Annaly Capital Management, Inc.

Michael A. J.

Farrell – Chairman, President and Chief Executive Officer Kathryn F. Fagan – Chief Financial Officer and Treasurer

Bill Carcache – Nomura Securities International, Inc. Jason Arnold – RBC Capital Markets Jade J.

Rahmani – Keefe, Bruyette & Woods Steven Delaney – JMP Securities Daniel Furtado – Jefferies & Co. Richard Shane – JPMorgan Chase & Co.

Michael R. Widner – Stifel, Nicolaus & Co., Inc.

Matthew Howlett – Macquarie Research Equities

This earnings call may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements which are based on various assumptions, some of which are beyond our control, may be identified by reference to a future period or periods or by the use of forward-looking terminology, such as may, will, believe, expect, anticipate, continue, or similar terms or variations on those terms or the negative of those terms.

Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, changes in interest rates, changes in the yield curve, changes in prepayment rates, the availability of mortgage-backed securities for purchase, the availability of financing and, if available, the terms of any financing, changes in the market value of our assets, changes in business conditions and the general economy, changes in government regulations affecting our business, our ability to maintain our classification as a REIT for federal income tax purposes, risks associated with the broker-dealer business of our subsidiary, risks associated with the investment advisory business of our subsidiaries, including the removal by clients of assets they manage, their regulatory requirements and competition in the investment advisory business. For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see Risk Factors in our most recent Annual Report on Form 10-K and all subsequent Quarterly Reports on Form 10-Q.

We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. I’ll now turn the conference over to Ms.

Wellington Denahan-Norris, Vice Chairman, Chief Investment Officer and Chief Operating Officer. Please proceed.

Thank you, Valerie. Good morning, everyone, and welcome to the fourth quarter 2011 earnings call for Annaly Capital Management.

I’m Wellington Denahan-Norris, and joining me on the call today is Kathryn Fagan, our CFO. Our call today will start with some prepared remarks, after which we’ll open it up for questions.

So before I begin, I just wanted to take a moment to let everyone know that Mike Farrell sends his thanks for your expressions of support, and good wishes for his recovery. He is doing well, and we look forward to him leading our next earnings call.

As usual, the opening remarks to our call today will be posted on our website, and will include a few reference graph. The title of the missive today is called Paradise Lost.

There was a time when the market was the market, a large collection of free thinking participants who independently evaluated cash flows, earnings, and economic data among many other things in an effort to establish value. A time when skilled and ambitious managers could successfully outperform their less diligent competition through creative interpretation of all that was happening around them.

A time when very few people outside of the burn market knew the name of the Chairman of the Federal Reserve. A time when an excentric group of practitioners called Fed watchers would figure out the price of short term money by closely observing the supply and demand of each day.

A time when burn market participants would determine long term rate based on levels of debt, credit worthiness of the borrower and inflation expectations. A time when recessions were painful, yet natural part of the business cycle, a call for businesses to evolve or die or for companies and employees to retool, re-educate and re-evaluate the inputs of success.

In the past, we all had a sixth sense, call it commonsense; that protected us more than today’s ever creeping rules and regulations would suggest. We knew, a hot cup of coffee was hot.

Today we haven’t said that, not only tells us it’s every short-term intention, but in circular fashion finds it necessary to put out long-term predictions of future policy responses to its own economic forecasts.

Greenspan also ignored both economic and anecdotal data that would suggest his slow and steady policy of small incremental tightening from 2004 to 2006 with insufficient to rain in the growing housing bubble. Minutes to the 2000 FOMC meeting show, there was barely a perception of a problem in housing.

And his successor, Mr. Bernanke was tightening policy in the face of overwhelming evidence that the housing bubble was in full deflationary mode.

He held the Fed funds target rate at 5.25 well into 2007, when so many cracks had already occurred. And then finally began emergency easing in September of 2007, I’m not advocating that he should have come to the rescue of all that he did, but if that was his intention, he was very late.

