfolio by in the first quarter. Regarding the health care portfolio, although these assets are unique to our current strategy, we do have specific
expertise in the sector within both our commercial and middle market-lending businesses that has been instrumental in evaluating those assets, and we are enthusiastic about the introduction of the health care portfolio into our current
diversification strategy. Furthermore, the combined efforts of our commercial and MML platforms will be instrumental in optimizing the value of those assets. Given the
stock-mix,
we do expect overall
leverage to increase very modestly, but this is within our target range, and we are comfortable with the additional agency exposure at current interest rate and spread levels.
Lastly, regarding our views going forward, we are considerate of the prospect of rates rising further, driven by the same dynamics that led rates to rise in
Q1. Thus, we expect to maintain greater interest rate protection over the near term than we would typically operate at current rate levels. That said, several factors including the relative attractiveness of U.S. yields and a fading
storyline of synchronized global growth suggest there to be a plausible ceiling on rates, which we will reach should the selloff continue at a pace similar to Q1. In credit - Securitized products both
Non-Agency
and Commercial, present somewhat of a challenge for levered investors given that asset spreads have tightened significantly more than the compression in financing spreads. Our broader
diversification strategy however, enables us to focus on areas where we have a distinct advantage, such as residential whole loans and middle market lending, both of which we expect to grow over the near term. We are seeing more opportunities
in the commercial space, but we will remain disciplined in light of asset valuations and focus on credit fundamentals as we seek value in that sector.
With that, I will hand it over to Glenn to discuss the financials.
Glenn Votek Chief Financial Officer
Thank you
David, and good morning.
Beginning with our GAAP results, first quarter GAAP net income was $1.3B, or $1.12 per share, compared to approximately $750M or
$0.62 per share for Q4. The primary factor driving the results was unrealized gains on interest rate swaps, which improved by approximately $490M for the quarter. Additionally, net interest income increased over $85M on a combination of increased
coupon income and lower premium amortization expense as CPRs slowed.
Core earnings excluding PAA were relatively flat to last quarter at $385M, or
$0.30 per share. This compares to core earnings including PAA of $0.41 per share as the PAA for the quarter was a benefit of approximately $0.11, versus a cost last quarter of $0.01 and was driven by the slower speeds.
Among the highlights for the quarter Higher agency MBS average balances produced an increase in coupon income, which was partially offset by higher
amortization ex PAA. Additionally, our Resi loan and MML portfolios contributed to the increase in interest income, while dollar roll income was relatively flat. Interest expense increased driven by higher repo balances in the quarter and higher
rates, with the average rate rising to 164 bps from 141 bps the prior quarter. A significant portion of the increased funding cost was mitigated by a reduction in interest costs related to our swap hedges, which were impacted by the factors that
David enumerated. As a result, the hedge portfolio at period end is now in a net receive position which will benefit us in future quarters. The hedge book limited the rise in our overall funding cost to a mere 7 basis points, which also limited the
impact on our net interest spread for the quarter, as well as our net interest margin which actually increased slightly.
Our key financial metrics
remained solid. In addition to net interest margin and net interest spread, Core ROE
ex-PAA,
was unchanged at a healthy 10.7%, and our operating efficiency metrics remained at favorable levels consistent with
the scale benefits of our operating platform. Turning to the balance sheet, while average interest earning assets were up slightly during the quarter, portfolio assets ended the period down approximately $1.9B, with the decline largely coming from
the agency portfolio, additionally the TBA notional position ended the period down approximately $7B. The middle market lending portfolio grew $141M or 14%, and our Resi loan portfolio likewise saw further growth in the quarter. From a capital
allocation standpoint, the credit portfolios represented 26% of allocated capital, up from 24% the prior quarter. Balance sheet leverage was up modestly to 6.1x, while economic leverage declined to 6.5x. And book value declined to $10.53 per share,
from $11.34 the prior quarter.
During the quarter we further enhanced the depth, diversification and economics of our funding and capital sources.
Beginning with repo, we took advantage of the rates market and termed out portions of the repo book with the weighted average maturity extended by 14 days, ending the quarter at 72 days. We also continue to have success growing our counterparties
both at the Annaly and Broker/Dealer level. Additionally, we diversified our resi whole loan funding beyond FHLB with the debut securitization that David noted, establishing another source of attractive funding for that business.
