Annaly Capital Management, Inc.

Michael Farrell – Chairman, President and CEO Kathryn Fagan – CFO and Treasurer Wellington Denahan-Norris – Vice Chairman, CFO and Chief Investment Officer

Michael Taiano – Sandler O’Neill Bose George – Keefe, Bruyette & Woods Jason Weaver – Sterne, Agee & Leach Douglas Harter – Credit Suisse Michael Widner – Stifel Nicolaus Stephen Laws – Deutsche Bank James Ballan – Lazard Capital Markets Joel Houck – Wells Fargo Securities Daniel Furtado – Jefferies & Company Kenneth Bruce of Bank of America Merrill Lynch Steven DeLaney – JMP Securities

Thank you, Roger. Good morning and welcome to analyst call for the second quarter of 2011.

I’m Mike Farrell and with me today are Wellington Denahan-Norris, our Chief Operating Officer and Chief Investment Officer; Kathryn Fagan, our Chief Financial Officer and Nick Singh, our General Counsel and other members of management. As customary, I’ll begin the call with some prepared remarks and then we will follow up with a question and answer period.

The text of my comments could be found in our website www.annaly.com as well as the video companion to today’s remarks. The title of this missive is “The Face that Launched a Thousand Ships, or In This Case, Bankers” The title of this note is taken from the 16th century play “Doctor Faustus” by Christopher Marlowe.

It is the iconic story about a man who trades his soul in exchange for power and knowledge. Faust uses this phrase when expressing his desire for the most beautiful woman in history, Helen of Troy.

The legendary Helen, considered a Greek treasure, was so beautiful that wars were fought over her. Homer’s Iliad describes the theft of Helen by the Trojan prince, Paris, from the Greek province ruled by her husband, Menelaus.

Menelaus and the Greeks tried to get her back during the decade-long Trojan War, one of the greatest organized sieges in history that finally ended with the infamous ruse of the Trojan Horse. The rest is history: Cassandra warned the Trojans not to keep the gift brought by the Greeks, but she was ignored and the soldiers hidden in the belly of the giant wooden horse came out at night, opened up the city gates to let in the soldiers who ransacked the city and massacred the sleeping population.

These stories are rich with metaphorical possibilities as it relates to the present-day situation in sovereign credits. I am going to use all of them today.

Let’s presume that the treasure of Greece is not Helen but its national assets, and the euro is the Trojan Horse. The promise of the beauty of cheap money and the consumption benefits that emerged from it drew Greece into a siege that may end with the release of its treasure – islands, buildings, national companies, its economic way of life – or risk a long, costly siege from neighboring nations, creditors and rating agencies.

The euro took about 10 years to create this position for Greece; the Trojan War took about 10 years. The only question today is which re-structuring will the diplomats accept.

As I write this, economic conditions in Greece are worsening, interest rates are pricing into default. Companies are not shipping goods to Greece destinations.

Hospitals are not receiving supplies from big pharma and the requisite strikes are occurring as the bill for the last 10 years of cheap money is now being delivered. Marlowe’s play suggests a different metaphor.

The Euro represents temptation and Doctor Faustus is Europe, so obsessed with the pursuit of knowledge and the power it brings that he calls on Mephistopheles to give him the power to rule, to heal others through science and to resurrect Helen in return for acceptance of eternal damnation. The more he bargains the deeper in debt he gets.

His desires become so intertwined that he loses the ability to negotiate his grand Faustian bargain and he loses his soul. Faust is still obsessed with the power of the Euro and the relative benefit that it has given it in the export markets, and is desperately trying to hold together the Eurozone by throwing more and more debt at the problem.

All politicians eventually learn that their people become tired of the monetary and human costs of the bargain and they will lose their souls in their offices either through revolt physically or in the voting booth. Just ask the people of Iceland.

For over 2000 years, most people believed that the city of Troy was a figment of Homer’s imagination and that the story of the Trojan War and Helen were legends linked to Greek mythology. It turns out the legend may be rooted more in history.

One of the first books I ever read was on archeology and the discovery of Troy in 1871 by a German amateur archaeologist named Heinrich Schliemann. His identification of the city’s walls, consistent with Homer’s descriptions in the poem, convinced the world that the Iliad might be more than an epic novel; it may actually be a historical document.

The city was buried below seven other cities that were built over it after the destruction in Helen’s time. Over time, urns and other artifacts describing Helen and Paris have emerged.

It seems hardly a coincidence that on June 29th, the day that the Greek Parliament voted on the austerity measures, a lightning bolt-probably thrown in frustration by Zeus nearly hit the Parthenon. There is a picture of the lightning bolt posted on our website and in the Greek version of my remarks.

