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Executives

Michael A. J. Farrell - Chairman, CEO and President

Kathryn F. Fagan - CFO & Treasurer

Analysts

Andrew Wessel - JPMorgan

Robert Napoly - Piper Jaffray

Kenneth Bruce - Merrill Lynch

Donald Fandetti - Citigroup

Steven Delaney - JMP Securities

Michael Cohen - SuNOVA Capital

Bose George - KBW

Mike Widner - Stifel Nicolaus

Jason Arnold - RBC Capital Markets

Stephen Mead, Jr. - Anchor Capital Advisors

Annaly Capital Management, Inc. (NLY) Q4 FY07 Earnings Call February 5, 2008 10:00 AM ET

Operator

Good morning and welcome ladies and gentlemen to the Fourth Quarter Earrings Call for Annaly Capital Management Incorporated. At this time I would like to inform you, that this conference is being recorded and that all participants are in listen-only mode. At the request of the company we will open the conference up for questions and answers after the presentation. 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 assumption, 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 except, anticipate, continue or similar terms or variations on these terms or the negative of these 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 yield curve, changes in pre-payment rates, the availability of mortgage backed securities for purchase, the availability of financing and is available to terms of any financing, changes in market value of our assets, changes in business conditions and general economy and risks associated with the investment advisory business of FIDAC, including the removal of FIDAC's clients of assets FIDAC manages, FIDAC's regulatory requirements, and competition in investment advisory business, changes in governmental regulations affecting our business, and our ability to maintain our classification as a REIT for federal income tax purposes. 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 of all subsequent Quarterly Reports on Form 10-Q. We do not undertake, and specifically disclaim any obligation, to publicly release the results 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 would now like to turn the conference over to Michael Farrell Chairman, CEO and President of Annaly Capital Management, Inc. Please proceed.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you. Good morning everyone and thank you for tuning into our fourth quarter 2007 earnings call. Joining me today are Wellington Denahan-Norris, Kathryn Fagan, Nick Singh, Ron Kazel and Jay Diamond, we are happy to take any questions you may have about our results for the quarter and our views on our markets, but before that I would like to read a prepared statements on the current environment. As always let me say upfront, that these remarks in my own opinion they don't necessarily reflect any portfolio decisions. The tax that ramp my remarks will be available on our website this afternoon. The title of this is welcome the Keynesian nightmare. British economist John Maynard Keynes was an advisor to the American government in the 1930 when it was struggling to restart the domestic economy. The depression was tragic, but to put in historical context, Keynes and his client with dealing with the cyclical problem had that had by the 1930s already happened regularly during the US history.

Before World War II, the US had many serious recessions or depressions, including 1807, 1837, 1873, 1882, 1893, 1907, 1920, 1933 and 1937. During the 1930 depression Keynes’ interpretation of the economic problem was that the US, indeed the world was caught in what he described as a liquidity trap. A liquidity trap is defined at a time when institutions and consumers hoarding money and refuse to spend, protecting their own financial assets for fear of losing them. [inaudible] for a solution to the problem which we now call Keynesianism. To simplify, he wanted SDR to prime the pump of the economy to put so much money in people’s hands that the increased consumption would lead the way as a liquidity trap and that the resulting improvement in consumer confidence and the normalization of lending habits would re-establish the footing of the economy.

The Roosevelt administration and the economic community initially dismissed his ideas as too simplistic. But the new deal came to look a lot like the Keynesian construct. Ultimately the US was dragged out of the depression by the deficit spending of World War II, but Keynesianism got the credit, this setting the course for economic policy for most of the post World War western world. Keynes, who died in 1946, didn’t live to see the implementation of his theory in the real world. Since World War II, there have been ten recessions in the United States. But unlike the pre-war recession, none of them turned into a depression. I think that this is because the Keynesian prescription of deficit spending in heavy government prom priming has been engineered on a massive scale or as Richard Nickson famously claimed in 1971, I guess are all Keynesians now. Keynesianism had triumph and the result is that Keynesian spending provided for the foundation of the greatest economic boom that the world has ever experienced.

Capitalists throughout the world piled into the example of the United States and the process turned Keynesian’s dream into a nightmare. The nightmare of economies powered by huge amounts of debt and an inescapable liquidity trap. So, here we are, 60 years past America’s emergence as the world's dominant super power and the perversity of the Keynesian theory has grown like a weed. I think it is fair to say that the world we are in today is not the world that Keynes foresaw when he rose general theory of employment, interest and money in 1936. The most pronounced change to me is the amount of debt capital issued in the United States and it's changing composition.

The US grew during the cold war economic boom. Thanks to the issuance of the US Treasurers’ full faith and credit notes and bonds. And since then the rest of the has fallen suite as society has gotten more and more comfortable with credit risk. First corporate, then consumer, then jump on, then mortgage debt and then structured debt. As a result, today the dominant part of the total debt structure in the United States, the part that has played the role… largest role in driving GDP growth over the past decade has accrued outside of the Government’s purview and issuance. It is no secret that the US is a country driven by debt. It now takes about 3 ounce and $0.25 of total debt in the United State that generates just $1 of GDP. A significant increase from 1952, only just took just $1.30 in debt to generate $1 of GDP. However in 1952, government debt, Federal, State and local was $244 billion and accounted for 55.1% of the $443.6 billion in total debt outstanding in the United State.

Today, Government debt stands at about $7.2 trillion, but accounts for just 15% point… 15.7% of the $45 trillion in total debt. Household debt today has a much larger impact on economic growth in government debt at $13.6 trillion it is almost twice as much as government debt, while in 1952 it was just one-third of the government debt. The first part of the Keynesian nightmare is related to this change in the composition of debt in the United States. If we are counting on deficit spending and the resulting debt capital creation to pull the economy out of recession, the non-governmental borrower, who has driven economic growth over the last half a decade won't be there, don't count on them. That borrow mark to market and has the covered debt service out of earnings.

Visibility to borrow today is severely restricted by the asset deflation in house prices and on bank balance sheets. The government on the other hand doesn't have to mark-to-market and owns a printing press. So, we would be on the watch for a much deeper government deficits and a surge in government debt issuance going forward.

The second point of the Keynesian nightmare is that we might be in the middle of one of the worst liquidity traps ever. Banks are hoarding liquidity, not so much because they're afraid to lend to weak credits, but because they are protecting their own capital ratios.