Following our $425M offering of 6.5% preferred stock early in the quarter, which was a record low coupon among
unrated issuances, we called $412M of higher cost preferreds, which contributed to, what is now, an aggregate 56 basis point reduction in the cost of our preferred capital.
And a final thought on the MTGE transaction to add to the remarks provided by Kevin and David, the transaction is accretive to earnings and allows us to take
further advantage of our operating platform as we expect to generate run rate cost synergies of over $15M per year, with a major component coming from the reduced management fee. And the consideration structure, including Annaly stock, allows both
companies shareholders to participate in the future value of Annaly.
With that, William, we are ready to open it up to questions.
Operator
Thank you, we will now begin the question and
answer session. To ask a question you may press star then one on your touch-tone phone. If you are using a speaker phone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two, and at this time
we will pause momentarily to assemble our roster. And it looks like our first questioner today will be Doug Harter with Credit Suisse. Please go ahead.
Doug Harter
Thanks. Kevin, on the acquisition, the prior
two acquisitions you made were at discounts to book and while I hear the other benefits you have to the acquisition, can you just talk about why at this price versus the discounts on the other two deals?
Kevin Keyes
Sure. I will give you the short
Readers Digest version and we can go into as much details as you like, Doug. First, you know the way we value these companies, the public companies anyway, externally and anything we value internally, we look at more than one metric, as you
might imagine. But in terms of your question, you know book value relative to the previous two deals, the short answer is that this portfolio, frankly, reflects the least risk versus the other two. A large percentage of the assets are obviously
agency and resi credit, of which not only is it fairly transparent in terms of those relative valuations but frankly, I think we are probably one of the best in the world at understanding not just the current valuations but frankly the potential
valuation given where we are in the cycle. So the multiple reflects, really, a relatively pristine portfolio on the agency and resi credit side and then you know the ultimate call option here are the other assets predominantly made up and
represented by the healthcare portfolio.
So you know in CreXus, that was a different and a different cycle. That company was smaller and more of a
liquidity trap with a different type of origination model, so that discount made sense, tied to the assets in the portfolio at the time. And with Hatteras, you know that company not only was predominantly made up of floating rate ARMs but it had an
operating entity within it that was highly costly to run which not only impacted their valuation, it impacted their liquidity. So all these deals are relative and I think where we ended up striking the price here, I think is a very good balance of,
we definitely have potential upside with the portfolio across the board and the transaction structure was structured accordingly for that for the shareholders. So you get the premium and you get the upside, but basically this valuation and where it
came out is really tied to the transparency of the assets in the portfolio.
The other thing, the additional vig here is you know folding into our company
and our operating platform, you know we are going to this run this thing three times more efficient than it was as a standalone company, which is always our goal to
plug-and-play
and make it accretive not just on earnings, but make it accretive tied to additional cost savings.
Doug Harter
Thank you Kevin. And then on the healthcare
assets, is that something that you will look to continue to originate or just hold the existing assets?
Kevin Keyes
You know were analyzing it now. What I think is unique about this is, we are one of the few companies that have the internal expertise to not just manage
these assets, but to figure out the strategy of a healthcare portfolio. So you know were assessing it. I think its a platform that we think, on a relative value basis, is a good entry point. I think any time you do these types of deals,
people are kind of skeptical about our diversification, but the fact that were able to onboard that type of portfolio should exemplify the people that we have businesses within our businesses. We have expertise within the
commercial real estate group, you know a group within a group that manage these portfolios historically, both on the equity side and the debt financing side. This is a real diversification play and we are not guessing about how to manage them. We
are just early-stage in terms of how we are going to think about growing it.
Doug Harter
Great. Thank you.
Kevin Keyes
Thanks.
Operator
And our next questioner today will be Bose George with KBW. Please go ahead.
Bose George
Hi. Good morning. Actually, in terms of the
deal, once we include the cash component of the deal, will your leverage go up? Or are you just going to rotate cash from other investments to finance the deal?
David Finkelstein
Hi Bose, this is David. As I said in
my prepared comments, leverage should go up about
two-tenths
of a turn. But again thats perfectly well within our comfort range. So we ended the quarter at 6.5 times. Right now, I would say we should end
around 6.75 but will oscillate around that and things could change.
