Investment Committee Memorandum

Executive Summary

This memorandum provides a comprehensive assessment of Annaly Capital Management, Inc. (NYSE: NLY) as we enter 2026. As the largest publicly traded mortgage REIT with an $89+ billion portfolio, Annaly remains a dominant player in the agency MBS market and is strategically positioned at the intersection of multiple favorable macroeconomic tailwinds.

Our analysis suggests that NLY is well-positioned for a moderately constructive 2026, benefiting from stabilizing interest rate volatility, improving mortgage spreads, and strong capital management. However, elevated payout ratios, book value volatility, and macro uncertainty warrant a balanced stance rather than aggressive overweight positioning.

1. Current Operating Performance

Q3 2025 Results Highlight Momentum

Annaly delivered strong Q3 2025 results that exceeded expectations and demonstrated operational execution:

The company generated positive economic returns across all business segments, with performance driven primarily by spread tightening in its agency MBS portfolio. Net interest spread excluding PAA expanded to 1.5%, up from prior quarters, while maintaining disciplined leverage at 5.7x (economic basis).

Portfolio Composition & Capital Deployment

Annaly successfully raised $1.1 billion of accretive equity in Q3, including $800 million through its ATM program and $250 million via its 8.875% Series J preferred offering. Capital was deployed strategically:

• Agency Portfolio: $87 billion market value (+10% QoQ), representing 64% of dedicated capital. Focus on specified pools with call protection in 5.5% and 6.0% coupons.
• Residential Credit: $6.9 billion economic market value. Annaly was a top issuer in 2025, pricing 24 securitization transactions YTD.
• Mortgage Servicing Rights (MSR): $3.5 billion market value (+$215M QoQ). New partnership with PennyMac enhances servicing capabilities while managing ~680,000 loans with $219B unpaid principal.

The diversified approach provides multiple alpha generation opportunities while reducing single-factor risk exposure.

2. Interest Rate Environment & 2026 Outlook

Fed Policy Trajectory

The Federal Reserve has pivoted from aggressive tightening to measured easing. Following 75 basis points of cuts in 2025, the current fed funds target range sits at 3.50%-3.75%. Chair Powell's guidance suggests the median FOMC participant expects rates at approximately 3.4% by end-2026, implying 1-2 additional cuts during the year.

Mortgage Rate Outlook: Gradual Improvement, Not Dramatic Relief

Despite Fed easing, long-term mortgage rates remain stubbornly elevated due to their tethering to 10-year Treasury yields rather than short-term policy rates. Key 2026 forecasts show meaningful dispersion:

Source	2026 Avg Rate	2027 Forecast	Notes
S&P Global Ratings	5.77%	5.43%	Most optimistic view
Reuters Expert Poll	6.18%	5.88%	Consensus baseline
Realtor.com	6.30%	N/A	Cautious stance
Bankrate Forecast	5.50% - 6.50%	N/A	Wide range reflecting uncertainty
Current (Jan 2026)	6.37%	—	HousingWire Mortgage Rates Center

Key Implication: Mortgage rates are expected to trend lower but remain elevated by historical standards. A slow glide path benefits mREITs with hedged portfolios and diversified strategies, as financing costs improve gradually without triggering massive prepayment waves that would erode MSR portfolios.

Volatility Environment: The Crucial Factor

Interest rate volatility has been a major headwind for mortgage REITs over the past three years, driving up hedging costs and compressing spreads. Q3 2025 showed meaningful improvement, with realized volatility declining and allowing Annaly to manage hedge costs more effectively. CEO David Finkelstein noted that low volatility has been beneficial, with the company achieving a blended hedge yield around 160 basis points.

If volatility remains subdued, Annaly's net interest margin and book value should exhibit greater stability, supporting dividend coverage and potentially enabling modest book value accretion.

3. Dividend Sustainability Analysis

Current Dividend Profile

Annaly's 12.23% dividend yield is the primary attraction for income-oriented investors. The company currently pays $0.70 per quarter ($2.80 annually), representing one of the highest yields in the mortgage REIT sector.

Dividend Coverage Assessment

Our analysis considers multiple scenarios for 2026 dividend sustainability:

Scenario	Quarterly EAD	Annual EAD	Payout Ratio	Probability
Base Case	$0.70 - $0.75	$2.80 - $3.00	93% - 100%	55%
Bull Case	$0.76 - $0.82	$3.04 - $3.28	85% - 92%	25%
Bear Case	$0.60 - $0.68	$2.40 - $2.72	103% - 117%	20%

Base Case Drivers: Gradual improvement in net interest spreads, stable prepayment environment, modest book value appreciation, continued low volatility reducing hedge costs.