Their massive write-downs and equally massive capital infusions, neither of which are done aren't working. So, while the ECB and the Fed are trying to break the excess liquidity preference of financial institutions through extraordinary measures, the market is doing the opposite. While the Fed may be accommodative, the widening of credit spreads is restricted.

I suggest that this would severely offset the inflationary potential of the Fed's actions. The struggling consumer will also likely have to pull in his horns and spend less and save more. We'll see whether these election year, fiscal stimulus checks changes consumer confidence. But my guess is that $600 or $800 or whatever the package provides to consumers will be a transient event of the economy.

In short, the Keynesian nightmare is that it won't work. Maybe that's why the Fed cut a 125 basis points in just eight days, and maybe that's why they have a lot more to do. So, with that said, we now open up the call for questions on the quarter.

Question and Answer

Operator

Operator: Thank you sir. [Operator Instructions]. And your first question comes from the line of Andrew Wessel of JPMorgan.

Andrew Wessel - JPMorgan

Hi, good morning.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Good morning, Andrew.

Andrew Wessel - JPMorgan

I just had a portfolio question and then a G&A question. On the portfolio, I know you get the iteration once a year. Can you tell us what that portfolio adoration was?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

It is still inside of about a year and half, possibly less than that. But again, we don't give a solid number. We calculated from book value changes and interest rate changes relative to the two year if you want.

Andrew Wessel - JPMorgan

Okay. And then... I know in the Q you usually put out that the average month to maturity of your repo [ph]. Can you give that on the call?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Yes. The average month to the repo is dated 234 days. And on the asset side it is 39 months on the arms.

Andrew Wessel - JPMorgan

Great. And just a last question...G&A has been trending around 15 basis points at average assets. Is that... is that still a good level to use going through this year?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Yes.

Andrew Wessel - JPMorgan

Great. Thanks a lot.

Operator

Your next question comes from the line of Bob Napoly of Piper Jaffray.

Robert Napoly - Piper Jaffray

Good morning.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Good morning, Bob.

Robert Napoly - Piper Jaffray

Congratulations.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you. Is that for the giants or for the quarter.

Robert Napoly - Piper Jaffray

For both.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

All right. I'll take it.

Robert Napoly - Piper Jaffray

But hopefully not for the Yankees. You guys have done a great job...and timing your capital raises and wasn't shocked to see you guys come to market right after the 75 basis points move by the Fed and you guys have raised a lot of capital. I just... my question is how much... well, your stock price is, it's still... it's obviously very accretive, you have been very timely over the years raising capital when it makes sense for investors from a long-term perspective, as your stock continues to appreciate as it has, your portfolio continues to grow, how much capital is, too much capital and do you still view it as very timely to continue raising equity?

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Well I think you are right, I think the thing that we have tried to be extremely aware of over time has been, to be ahead of the curve and to capture a lot of the value. I think in looking back over the past 10, 11 years and being self critical of my efforts since say 2000 to try to get ahead of the dot.com curve, one of the things that I felt, that we and then I specifically could have done better in 2000 was gotten in front of that a little earlier. We did try to raise capital, but the size of the company dictated restrictions in that light. So from the perspective of what we have done over since 2005, at the end of 2005 through to the beginning of this year, I think we have done an exceptional job of getting in front of and capturing much higher yields in the portfolio. That said, this is a very deep and liquid market as evidenced by what happened last year especially, I think people definitely appreciate the nature of the assets probably better than they ever did.

We are extremely gratified by the reaction of the markets to give us capital in recognition of this performance, but we recognize it comes down to performance. One of the more interesting things that I think people should be looking at in this report in particular things I would like to highlight, is that these returns were achieved using lower amounts of leverage, than we have used over the past two years and in fact we were still in the middle, everyone has a short memory. The fourth quarter was an extremely difficult fixed income operating quarter, especially in the month of November, the Fed was still trying to bring Fed funds in line with LIBOR. We think that the markets are going to continue to be extremely volatile. This war is not over, in terms of the central banks trying to get in front of what I think is deflation and I think that the theme that we expressed in these past few earnings calls speaks to that. So it's time for prudence and to grow our asset bases in a lot of different ways. Clearly, we are extremely active in not only Annaly, but in FIDAC, we can add values to shareholder in a lot of different ways and contractual obligations and commitments within the FIDAC restructure, I think are going to grow going forward. Wellington and the team is on a very good job of navigating some of the credit sensitive pieces that we think are going to grow in the future like Chimera.

So from my perspective we have a lot of things to do, it's a very big market. And I think that we will be recognized as an asset manager that which is what we are at the end of the day and not just as a mortgage REIT that’s a tax selection [ph] for us. So, when it's accretive in the long-term interest of the company and the shareholders we will definitely be prepared to do something and I think that we are prepared at any time to do what we need to do for the company.

Robert Napoly - Piper Jaffray

And just last question on, interest and your in your on the mortgage insurance industry as, I mean your assets are guaranteed by Fannie and Freddie and they get a lot of support obviously from the mortgage insurers and they are obviously under a lot of stress. So, I was just wondering how you think through, whether or not at the end of the day there is the chances that you could be taking some credit risk based upon fallouts in various portions of the mortgage market?

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

That's a great question. And let me just give you some background about how we think about mortgage insurance as a fixed income manager first. In the Chimera structures and even in my career over the past 30 odd years, whenever we would trade unsecuritized pools of [ph] mortgages. We would never pay a premium for any insured pool by any private insurer ever. We didn't care what his rating was... the mortgage insurance business is a very competitive business now for Fannie Mae and Freddie Mac because they basically can charge whatever they want. They're the only ones that can wrap things. So, I think that they have some exposure within their equity base to mortgage insurers in general. I think mortgage insurers in general are going to continue to be under pressure. I think the next issue that's going to drop in here is going to be on these negative AM loans where people are basically exercising the option not to pay in a given month and tacking a payment on to an asset that's falling in value. And that's going to continue to create strains and stress within the servicing environment as well as within the mortgage insurance environment.