Within 14 months, the Fed was at the zero-bound, and we have been perched here ever since. And if the Fed’s telegraph policy responds to its central tendency can be relied upon, we will be here for at least another three years.

As we know, the Fed isn’t engineering this accommodative environment just with this policy REIT. It now owns over 20% of the short-end of the treasury market, and almost a quarter of everything 10 years and longer.

By the time Operation Twist is done, the Fed is estimated to own 35% of the long-end of the treasury market. The Fed also now holds about a fifth of all agency mortgage backs, up from zero just three years ago.

Now, I feel we only need to look to the east to Japan, to see how long we may find ourselves in this predicament. At a Fed sponsored conference in 1999, a bank of Japan policy member issued a warning to its largely American audience.

Do not put yourself into the position of zero interest rates he said. I tell you, it will be much more painful than you can possibly imagine.

Of course there are differences between the two countries and their respective markets, but it is instructed to compare them. Like us, they have been in an extended period of zero-bound monetary policy, and they have engineered multiple tranches of quantitative easing.

The BOJ now owns 9% of the JGB market, which is equivalent to 15% of Japan’s GDP. They also embraced in 2003, five years after they first cut their overnight rate to 25 basis points, a series of measures designed to enhance their transparency of monetary policy.

The result of all this central banking has been a stagnant economy, deflation, hollowed out saving, a sinking stock market and microscopic returns. It’s not just Japan and the U.S., in most of the developed world, fiscal deficits and easy money policy are the norm.

Now, debt-to-GDP ratios are rising and sovereign credit ratings are dropping, yet interest rates are falling. As I mentioned earlier, there was a time when credit worthiness mattered.

In any event, few participants have ever operated in an environment where the cost of carrying your assets was potentially fix, in advance for such a long period of time. Since the inception of Annaly 15 years ago, we’ve had to prepare for and navigate the twists and turns of carrying costs that could change at any time.

Yet now, it appears that we can rely on the zero balance through 2014. All these apparent certainty comes out of price.

If you look around the world, you will see rates of return that’s reflected in engineered market environment. On a GDP weighted basis for the G7, the average yield on a two year sovereign is about 0.5%, while the average ten year sovereign yield is about 2.5%.

The problem with controlled environment is that they stay controlled until of course they are not. So the management team here will continue to take advantage of what this market has to offer, while keeping a keen eye on the potential risk blooming, however far off they may now appear.

There was a time when the equity markets would wait until whether hemlines were short or long, or which team won the Super Bowl. I long for that kind of absurdity over the seriousness with which our policy makers work to control the market.

Friedrich Hayek warned about the effects of this kind of [furies] in the road to stop them. Near term, there is opportunity to harvest, but I have to ask, who will save essential bankers from themselves?

This concludes our opening remarks, and I’ll now open it up for questions.

Good morning. Thank you.

Can you talk a little bit about some of the conservatism underlying your leverage levels, is it just the fact that you’re so much larger than your competitors that you feel you’re relatively more – you could be more adversely exposed to negative tail of that? I’m just hoping for some perspective on why your leverage levels are so much lower relative to your peers?

Well, as I mentioned, if you just look around the globe, rates of return – quality rates of return have diminished dramatically. And you could argue the quality of those returns.

Now the management team here, what we are producing in this environment, I think is a very attractive level of returns and at a fairly conservative leverage level. It says nothing about our size, and I would remind everybody that, everybody is exposed to the same market.

We continue to maintain a nimble sans in the portfolio, and yes, deliver what I would argue a very attractive returns relative to everything else you can do out there.

Okay, understood. But can you give us a sense, maybe of what it would take or can you kind of envision us there or you feel comfortable maybe taking up leverage a little bit from current levels, and then finally my last question is, we saw decline in book value per share despite positive earnings, can you just talk a little bit about the different things happening in OCI, and the share count that contributed to that decline?

Thanks.

Yeah, I mean, book value is impacted not only by – you can take gains that move book values gains into earnings, you also have prepayments that will impact the underlying book value. The market was generally unchanged quarter-over-quarter.