If you do it a clockwise turn and look at it from a Y-axis point of view, it looks a lot like the Greek yield curve, which is also one of our website. In all seriousness, the point of all this is that history teaches us much, and we are prone to repeat it.

The price of mortgaging the future is incredibly transparent in the relatively small economies of Greece, Portugal, Ireland, Italy and Spain. It is a Faustian promise of an easy life, sprinkled liberally with the open-ended debt restructuring.

It is much more opaque in the more complex economies of France, Germany, the UK and here in the US. Nevertheless, it is still present and creeping towards judgment day.

To stay with my metaphors, we have dragged into the front gates of capitalism a Trojan horse of amend, extend and pretend quantitative easing and austerity promises that cannot be kept. Inside, it is the main weapons of capitalism; capitulation, creative destruction and the reprising of risk, and they are just waiting for their moment to be released.

Today’s metaphorical Trojans will be twice as surprised by the wreckage of their sovereignty. America is hardly immune, as our sovereign credit moves into unknown territory.

As we have discussed on prior communications and earnings calls, the mortgage market has been Cassandra: the correction of spreads on asset opportunities has been predicting this outcome and downgrades since 2008. The evidence of this is offered in the accompanying chart also found in our website that demonstrates the performance of agency current coupon mortgages versus the Canadian covered bond market credit.

The market has already adjusted the American mortgage market to wider spreads, allowing us through an ally to capture lucrative opportunities against funding rates. Like the Cassandra of legend, will the mortgage market suffer the frustration of having her prophecy ignored?

I don’t think so. I think that the world is finally figuring out that Cassandra has been correct, and that the mortgage market has already adjusted to the new realities facing America.

Informed investors recognize that they should invest in markets that have already corrected and adjusted to the new fundamentals. In closing, I think that maybe the mortgage market is more like Heinrich Schliemann, who dug down through seven layers of history and proved that myths can indeed turn out to be fact.

With that said, we open up call for questions.

Hi, good morning. Thanks for taking the question.

I guess the first question obviously repose on a lot of people’s mind for last week or so. I’m just curious – given the environment that we are in, it seems like the repel market and the short-term in general are destiny to continuously run into these short-term clutches.

And just from your standpoint, I’m just curious other than obviously keeping leverage relatively well and investing in a high quality liquid asset class. Is there anything else that you can do to protect against the short-term volatility such as backlines, backup credit facilities anything of that nature or would that be just too high cost at this point.

It’s not about the cost. The issue is Mike, that none of those facilities save anyone into 2008.

Those systems were not reliable. The commercial paper market has not recovered.

None of those back up lines are worth a credit, of a sovereign credit bank or at surrogate that is not performing. Liquidity is the best option for everyone.

It would have been the best option in 2008. It certainly was for Annaly and the other people who navigated through this.

So, you can rely on us to continue to operate the company in the same conservative manner that we’ve operated for the past two, three years. And because the market has recognized already that mortgage spreads are wider, it’s allowing us to generate the highest amounts of income that we ever generated on the most shares outstanding and the least amount of leverage that we’ve ever used and we will continue to be opportunity in that way.

Okay. And then, just a second question if I can.

Just seems like the macro economy seems a little bit like the Asia move all over again going back to last summer on the sovereign issue that you kind of talked about in your comments and they give me the comments last summer about you thought the government was going to pull back and sort of try and to bailout the housing market and just curious how the situation now compares to where we were last summer in your view. Is it better or worse or the same?

With regards to the housing market, I think that we’ve been pretty consistent with our message to markets that we felt that half prices were going to continue to be under pressure. I mean there certainly are enough media reports now going through about houses being bulldozed by banks loan on them because they’d rather foreclose and knock them down rather than maintain the properties.

We think that there is a shadow inventory of housing out there. The government, in my mind in June of 2010, as it allowed the tax credits to expire and federal reserve finished its purchase program as well as expanding its unusual credit facility, the PDCF et cetera.

I think at the point they were looking forward to sovereign issues that were going to exist in the market going forward. That said the repo markets are extremely liquid.

They have been extremely reliable. The Federal Reserve is extremely well prepared compared to where it was in 2007 because of the education that they went through over the past four or five years.

We feel that they are supervising this in an extremely delicate and diligent way and that they understand that the repo market or the canary in a coal mine in terms of liquidity as well the health of the banking system globally. So, I don’t see any issues that would emerge that would be different than anything that happened in 2008 and I think that because of all other things that the fed is put in place and learnt especially on the supervisory side that they are well ahead of the curve in terms of the protecting the repo market.