So, against that backdrop, Fannie Mae and Freddie Mac, if you go to their website, their financial trouble so far has not had anything to do with creditness it has had more to do with the way that they manage their portfolio. And I think their loan to value ratio was in the low 60s to mid 60s on the overall portfolio. They have a lot of exposure to mortgage insurers in general. But, a lot of these guys are extremely strong financial entities that are going to be around for a long time. But, I don't think that, it's wise to let off the gun yet on the, on the insurance business I think, but that's still going to be under pressure going forward in the private side. And as a bond investor, as I said earlier, we've never placed a premium on anything except the Government guarantee from an insurance point of view.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Yes. One thing I wanted to add is, with everything else there that is spooking the market, this mortgage insurance issue has been out there for months now. And you were not seeing a widening in the agency mortgage-backed securities to signal any kind of concern out of the marketplace? I think ultimately the market realizes that the ultimate insurer behind Fannie and Freddie is the United States printing press. And they're willing to save the small sliver of subprime borrowers that there is no question that they would be willing to step in very quickly if anything was ever to happen to the agencies themselves.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Fannie and Freddie are definitely part of the solution now, not part of the problem. That's not to say that they're not going to struggle, but they are definitely part of the solution as far as the government is concerned.

Robert Napoly - Piper Jaffray

Thank you.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

We would have liked to see a little widening from some of this talk. But, we haven't had.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

It hasn't happened. As the ultimate vote by the capital markets, right? Anything else Bob?

Robert Napoly - Piper Jaffray

No. That's it, thank you very much.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you. Next question please Gracin.

Operator

The next question comes from the line of Ken Bruce of Merrill Lynch.

Kenneth Bruce - Merrill Lynch

Good morning.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Hi, Ken.

Kenneth Bruce - Merrill Lynch

That’s an interesting answer actually. I didn't expect that for your interpretation of the Fannie-Freddie and the MI companies. What are you thinking in terms of the government printing press is being on to a degree, obviously you think that there is going to be a continuation of an easing monetary stimulus and potentially physical stimulus. Obviously everybody is focused on now the potential for refinances and I think with the backdrop of deflation obviously that is going to be I guess an open debate and I would like to get your thoughts as to how you think that is going to play out what you are positioning for in the portfolio and if you would mind maybe giving us some sense of where dollar prices are for new acquisitions into the portfolio if we should be I guess that tailoring our models to more premium coming in and has been the case thus far.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Yes let me just… I'm not sure I'm going to cover everything that you said Ken, so make sure I do please. I didn't write down all the bullet points but… the first thing is that, as I said earlier, I think one of the things that we did extremely well as a management team looking back in time now was being in a position to raise capital in 2006 when no one else was able to do it. And the result is that we significantly lowered the historical acquisition price of the portfolio into about par in a quarter, par in a half range. So Welli and the team were able to buy a lot of assets at or around par or below par, which will continue to serve the investors and shareholders well going forward. Because obviously we are not yet exposed the prepayment risk as we were in the past. We think that this prepayment spike that you are seeing, you have to break it down into two segments in my mind. One is, is that yes applications were up, but the second thing is that, that doesn't mean the completions of loans are also up. So these applications may not lead to refinancing and that is something that I think the markets are going to have to deal with in terms of measuring the duration of mortgages for the next few months because in a world where three years ago if you went to refinance your house you not only got a lower rate but you probably also took out some home equity along the way and then used that to go buy an SUV or go to Disney World or whatever.

Now when you go to the table to refinance, is it pretty high likelihood that because of tightened restrictions on credit lending as well as from just house price deflation in general you might actually have to bring a check to that closing keep your loan to value ratio in line. That’s a very different mentality. So you may have a lot of people that are rushing in to try to get out of adjustable rates to go into fixed and etcetera to pay them down. I think that may cause some risk to some of the arms that are out there and keep prepayments relatively higher and I think that is where part of the exposure may be. But we have to see whether or not these applications can really turn in to real completions of loans. But the second thing is that the government printing press, I don't want to speak as I said earlier, I always covenant this by saying don't confuse this with what Welli and the team does in terms of the way they manage the portfolio, but I've been on record for believing that the Fed funds rate is on its way to at least 2% and that the yield curve is going to be an extremely steep yield curve, which will lend itself to pretty good performance in mortgages going forward. It is a big market and there are a lot of assets out there, but they are amortizing assets and they are not being issued at the same rate that they were a year ago. So we can't underestimate the value of AAA credits, obviously at a time when there is a lot of uncertainty out there and especially in the agency space when we believe that they are part of the solution not part of the problem. So, the government printing press is going to be on in full force. Our question is, are we entering a Japanese like environment where you got property deflation across the board for a number of years trying to work through the system, which is personally where I believe that we are or are you going to model through it and there will be some sort of wave of new energy and capital that comes into the markets that will re-ignite the economy. I honestly don’t see that happening right now.

I don't see the place where that could come from. The two places that are most likely forward to come from are probably the energy markets is probably two guys [inaudible] that are going to come up with pilot runs on [inaudible] or in technology or perhaps even in health care, but I don't know what the next stimulus is going to be. I heard this morning that the parent company of one of the biggest moving companies in the United States declared Chapter 11. And nobody is bigger than what's going on in the asset deflation and mortgage business and housing as far I am concerned and it is leaking over obviously into commercials and it is leaking over... it is a global issue, it is not a US issue alone. So all the central banks in the world are all going to simultaneously [inaudible] when they get the idea that how powerful the deflationary impact of this against the backdrop of what they have been fighting, which they felt was inflation.

Kenneth Bruce - Merrill Lynch

And dollar prices for a investments --?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

No, it all depends on where you are in the coupon stacks, but you are anywhere from 4.5 to 1 to 1.5. You can go way up in coupon, it all depends on the risks you want to take. There is no such thing as a risk less purchase. But to put it into context, the total premium in the portfolio is about the same size as $7 billion-market cap as it was when we were at about $1.8 billion market cap. So obviously, our early entry into the market in pretty good size has allowed us to take advantage of the much lower dollar prices that were out there. And now you are really entering a very interesting prepayment backdrop that remains to be seen what is the ultimate conclusion to this changing environment that the mortgage market is going through. But there is a lot of opportunity to move about the coupon stack as you try and take advantage of that. So I don't want to say a high dollar price is necessarily bad to getting compensated properly.

Kenneth Bruce - Merrill Lynch

And maybe one last question with the Fannie and Freddy changes potentially coming online and allowing them into the jumbo market, is that you think an important event for Annaly? Does it have any impact?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

That’s huge. I love the idea of that. It creates a tremendous amount of opportunities for us in an asset class that we haven’t.. Annaly hasn't been able to participate in, but to me it's a whole another dynamic with the government guaranteed wrap on it, it's a tremendous opportunity.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Yes, obviously we've been building a team over the past four years to go into that space, so a lot of that is being centered on Chimera here but we obviously had expertise in jumbo loans before that too in portfolios we were running debt under the FIDAC umbrella just because Annaly didn't participate in it. But I think what you are seeing is this web of stuff that we’ve put together becoming extremely influential in a way that it executes in the markets.