So I think, the movement was very minimal, given every thing that has gone on. And what was your other question?

I’m sorry.

All right. The other part was just if you could, just give some perspective on what it would take for you to potentially, if you could tell us what kind of scenario, maybe you’d feel…

We are constantly evaluating the landscape, and one thing that I personally would like to see is, us getting through the selection cycle. There is always a risk that the administration is going to come out with any kind of policy to ensure that it gets reelected.

And so, you have a lot of – whether you throw it out there in speech or you start a strong arm, the agencies to enact policy to ensure that you get reelected. That kind of overhang in the space as that starts to become a little bit clear, and as I mentioned earlier, I think we’ve never been in an environment where the Fed has basically said, they’re going to keep interest rates at zero for several years out.

So we will continue to evaluate the market, and its reaction to it. There is the possibility that we adjust leverage accordingly.

All right, I appreciate your perspective, and thank you for taking my questions.

Hi, good morning. Just curious on the prepayment trends over the past couple of months, from the JC full data for your portfolio, and perhaps your outlook for potential – kind of on an organic perspective, going forward?

Thank you.

No. I mean, I think prepayments will potentially be impacted one to two type CPRs going forward based on HARP being fully reflected in the numbers.

In the grand scheme of thing, I think prepayments are still well below where they otherwise would be, given the level of interest rates. I think you’re going to see more of the same.

That makes sense. We’re not all that far off of the historical average there, I don’t know for sure.

One other quick follow-up, if you can just update us on your swap book, with still higher pay fixed rates on your book, should we expect some more substantial declines in that pay fixed rate, average pay fixed rate this year given that it was – you guys roughly five years ago or so that saw swap rates start to move down?.

Yeah, the book will continue to roll into much lower rates.

And is that kind of more – do you – would you say 2012-ish kind of event, more weighted there or 2013 perhaps?

No, I would say it’s equally risk-weighted.

Okay, perfect. Thank you for the color and best of Mike.

Thank you.

Yes. Hi, this is Jade Rahmani on for Bose.

I wanted to ask, if you could comment on where you’re seeing incremental spreads, and where you see the most relative value in the market right now?

Generally we don’t comment on specifics that where we’re concentrating, there is no question that the Fed has done a good job of engineering a flatter curve and spreads. I don’t care who you are, spreads have come in for everybody, and you don’t get protection without a price.

So we continue to balance between all the options that the market has to offer.

And you gave an indication with the hedge ratio you assumed, where you would see incremental spreads right now?

I mean just based what we are seeing at the end of the quarter, we showed 152 basis points, that’s a snapshot of the portfolio, the swaps and the repo book at quarter end.

Perfect, thanks.

Which is still, just to put it in perspective, it’s still historical way.

Great, and then secondly are there any updates on the SEC concept release?

We don’t have any updates, the SEC hasn’t responded yet, we don’t expect any adverse outcome for the industry.

Thanks a lot.

Good morning, Wellington. How are you?

Good morning, Steve. Good.

I realize that with prepayments, and when we talk about averages like CPR, the different cohorts are paying at different speeds.

Yeah.

But one thing that struck me looking at the release, CPR went up about 20% to 22%, we had 23%, but when I look at the premium amortization that jumps like 45%. So can you guys help me try to understand why – understanding that the speed is just an average of a lot of the different segments, but it just seem that, that percentage increase in CPR and amortization, that delta is just too wide…

Well, you don’t. I mean you can’t assume that.

Let’s just say, if you have speeds associated with a higher dollar price, asset and those speeds are faster than the lower price assets, and you would get this divergence between what the reported CPR is, and what the premium amortization is.

Steve, I’d also look to just the total amortization in portfolio when you are doing your analysis. I think that the weighted average CPR gives you a good indication of where the trend is going.

Right.

Of course, back into the number that we – the apple value of amortization taken because of the points that Welli, made.

Yeah. I guess, yes.