Bull Case Triggers: Mortgage spreads tighten further than expected, GSE buying accelerates, refinance wave boosts MSR origination volumes, successful deployment of 2025 equity raises into high-yielding assets.

Bear Case Risks: Renewed rate volatility spike, spread widening from unexpected credit events, geopolitical shocks affecting Treasury markets, persistent inflation forcing Fed hawkish pivot.

Management's Track Record

Annaly has a history of adjusting dividends to reflect earnings power and market conditions. The dividend was increased in late 2024 from $0.65 to $0.70 (7.7% increase), suggesting management confidence in sustainable earnings. However, the company has also cut dividends multiple times historically when market conditions deteriorated.

Our View: The current $0.70 quarterly dividend appears sustainable but not comfortable through 2026. We assign 70% probability the dividend remains flat, 15% probability of a modest increase to $0.72-$0.75, and 15% probability of a cut to $0.65-$0.68 if bear case materializes.

4. Sector Positioning & Competitive Landscape

Mortgage REIT Sector Performance in 2025

The mortgage REIT sector significantly outperformed equity REITs in 2025, benefiting from stabilizing rates and improving credit markets. The FTSE Nareit Mortgage REITs Index rose 16% in 2025, with total returns exceeding 26%, substantially ahead of the 2.3% return for equity REITs.

Annaly's Competitive Positioning

Within the mortgage REIT universe, Annaly maintains several competitive advantages:

• Scale: At $89B+ total portfolio and $15.6B market cap, Annaly is the largest pure-play mortgage REIT, providing access to capital markets, repo counterparties, and deal flow unavailable to smaller competitors.
• Diversification: Unlike peers concentrated solely in agency MBS, Annaly's three-pillar strategy (Agency, Residential Credit, MSR) provides multiple return drivers and natural hedges.
• Issuer Status: Top-tier position as non-bank issuer of Prime Jumbo and Expanded Credit MBS creates origination optionality and spread capture opportunities.
• Balance Sheet Discipline: Conservative leverage (5.7x economic, 7.1x GAAP) below many peers, providing cushion for volatility and capacity for opportunistic deployment.

Key Competitors Comparison

Company	Market Cap	Div Yield	P/B Ratio	Key Differentiator
NLY (Annaly)	$15.6B	12.23%	1.19x	Scale + Diversification
AGNC Investment	$9.8B	14.2%	0.92x	Pure agency focus
Two Harbors (TWO)	$1.2B	13.8%	0.95x	MSR-centric model
Starwood Property (STWD)	$6.1B	9.7%	1.08x	Commercial focus

Annaly trades at a premium P/B versus peers AGNC and TWO, reflecting market recognition of its franchise value, though its dividend yield is modestly lower than some higher-risk competitors. This positioning is appropriate for a large-cap, diversified mortgage REIT with institutional-quality governance.

5. Key Risks & Mitigating Factors

Risk Factor 1: Book Value Volatility

Risk: Mortgage REIT book values are inherently volatile, fluctuating with interest rate movements, spread changes, and prepayment speeds. Sharp book value declines can trigger margin calls, force asset sales, or necessitate dividend cuts.

Mitigants:

• Annaly maintains 92% hedge ratio, providing substantial interest rate protection
• Diversification across Agency, Credit, and MSR reduces single-factor sensitivity
• Q3 2025 showed 4.3% book value increase, demonstrating positive momentum
• Management has demonstrated disciplined hedging during volatile periods

Risk Factor 2: Dividend Cut Potential

Risk: Elevated payout ratios (95%+ on Q3 EAD, 117-127% TTM) indicate limited margin of safety. A bear case scenario with sustained low earnings could force dividend reduction.

Mitigants:

• Recent dividend increase (Q4 2024) signals management confidence
• Eight consecutive quarters of positive economic returns demonstrate earnings stability
• Multiple levers to improve earnings: spread tightening, volatility normalization, GSE technical support
• Preferred issuance provides lower-cost equity capital to support common dividends

Risk Factor 3: Macro/Geopolitical Shocks

Risk: Unexpected events (banking crisis, geopolitical conflict, inflation resurgence) could trigger Treasury volatility, widen mortgage spreads, or disrupt repo markets.