Kenneth Bruce - Merrill Lynch

Excellent. Well, great quarter. Thank you very much.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you, Ken.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Thank you.

Operator

Your next question comes from the line of Don Fandetti of Citigroup.

Donald Fandetti - Citigroup

Hi, good morning.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Good morning, Don.

Donald Fandetti - Citigroup

Mike, you are laying out a scenario of aggressive Fed cuts, some structural inhibitors to refinance activity potentially. So any reason why your spreads wouldn't equal or exceed your historical peak?

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Well, I may not speculating and these guys don't speculate, they basically run the bar bell [ph] to where the best value is in the curve, but I do think we are headed towards an extremely steep yield curve which we have not experienced in any of the public structures that we've run before, Don. When we started this business back in early 1990s, there was an extremely steep yield curve that existed, that would suggested that yes price can be pretty wide for a long time here. If you go back to look at the early 1990s, and the Fed's reaction, the mortgage coupon back then was pretty sticky on fixed rates, was around 6.5% to 7% and the front end came down to 3% from 8.5%. So you had pretty wide operating margins against the backdrop of what we think is a much smaller problem than what exists in the market today and the one that we've been painting for people for the past three years. So, I would suggest that probably you are correct, but you need to able to be careful about how you exit and enter capital inflows into those, those parts of the yield curve right now, because the mortgage curve is definitely going to struggle with the idea of what the duration of these assets are. So...

Donald Fandetti - Citigroup

Okay. Secondly Mike...

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

I guess my points is it might be best to leave a little bit of money on the table while you are operating to try to... until the smoke is a little clear.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Yes, you never know too... I mean we had nearly 20 years of Alan Greenspan and now you have Ben Bernanke who, you don't know if he's going to get into good solid easing cycles, we already saw them do some uncharacteristic things and there's no question he might be out there if inflation doesn't settle down in soft commodity arena that he might start reversing what he has done. So you always have to be prepared for, you have a whole new regime and your portfolio to better be able to deal with it.

Donald Fandetti - Citigroup

Okay. That's all I have. Thank you.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you, Don.

Operator

Next question comes from the line of Steve Delaney of JMP Securities.

Steven Delaney - JMP Securities

Hello everyone.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Good morning Steve, how are you doing?

Steven Delaney - JMP Securities

Great, thanks. Mike it looks like you guys added about $1.5 billion to your swap book in the fourth quarter and I was wondering if Kathryn might have the average rate of the $16.2 billion compared to the, I think it was 5.15 at September 30?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

The average pay rate is 5.03 and the average receive rate is 5.06.

Steven Delaney - JMP Securities

5.06, great. And did guys make any change to your, you had some term repos, I think it was $5 billion at September 30. Did you increase term repos or other than swaps did everything stay fairly short?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

No, the term repos did go up a little over a billion.

Steven Delaney - JMP Securities

So that's about $6 billion. Okay, you can obviously figure it out what I'm trying to get to is just how much short funding we have to benefit from all these wonderful cuts. And then I guess one other thing, maybe this is just housekeeping.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

One thing I want to point out though on term repo, a lot of times you have several cuts that haven't even taken place you have that in your term repos.

Steven Delaney - JMP Securities

All right, when they buy again I didn't understood.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

The financing curve is inverted.

Steven Delaney - JMP Securities

Yes. Of course.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

So if you term things out you can take advantage of cuts that have not happened yet.

Steven Delaney - JMP Securities

Absolutely, I hear your now, you're actually... you're saving money going longer.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

You never no I mean, your hope is that those traits are bad, but it may turns out that you never get the cuts that they are pricing in.

Steven Delaney - JMP Securities

Right. No thanks you are absolutely right, I get what you are saying absolutely. On the leverage, I mean does it make sense, I know you reported it down at 8.7, should we consider adding your payable for securities purchased and with the repos when we calculate it to kind of get a pro forma because it seems to me those were trades, you got the asset on the books and that's going to become a repo at some point in the next 30 days.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

But you are also receiving principle, pay downs and securities, so I would not include it.

Steven Delaney - JMP Securities

Okay.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

You will also have sales that have not settled.

Steven Delaney - JMP Securities

Yes. So just stick with the… just stick with repos divided that equity, okay. So then on the 8.7, the fact that it came down from 9.9, I guess does that… should we take that as just being reflective of kind of general tighter or uncertain conditions at year end or does it reflect more of a specific compensation for a specific portfolio risk that you were trying to compensate for with lower leverage? And I guess what I'm getting at there is what conditions would change that might cause you to take the leverage back to say 9.5 or 10 times?

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

I think that if you go back and look at our historical operating leverage when we do get a steep yield curve we tend to keep some powder dry by going to the lower end of the leverage ratios.

Steven Delaney - JMP Securities

Right.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Simply because that steepening usually brings some sort of force liquidation into the markets and we want to have money around so we can go get it and have the flexibility to navigate. Definitely over quarter end here you did not see the benefit of the full leasing that Fed had done going to year end, because LIBOR and Fed funds are still out of whack and I think that you're still going to have that for some time going forward here. The central banks don't have their act together in terms of keeping that relationship near at historical means. So from our perspective going over the quarter end is a combination of we don't have a higher hurdle to jump through, our G&A obviously is not going to... we are not going to build Annaly tower in Midtown any time soon. So from our perspective this is the opportunity for us to keep some powder dry, navigate through what we think is going to continue to be extremely volatile markets. I think the point that Willi made and I heard the recognition in your voice is that the far end of the LIBOR curve is inverted, we're taking advantage obviously because of our long term track record with these credit departments to access some extremely attractive rates in the longer term repo markets. Our guys on the financing side had done an excellent job of keeping those relationships very strong throughout all [inaudible]. So I think we are going to provide extremely good returns and extremely competitive returns against the backdrop of not having to stretch and that's where you want to be right now. It may mean we will bounce around between, say 8 and 10, but if you look at '97 and the transition into the CBO curve in '98, there was times when we actually ran 6 to 1, debt to equity. So it's going to bounce around, I'd suggest that's probably going to be at the lower end of the range, somewhere between 8 and 10.