It’s just – it’s one of those things where averages can be – can give you the wrong outcome. So I thought that was probably yes, but it just, I mean we’re just saying that it’s the methodology, everything is being consistently applied, there was no catch-up, true-up adjustments or anything like that, it just – it was depended on what paid off in that quarter, and what the cost basis was, right?

Exactly, and you know that you have to project forward. So when you are projecting forward in your yields, you will see that in end of period yields that I’ve reported, and also in the amortization, because it is a forward-looking projection for last month of the quarter.

Well, I appreciate that. And all the best to Mike.

Thank you.

Thanks for taking my questions. Could you help me understand, would a slow down in CPRs or greater stability in Europe go further and given you some more confidence to take leverage higher?

Well, I think a slowdown in the introduction of potential changes to the underlying prepay landscape. The President throughout there, possibility that he is going to try and harp other things that are currently commanding pay offs in the market place as a place of safety.

So I think if there is just some kind of relief from the constant changing of the policy intervention that would be one thing. One thing I would love to see is, the economic data continue to get stronger and potentially put QE3 clearly in the rearview mirror, and that potentially the Fed would be in a position where we’d start to weigh out a plan potentially.

One of the transparencies I would love to see out of the Fed is, what they indent to do with their portfolio going forward.

Understood. Thank you for that color.

And then I guess the other question here is, it sounds like this is really more of a defensive posture from a policy standpoint. But could you help me understand how much of a factor is that IO strip, security portfolio had on your approach to leverage you with higher prepays.

Yeah, the IO component is very small. It has no bearing on our leverage, whatsoever.

Great. Thank you so much for the time.

Sure.

Thanks guys, good morning. Most of my questions have been asked, but I just want to circle back on the swaps question as they roll over.

The pay rate has been falling really steadily over the last, basically two years. And you indicated that you expect it’s going to continue to fall over the next two years, and that all makes sense.

It only fell two basis points this quarter, just curious if there was something, if there was just sort of inflection point in the portfolio or in the swap book that cause that, or if there was a little bit of a strategic shift there. And sort of how we should think about that trajectory going forward?

We can’t simply weigh what we’re doing in swap book, again not only where the mortgage market is and what the duration of that market looks like or could look like, but also where we think how well the Fed has got a handle on its policy in the future. Now, there is no question that, had we had no swaps or a lot of less swaps during this period that we would have been better off from an earnings perspective.

So we can’t simply, will weigh whether we want to move out on the curve, how we want to do that relative to the underlying assets. So there’s no set schedule if you will.

But we will constantly balance it with what we can get on the asset yields, and what those look like and what they will look like in an environment where potentially rates are higher.

All Right, and presumably I mean, you’re at this sort of weird juncture where duration on your asset is probably more uncertain than it typically is giving government intervention, but once were through that window, you’re in a scenario where durations are likely to be extremely long and relatively predictable. And does that suggest that, as you approach that point, you will increase the swap up because you’ll have an opportunity to lock in relatively low rates against long term duration assets?

Yeah, you always hope that you have a pretty clear picture of how your assets are ultimately going to settle in. There is no question that, I think the mortgage market, the Fed has taken a lot of duration out of that market.

The big question is, is it going to keep it out, and what is going to remain of the assets that are available for the private sector. We’re still in this very controlled market environment, as I mentioned it’s controlled until it’s not.

And so, we constantly weigh the possible outcomes as we continue to rebalance the portfolio or set the portfolio up for what we feel is the best long-term stance to get us through whatever may come out of this. And whenever it does come out of its current state.

Got it. Thank you very much, Wellington.

Good morning, and thanks for taking the questions. I guess one thing that strikes me about you guys, you talked a lot about the Barbell Strategy and that sort of thing, and at the end of the day, it’s for a long-time been the case, the sizable majority of your assets, the actual MBS are in 30-year fixed assets, which obviously puts you sort of alone in the group.