Kevin Keyes
And the structure was meant to you know come up with the optimal pro forma capitalization and its even frankly more conservative on a leverage basis than
at the time of Hatteras where I believe on that deal our leverage went up about 0.5 turns. So we backed into where we wanted to be. We didnt end up where we didnt want to be.
Bose George
Okay. That makes sense. Thanks. And then
actually switching to the
LIBOR-OIS
spread, can you just quantify the benefit as long as that kind of remains where it is, what the benefit to your spread is?
David Finkelstein
Sure. So right now
LIBOR-OIS
is about 51 basis points, Bose. Its been as high as about 59. Its come up over the past couple of weeks. We think its probably in upwards currently of 20 basis points outsize relative to
where it will normalize roughly a year from now but a lot of that normalization will come over the very near-term. In fact, the forwards price
LIBOR-OIS
to converge by about 10 basis points just this quarter.
So its a small tailwind for us but nonetheless, it will help this quarter. In terms of our overall swap expense, I think we were at $48 million for this quarter. With a positive spread, now we expect our swap expense to actually be a
benefit to the tune of around $35 million to $40 million based on the forwards this quarter at the end of the quarter. And again repo expenses are going up with the fed hikes, so that offsets that to some extent.
Bose George
Okay. Great. Thanks. And then actually just one more on book value. Can you just comment on how book value has trended
quarter-to-date?
David Finkelstein
Sure. So as of
month-end
on Monday, we were roughly unchanged on the quarter. The snapshot was $10.50 versus $10.53 at
the
quarter-end.
Bose George
Okay. Perfect. Thank you.
Operator
And our next questioner today will be Rick Shane with JPMorgan. Please go ahead.
Rick Shane
Hi guys. Thanks for taking my questions this
morning. I just want to talk about the swap strategy in the implications. Obviously, you increased the hedge ratio. You chose to do that frankly in a shorter duration than you have over the past couple of years. Was that just a function of pricing?
Or how should we be thinking about this?
David Finkelstein
Rick, this is David. So the reason why its shorter duration is because we replaced our Eurodollar futures which are all relatively short duration. So
those were roughly duration matched. When we took off the Euros, we simultaneously added swaps. And since those were short duration, the swaps matched those duration. But we didnt change our overall curve profile. In fact, currently we are
somewhat spread across the curve, I would say, in terms of our hedges. We do think the front end is relatively inexpensive. But I would say that we are considerate of both Fed expectations as well as investor constraints at the long end of the curve
that necessitate investment out of the curve, despite a relatively low longer term rates, such as pensions. And so were agnostic in terms of the curve and do not have curve trade on.
Rick Shane
Got it. And I am going to ask a dumb equity
guide question, but the Eurodollar position was $17 billion position. The notional value of the swaps went up by about $30 billion. Is there something thats different in the convexity of those two instruments, why you would increase
why effectively it would be 2X in terms of swap position?
David Finkelstein
No, Rick. They were
one-for-one
match. There is not an economic difference or
material economic difference between Eurodollars and swaps, but why you see the increase in balance is, as we talked about last quarter, the increase in hedges associated with the rate selloff and a desire for greater interest rate protection.
Rick Shane
Okay. Got it. Thank you guys.
Operator
And our next questioner today will be Ken Bruce with Bank of America Merrill Lynch. Please go ahead.
Ken Bruce
Thanks. Good morning. I have a couple of
different questions. I guess first on the acquisition and the diversification. Kevin, do you feel like you know at this point this is diversification for diversification sake? Or are there specific capabilities or different asset classes that you
are looking to add to the portfolio?
Kevin Keyes
I
dont think we are confusing motion with progress, if thats your question. I think, what we have done is we have just I picture us as were a company built for the future and I dont want to get too hokey but this we
spent a lot on R&D within our strategies over time. And you know the resulting factors, did I expect to have 37 different options in the four businesses three years ago? No, we didnt target each and every one of them. We have recruited and
hired people that are really good athletes that can do more than one thing and thats how we have been able to scale, grow and diversify.
So the
product of our strategy, you know diversification for diversification sake, its really been a function of having the most athletic talent in complementary businesses in both highly liquid sectors and in credit businesses that are more opaque
and less competitive. So its really been a plan. It hasnt been like random. And I think, at the end of the day, the takeaway or the easiest way to describing what the goal was, was really to have a
plug-and-play
strategy where you can be opportunistic when you have the most options and the most cards on your side of the table.