Thanks. I appreciate the comments.

Hey, good morning. Just to follow up on Mike’s question.

If there is downgrade of sovereign debt by the S&P, do you think that will have any impact on the agency market or on repo.

Well, thank you for that opportunity Bose. I’m very well prepared for that question.

We’ve done a complete study going back into 2008. One of the things that people should be aware of on this call is that the definition of a government security starting with that of a broker dealer rule 50 c31-1 under the SEC.

It’s stated pretty much along these lines. In case of a security issued or guarantee as the principal of interest by the United States or any agency there, the applicable percentages or the market value, the net or long or short position in each of the categories is specified below and then they are broken out by percentages and also by maturity date.

The bottom line is, is that there is a no link in any of the broker dealer documents, the banking documents, the money market funds or any of these investment adventures that cover agency investments across board with the exception or perhaps of some corporate funds that rely on either S&P, Moody’s or Fitch or any outside credit rating agency. It refers to sovereign credit.

Therefore, anyone who has concerns about selling off of assets under force liquidation because of a downgrade, it’s making the severe misjudgment in my view. The second thing is that in the event of a default or if there really was a default by the government, mortgages have been excluded since 2008 as pass through securities and in fact, they were verified by the Housing Reform Act, ATRA in 2008.

It’s been outside and we hold a private claim under constitution on those cash flows. So, under the extreme circumstances over default by the United States government, the agency securities because they are off balance sheet and that $5 trillion market is secured by loans and borrowing activities underneath the Fannie and Freddie umbrella and Ginnie Mae umbrella.

Those asset cash flows are to be outside of any default that would happen to the general obligation debt of the agencies and/or the treasury market. So, I think that there is a great deal of hysteria in this information about that and in fact, we are prepared to talk about it at length if you want to go any deeper than that.

But, that’s the highlights of that conversation.

Mortgages could actually be the beneficiary of a slight equality.

Yeah.

If you will. They are the premier asset backed security.

Okay, great. It makes sense.

Thanks. And then, just one question on the portfolio.

Your prepayments were down very sharply this quarter. I’m just curious where the number was in July and where you see that for the back half of the year.

We continue to see prepayments moderating. Housing is a big factor there, the house price depreciation or stabilization and you had a significant number of borrowers actually refinance and bring money to the table.

So, you do – they are putting themselves in a better equity position. But nonetheless, I don’t think rates are going to the big driver that they were in the past because of warehouse price depreciation is.

Hi, good morning. Thanks for taking my question.

Just first in more broadly Mike, I know try to say in this in your release. But, it seems that the implications of both the current legislation as well as some of the numbers coming out points to even longer period of lower short rates and prepayment going forward.

I guess my question is, is there any inflection point in there where you start to become concerned about downside risk rising from involuntary prepares as we saw last year with buyouts.

Yeah, I think that the opposite is occurring. If you look at the credit stack, there was a headline out yesterday that in the first half of the year from the Freddie Mac that 77% of all people who refinance their mortgages actually put more money down into their mortgage in order to buy the lower rate.

So, our view of the agency credit stack is actually that the credit, the underlying credit is actually getting more powerful and more clean than it’s ever been as people are doing what we consider rational activities. They are presenting their arms and they are moving in long dated of financing that’s available to them from the government, extremely low generational rates.

So, the credit stack underneath and the underwriting LCVs are in probably the best shape of my carrier as a result of this. This is the first we bought this up.

Actually, if I could just be a little redundant on the fourth quarter’s call about we had noticed that in December, we noticed that again in the first quarter and certainly the first half’s information would lead us to believe that the credit stack is going to protect the great deal of what’s left out in the mortgage from prepaying involuntary unless you’re talking about 25% unemployment et cetera. So, it is – it’s going to fish along the bottom here we think, right.

Obviously, people aren’t building new homes in any great detail. The banks are still under the cloud of the foreclosure.

House price depreciation is not going to lead probably the market forward in terms of credit access or ability for people to move easily between different states et cetera. But, I feel pretty comfortable that great deal of damage by poor qualified buyers is behind us.

Okay. Thank you.

And just a little bit more specific. I know that you don’t explicitly disclose your hedge book competition.

But, can you give us any insight on the book value gross and net duration that includes the impact and loss.

My hedge fund?

No, the…

The hedge book.

No. Again, we will constantly adjust it based on our outlook in the market and we continue to be a conservative player in this space, we’re not going to give specifics about where we see value or but we will always, I think our macro view is, is that we are going to be in this environment for some time.