And given what’s going on, given the environment, given the difficulty of hedging those, the policy risks most directed towards that kind of asset, the Fed buying almost exclusively that kind of asset. I’m just wondering if you could comment on the relative attractiveness of those today versus other products, 15-year fixed, 5/1 ARM, 7/1 ARMs.

And also in there, I mean the traditional wisdom or a word on the street or general philosophy is that you guys were too big to play in those other areas, and that’s why you’re sort of constrained in the 30-year fixed. I’m wondering if you can talk about all of that, and whether you do find the risk adjusted returns, the most attractive and all that in that sector still.

We still do. Whether the Fed concentrates in one part of the market or another, the fact that there is all of that liquidity around, it’s not like any part of the market is immune to the influences of this liquidity that’s being injected into this system.

There is nothing in the mortgage market that you get for free. So it’s not like one area you didn’t pay for the shorter duration that you’ve got or you didn’t pay for the prepayment protection that you got.

It may not evidence the cost, it may not evidence itself. In the near-term, but that cost does exist in one form or another.

So to presume that because you’re in one area of the market, all the other areas seem to be full of incredible value that Annaly can’t take advantage of, I think is a silly notion. We can participate in any part of the market.

There is a number of reasons why we do what we do in the sectors of the market that we do it. So, I think people are misguided if they think that you somehow get something free out of this mortgage market and because you’re not Annaly, you’re getting it at a much better price, everybody is at the same price, sold it to us.

And our size, I think is irrelevant with respect value in the market.

Understood. I mean it’s just sort of – it’s unusual and a little bit curious at this point that all things considered, you are running in the lowest leverage, but at the same time, you’re kind of toward the bottom-end of the range in terms of overall ROE.

And so as investors think about it, they grapple with the risks inherent in the 30-year fixed product. Again, its policy risk, as well as interest rate risk, but the difficulty of hedging those not knowing the duration, it just seems that given all of the sort of induced uncertainties as oppose to sort of the natural economic uncertainties that maybe the relative attractiveness if 30 year fixed is less than it otherwise might have been.

But it sounds like you guys don’t feel that way at all and you continue to look at the product?

Well, I mean, one thing I would tell you too on this notion that we have a 100% fix, 30 year fix is not the case. And so we will always look for the best relative value in the market, whether it’s 15, 20, 30 year there was a point where there was 40 year options, things like that.

From a ROE prospective, one way that we like to look at things is, per each unit of leverage what’s your ROE. And I think, when you look at us relative to others on that metrics, I think we outperformed.

And people can do different things, I mean, we’re in the business of managing for the longhaul. If others feel that it’s better to enter this market with higher leverage or different parts of the curve, great.

And I wish them all well. But we will continue to do what we think is right over the longer-term with the company and the shareholders.

So, thank you, and then just one quick final question. As you look at weighing the alternatives of, you’re trying to hedge to protect book value and that’s essentially what creates your ability to generate earnings three, four, five years from now hedging book value as opposed to hedging current earnings, or preserving current earnings power.

We just say today it feels a lot different than prior parts of the cycle or other parts of the cycle. And then where do you guys mostly focus right now on kind of generating a dividend or preserving book?

We’d focus on both. And if you don’t focus on both, I think you’re doing yourself a disservice.

One thing I will say is, there is no perfect hedge, there is – mortgages are not – they’re not great trading assets, you’re dealing with a very interesting asset class that anybody would profess that they can hedge book value and earnings, and not be concerned what’s the lever. I think they were sadly mistaken on the true nature of what they’re investing in.

So we tend to continue as always to focus on both.

But as you just said, is it your delusion what you think that you can hedge both, and so I guess the question is more…

I don’t know, if you think you can do it without any, that you’re going to successfully hedge every little movement in both, it’s not possible.

Right. And so I guess the question is really just that, do your priorities feel any different today given the level of uncertainties that, book is more important than earnings and you will sacrifice little earnings power, if that’s what it takes to make sure you preserve your (inaudible) generate earnings in the future.

It sounds likes you’re going to give me the answer, which is just fine, I didn’t expect one, but I just want to hear your views on that topic.

