Executive Summary / Key Takeaways

• Diversified Strength: Annaly Capital Management (NLY) stands as a leading diversified capital manager in mortgage finance, consistently delivering positive economic returns for seven consecutive quarters by leveraging its Agency, Residential Credit, and MSR segments.
• Strategic Capital Deployment: The company's prudent capital management, including a recent $750 million accretive ATM capital raise in Q2 2025, positions it to capitalize on attractive spreads in Agency MBS while strategically growing its Residential Credit and MSR portfolios long-term.
• Technological Moat & Operational Excellence: Annaly's proprietary Onslow Bay platform and strategic MSR partnerships, bolstered by significant technology investments, provide a competitive edge through efficient loan manufacturing, superior securitization execution, and enhanced servicing capabilities.
• Robust Financial Health & Outlook: Annaly's Q2 2025 Earnings Available for Distribution (EAD) of $0.73 per share out-earned its dividend, supported by higher asset yields and lower financing costs, with management confident in continued dividend coverage for 2025.
• Disciplined Risk Management: A conservative leverage profile, ample liquidity, and dynamic hedging strategies enable Annaly to navigate interest rate volatility, credit risks, and evolving market conditions, ensuring stability and long-term shareholder value.

The Foundation of Diversified Mortgage Finance

Annaly Capital Management, Inc. (NLY), established in 1997, has evolved into a prominent diversified capital manager within the mortgage finance sector. Its core objective remains to generate net income for shareholders by investing in a broad portfolio of real estate-related assets, operating as a Real Estate Investment Trust (REIT). This strategic diversification across Agency mortgage-backed securities (MBS), Residential Credit, and Mortgage Servicing Rights (MSR) has been foundational to its resilience, enabling the company to deliver positive economic returns for seven consecutive quarters, a testament to its robust, multi-faceted approach to housing finance.

The company's strategic evolution has been marked by key initiatives that inform its current market positioning. Annaly expanded into non-qualified mortgage (non-QM) loans as early as 2016-2017, anticipating shifts in the residential credit landscape. A pivotal moment was the 2020 management internalization, which streamlined operations and paved the way for the 2021 launch of its correspondent channel for residential credit. This channel has been instrumental in organically creating proprietary assets through direct loan acquisition and securitization.

Technological Edge and Operational Moats

Annaly's competitive differentiation is significantly enhanced by its technological investments and strategic operational partnerships. The Onslow Bay platform is a prime example, serving as a sophisticated engine for its Residential Credit business. This platform enables efficient loan manufacturing, from origination through securitization, providing a distinct advantage in a market where many peers rely on third-party channels. The platform's ability to execute securitizations at competitive spreads is a tangible benefit; for instance, in Q2 2025, Onslow Bay priced AAA bonds for its Non-QM 13 transaction at 138 basis points over SOFR, notably tighter than other issuers and sponsors who were in the 140-150 basis point range. This pricing efficiency directly translates into higher-yielding, proprietary assets for Annaly, bolstering its profitability.

In the MSR segment, Annaly leverages technology through its strategic subservicing and recapture partnerships. The company does not directly service loans but partners with industry leaders like Rocket Mortgage (RKT), announced in Q3 2024. These partnerships are critical as they allow Annaly to benefit from best-in-class recapture capabilities and lower servicing costs, without incurring the operational overhead and cyclicality of an originator. Management highlights that technological enhancements in the servicing sector are "escalating and accelerating," leading to cheaper subservicing expenses that flow directly to Annaly. This model enhances portfolio yield and provides a superior borrower experience, reinforcing Annaly's competitive moat against less technologically integrated MSR investors.

The "so what" for investors is clear: Annaly's strategic investments in platforms and partnerships create a durable competitive advantage. These technological differentiators contribute to its ability to generate high-quality assets, optimize financing costs, and enhance overall portfolio returns, thereby strengthening its market positioning and long-term growth prospects.

Competitive Landscape and Strategic Positioning

Annaly operates within a dynamic mortgage finance sector, competing with other REITs like AGNC Investment Corp. (AGNC), Starwood Property Trust (STWD), and Blackstone Mortgage Trust (BXMT). Annaly's diversified investment portfolio is a core competitive strength, offering a broader market positioning compared to AGNC's more concentrated focus on agency securities. This diversification allows Annaly greater adaptability to market shifts, potentially leading to stronger operational resilience and more balanced revenue streams. While AGNC may exhibit a streamlined cost structure due to its specialization, Annaly's comprehensive approach, including its middle-market lending capabilities, differentiates its value proposition.