Nonetheless we still take precautionary measures by having a large swapped put portion of the portfolio and maintaining the duration of the portfolio in line with it where it has been in the past and again running leverage at very historically low levels and maintaining liquidity via the assets that we invest in. All these things combine to make the portfolio and the company as flexible as possible to deal with things that we have been mentioning quite regularly on our calls about the volatility that we expect the markets and as the markets transition from the easy money and potentially other challenges that it needs to face going forward.

The company I think is very well positioned to deal with a lot of those variables.

Okay. Thank you very much.

Thanks. I was wondering if you could talk a little bit about the benefits you are seeing from being able to source your own repo from your broker-dealer subsidiary?

Sure. Doug, I’ll give you an overview.

Obviously as we’ve grown the company, just to update everybody on a quick timeline review, back in 2007 as we’ve started to become concerned about what we thought was going to be balance sheet impairment in the banking system. We began to create our own balance sheet inside of Annaly and founded RCap our broker-dealer subsidiary to act as a complement to our lending activities with other bands and broker-dealers around the world.

The result is that we’ve capitalized that broker to prepare it to access the repo markets where balance sheet is impaired or to be flexible on the markets when people are closing down quarter-ends et cetera and they need to window dressing on their balance sheets. We have a tremendous amount of flexibility at the wholesale level inside of Annaly to take advantage of those dislocations in the market, to those opportunities to move collateral around to the markets.

Secondarily RCap clearly has been giving us not only on the repurchase side some strength away from an creation of balance sheet so we could become more independent from a landing point of view and a borrowing point of view, but we’ve also used it in the equity markets. As you’ve noticed as we get capital, RCap has been an underwriter and in some cases it’s been the lead underwriter in the league table.

For a company of its size to have that position is very enviable but it also has reduce cost to capital when we are raising secondary markets and it’s adding to our bottom line and efficiency rates in terms of the forming of capital of course the entire Annaly family. So RCap today is well capitalized, it’s been quoted by one of the clearing banks as being the largest and fastest growing broker-dealer in the system in terms of capitalization.

Every time we raise money we consider adding more capital into that so that we could add more repo capacity into it if you need to. And it’s just another very powerful weapon in our belt in terms of taxable REIT subsidiary that gives us a view on the markets, but also gives us efficiency and scale.

Currently it’s clearer than $15 million to $20 billion worth of repo through there and all margin through the FICC and the clearing corporations were fully incorporated into that clearance system and supervise system and its manage by a great group of people here on the repo side.

Thanks. I was wondering will quantify any benefit you get by sort of by doing it direct.

Well, I mean certainly we do get some better flexibility on haircuts relative to the market. We have more control over that.

In terms of rate structure it is in arm’s length transaction as a taxable REIT subsidiary. So Annaly has to pay RCap for access exactly on market along with other transactions that happen in the market so we have to satisfy all regulatory arm’s length transactions that go on there.

And in fact if you ever come up to visit our space, you’ll see that RCap is located in an entirely separate area away from the advisory and public company actives (ph) on the floor, separated church and state just the way regulations are going for.

Great. Thanks Mike.

Thank you, Doug.

Good morning, guys and congrats on another solid quarter.

Thank you, Mike.

I am going to just follow-up on a couple of the other questions, on the repo pricing specifically people following Bloomberg, Takers (ph) and what not are just kind of getting commentary. We heard chatter that repo had kind of blown out to 50 basis points, that order kind of as of Monday morning and sort of by midday was sort of coming in closer to 30 basis points.

And so just wondering if you could comment a little bit on sort of what kind of hiccups we might have seen and sort of where we stand today. And again where you think we might be heading on that sort of pricing front as all this sort of nonsense that rolls through?

Yeah, I mean. First of all there is a direct correlation between repo expenses and asset yields and the market should understand that.

The thing that we find amusing about the chatter, that’s being spiced around on the repo market in the past week or so is that, all that’s based off of overnight money and no one was chattering when the overnight money went actually negative. Actually in the first quarter when we could basically do the repo book below 10 basis points nobody was calling us up as we were boosting earnings at that point.

We’ve taken a long-term view as I think is expressed in our activities and you can see sort of where that view is expressed in our repo dates of maturity that we have relied less on overnight money. We have made some very strong decisions over time that were sometimes costly from an economic point of view but important for us to build up a long term reputation in the swaps market and the borrowing market for longer dated maturities.