Mitigants:

• Agency MBS portfolio benefits from implicit government backing
• Diversified repo counterparty base (multiple large banks) reduces funding concentration
• Low leverage provides cushion to absorb shocks
• MSR portfolio acts as natural hedge (gains value when rates rise)

Risk Factor 4: Prepayment Risk

Risk: If mortgage rates drop below 6%, refinancing activity could accelerate, causing premium amortization losses on agency MBS and MSR runoff.

Mitigants:

• Focus on specified pools with call protection (low FICO, high LTV, investor properties)
• Current portfolio has prepayment penalties and structural protections
• 6% threshold appears unlikely in 2026 based on consensus forecasts
• MSR partnerships (PennyMac) provide subservicing revenue even if book value declines

Risk Factor 5: Regulatory/GSE Reform

Risk: Changes to Fannie Mae/Freddie Mac structure, capital requirements, or guarantee fees could alter agency MBS economics.

Mitigants:

• GSE reform has been discussed for 15+ years with minimal progress; unlikely near-term
• Current administration likely to maintain status quo
• Any reform would likely be phased gradually, allowing portfolio adjustments
• Residential Credit business provides non-agency alternative if agency economics deteriorate

6. 2026 Outlook & Potential Catalysts

Positive Catalysts

1. Continued Spread Tightening: Agency MBS spreads have tightened meaningfully in late 2025. If this continues driven by GSE buying and low volatility, NIM expansion should drive higher EAD and support book value growth.
2. GSE Retained Portfolio Expansion: Fannie and Freddie increased MBS holdings by 77% YoY through November 2025, approaching but not yet hitting their $225-250B PSPA caps. Continued buying provides technical support for spreads.
3. Volatility Normalization: If implied and realized volatility remain low, hedging costs decrease and carry improves. This single factor could add 10-20 bps to quarterly ROE.
4. Housing Market Stabilization: Even modest improvement in transaction volumes and affordability supports MSR origination and residential credit securitization volumes.
5. Capital Deployment: $1.1B of equity raised in Q3 2025 now fully deployed should contribute incremental earnings in 2026.
6. Sector Rotation: As equity REIT valuations become stretched and income alternatives less attractive, institutional flows may return to mortgage REITs for yield and total return potential.

Negative Catalysts

1. Rate Volatility Resurgence: Geopolitical events, inflation surprises, or Fed policy errors could reignite Treasury volatility, widening spreads and increasing hedge costs.
2. Credit Deterioration: While residential credit quality remains strong (avg FICO 757), economic slowdown could pressure delinquencies in non-QM and Alt-A portfolios.
3. Prepayment Surge: Faster-than-expected rate declines triggering refi wave would hurt both agency MBS and MSR portfolios.
4. Competitive Equity Issuance: If multiple mortgage REITs issue equity simultaneously, it could dilute returns and pressure valuations sector-wide.
5. Dividend Cut: Any dividend reduction would likely trigger 10-15% stock price decline, as yield investors exit positions.

Valuation Framework

We employ multiple valuation methodologies to assess NLY's fair value:

Methodology	Fair Value	Current Price	Upside/Downside
Book Value + Premium	$21.00 - $23.00	$22.90	Fair Value
Dividend Discount (10% req. return)	$23.50 - $28.00	$22.90	+3% to +22%
P/E Multiple (6x-8x)	$16.50 - $24.00	$22.90	-28% to +5%
Peer Relative P/B	$19.00 - $22.00	$22.90	-17% to -4%

Weighted Average Fair Value: $22.50 (consensus of methods weighted by reliability)

At current price of $22.90, NLY trades slightly above our fair value estimate but within a reasonable range given the 12%+ yield and improving fundamental backdrop.

7. Conclusion

Annaly Capital Management enters 2026 from a position of operational strength, with eight consecutive quarters of positive returns, improving book value trajectory, and successful capital deployment. The macro environment appears moderately favorable, with gradually declining mortgage rates, reduced volatility, and technical support from GSE buying.

However, the investment case is not without risk. Elevated payout ratios leave minimal margin for error, book value remains vulnerable to rate shocks, and the 12%+ yield partially reflects these structural risks. The stock's premium valuation to book value (1.19x vs. sub-1.0x peers) suggests the market has already priced in some improvement.

For income-focused portfolios willing to accept book value volatility and mark-to-market fluctuations, NLY offers compelling total return potential combining high current yield with modest capital appreciation opportunity. The key to success in 2026 will be monitoring quarterly earnings for signs of sustained dividend coverage above 100% and book value stability.

The Investment Committee should maintain existing NLY exposure and consider opportunistic additions on weakness below $21, while remaining vigilant for any deterioration in the three key metrics: EAD/dividend coverage, book value trends, and interest rate volatility.