Steven Delaney - JMP Securities

That's very helpful, Mike. Thanks a lot.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you.

Operator

And your next question comes from the line of Steve Covington of Steven Capital [ph].

Unidentified Analyst

Good morning, guys. Actually, this is Joe Stephen. My question --.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Good morning, Joe.

Unidentified Analyst

Thank you. My question was somewhat just covered, but I'd go ahead and hit you with a couple of more. Number one, what is your view, or give us your sort of big picture thoughts on the LIBOR Fed fund spread right now, and where do you think it's going? That's question number one. Question number two is, can you help us quantify the benefit because of the LIBOR Fed funds tightening that happened earlier in January prior to the Fed cuts? And then number three is, can you talk about obviously the Fed action and can you help us sort of quantify in our own models how big a benefit that's going to be? So those were sort of my three questions.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Basically, you want to us to tell you what earnings are going to get.

Unidentified Analyst

I won't be that straightforward.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

I guess the first point is that, I mean clearly, what the Fed has done after the quarter end in conjunction with the European banks, they are reaching for new strategies in order to try to break this liquidity trap that we described in the opening comments, and that is clearly having some benefit between the spread. But we don't think that, that variability and that volatility is over yet, and in actuality, it's benefiting us now in a material way because obviously, as we're resetting, we carried stuff over year-end. We started that process in October in anticipation of what we thought was going to be an extremely volatile fourth quarter and we thought that that was correct. And when we had conversations with people over the fourth quarter, it was clear that the Fed was going to continue to try to struggle for ideas here to figure this out. So we didn't go on the road, until we were certain that a lot of this benefit could be translated into a material benefit for the shareholders. So there were a lot of people that were pressuring us, obviously. Why aren't we on the road, why aren't we doing any transactions? We definitely wanted to make sure that we had all of our bullets covered. We had meetings with every major financial institution over the first two weeks of the year to make sure that when we do something, we do it well for you. So, we are definitely seeing a benefit, we don't call these things inter-market, but the spread between LIBOR and Fed funds did start to normalize significantly during the course of January and into early February, it looks like it's becoming a little unstable again. But I wouldn't say not back to where it was in November.

And going forward, I think that the return on the... average return on equity for the company has been in the low-teens like 13% or 13.5% or 7 and something like that. And that's created a pretty significant total rate of return over a ten-year period. We've only had a period when we were in the 20% range in the 2000 period. So, middle teens to high teens return because our G&A is going to jump out of control here it is going to be an extremely lucrative return for the shareholders and that's the way I would like to quantify this for you. And we are not stretching to do that. Clearly you can see that from this report no matter how stressed the fourth quarter was, we didn't feel an urgency to have to stretch in order to do this. And book value obviously went up even though it wasn't a great December for fixed income products in general. [inaudible] that move in book until the beginning of January when the real rally started to take hold. So, I think that we have done a good job so for. We continue to focus on that. We continue to focus on the elements in FIDAC that are going to grow for us and we feel pretty good about being able to provide a very strong return in terms of dividend but also in terms of growth element of FIDAC business. And that's the best characterization I think I can give you about where we are going.

Unidentified Analyst

Great. Thank you.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you, Joe.

Operator

Your next question comes from the line of Michael Cohen of SuNOVA Capital.

Michael Cohen - SuNOVA Capital

Hi, could you just talk about why you would or not why I guess what activities are leading to kind of the wider spreads on new mortgage purchases for you guys and all of the passive mortgage REITs? Are the GSCs selling actively into the market and that's kind of flowing out spreads a bit or is it just kind of the short end of the curve coming in more rapidly than pricing is adjusting? Could you kind of characterize the factors that have lead to the wider spreads?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

I mean a lot of it has to do with the Fed getting on board but mortgages, just so you understand, mortgages will typically widen as interest rate fall and the reason is the prepayment option, and as that prepayment option becomes more and more in the money for the borrower that option have to detract, if you will, from the price of the asset.

Michael Cohen - SuNOVA Capital

So marketing is definitely going to struggle with the price that option right now?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Right. And then it is a great opportunity because this is the first time that that option is going through tight credit and falling house prices.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Just to give you an idea, Michael, of the historical perspective that you have to put that into is that in 2003, we had every investment back around Wall Street pounding on our door telling us that we needed to be out there raising capital when Fed funds is at 1% and the tenure was at 3%, yes, this positively sloped yield-curve to 200 basis points. Our view internally here was that even though we could issue stock that we should not issue stock because the value of that option was being mis-priced by the market and in fact you were getting 85% to 90% of the entire mortgage inverse refinancing sequentially as all of these interest rates and affordability products were making lower rates available for everybody. So, we withdrew from the market during that period at a time when it looked like we should be out there raising money. That's the uncertainty that calls on one way, the uncertainty that calls on the other way is the one that the market is going to deal with here. That's going to... that uncertainty is what provides the opportunity for the spread opportunity while people are trying to sufficiently price the refinancing option and [inaudible] option. So without giving away the secret source, one of the reasons why people hire annually through a share purchase and buy the company is for our view of what those mortgage cash flows teach us about. Not only mortgage activity but consumer activity and it was definitely the canary in the coal mine for us in 2003 that the housing market was going into bubble-like condition and the only way to win in that game was to not play. Everybody has tried to catch it ever since and have gotten their fingers chopped off. So, that is what is providing the spread opportunities, the certainty of the option.

Michael Cohen - SuNOVA Capital

Sure and as we kind of think about that optionality and we think about potential refinanced ways, obviously it certainly looks like it is going to be different, certainly not a re-live of 2003, 2004. Do you have a sense of if anybody would tell you that maybe 40% to 50% of their book at this point is refi eligible in terms of based on the value of the optionality, based on sort of the movement in the tenure?

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

In any stretch that is correct.

Michael Cohen - SuNOVA Capital

But what we don't know obviously which is what you are pointing to is what it means in terms of people's home prices and what it means in terms of credit availability. Do you have a sense as to how that shakes out in terms of the average of every ten barrowers that the option on paper is in the money but they practically, either their home is down 5% or 10% in value and therefore they can't do it or...