Our liability desk has done an excellent job of taking advantage of that over time and I don’t think that these overnight aberrations of 15 to 20 basis points are really going to impact us particularly in this sector. I realize that others may operate on a very short duration overnight basis.

And I’m sure that these variations might affect them but I don’t see it posing major hiccups in the system.

As a repo player, anybody who hasn’t been doing it for a long period of time should understand that there is always – everybody will always be opportunistic when they can but we should all keep it in mind a couple of basis points here and there is really nothing and it’s almost comical to in terms of a blowout in the repo market with a couple basis points either side. We were at a historic event with the country potentially defaulting.

And the repo markets, I think are the place that is the most smoothly operating and most fluid and as Mike mentioned earlier, the canary in the coal mine. And we treat them with a tremendous amount of respect and discipline.

And, the company has been communicating for some time now, about the potential volatility in the markets and why liquidity is important during these transitional times in, not only the country, but the global macro-economic backdrop. And so, repo is always something that moves around, I don’t think it’s anything new.

Haircuts, potentially, always move around. I don’t think that should be surprising to anyone.

And if it is, they probably shouldn’t be in the market.

Thank you for that perspective and the color. Just another follow-up on that topic.

I recognize that you don’t like to disclose all a lot about the specific composition of your hedging and sort of how you look at that. Let me ask you sort of philosophically and comparing sort of where you’ve been and where you are today.

A couple of years back, there was obviously much broader availability of long-term repo, 120 days plus, but also add to sort of 365 plus, that more or less vanished and sort of come back a little bit, but as we understand it, there is a little bit of a pricing premium there. So, as you guys think about overall hedging of the liabilities, or hedging of your funding costs, can you maybe comment a little bit about sort of the relative level of notional swaps, the duration of notional swaps and the interplay of that with the availability of longer-term repo.

And In general for a long-term, you guys – when you add up all the numbers somewhere in the vicinity of 50% of funding was hedged. It looks like it had shy of that at the moment, but again, it’s kind of – kind of in the ballpark.

So any comments on sort of relative mix shift duration changes or anything along those lines?

No, I mean we continue to look at, we cannot ignore the global macro backdrop. As much as we would like to and say, I didn’t – we probably didn’t need to be doing any hedging whatsoever.

And we would have been well served to have the longest duration portfolio, had no hedges on for the last couple of years. What we will always do is the constant assessment of the marketplace, the rate structures, and how the cost of hedging stacks up relative to your economic outlook and what it could cost you to be wrong in that.

So, the team here will be constantly navigating the various markets whether it’s – how price depreciation is going to impact long-term duration of the assets versus global economic forces that may set the United States on a track that looks very similar to Japan. These things all come into play when we are constructing the portfolio.

So, there’s not any one thing that will overly outweigh another, but we will, and I think the company has shown through its track record that it has done a pretty good job of not getting everything exactly right but being able to have the flexibility in the portfolio and the balance sheet to be able to navigate the changes and landscape that we have to face every single day. So, with respect to how we have the portfolio setup again, I think it’s a fairly conservative position that we maintain and have always maintained that you see reflected in the numbers.

Great, thanks. And I guess there is only quick final one, if I might.

Obviously, you guys have done a great job with RCap standing there getting into really all the requisite business there. You know arguably the next step there for you guys would be getting to be a primary dealer.

So, just wondering how many months away that potential changes.

We’re not going to comment on that. Thank you.

Thanks guys.

Hi, good morning. Nice quarter.

Thank you, Steve. Good morning.

Most of my larger picture questions have been hit on. But, maybe could you comment about really what you guys have done since the July, I think it was 15th secondary offering, I think sort of mid 15th, but, mid July raising about 2.4 billion.

How you are doing leverage investment opportunities over the last couple of weeks versus potentially what you think might be coming in the next few weeks. So, maybe how you view the capital from that deal and where leveraged investment spreads are today?

We continue to be opportunistic and we conveyed to investors that participating in that transaction that we felt it was prudent to continue with a very conservative leverage level, which is exactly what we’re doing and has served us well not only during this period, but during a lot of the other volatility in the market and we will continue to be opportunistic. I mean I think the market is dealing with a lot of transition that it has to face a lot of challenges, not only from domestic forces, but global forces.

So, we are lucky enough to be dealing in the largest liquid asset class. And as we mentioned earlier, it isn’t asset-backed security.

So, default is not as meaningful as being waiting for you bills to mature.

