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Today, I'll provide an update on the broader market, our capital allocation trends, including credit activity, and our outlook.
Ilker Ertas, our head of securitized products will follow-up with specific commentary on our agency and hedging activity, and Serena will review our financial results.
And as Sean noted, our other business heads are also present to provide additional context during Q&A.
The primary themes, the dominated markets in the fourth quarter are largely consistent with our third-quarter narrative.
The Fed's monetary policy accommodation provided considerable support for risk assets and contained interest rate volatility.
This backdrop, coupled with active portfolio management, drove our strong performance to close out the year as we delivered an economic return of 5.1% for the quarter, ensuring a positive return for our shareholders for 2020 which is particularly notable given the historic disruption we all faced in March.
Now turning to the macro environment.
The yield curve bears steepened in the fourth quarter in light of optimism about the post-COVID economic recovery which outweighed the negative developments of record virus cases and the resulting lackluster economic growth to end the year.
We have seen a continuation of this rate move into 2021 largely due to the results of the January runoff election and democratic control of each branch of government, leading to greater prospects' further stimulus.
witnesses a meaningful recovery in labor markets and higher inflation readings.
Thus, the Fed is expected to continue purchasing assets at their current pace through 2021 while forward guidance will keep the front end anchored.
We do think the shift to higher longer-term rates will be gradual.
Nonetheless, it remains prudent to hedge the tail risk of a spike in rates as we'll discuss shortly.
Now to address how this landscape influences our positioning and capital allocation, monetary policy tailwinds maintain agency as the primary vehicle for reinvestment of portfolio runoff.
And we remain comfortable with the agency market for reasons Ilker will discuss, but the continued spread tightening does leave us cautious on higher levels of leverage.
Fiscal stimulus should ensure healthy consumer spending once the economy reopens more broadly and service consumption can resume which should be a constructive backdrop for credit.
Our allocation to credit marginally increased to 22%, as we began the fourth quarter at the lower end of our range.
And targeted opportunities, largely in residential credit and middle market lending modestly tilted the relative value equation back toward certain pockets of credit.
It should be noted, however, that risk assets continue to see strong sponsorship and associated spread contraction, given liquidity in the system, and optimism for a cyclical recovery which necessitates a very disciplined approach to asset selection as our investment teams consistently employed.
With respect to our residential credit business specifically, we found the unrated NPL and RPL securities sector attractive, as we discussed last quarter which drove much of the $400 million growth in our residential securities portfolio during the quarter.
Within the CRT universe, we have rotated our investments up the capital structure with a focus on very short spread duration assets that have strong deleveraging profiles in light of elevated prepayment speeds.
Spreads on our non-agency securities purchased in the fourth quarter have rallied over 100 basis points, given the strength of the market to date this year.
Although securities remain an important part of our portfolio as they provide opportunistic relative value, we were encouraged to see volumes once again gained traction within the non-QM loan market.
Our expanded prime whole loan effort continues to be a priority and we are focused on new strategic relationships to grow our sourcing capabilities which builds further optionality for us within residential finance.
Turning to middle market lending.
Activity picked up in the fourth quarter as liquidity reentered the sector and we were able to grow our portfolio nearly 10% to $2.2 billion.
Of the nearly $400 million of gross activity in the quarter, 80% was first lien and included both new and existing borrowers.
As discussed on recent earnings calls, our targeted investment strategy continues to differentiate our portfolio relative to our peers, and our middle market lending group's disciplined credit focus has proven itself out through strong fundamentals with underlying borrower LTM EBITDA, increasing by 14% on average since initial close.
We continue to maintain an active dialogue with our borrowers and sponsors, and our watch list performance improved by 43% this quarter, underscoring the health of our portfolio.
Our commercial real estate portfolio decreased somewhat quarter over quarter.
While we were able to resume origination activity this past fall, volume did not offset the $108 million in pay downs, as well as, an opportunistic sale in our healthcare portfolio.
The $150 million sale price for a portion of our skilled nursing facilities which closed in the fourth quarter, resulted in an IRR of 35% for the portfolio and then nearly 2 times equity multiple.
