Annaly Capital Management, Inc.

Michael Farrell – Chairman, CEO & President Wellington Denahan – Vice Chairman, Chief Investment Officer & COO Kathryn Fagan – CFO & Treasurer

Jason Arnold – RBC Capital Markets Mike Widner – Stifel Nicolaus Andrew Wessel – JP Morgan Steve Delaney – JMP Securities Ken Bruce – Bank of America Merrill Lynch Stephen Mead – Anchor Capital Advisors Bruce Silver – Silver Capital

Thank you, Wayne. Good morning, everyone, and welcome to the fourth quarter earnings call.

I'm joined here today by Wellington Denahan, our Chief Investment Officer and the Chief Operating Officer; Kathryn Fagan, our Chief Financial Officer; Nick Singh, our General Counsel; and Jay Diamond, the Managing Director. As usual, we will open up with some opening comments and then we will open it up to Q&A to go through the numbers and your questions.

Some brief comments first. The title of this missive is Just Save, Baby, Just Save.

As we sit on the precipice of the greatest fiscal stimulus package in our nation's history, the question we are asked most often during our discussion with market participants is, when will it end? Well, we can't tell you the exact date, but I can believe that a precursor to the stabilization of mortgage flows will be the clue.

I can say that with certainty because from where we sit with the current instability in the economy began showing its teeth in the mortgage market in 2002 and it will ultimately end once those cash flows stabilize again. When this occurs at some uncertain future date, property valuations will have found a bottom and new run rates and GDP will have been established.

The sooner this happens, the better. But in the interim, we, as a nation, are faced with policies designed to maintain the consumption during the course of our domestic economy.

My view that this is what got us into the problem in the first place and it runs counter to what Americans are now doing as rational economic human beings, we are reducing consumption and increasing savings. The following is a construct of Newton's principles.

For every action there is an equal and opposite reaction. We are witnessing the reaction of America's primary gross domestic component, its consumers, as they retrench and repair their own balance sheets.

As the title of these remarks infers, I believe that consumers are embarking on a reversion to the mean of the national personal savings rate as a percentage of disposable personal income or the savings rate. The average since 1953 has been almost 7%, but with a very sharp downward trend at the end of the subsequent half-century.

The average savings rate from 1953 to 1989 was 8%, with peaks over 12% in 1975 and 1982. In the ten years ended December 2008, however, the average has been less than 2% with a low of a minus 2.7% in 2005.

In the closing months of 2008, terrified consumers have pushed this rate positive again. The just released data for December shows a savings rate of 3.6%.

The average for the fourth quarter is the highest quarterly average since the second quarter of 1999. A rising savings rate is consistent with slower economic growth.

According to Merrill Lynch's David Rosenberg, because of multiplier effects every 1% rise in savings takes away about 1.3% in consumer spending. In the mid-1970s and the early 1980s, the savings retrenchment led to negative GDP trends as consumers acted to preserve their balance sheets.

Encouraging savings to preserve the nation's fiscal house is exactly what is needed to provide the capsized ship of capitalism and truly secure the national interests. As a citizen, one would hope that in its noble rush to save the economy the Obama administration would also be considering the long-term solution of the nation funding its own debt by jumpstarting the savings rate instead of the consumption rate.

At the same time, I recognize that it would be very painful to initiate such a program, as there is clearly no corporate or political constituency for a remedy that virtually guarantees a recession. It would be a recognition that the thriftiness of Aesop's ant is purposeful.

It also means fewer cars in the driveway; fewer travel vacations; fewer dollars allocated to private education choices; fewer dinners out; difficult choices about healthcare; smaller homes that are colder in winter and warmer in summer; fewer must-have electronic toys; delayed retirements and, in general, tougher choices about personal disposable incomes to the detriment of consumption-based and export-based economies. Tough as it may be to sell this policy agenda, I submit that that is exactly what the country needs to do to secure its future.

Our policymakers, given the information that they now have about the mess that has been created, should include a savings incentive in order to accelerate the long-term healing process for the United States. History has shown us that people will choose this route of their own accord when faced with the uncertainty of job losses, stagnant income, and declining values in financial assets.

The generation that lived through the Great Depression had, as economists at JP Morgan called it, a precautionary savings motive. As for the past decade, Americans haven't had that motive and accordingly have reduced their savings rate for a number of reasons – the rising value of financial assets, easy access to credit, and the economic stability of “the great moderation.”

Today these reasons are gone. We are increasing our savings so we can repair the hole in our personal balance sheets, which through the third quarter of 2008 is a cumulative $7 trillion decline from the peak.

My argument is that the faster that we get there the faster the repair process will begin. Perhaps tax incentives can be added to accelerate the process.

To strategically direct the increased savings, the tax benefit can be structured to target investment in the public or the private sector. We should set a national target personal savings rate of 15% to provide the balance required to properly value and control our domestic economy.

The increase to 15% amounts to a diversion of about $1.2 trillion in personal savings away from consumption or a little more than the size of the proposed stimulus package. Our national security interests are at stake here, not simply the price of our standard of living.

We all sense and we know that higher taxes are coming at the federal and municipal levels. Entitlements are going to have to be negotiated.