I think the broader issue that we were able to deliver to the market with that offering which I think really validated vision that we’ve been able to communicate since January about what’s happening in all of the mortgage sector residential and commercial as well, is that we are sitting in the middle of the largest privatization opportunity in the history of the financial market. And that there is no appetite on portfolios of anything at the government level as they as they struggle with the budget deficit and the issues that are going to be around retrenching the economy around the budget deficit over the next 10 years.

In the meantime, this asset class is the premier asset-backed security up until Thursday of last week. It was a outperforming everything in the markets including the sovereign credit treasuries until things started to fall apart at the Senate level and the Congress level about the discussion on that deal.

And then, treasuries took off and mortgages just couldn’t keep up with them. But, this asset class is worthy of capital allocation.

The spread that we are enjoying in here reflect the fact that the mortgage market as I said in my opening comments, realized in 2008, that the downgrade was coming and that the spreads had to be wider. It downgraded the entire mortgage market stack across every aspect of it.

Essentially, in some of the non-agency spaces, we were making assumptions on asset acquisitions that every mortgage in the United States was going to go bad at some point during 2008. So, I think that there reality is those wider spreads, are providing us with the unique opportunity in the 14 year history of the firm to capture some very valuable cash creation relative to any other market and any other asset classes that’s out other.

Great. I appreciate the comments and it’s always nice to see you guys beat the numbers on a wider spread as opposed to higher leverage.

So thank you.

Thank you Steve.

Great. Thanks a lot.

I wanted to ask about the – there was about I guess about $1 billion increase in the accumulated OCI in the quarter. If you could talk a little bit about the factors that caused the increase and also just given that that was – that contributed to the decline in leverage, what the implications of that kind of an increase in AOCI, the impact of your target leverage going forward.

No, that is just a snapshot evaluation of the assets at quarter end. You can have periods where mortgages are outperforming swops and vice-versa.

Again, we will always take a broader view of our leverage position, keeping in mind that your assets do move around and move leverage up or down either way. So, you know, we tend to not overlook, but not put too much into small movements other way when we are making our broader outlook on where we want to carry the leverage of the company.

We also always stress the portfolio in a number of ways and how it will impact that leverage number outside of just taking a quick snapshot of the company’s assets.

All right, got it. Just one other very quick thing.

It looks like there is about a 27 million share, increase in the share count between mid-May and the end of June. What was the source of those incremental shares?

We have a direct purchase program. We actually sell shares into that program during the quarter.

Got it. All right, terrific thanks a lot.

Thanks and good morning. I’m wondering if you can provide a little more color on the weighted average yield on assets, it is 25 basis points in the quarter.

You know, obviously, I don’t think you guys – big capital raise was after the quarter. So, maybe talk about what drove that significant increase in the quarter?

Again, prepayments were impacted. Dollar prices, in my mind it’s not – these are all snapshots.

I think longer-term, if you just look longer-term at our markets, you’re going to be in a position. I don’t think anybody participating in these markets will be in a position where you have very attractive spreads relative to certainly where Annaly started relative to the recent path.

So, I think this is the backdrop that we are faced with and all financials due to the fact that economic activity is where it is and uncertainty is where it is. So I think you’re going to see attractive spreads for quite some time.

Okay. And then, I guess on related question.

When you kind of look at what’s happened in the last couple of weeks in the face of potential default which looks like it’s passing, but certainly the downgrade threat is still out there. Yeah you seen this massive rally in treasuries, which would argue that we are more in Japan type of situation as opposed to Greece or Europe.

How do you think about the business if we are in that scenario, which perhaps would imply even lower rates, flattening of curve and a long end? How do you think about that both with respect to investing and hedging?

Well, the mortgages will always stay wide on a flattening of the curve whether it’s bear market selloff, or rally. It doesn’t matter.

Mortgages that you are seeing here, the uncertainty of the prepayment option is allowing for greatest rate opportunities and yet lower amounts of leverage. And I tried to Marlowe in the opening comments is that, the dirty little secret of the capital markets for the past three years, is that the downgrade has been predicted by the agencies, by the mortgage market.

So, from the perspective of the way that these cash flows have to be thought up, they are outside of the government. Any downgrade is not going to force any selling of any treasuries and certainly, in Japan, after they were downgraded, their sovereign credit yield fell to all-time lows because, what it does, it just widens out spreads on a deflationary basis for other borrowers in the market.

So, a $5 trillion market, there is a lot of activity in there. At a $100 billion plus worth of assets, we’re still around or inside of that market and we’re going to continue to be opportunistic going forward to take advantage of what we think a dislocation and these are through the greater amount of flexibility was opening to the operating structure in terms of not only leverage but operations in RCap, et cetera or build out our money marketing business and our money management business like Merganser and FIDAC continue to grow those companies.