Now shifting to the financing of our portfolio which Serena will discuss in greater detail, I would just like to note that borrowing conditions that exist today are the best we've seen during the company's two-plus decade history.
The liquidity in the system has shifted the market advantage to the borrower, much more so than in past periods of monetary accommodation.
It's not just the absolute low level of rates, but also the flat term structure of the repo curve which signals the persistence of an ample borrowing capacity and also affords us the ability to fund agency MBS out a year inside of a mere 20 basis points.
Additionally, on the financing front, securitization markets have rebounded substantially, resulting in execution inside of pre pandemic levels.
This continued momentum provides attractive nonrecourse term financing to bolster our asset generation strategy and diversify funding for our whole loan business.
Now prevailing financing and securitization dynamics have made both balance sheet and structural leverage more attractive than capital structure leverage in the current environment as evidenced by our recent preferred stock redemption which was prudent from both the capital management and efficiency standpoint and follows a series of transactions since 2017 to reduce our cost of capital and preferred equity.
We have differentiated ourselves from others in the REIT sector by growing capital structure leverage more slowly and maintaining a relatively stable amount of total leverage on common equity which is important as we've seen a higher portion of capital structure leverage lead to higher volatility in returns, if not well managed.
Annaly is unique in that our size, expense ratio, and liquidity afford us the flexibility to manage our capital exclusively in an accretive fashion.
Proactive capital management remains a priority and we renewed our common stock repurchase program authorization following $209 million in repurchases in 2020.
Lastly, despite the attractiveness of balance sheet leverage and funding, we remain disciplined with respect to our overall leverage profile.
We've reduced leverage in each quarter since the end of 2019 through last year and maintained leverage at 6.2 times quarter over quarter, the lowest we've had since the first quarter of 2017.
We strive to deliver the highest risk-adjusted return for our shareholders and I'm confident our current risk construct is appropriate to yield book value and earnings stability going forward.
Now with that, I'll hand it over to Ilker to dive deeper into our agency portfolio activity.
As David mentioned, the agency portfolio had a strong quarter, supported by healthy investor demand, both low in-flight and realized interest rate volatility, and steepening yield curve.
Lower coupon TBAs were the strongest performing part of the agency market as they benefited directly from Fed purchases.
However, in contrast to prior episodes of QE, specified pools have also demonstrated solid performance.
Given the current elevated prepayment environment, the desire for more cash flow certainty and a strong bid for longer duration mortgage assets, we are seeing the level of pay-ups which stand higher rates and steeper curve experienced over the quarter and into 2021.
Apart from Fed, Agency MBS demand remains robust, led by notable appetite from commercial bank community.
In the current environment, banks are seeing strong deposit growth while C&I loan growth remains muted.
In fact, the loan-to-deposit ratio for the sector is the lowest we have seen in the past 50 years.
With deposits continuing to rise, banks have chosen to grow their securities portfolios which directly benefits MBS valuations and strengthens the specified pool market.
Looking at 2020 data, banks [Inaudible] set net bought over $1 trillion MBS in aggregate which was more than twice the available net agency supply last year.
Turning to composition of our MBS portfolio.
Our lower coupon holdings remain largely in TBAs while our higher coupons are predominantly improved.
This barbell approach maximizes liquidity and benefits from high levels of nominal care in the dollar roll market while providing cash flow stability across diverse interest rate environments from our pools.
Approximately, 86% of our pool portfolio consists of higher coupon quality specified pools which provides us with improved convexity and prepayment protection, while the remainder is mainly concentrated in seasoned pools, which are beginning to experience prepayment burnout.
The value of our asset selection is evidenced by the prepayment speeds on our portfolio of just under 25 CPR or roughly 10 CPRs slower than the MBS universe over the quarter.
In terms of portfolio activity, portfolio runoff was reinvested in lower coupon TBAs and we also rotated out of some of our higher coupon TBAs into specified pools.
On the hedging side, we added to our treasury features and swaption positions, mostly in the 10-year part of the yield curve which benefited from the steepening in the fourth quarter.
Hedging costs remain relatively inexpensive in this low rate and low volatility environment.