Kathryn F. Fagan - Chief Financial Officer & Treasurer

So this whole debate is really the debate for the mortgage market for 2008. What really is the bigger influence here, because if you just had house price depreciation and you could knock out several vintages to say that as Fed house price depreciation accelerates that you are moving into 2004 and 2003 and 2002 borrowers. It really remains to be seen how much of it you are experiencing in any region of the country, how quickly it accelerates and then how much of the originator capacity that was lost is affecting us. So that is the big wild card in the mortgage market right now, which makes it such a interesting place to be.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

I think that Welli is right, is that... you are really moving to a period where observing where the bubble has cracked the worst is going to severely affect the way that people value that option. But the other way that it needs to be valued is what’s the documentation on that loan worth? If you had a 100% loan to value and you had an arm and you think you can go refinance that or even if you had a 75 and you took out 25 on a second you are in for a stunning shock when you go in and see what these valuations have done from an appraisal point of view. So you might be writing that application but you might not be eligible for the loan without having to put another check down. So, what you are paying us for is to figure out the value of that option and the value of those vintages. And I believe that will be just as good as executing that as part of the strategy as we were as staying away for the markets in 2003.

Michael Cohen - SuNOVA Capital

Based on your commentary it doesn't sound like you are too bullish on the value of that option meaning... if people value it like they have traditionally they are going to overvalue it.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

You always have… with the way I always approach it, we always have to be prepared to be wrong and that all these jumbo borrowers move into the agency space and they can... their read by options at least one of their credit tightness have been removed and now they just have to deal with house price depreciation, but the way we are looking at it is it’s an open argument that there is a lot of different angles you can take on it and obviously we are going to try and get as close to being right as possible, but I think everybody is still up in the air about what it truly means, because this is the first time the mortgage market has ever gone through this.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

This is the first time in modern history where you had this. So there is no model that we can point to with any a degree of certainty. I guess what we are trying to express to you is the caution by which that option has to be valued, and we are very aware of it and we are trying to be extremely prudent in the way that we execute.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

And just in case any of our salesman are on this call, we argue one thing with them and hope for another thing once it gets in our portfolio. So we always have to be able to argue both sides of the story when we are dealing with them in buying those assets.

Michael Cohen - SuNOVA Capital

Okay thank you very much, I appreciate your time.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you Mike.

Operator

The next question comes from the line of Bose George of KBW.

Bose George - KBW

Hi, good morning.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Good morning Bose.

Bose George - KBW

Had a question first just on your capital structure, you guys have very little preferred equity relative to the past and relative to your peers and your returns are obviously well ahead of your cost of preferred equity, so given that, would you consider raising some private equity as a way of increasing the leverage to the common shareholders?

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

We are definitely going to do what's the right thing for the long-term value of the shareholders and definitely their opportunities in the preferred space to do things. We always take the caveat of can we do something long-term accretive, the returns on equity and also the portfolio acquisitions that we take on because clearly this is not a portfolio where you just blow out positions once you get a profit in them. We tend to think of all of that within the context of the bar bell and how we can do it. But definitely that's there and we try to be prudent because we think that if you look at the preferreds that are out there, some of these preferreds will raise with extremely rich coupons, which in the environment that we are painting a view on to, are going to be extremely hard to maintain and also grow your common dividend. So we want to make sure that when we execute the preferred, we execute it well. I guess it's the best way to say, we didn't have to do any of these really big dilutive preferreds during the course of disruption that has gone on in the past several months and I think that will be a big benefit for the shareholders going forward.

Bose George - KBW

Okay great and I just had a follow up, to Mike sort the question on the prepayment issue. If the value of that prepayment... if you perceive that the value of that prepayment option has increased and if you think prepayments are going to increase, I was thinking what are the responses, I mean there is one to reduce the amount of assets that you have funded by swaps because I would think that’s one of the potential risks if prepayment do spike significantly?

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

We always leave the tail out there, we were always in that long investor, there have been lots of people who have tried to match up swap-for-swap and gotten destroyed by it. I would argue in 2003 the move to 3% on the 10 year was driven by Fannie and Freddie trying to manage their duration against the value of that call. It just became a self-fulfilling prophecy at that point. So, we try to manage it with a slightly long bias, which we're a long investor anyway. And I think that we have a handle on that, a pretty good handle on what that looks like, because we've done autopsies obviously on guys who have not performed that execution very well, and we have learned from that.

Bose George - KBW

Okay. Great. Thank you.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you.

Operator

[Operator Instructions]. Your next question comes from the line of Mike Widner of Stifel Nicolaus.

Mike Widner - Stifel Nicolaus

Good morning guys, thanks for taking the call.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Good morning, Mike.

Mike Widner - Stifel Nicolaus

Just a couple of quick questions. Most of the substance at once have been asked already. But I was wondering if you could comment first just on the reasonably small amount of portfolio liquidations you did in the quarter, I think $550 million or so along with $600 million of swaps. What was in your... what's your decision, anything we should think about?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

No. We're always trying to maximize portfolio value for the shareholders and certain sectors of the market. We feel like they've become fully priced, we'll take advantage of it. So, you will always see some kind of activity going on there. But again we're not going to... I don't want to say exactly what we do with any given trade that we do.

Mike Widner - Stifel Nicolaus

All right. Certainly appreciate that. I guess the other question is if I look at your overall mix. On the surface you were 30 year fixed as a percent of the total assets. [inaudible] basically flat q-over-q, your notional amount of swaps actually dropped a little bit. Just thinking about what we're seeing in the environment now and looking forward if we really do get sort of the additional Fed rate cuts that Mike talk about. Would you guys envision changing kind of the waiting of the bar bell at all and sort of moving a little further away from...

Kathryn F. Fagan - Chief Financial Officer & Treasurer

No. We generally have run the company since inception roughly two thirds adjustable and floating to one third fixed. You will not see a dramatic shift from that general composition. And, like I said earlier, the portfolio needs to be able to withstand changes in the way the Fed interacts with the market, changes of the market. So, you can never get too committed to your view if you will with the portfolio. It needs to be able to handle your view of being incorrect. So, with that said, we are always willing to leave some money on the table, and still generate very attractive returns doing that, you'll never see us step the ranch on any one view.

Mike Widner - Stifel Nicolaus

Okay. So, even if… so, if we get… the Fed is 2% and we get a steepening of the yield curve, it might sort of interpret your response as you would still see yourselves as roughly one-third, two-thirds even in… if we look at the end of '08.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

[inaudible] so much the mortgage market is such a unique place that there is so much you can do within those composition.