Great. Thank you.

Thank you.

Thanks for taking my question. My question is actually on Shannon Funding.

I’m just trying to get update there in terms of what you’re seeing on volumes and how that is – how that segment is being – how the integration is coming along or kind of, the growth of that business.

Yeah, it’s going to be consistent with the other things that we brought on board over time. It’s going to take a while for that to grow to some scale.

We are very careful about how we integrate businesses in here. We take our time and make sure that all the licenses are correct and that all of the incentives and characteristics and underwriting standards for warehouse lending or where we want them to be.

But, I feel very good about that business and I think as the mortgage market get some more clarity in terms of where the government is going to be and it’s spot in it as well as where the banking sector is going to be, we’re going to continue to see growth in there. We are closing loans through that.

They are not material in terms of the operations or the expenses of the company. But, we think that that’s going to be a valuable outlet for us to feed into all of these companies going forward.

Thanks Mike – Michael. And, then, where, after the loans close, where do they typically go from there?

We’re going through the first closing, but they had to be priced out in that market. So, they might go into the secondary market or they might go up into one of our subsidiaries.

Okay, understood. Thank you.

Thanks. Good morning Mike.

Good morning, Ken, how are you?

I’m good. Thank you.

I want to first congratulate you on showing that a large wholesale funding company can operate quite nimbly through periods of market disruption again, so, congrats on that.

Thank you. Ken I wanted to make a point that these guys are awesome that I work here.

Well, you seem to have a sixth sense. So, continue to use it where appropriate.

On the – I guess my question really does relate to size. How much counterparty risk with anyone banks are you willing to take and do you think that the repo market is a deep enough for you to get diversification across counterparties and how do you think about, what the growth profile of the company needs to look like for needs to expand outside of the traditional repo?

Well, I think that, we typically have concentration issues that we review on our credit committee and we do regular reviews on all the banks and all the people who we do business with. By being a participant in of FICC, we obviously get some mitigation of that because it gets dispersed through the clearing corporation and marketing facilities that are there.

I guess, my quick answer to that would be that there’ve been more people joined the ranks of potential lenders into the repo markets over the past year than there have been people withdrawing. So, we’ve been very careful.

There has been a number of definite opportunities to work with new entities that are global entities that are coming into the market and looking for new outlets of investment, short-term investment. So, as the emerging markets create some of these new powerful banks, some of those guys are entering and other guys are either stagnant or clearing out.

But we feel that the Fed has a pretty good handle on the repo markets in general. One of the things that probably everybody should be aware of is that post the 2008 blowup in Bear Stearns that there are actually supervisory teams inside of every one of the primarily dealers from the Federal Reserve who help mitigate some of these direct risks that were created through Lehman and Bear Stearns’ activities during that blowup, for instance repo 105 et cetera.

So I think that careful supervision has led to a great deal of confidence in the market. As a result, they’ve also done a tremendous amount of work in the tri-party arrangements.

The primary dealers operations committees have worked very closely with clearing banks, especially JPMorgan and Chase to put in tighter safeguards for the way the cash flow works in the daylight exposure. So I’m very comfortable in that market that is being well supervised and is being well monitored by Federal Reserve and what I’ve learned earlier in my life is don’t fight to Fed, especially in the credit markets.

The equity markets might get security (ph) from time to time, but the credit markets certainly respect the Fed here. And the Fed has been respecting the credit market and listening to participants both on the buy and sell side.

So we are not at any point where we don’t feel like the balance sheet of the borrowers around us, and we certainly need you to understand I think that we are replacing multitrillion dollar companies’ balance sheets that have existed in these markets for well over 30 years. We are not – we will never to be the size of scale of say Fannie Mae and Freddie Mac, but their each independent balance sheet were over $1 trillion.

All of the process that were out in Wall Street are no longer doing this activity. George Soros has retired from this lending market.

So, the competition for those balance sheet and those assets is not at the same level that it has been for the balance of my career. So, I really feel, as I’ve said on the first quarter’s earnings call that this is like a rebirth of the mortgage market and the credit market.

And this is a huge opportunity, having seen what went wrong to take that which is right and to make it work better.

Great. Thank you for that comment.

And, if I could stick with the credit markets, I would be very interested in your comment on the recent change in the tune from S&P and how the rating agencies are acting at the moment. How you see that kind of percolating into the broader Annaly businesses.