We also want to be positioned for further rising yields under the scenario, where optimism on the economic recovery leads to higher long end interest rates in the medium-term.
Given how well risk assets have performed since the second half of 2020, the agency reinvestment landscape is somewhat less attractive than earlier in the year.
However, our outlook for agency MBS remains constructive due to a number of factors.
First, the availability of attractive funding in the repo and dollar roll markets.
David addressed the repo market.
And as for rolls, as we forecasted on the last call, gross specialness has moderated somewhat with market being repopulated with new collateral beyond that, which has been delivered to Fed.
We still achieved a net negative financing cost for our TBAs over the quarter and we expect current production coupon rolls will remain modestly special over the near-term.
Secondly, we expect the technical backdrop of strong demand for agency MBS to persist over the course of this year given nominal carry and continued bank demand.
And finally, there is a -- there is potential for improved prepayment profile, resulting from steeper yield curve and very early signs of burnout in prepayments.
To expand on that point, we observed from recent data that the primary secondary spread is narrowing despite more than 75% of the universe having greater than 50 basis points of refinancing incentive.
In addition, average time to refinance loans has steadily increased from 40 days this past spring to almost 60 days as of late.
This suggests that [Inaudible] of easily refinanced target is decreasing for originators, requiring incremental efforts to find eligible borrowers.
So for the first time since last spring, the prepayment environment may not be as big of a headwind for higher coupon MBS.
As a final point, we note that we cannot look at Agency MBS in isolation.
During previous QEs, other risk assets like the MBS tightening and gave private investors opportunity to rotate into these asset classes.
In contrast, during the current QE, nearly all spread products tightened in line, if not more than agency MBS.
As a result, we remain constructive on the outlook for agency MBS.
Before I get started with the numbers, I just wanted to comment that December 2020 marks my first year with the company as CFO.
Over the year, the company performed exceptionally well given the challenges we faced.
Our results and performance during 2020 reinforced the reasons I was compelled to join the Annaly team which include our human capital, differentiated risk culture, and robust infrastructure built around the businesses in terms of finance, legal, technology, and other support functions.
During 2020, Annaly demonstrated a 23-year old company's steadfast nature while exhibiting an adept industry leaders agility.
So with that as a backdrop, today I'll provide brief financial highlights for the quarter ended December 31st, 2020 and discuss select year-to-date metrics.
As David mentioned earlier, the primary drivers of performance were an extension of themes from last quarter.
We took advantage of the interest rate and financing environment to generate strong results while prudently managing leverage.
To set the stage with some summary information, our book value per share was $8.92 for Q4, a 2.5% increase from Q3.
Book value increased on GAAP net income, partially offset by the aggregate common and preferred dividends of $344 million or $0.25 per share and other comprehensive loss of $215 million or $0.16 per share.
We generated core earnings per share, excluding PAA, of $0.30, a decrease of 6% or $0.02 per share from the prior quarter.
Our core earnings also represent 140% of our dividend and we saw back-to-back quarters of 13% plus of core ROE.
Combining our book value performance for the $0.22 common dividend we declared during Q4, our quarterly economic return was 5.1%.
We generated a full-year economic return of 1.76% and a total shareholder return of 2.43%.
While down compared to prior years, we are proud of our positive 2020 return given the unprecedented market conditions we faced earlier this year.
Delving deeper into the GAAP results, we generated GAAP net income of $879 million or $0.60 per common share for Q4, down from $1 billion or $0.70 per common share in the prior quarter.
GAAP net income decreased primarily due to lower realized gains on investments resulting from fewer agency MBS sales in Q4 versus Q3.
However, GAAP net income benefited from higher unrealized gains on interest rate swaps driven by higher rates.
Additionally, we recorded higher gains on other derivatives, largely futures, offset by lower gains in fair value option loans and securities, and lower interest expense on lower average repo rate, down to 35 basis points from 44 basis points, and lower average repo balances down to $65.5 billion from $67.5 billion.
Moving on now to CECL reserves.
In the current quarter, we continue to see a general improvement in market sentiment and the economic models we use in this process.