Social Security will be reformatted to reflect that we are living longer and the pool of payers is shrinking. Medicare, Medicaid, and healthcare will be restructured to a socialist model.

But we still need to pay for it. At this point in the economic cycle, savers are the key to the survival, not consumers.

With this in place, the America of the immediate future will look, at best, a lot like the America of the 1950s. If we truly think that there is a short-term solution via consumption then we deserve our collective fate.

The long-term view and solutions are much harder to take in the short run, but if Americans are incentivized to save their stimulus checks rather than spend them, it would help to provide structurally sustainable fiscal health in the long run. This would position the country to win the economic war rather than the current battle.

The answer is that we need to swallow the full tablespoon of medicine or, to paraphrase Al Davis, the legendary owner of the Oakland Raiders, “Just save, baby.” There is a chart on the website that we released with these comments and closing them out here, this is the answer for the long-term.

It's not one that's easy for everyone to take. But I think everyone realizes that that's what you would do and that's what the nation needs to do.

With that said, we close out those comments and we open up the call for questions about the company's performance in the fourth quarter.

I will give you some – we have some very, very specific things that we would prefer not to discuss on an earnings call. Let me just give you some background behind that statement, if I may.

We began a project here at the end of 2007 called the involuntary prepay project. And essentially what we did is we began to grind down and create analysis across the country and across different issuers and geographic concerns to try to figure out who was going to be affected most by changes in defaults, delinquencies, and the foreclosures or, as we like to think of it, involuntary prepays.

We knew a lot of it was going to feed back up into the mortgage insurance business as well as into Fannie and Freddie and into the lenders who created some of these affordability products, like WaMu and Countrywide and everything. But we wanted to try to begin to quantify it on a theoretical basis and then perhaps to see how it played out.

In general, and this is a very general statement, with a lot of work – and obviously we have been working on it for two years and so we have got some view in this that I think is one of the reasons why people pay us to take a look at the valuations across the curve and why I'm very protective of it is that even though you have had a huge spike in applications that in general roughly 50% to 60% of those applications are being thrown away and not serviced at the originator level for a couple of reasons. One is that some of them don't reach up to documentation standards.

The second is that most people don't realize that they are upside down in their house and therefore are not able to take advantage of any lower rate that is out there, that the speed of those prepayments may be slightly faster on some parts of the existing mortgage curve, but overall it will destroy value maybe in selective sectors, which I'm not going to identify for the purposes of this call, where people are trying to lock in longer-term rates and maybe get rid of their exposure to short-term rates, that kind of thing. So, overall, I would say we are going to have some wave of prepayments across the board.

From Annaly's perspective, especially, I think that the job that Welly and the team has done in terms of lowering the overall historical acquisition cost of the portfolio, the capital raises that we did in the past that allowed us to take on legacy assets that have given our book value for historical purposes a 101-ish handle of acquisition, means that we are very comfortable with the prepayment exposure that's out there in terms of its effect on our earnings from writing down principal and premium. We don't have much premium in the book.

And we are in much better shape than we were in 2003 when we saw a 104 mortgage market, for instance, versus a 101. So I think that the asset management team has done an excellent job of identifying value.

I think we have done a lot of work that is proprietary on where we think valuations are going to be occurring or where destruction of capital is going to happen in the mortgage sector.

I think, Mike, it's safe for us to make a broad statement here that against the backdrop of what's going on globally that there are too many uncertainties out there in too many different economies that may wind up affecting banking counterparts or asset selection across the board. I'll give you just a brief synopsis even from this morning's reports that were released by European Central Bank, Trichet, in basically four comments this morning.

He said that he is very worried about inflation, that he is not worried about inflation. He thinks that inflation is this minute diminishing, and that he thinks that they are going to hold rates steady to fight inflation.

He basically said that in about four different minutes this morning. So I don't have a great degree of confidence that the central banks of the world, especially the European banks, fully understand the nature of what is going on and how far behind perhaps they are in the curve.

I think Great Britain – you know, Reykjavik-on-Thames is the article in The Economist. There are real risks across the board in these different countries.

You have – Russia has to roll over $700 billion worth of debt in an economy that is clearly struggling with recession/depression kinds of influences within it. So this is going to be a broader problem across the global economy.

We spoke about it a little bit in the third quarter's earnings call when we talked about decoupling and how false that is. Everybody is interlinked here.

Well, I appreciate the comments. I think most people would agree with you on the value of the swaps.

It's just the bizarre accounting treatment of non-hedge just, you know, heavily distorts the GAAP results, which unfortunately a lot of folks focus on when they look at the headlines. Anyway, I do want to say congratulations on a solid year.

17% ROE in 2008 is certainly a track record that a lot of other companies would envy. Anyway, thanks, guys.

I appreciate the comments.

Thank you, Mike.

Hi, everybody, Good morning. Thanks for taking my question.

Good morning.

Okay, great. Thank you very much.

Thank you.

Thank you. Good morning.

Good morning, Steve.

That's great, Mike, and very helpful. Thank you.

Thank you, Steve.

Good morning, Mike, Welly.

Good morning, Ken.