Mike Widner - Stifel Nicolaus

Right.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

You can go up and down and coupon in the fixed in and out on the curve on the fixed, same thing in the adjustable. There is a lot of options out there. It’s unlike any other fixed income market in the world.

Mike Widner - Stifel Nicolaus

Okay.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

So, we'll always try and take advantage of it again keeping that general mix.

Mike Widner - Stifel Nicolaus

Okay. And the reason I asked that, it’s just one of the concerns we hear from investors is people worried about the extension risk for portfolio, at least on the surface seems to be heavily weighted toward the --.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Yes. I mean the thing is that, that could... there is always a risk. You never... if anybody tells you that they don't have a risk in their portfolio, they’re lying. There is always a risk and the bottom line is, are you getting compensated for it or aren't you? And how do you deal with that risk as it changes over time? We are dealing with amortizing assets.

So even if our portfolio is extending, all new cash flow coming in can be utilized to change that composition. And we've always dealt with this risk and we've always been a long player. We've never tried to characterize ourselves as being a riskless portfolio. There is no question we take risk and so does everyone else, whether they proclaim that or not.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

I think there, Mike, needs to be that at a time when dividends are going to be cut, and are being cut, across the board and financials probably are going to continue to be under pressure here for at least '08, in part '09 which means that the S&P dividend rates are going to fall as well. To be providing these rates of return in a rising dividend stream or rising income stream, that's a very important concept and value of these stocks, and if you look at Annaly over time, Annaly has traditionally provided most of its total rate of return not from stock price appreciation but from dividend income.

Of the 350-odd percent I think at one point in the history, let's say, over the past 90 days that it's returned over the past ten years, over 270% of that I think came from just dividend income alone. So that's the context of what do we need to attract capital, how are we attracting that capital, and how are we executing that within the mortgage market, that speaks to the barbell, we're the only guys that use it in the sector and I think it's a unique and defining mechanism that we have. These are not great total rate of return assets, these are great spread assets.

Mike Widner - Stifel Nicolaus

Yes. Well, thank you for the answers there, I'm going to ask you one more that I think I know the answer to or that's what you're going to tell me, but any color on sort of the magnitude of spreads that we are seeing in January relative to kind of what we saw in the fourth quarter.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Better.

Mike Widner - Stifel Nicolaus

All right. Thanks guys. Appreciate it.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Okay, Mike, thank you.

Mike Widner - Stifel Nicolaus

Yes, thanks.

Operator

Your next question comes from the line of Jason Arnold of RBC Capital Markets.

Jason Arnold - RBC Capital Markets

Hi, yeah, good morning guys.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Good morning, Jason.

Jason Arnold - RBC Capital Markets

Nice job on the quarter and on a macro view, you guys have been talking about the slow-motion car wreck on housing here for a long time and you've positioned yourselves well to benefit. So great work again on that.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thanks again.

Jason Arnold - RBC Capital Markets

Most of my questions have already been asked, but just one quick one. Where do you guys currently see value in MBS? Are you really aiming more towards fixed ARMs, more-seasoned MBS or new originations, any comment [inaudible]?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

No, Jason, I hope you understand it. We respectfully declined to answer that in detail.

Jason Arnold - RBC Capital Markets

Okay, sure, just a general --.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

There is a tremendous amount of value out there and we try and obviously take advantage of it, but we don't really want to hear and tell everybody where they should look.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

We have about 9 billion reasons not to answer that question.

Jason Arnold - RBC Capital Markets

Okay, fair enough, fair enough, that sounds good. And I think that's actually about all I had, thank you.

Jason Arnold - RBC Capital Markets

Thank you.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Thank you.

Operator

Your next question comes from the line of Stephen Mead of Anchor Capital Advisors.

Stephen Mead, Jr. - Anchor Capital Advisors

Good morning.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Good morning, Steve.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Hi Steven.

Stephen Mead, Jr. - Anchor Capital Advisors

You never really answered... at least I didn't feel I got an answer to the question of size and as I look at sort of your history, there is a certain point where getting too large relative to the space that you are operating in reduces sort of return potential and then, also the sustainability of returns, it's very difficult to do that through the cycles. So how do you deal with the size issue?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

The thing is that the portfolio, whether we go out to the market and raise money or we have the portfolio of amortizing, the company, if it decided never to do another offering, would still take advantage of the market.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Because it's always average costing into whatever the current interest rate environment is via amortization.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

I mean even through the ‘97 through 2001 period, I think we delivered probably 16% ROE, when we did not raise capital. So to think that you only have to keep growing and issuing more equity to increase earnings is incorrect.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Yes, I think --.

Stephen Mead, Jr. - Anchor Capital Advisors

Well, understand now. I was just wondering what… right now, at what point… or how do you make the calculation as to whether it makes sense to raise another dollars worth of equity. As you get --.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

It always would... it's always a portfolio... I'm sorry, finish your question, I'm sorry.

Stephen Mead, Jr. - Anchor Capital Advisors

No, no, just as… I mean there is a certain point where in terms of the flexibility associated with managing a portfolio, as you get up to a portfolio that's $50 billion, $75 billion, $100 billion, the ability to operate and do things in the market becomes… it becomes more difficult.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

It actually becomes easier and scaleable in fixed income rather than what goes on in equities. This is a $5 trillion marketplace and it's dominated by two government agencies.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Yes, those guys can come in and do $30 billion in purchases or a liquidation, then you don't see that much movement.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

There's not that much movement in spread. So the scalability of the business model I think is something that we definitely demonstrated over the past ten years. In terms of the capital raising, let me just give you my view of that over the past ten years just to give you some of the frustration and the perspective that we have, when we first raised the capital in the IPO in 1997, we didn't… we didn’t take all the money that was offered to us.

The deal was about $400 million, we took about $100 million out of the $400 million which made the underwriters crazy, but we felt that sequential access to capital is definitely one of the key elements of success in this sector and we didn't know in 1997 as did anybody else that the next four years, we would be essentially shut out from the market because of the dot-com bubble, even though we were creating double-digit yields in terms of returns for investors, because in conversations with equity guys during that period, they tell us that it’s fine making… they can make 25% in Yahoo in the morning and go out play golf in the afternoon while we were trying to carve out 15% a year dividend.