I think it’s basically opening up opportunity because as we’ve been able to express on some of the earlier calls, if you look at all the regulation that’s going through FASB 156, 167 which has morphed into a new role, the Basel III restrictions that are being put on Tier-1 capital which is raising the percentages and therefore shrinking the lending pie. All of these activities, Dodd Frank et cetera, are doing nothing more than opening up opportunities for comedies like REITs to be the long-term capital raising and initiatives inside of the real estate markets as well on the commercial side as well as on the residential side.

And we are in discussion daily with people both on the residential and commercial side about how we can play a role as a partner. Certainly in the Barclays transaction that took place in CreXus we saw that, we saw it in (inaudible) over the past year and a half.

All those opportunities are wide open for us now and, we’ve been able to prove that structure. The 5x structure is extremely powerful beneficiary of all the restructuring that’s going on in the markets as a result of S&P and Moody’s playing games with the rating agencies as well in the CMBS structures like they did last week.

Real institutional investors never relied on the rating agencies to validate or mortgage insurers to validate that credit. We did our own work, we checked our own cash flows and we put our own capital at risk.

That’s what the capital markets are supposed to and that’s what we’re doing.

Great. Thank you and good to hear from you as always.

Thank you, Ken. Good to hear from you.

Thanks. Good morning everyone and congrats on an excellent quarter.

Thank you, Steve.

Wellington, you and Mike had a conversation earlier about your hedge position, your swap book specifically. And how well hedged you are, I think you’ve put in your press release that your swaps were 39% or something of MBS, but I was just wondering, how – I mean I don’t necessarily know that that reflects your true hedge position and I wondered if you would comment on how you view the use of interest only securities as part of an overall hedging strategy and I guess specifically under that, there’s a new line item in the P&L about IOs and I wanted to confirm that that was simply just a fair value mark on some of the IO positions and also with the use of IO possibly, part of the reason why your average purchase price in the quarter actually fell from a little over 103 down to 102.6.

Sorry for the long-winded question, but I wanted to ask am philosophical about IO and then there is couple specifics. Thank you.

No, I mean IOs have been a part of our hedging strategy for some time now. And on a weighted average dollar basis, we will always present things on a market value.

So, a notional representation of the IO position will not drag down, make the dollar price look a lot lower than it actually is. There is always a lot of portfolio rebound things going on where we take advantage of market forces and, we may have changed things around a bit to lower the dollar price of the overall asset.

But…

So more – that really and the phenomenon in the second quarter, I should really look as maybe of more of a shift to maybe lower coupons and the mix rather than really any impact from IO.

Our weighted average coupon didn’t changed dramatically. And again our weighted average dollar price has been around 102 handle for some time now.

So, I’m not sure where you’re focusing on a big price drop.

Okay, I’ll have to go back and check my 103 from last quarter. I may have a bad number, Welli.

Yeah, no problem.

You said you are just looking at one of the tables in the 10-Q that give amortized cost to principal amount.

Right.

So that might be where you are getting the number.

It was, yeah.

But no, IOs have been a part of our hedging strategy for some time. And I won’t go into detail of why we choose certain things over others.

But again, it’s not any – it’s not a new addition to the portfolio. Now, the breakout on the financial statements is, and I will let Kathryn just go into detail there, the presentation is a little different.

So any IO that was purchased in the second quarter and going forward, the fair value election (ph) was made. So the market value change will run through income statements.

Economically this has – it’s no different than what we’ve done in the past. But you will see that market value running through the income statement.

And we should make an adjustment there to get back to core from GAAP?

That is correct. And in all of our numbers that’s what we are reflecting.

And so you will see that disclosure.

Okay. Well, thanks very much for the color.

That was helpful.

Thanks, Steve.

Okay. Well, thank you all for joining us today.

Certainly looking forward to hearing what the Senate has to say in a couple of hours. But I want to take a moment to reflect that the power inside of the mortgage market I think has been a predictor over the past couple of years, these wider spreads certainly have provided a generous opportunity for shareholders and investors in this sector.

We think that that’s going to continue for some time to come. Our outlook remains unchanged from where we were probably at the end of 2008 where we think that Fed is going to continue to be accommodative and is going to fight this recession as hard as they can with monetary influence.

So, the result is the mortgage market is an extremely valuable component of these assets and liabilities that are run by the Federal Reserve through the balance sheet every day and we continue to look forward to providing you with many years’ worth of color and earnings regarding the performance in that market going forward. I will take a second to congratulate the management team for providing the kind of returns that we are in this environment especially to all the uncertainty that existed over the past few years.

I think they have done a terrific job and I congratulate them. With that said, we look forward to speaking to you in the fall for the third quarter’s remarks.