Well, great. Thanks for taking my questions.

What would you say is the excess capital [fixed] at Annaly, I have asked this before but I know Annaly gone through a transition last two years there is capital and tax law subs and then other REIT investment, I mean, I guess where could that leverage go inside the REIT, if you were to sort of maximize the leverage today as fixed end?

I’ll address the question of excess capital. When you get the Form 10-K, we do you put market value to collateral pledge, and so you can easily calculate the excess capital that is less low leverage spends, there is obviously lots of excess capital, even with the cash flow recess.

Okay. And then, I guess, obviously, we’ve asked this question before, but would Annaly meets its QE3 doesn’t happening and long in the yield Bernanke gets his way.

I mean would Annaly consider obviously alternative investments in mortgage, obviously on agencies or other REIT investments, I mean there are other things that you could look at for deploying that excess capital?

Annaly always considered based on our view here through our relationship with both Crexus and Chimera. We have a pretty broad view of the returns that are available.

And we always keep it in mind of what is the best long-term thing to be investing in for the shareholders. Now I have to say that given this broad view that we have had over the last couple of years with respect to mortgage not only interest rate risk, but credit risk and things like that, it would take a lot for the agency part of the market to render itself, not as attractive as it is.

Even given everything that has gone on, it’s still one of the best places to be. And I’d like to remind people that these kinds of returns and the quality of the returns that you’re getting from the entire REIT factor than your entire REIT mortgage factor compare attractively to any other thing that you could be doing.

It was, if you look at the high yield index for insurance, so one is the high yield EPS, you’re looking at what roughly a 77% type yield. As I mentioned in my comments, in my opening comments, if you just look around the world and see sovereign debt that the credit worthiness is clearly deteriorating, yet, the yields are also deteriorating.

And what you have with the cash flows underlying, the mortgage REIT sectors, yeah, they are coming from the housing market and they are insured by the government. Yet they’re backed by actual credit worthiness of the underlying borrower, however weak that may appear at times.

It still, I think is a much better credit than a lot of your other options out there. And the returns associated with that credit, I think are incredibly attractive.

It certainly has been, and you don’t get in argument from me on that point, but just at the leverage where it stands today, it’s where it’s been in the last several quarters, there’s still tremendous drag on earnings and the earnings power of Annaly, and at some point, if the world doesn’t change, and again, QE3 presumably, which is really a rich in agency, I mean, yes, potentially. Could we be in an environment where may be it makes sense to put some capital elsewhere and wait for a better opportunity in agency MBS.

I mean, I guess in other words, how much longer you’re willing to stay at five, in terms of leverage for the opportunities to arise in the CMBS market, I don’t know how much time…

How much longer we’re willing to stay at 15% ROE…

Right.

Now that’s not a hard place to stay. I have to let you know that.

No, fair. Just when you just look at that the leverage of some of the peers, they’re much higher and in earning you have similar or even higher ROE.

I just…

Well, it should be earnings, higher ROEs at the higher leverage.

Right.

I just, again, well I feel very comfortable with the kinds of returns we’re delivering at the leverage levels that we’re delivering them. And longevity of that kind of profile, I think it should be very attractive.

It certainly, I think again compete very well with anything else you could be doing. And if our peers in this space would want to run at higher leverage, that’s fine, they can do that.

But the management team here is going to continue to do what it think is right for long-term environment. I don’t think, I’m going to apologize for the kinds of ROEs that we’re delivering at the leverage levels that we’re delivering them.

That is certainly been great returns and with this, I guess some more clarity on that. And then just a last question, did the elevated repo rates some of the peers had mentioned, your peers had mentioned that repo rates were elevated towards another year, that have any impact on funding cost in the fourth quarter?

No.

No. (Inaudible).

Great, thank you.

Sure. Well, thank you all for listening to our call and again hopefully, you won’t have to put up with just me next time, and Michael will be back.

Again, we look forward to speaking to you in the next quarter. Take care.