In 2001 when we came back to the markets, we expressed to the markets our concerns about what was going on in dot-coms and we took the company from a $100 million to $1 billion over the first nine months in market cap and after… and we were actually on the road on 09/11 and we were the first secondary that was priced when the stock market reopened on 09/18. Now, that deal could have launched Anally into a whole different market cap of liquidity in terms of not only assets under management but also just stock market cap. But we actually kept the deal within reason, we took it from $200 million to $400 million because of the uncertainties that were in the market and we felt that the steepening that was obvious to everybody was going to happen and we will continue to grow.

In 2003 to 2005, we actually voluntarily removed ourselves from the market at the time when the market was throwing a lot of money at us in a lot of different structures. We took some of that into the FIDAC structures and made them opened end in nature, so people could get out, which cost us some money over time. But that discipline paid off in 2006 because we had a premium to book and we were able to capture assets for the shareholders.

So for… in terms of time period, for roughly half of the life of the company in a company that should be growing through sequential access to capital because it's paying out 100% of its earnings, we actually have been removed from the market for about 50% to 60% of the time. But when we do come back, we now have the credibility with people that what we are doing is accretive, we’ve thought it through, and we understand how it works within the structure and we've been able to… through our understanding of the consumer flows that happened to these mortgages, been able to express a macro view that's very important for people to hear, we think.

So, it's a large market, we try to grow cautiously and carefully. Clearly at a time when balance sheets were under constraint, we restrained ourselves, even though the Fed was lowering interest rates and steepening yield curve out for us. We were very cautious with our lenders, we worked with them very carefully, we didn't go through the disruptions that other people had, we stayed liquid and liquid government assets. We had a lot of great dialogs during that period that I think have set the company up for years to come.

And I think the broader context of your question is, how are the markets going to fix with this. More than 30% of the mortgage market that exists, which is $11 trillion market, can no longer be financed. The non-agency paper, sub-prime, etcetera, there are no vehicles. So, there is a lot of money that's available for a shrinking pile of assets and obviously, the first place where it’s going to go is in AAA. So, every time you see the stock market down 200 points, that means there is another dollar going into cash in some CMA accounts, somewhere that winds up in the refill [ph] markets. It’s a… it is a time and it's a place of caution and prudence, but it’s also opportunity for the shareholders here and I think we've done a good job in getting in front of it.

Stephen Mead, Jr. - Anchor Capital Advisors

How do you… and just one more question, just on the Fannie Mae paper, the underlying mortgages and what you are seeing in terms of delinquencies and some of the credit measurement?

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Delinquency for us is 100 cents on the dollar coming back to us where the agencies eat that on your balance sheet, that's what we are paying for an yield. So, we've been seeing delinquencies in the foreclosures throughout our history of investing in these things, 15 to 17 years. It's not broken out how we are getting the money back, whether it's a prepayment or a foreclosure. But the one thing that was clear to us in 2003 is that not everybody in the world should be buying a $700,000 house, that incomes were not going to grow at that ratio at a time when we were exporting jobs outside the United States.

So, we think the opposite is true today and it speaks to you better be careful about what you buy here because you may want to… you may be owning it for a long time. When I grew up in the mortgage market in the 1970s, I was taught not to invest in in Ginnie Mae, Fannie Mae or Freddie Mae paper that was issued from Colorado, Oklahoma, Louisiana, or Texas, and that was because the prepayment option in those states was so different than the rest of the country. Now, there is a lot of states where you have to be careful about that and it's not just in the oil patch, it's everywhere else.

So, the credit mess is still unfolding and Central Bank policies are not designed to take and clear up big credit messes. They are designed to take care of interest rate risks.

Stephen Mead, Jr. - Anchor Capital Advisors

Okay, thanks.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you.

Operator

Your next question comes from the line of Dan Mica [ph] of UBS Financial.

Unidentified Analyst

Thank you for a superlative job. I have been very pleased since August 29th of '07 and look forward to many more happy returns.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you.

Unidentified Analyst

Question, as I read through your barbell approach of 71 fixed, 29 variable?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Well, I just want to make a correction there. It's roughly 40% fixed after giving effect for the swaps.

Unidentified Analyst

Yes, okay, brilliant [ph]. About the barbell approach, my question is as quickly as the Fed has come to ease and everything, I believe the fans of inflation will be ever so present in the next 12 to 18 months and historical on the other way, how quickly are you able to make the adjustment from your large fixed portfolio to the variable? Should that pan out to be that over the next, let’s say, 12 to 24-month period of time, the Fed begins to increase the rates after they were decreasing, how quickly are you able to make adjustments to this portfolio for the variable side? Is it through more equity offerings?

Kathryn F. Fagan - Chief Financial Officer & Treasurer

You know what, no, we will still have roughly two-thirds adjustable and floating to one-third fixed.

Unidentified Analyst

Okay.

Unidentified Analyst

We are not going to go to zero fixed --.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

When the Fed is tightening.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

The nature of that fixed, Dan, might be different. It might be more seasoned pay for the shorter in duration.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

Maybe higher coupon.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Higher coupon.

Kathryn F. Fagan - Chief Financial Officer & Treasurer

The thing is the swaps portfolio will respond immediately within a month of Fed tightening.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

I actually hope that you are right, Dan, for the nation’s sake that they are in a position where they can actually tighten rates.

Unidentified Analyst

I got to believe so too. You can't flood the economy here with this cheap mining that’s continuing for our workers, the price to pay is so significantly… is dramatic. And I want to thank you for your prudence reading Annual Report straightaway from 2002 to 2005 when this era of idiocy is happening that you have that prudence, and let me... I explained that and have further prudence, thank goodness for people like yourself because you are the calm in the storm and I want to thank you again for that leadership. Thank you.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you, Dan.

Unidentified Analyst

You are welcome.

Operator

And there are no further questions, I will now turn the call back over to Mr. Farrell.

Michael A. J. Farrell - Chairman, Chief Executive Officer and President

Thank you, Grasan. Well, we thank you all for your patience today. I realize that it is a very busy day in the markets for everyone, there is a lot of earnings being released. Once again, I congratulate this team on a superlative job in 2008 and 2007. Happy days are far away, I think, for the economy, but I think we’re definitely prepared to take advantage of the opportunities here in the market today for Annaly’s shareholders and FIDAC investors. So, we will see you in the second quarter and go giant [ph].

Operator

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-888-286-8010 or 617-801-6888 with an ID number of 26909379. This concludes our conference for today. Thank you for your participation and have a nice day. All parties may now disconnect.

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Source: Annaly Capital Management, Inc. Q4 2007 Earnings Call Transcript
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