So as we talked before, in difficult market environments over different cycles, its nice to not have to be perfectly right every single time you are
making an investment. And when you have more options, you have more room for error. So we wont stay we are the smartest guy in the room. But we are the biggest, most liquid guy in the room with the most options. So by definition, we should be
the most stable and we should have more opportunities than anybody else. Its kind of that simple.
Ken Bruce
Right. The reason I ask is, I guess from my point of view, you have got a lot of the capabilities for investing in some of these different asset classes anyway
and obviously you could with those capabilities, you could replicate the portfolio. So I am trying to understand if you see this as a good financial transaction in the context of the assets or if this is an exercise in terms of consolidating capital
across the industry, which from my point of view ultimately is what is going to occur and for those managers that arent successful enough to keep up with their peers, those are the ones who are going to fall by the wayside. So I guess
thats what I am trying to understand, if this is a basically consolidation of capital?
Kevin Keyes
I would say, yes and yes. Right, I think we are built, the way we are going to consolidate is because we are diversified. There are certain companies you know
that if your one or two strategies or in this case three, they were complementary, there is not many companies that
match-up
that way. So diversification allows you to be more opportunistic. And the second
part of it is, yes, Ive said, I think people and we laugh about it, I think couple of years ago when I first opened my mouth about consolidation when my role transitioned, it was definitely my opinion, the markets are always about a race for
capital and the strongest survive.
And our sector just happens to be one where I will take the high road, but its been a sector with more smaller
companies than most other industries. And I also pointed to the BDC industry as another parallel. And the reason I bring up the equity REIT industry that you are familiar with, Ken, is obviously its a more mature industry today and its
close to $1 trillion in value in terms of market cap, but in the early 90s, you know no one even really knew how to spell REIT in the equity market.
So
not that we are going to $1 trillion as an industry in 10 years, I just think the strongest survive and it is a race for capital because investors are smart and capital is limited and they are only going to invest their capital in the best
companies. And I think that analogy directly applies to our industry and our strategy. And our goal is not just to consolidate for the sake of consolidating. Our goal is to tick off you know the best opportunities, both internally and externally
that maintain and grow our capital base and keep this engine churning out stable earnings and cash flow. So its yes and yes.
Ken Bruce
Yes. I appreciate that commentary. I guess from the perspective of the market today, there is still a target rich environment out there. My last question as it
relates to the increasing of the hedging strategy. I am not trying to be critical here. I guess I am trying to understand if in fact that you are increasing hedging at the time that volatility is also increasing. Is that an efficient way to
essentially position the portfolio? Or are you always chasing the market? Sorry for that types of questions, because I know its a little hypothetical, but if you could just give us some sense as to how you think about that?
David Finkelstein
Hi Ken, this is David. I would say, its perfectly consistent with the increased volatility. If you just look at this quarter, rates are 20 basis points
higher. We obviously went through 3% and I think the hedge positions that we added has certainly protected book this quarter. And just the fact that the matter is, you are just not getting paid as much for taking interest rate risk, given the
volatility and other factors like the flatness of the curve. And so it just makes more sense to have a better protected portfolio from a hedging standpoint. And we will maintain that position until we feel like rates have gotten to a point where the
market looks cheap or other factors through the diversification strategy enable us to take off hedges.
Kevin Keyes
And I think the endpoint is tied to your first question, why are we diversified and whats the goal of consolidation? And in here, I think your question
on just this quarter, the strategy, its been consistent with David and the team over the past three or four years. I dont think we have been really chasing much of anything. I went back and we studied for these calls but our book value
performance has been quite good.
I think we are about 300 basis points in better protection than the rest of the sector over the past six quarters, which
involve some of the most volatile time periods. So we are building this model to protect capital in order to be opportunistic to grow it. You have to got to protect it if you are going to net net grow it. But I think we look at over time, not just
one quarter and you know that whole speech, but the strategy doesnt just pop up once the market chips.
We monetized a good portion of assets in the
first quarter, you know because the market was getting more volatile and by the way, it freed us up to do this acquisition much more efficiently and our leverage barely had to move because we had positioned that way in front of it. So its all
tied together but I think
quarter-to-quarter
thinking is not what we are really preoccupied with where others probably are because they are financed
month-to-month
or
quarter-to-quarter
and they have you know
thirty-day
dividends and other short-term restrictive parameters that they have to keep to. We dont have to do deal with that stuff.