Compared to commercial-focused REITs like STWD and BXMT, Annaly's blend of residential and commercial assets provides a more balanced exposure. Its REIT status offers tax advantages, potentially enhancing pricing power and profitability. While STWD and BXMT might demonstrate agility in specialized commercial deal sourcing or scale, Annaly's consistent presence and "white glove service" in its correspondent channel, as noted by management, provide a competitive edge in loan acquisition. The company's ability to offer "certainty of execution and stable capital" to its correspondents, unlike some private equity peers, solidifies its market share in residential credit. Annaly's D60+ delinquency rate of 1.85% for its residential credit portfolio, which is lower than many non-QM issuers, underscores its disciplined underwriting and asset management, further distinguishing it from competitors.

However, Annaly faces vulnerabilities, particularly its sensitivity to interest rate changes and reliance on borrowed funds. While its diversified portfolio helps mitigate some of this risk, significant rate movements can still impact asset values and hedging costs. This contrasts with some competitors who might have different hedging strategies or less leverage. Despite these challenges, Annaly's strategic response involves maintaining conservative leverage ratios and a robust liquidity profile, ensuring it can withstand market volatility and capitalize on opportunities as they arise.

Financial Performance and Operational Momentum

Annaly's financial performance in the second quarter of 2025 underscored the strength of its diversified model. The company reported Earnings Available for Distribution (EAD) of $0.73 per average common share, an increase from $0.68 in Q2 2024, and notably out-earning its dividend. This performance contributed to a positive economic return of 0.7% for the quarter and 3.7% for the first half of 2025. The net interest spread excluding PAA improved to 1.47% in Q2 2025 from 1.24% a year prior, while the net interest margin excluding PAA reached 1.71%, up from 1.58% in Q2 2024.

The Agency Group saw its interest income grow to $913.3 million in Q2 2025, up 11.2% year-over-year, with total assets reaching $75.3 billion. The Residential Credit Group's interest income surged by 43% year-over-year to $505.5 million, and its total assets expanded by 40.3% to $32.9 billion. The MSR Group also demonstrated strong growth, with net servicing income increasing by 17.8% to $127.1 million and total assets growing by 15.3% to $3.8 billion. These segment-level improvements highlight the broad-based operational effectiveness across Annaly's businesses.

Annaly's liquidity position remains robust. As of Q2 2025, unencumbered assets stood at approximately $6 billion, including $4.7 billion in cash and unencumbered Agency MBS. The company's non-mark-to-market capacity for residential loan facilities significantly expanded from $150 million (6% of total capacity) at year-end 2023 to $1.9 billion (45% of total capacity) in Q2 2025, enhancing its funding flexibility. Total facility capacity for the residential credit business reached $4.2 billion, with a utilization rate of 40%, while the MSR business had $2.1 billion in committed warehouse capacity, 50% utilized. This disciplined approach to liquidity and funding ensures Annaly's ability to meet obligations and pursue investment opportunities.

Outlook and Strategic Imperatives

Annaly's outlook for the remainder of 2025 is shaped by expectations of continued Federal Reserve interest rate cuts and a dynamic housing market. Management anticipates the Fed will deliver on the two projected rate cuts for 2025, which should be supportive of the company's portfolio. In the near term, Annaly expects to be overweight in the Agency sector, given historically attractive spread levels and the potential for increased demand from banks and overseas investors. Over the long term, the company plans to strategically grow its Residential Credit and MSR portfolios, expanding Onslow Bay's presence across the housing finance sector.

The housing market is expected to see home prices soften further, potentially turning "modestly negative on a year-over-year basis in the next couple of months." However, Annaly believes it is well-positioned to manage this deceleration due to its control over its loan manufacturing strategy and the high quality of its underlying credit portfolio, which boasts a mark-to-market LTV of approximately 62%.

For investors, the company's guidance on dividend coverage is a key indicator. Management has expressed confidence in covering and potentially out-earning the dividend for the remainder of the year, "all else equal," based on strong earnings momentum from higher asset yields and lower financing costs. The recent increase in the common stock dividend to $0.70 per share, a decision made "very deliberately," reflects this confidence. Annaly's ongoing common and preferred stock repurchase programs, authorized in January 2025, further underscore its commitment to shareholder value and capital management flexibility.

Conclusion

Annaly Capital Management's investment thesis is firmly rooted in its diversified, actively managed, and well-hedged approach to mortgage finance. The company's strategic evolution, marked by the expansion of its Residential Credit and MSR businesses and underpinned by significant technological advantages, has enabled consistent positive economic returns even amidst volatile market conditions. Its proprietary platforms and strategic partnerships provide a distinct competitive edge, allowing for efficient asset origination, superior securitization execution, and enhanced servicing capabilities that translate into robust financial performance.

Looking ahead, Annaly is poised to capitalize on anticipated Fed rate cuts and evolving market dynamics, with a tactical overweight in Agency MBS and strategic long-term growth in its credit and MSR segments. The company's disciplined risk management, conservative leverage, and ample liquidity serve as critical safeguards, ensuring stability and the ability to pursue accretive opportunities. For discerning investors, Annaly offers a compelling blend of durable income generation, strategic adaptability, and a proven track record of delivering shareholder value in the complex landscape of housing finance.