Good morning.

Tying some strings together there, Ken, one of the cautions that I would put out there and just tying our strings together is that sometimes because the rules allow you to take more favorable treatment of accounting purposes, it doesn't necessarily mean that you should allow that to influence your economic decisions in judging valuations. And in most of the bank portfolios that we have been involved in in the past or credit portfolios we have been involved in in the past where people have screwed up, it's because they let accounting rules drive their business decisions because they didn't have to face up to the test of amortization or prepayments at a certain time.

They were allowed to smooth it out. I think those games are over, but there are still people playing by that rule and most of them are in the banking sector.

So, that provides opportunity when people are trading with two different sets of rules and that's what makes markets work. But ultimately, one of the things that frustrates everybody about Annaly is that its dividend moves up and down.

But our view has always been that we want you to understand the nature of what's going on in these cash flows because they are tied to the consumer. And that is 70% of the US GDP.

As always, thank you very much. Appreciate those comments.

Thank you, Ken.

Well, the volatility – what I would say is there have been two major influences as it relates to Annaly. The first is that the move to 0% interest rate policy.

Obviously, our cost of funds was higher because we made decisions about balance sheet access and quarterly, end of quarter financing much earlier in the quarter than other people did. We started in the end of September and the beginning of October to trade what they call in that market the turn, which is the 12/31 close.

And Welly very aptly described it as you just had to go forward with the assumption that every quarter in the fourth quarter, as an example of this, was going to be worse. There were going to be some black swan event out there in the fourth quarter; it wound up being Citibank.

So, that volatility and that cost of funds has definitely dropped and is dropping off of our balance sheet now. And we are getting the benefit of the move by the Federal Reserve to lower interest rates and by the market recognizing that.

There are still some gaps from day to day and it's still different between LIBOR, etc., but we feel pretty good about the quarter that we are in right now from that perspective without having to take on additional leverage or do anything creative in the asset selection or purchases of sales. As regards Fannie Mae and Freddie Mac, our feeling is that just on a broad basis, and this is our speculative view and I will confine it to my head if it's okay, is that Fannie Mae and Freddie Mac could have been saved in 2007 with a proper injection of capital and with some very cautionary steps in terms of stopping them – exactly back to our last discussion.

They were trying to manage the two masters. That's the point of that piece that Jay Diamond wrote.

They were managing to two masters. They were managing to the government and they were trying to manage to the capital markets, and they were being treated like a thrift.

From an insurance point of view, that cash flow stream, right now they are clocking it. They are just clocking it.

They can charge pretty much whatever they want as a mortgage insurer across the board. Any new origination that comes in, any refinancing that comes in is mitigating some of the move by interest rates because that is an ongoing cost of mortgage insurance in the portfolio.

So we think that that is a healthy – if you were looking at Fannie and Freddie as investments and you could stand back from some of the delinquency and default and foreclosure and social issues that are going to be extrapolated on them, that they are making pretty good money as a mortgage insurer. I think the bigger issue for Fannie and Freddie going forward is exactly what business are they in and how are they going to be separated.

As one of the earlier analyst points out, the company is going to downsize this portfolio. We see the Fed and the Treasury taking on larger roles here in terms of financing them and we see Fannie and Freddie taking larger and larger steps on the social side to provide, I would say, the soft touch of keeping people in their houses.

It's obvious that if you are looking at a 4% mortgage at par and you are financing it at, let's say, even 1%, not 0% or 25 basis points, you've got a positive carry of 200 or 300 basis points for every dollar that you are running. The question is what are you going to do with that 4% mortgage when interest rates go back up to 8% and what is that destruction going to look like?

I would bring the caution to the point there first that I don't think that a 4.5% mortgage rate in the United States really moves the needle of people who are able to go out and take advantage of it. And this is also, by the way, the opinion and the very strongly held opinion of some of the major originators and participants in the market after looking at this for Congress because it's not accessible.

In order for you to take advantage of today's mortgage rates, you have to have a FICO score of 720 or 740 or higher, you have to have 80% loan-to-value ratio for conforming loans, and you are not buying it as a second property. So what you need to take into consideration as an investor, and I think all investors have to do this, is that the housing stock in the United States probably peaked at around $12 trillion or $13 trillion worth of value at the peak of 2005 when the savings rate was below – minus.

That was a minus number, when it was below zero. So these assets in that market are now shrinking.

It's still substantial. The government is going to reach in there and fill the gap with treasuries and agency borrowings, etc., across the board.

But from our perspective, a dominant player in the market and well-capitalized player, this is a great market with a lot of size and assets in it that are going to be valuable cash flow instruments going forward.

Thank you.

Thank you, Bruce.

Thank you, Wayne. I want to thank you all for being with us here today.

We look forward to being able to exploit all the values that we've talked about here today in the market. I want to congratulate the management team here, especially our financing desk, for an outstanding job done in 2008.

Jim Fortescue and the team deserve a double pat on the back and I'll buy you a beer tonight. But if you have any questions on the follow-up, you know how to get us through Investor Relations.

And we look forward to speaking to you at the end of the first quarter with our first quarter's earnings call. Thank you.