Ken Bruce
All right. Okay. Thank you very much. I
appreciate it.
Kevin Keyes
Thanks Ken.
Operator
And this will conclude our
question-and-answer
session. I would like to turn
the conference back over to Kevin Keyes for any closing remarks.
Kevin Keyes
Thanks everyone for dialing in and for your interest in Annaly Capital and we will speak to you all next quarter.
Operator
And the conference has now concluded. Thank you
for attending todays presentation and you may now disconnect your lines.
Additional Information and Where to Find It
The exchange offer referenced in this communication has not yet commenced. This communication is for informational purposes only and is neither an offer to
purchase nor a solicitation of an offer to sell shares, nor is it a substitute for the exchange offer materials that Annaly and its merger subsidiary will file with the SEC. At the time the exchange offer is commenced, Annaly and its merger
subsidiary will file a tender offer statement on Schedule TO, Annaly will file a registration statement on Form S-4, and MTGE will file a Solicitation/Recommendation Statement on Schedule 14D-9 with the SEC with respect to the exchange offer. THE
EXCHANGE OFFER MATERIALS (INCLUDING AN OFFER TO EXCHANGE, A RELATED LETTER OF TRANSMITTAL AND CERTAIN OTHER EXCHANGE OFFER DOCUMENTS) AND THE SOLICITATION/RECOMMENDATION STATEMENT WILL CONTAIN IMPORTANT INFORMATION. MTGE STOCKHOLDERS ARE URGED TO
READ THESE DOCUMENTS CAREFULLY WHEN THEY BECOME AVAILABLE BECAUSE THEY WILL CONTAIN IMPORTANT INFORMATION THAT HOLDERS OF MTGE SECURITIES SHOULD CONSIDER BEFORE MAKING ANY DECISION REGARDING EXCHANGING THEIR SECURITIES. The Offer to Exchange, the
related Letter of Transmittal and certain other exchange offer documents, as well as the Solicitation/Recommendation Statement, will be made available to all holders of MTGE common stock at no expense to them. The exchange offer materials and the
Solicitation/Recommendation Statement will be made available for free at the SECs website at www.sec.gov. Additional copies may be obtained for free by contacting Annalys Investor Relations department at 1-888-8 Annaly (1-888-826-6259).
In addition to the Offer to Exchange, the related Letter of Transmittal and certain other exchange offer documents, as well as the
Solicitation/Recommendation Statement, Annaly files annual, quarterly and current reports and other information with the SEC. You may read and copy any reports or other information filed by Annaly at the SEC public reference room at 100 F Street,
N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Annalys filings with the SEC are also available to the public from commercial document-retrieval services and at the
website maintained by the SEC at
http://www.sec.gov
.
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expects, anticipates, foresees, forecasts, estimates or other words or phrases of similar import. Similarly, statements herein that describe the proposed transaction, including its
financial and operational impact, and other statements of managements beliefs, intentions or goals also are forward-looking statements. It is uncertain whether any of the events anticipated by the forward-looking statements will transpire or
occur, or if any of them do, what impact they will have on the results of operations and financial condition of the combined companies or the price of Annaly or MTGE stock. These forward-looking statements involve certain risks and uncertainties,
many of which are beyond the parties control, that could cause actual results to differ materially from those indicated in such forward-looking statements, including but not limited to the ability of the parties to consummate the proposed
transaction on a timely basis or at all and the satisfaction of the conditions precedent to consummation of the proposed transaction, including a majority of outstanding shares of MTGEs Common Stock being validly tendered in the exchange
offer; that required regulatory approvals for the proposed transaction may not be obtained in a timely manner, if at all; business disruption following completion of the merger; and the other risks and important factors contained and identified in
Annalys and MTGEs filings with the SEC, including their respective Quarterly Reports on Form 10-Q and Annual Reports on Form 10-K, any of which could cause actual results to differ materially from the forward-looking statements. The
forward-looking statements included in this Form 8-K are made only as of the date hereof. Neither Annaly nor MTGE undertakes any obligation to update the forward-looking statements to reflect subsequent events or circumstances, except as required by
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