Total CECL and specific reserves were relatively consistent with prior quarters.
We recorded an immaterial increase in reserves, primarily associated with our commercial real estate business of $1.5 million on funded commitments during Q4, driven by an increase in specific reserves, partially offset by a decrease in the general CECL reserve.
Total reserves, net of charge-offs, now comprise 4.48% of our ACREG and MML loan portfolios as of December 31st, 2020, versus 4.56% as of the prior-quarter end.
We remain comfortable with our existing credit portfolios and the associated CECL reserve, and we'll continue to monitor specific asset performance and economic projections as we determine future reserves.
Turning back to earnings.
I wanted to provide more details surrounding the most significant factors that impacted core earnings quarter over quarter.
First, consistent with my commentary around GAAP drivers, interest expense of $94 million was lower than $115 million in the prior quarter due to lower average repo rates and balances.
TBA dollar roll and CMBS coupon income of $99 million was lower than $114 million for the third quarter due to slightly more modest specialness in the fourth quarter.
We had increased expenses related to the net interest component of interest rate swaps of $67 million relative to $63 million in the prior quarter as the swap portfolio reset to lower market receive rates and two high strike receive swaps expired.
And finally, we experienced a continued improvement in G&A expenses.
On the financing front, our all-in average cost of funds this quarter was 87 basis points versus 93 basis points in the preceding quarter.
The fourth quarter brought the full-year average cost of funds to 1.34% versus 2.25% in the prior year.
Our weighted average days to maturity are down, compared with the prior quarter at 64 days versus 72.
Our Q4 weighted average days, slight reduction compared to Q3, results from the natural roll down from our longer-duration repo trades we executed in prior quarters.
Our treasury group's view in the latter part of last year was that term curve would continue to flatten.
What I can tell you is that we set this view based upon the Fed's forward guidance on remaining at the zero lower bound into 2023, as well as, a meaningful increase in already abundant reserves in the system in 2021 from both continued QE and a drawdown in treasury general account balances.
As we've entered the new year, this view has come to fruition as one year bilateral term repo for agency MBS can be locked in, in the upper high-teens currently.
Consequently, we are beginning to add duration to our repo book this quarter.
Concerning credit financing, we see further improvement in repo terms for our credit securities with increasingly lower hiccups and tighter spreads.
We have also renegotiated our warehouse facilities to support our direct lending businesses proactively and have realized cost savings accordingly.
The portfolio generated 198 basis points of NIM, down from 205 basis points as of Q3, driven primarily by the decrease in average asset yields and reduced dollar roll income offset by the decline in the cost of funds that I mentioned a moment ago.
And as a management team, we focus on providing value to our shareholders, including a keen eye on the company's expenses.
Having said that, we continue to see improvements in our efficiency ratios, being 1.27% of equity for the fourth quarter in comparison to 1.32% in Q3 of 2020 and 1.62% for the full year, compared to 1.84% for the prior year.
The 2020 annual opex results are within the range of expected cost savings disclosed in Q1 with our internalization transaction announcement.
And I would reiterate the 1.6% to 1.75% opex target we disclosed last year as an appropriate benchmark.
And to wrap things up, Annaly ended the quarter with an excellent liquidity profile with $8.7 billion of unencumbered assets, consistent with prior quarters of $8.8 billion, including cash and unencumbered agency MBS of $6.3 billion.
Lastly, before we move on to Q&A, I thought I'd provide broader perspective in two areas.
First, there is an abundance of metrics that underscore a growing disconnect between valuations and fundamentals.
Broadly, market indices are reaching historical records and consensus calls for them to continue to rise.
The S&P 500 at 40 times earnings, high-yield credit, and the proximity of all-time tight spreads and the $81 billion of SPACs raised last year as liquidity has flowed further out the portfolio balance channel.
Annaly, however, continues to be a source of responsible yield in a market where it's increasingly challenging to deploy capital.
As I mentioned at the outset, the fundamentals are positive for Annaly investors with a low-cost, stable financing environment, an upward sloping yield curve, low interest rate volatility, and a strong supply and demand backdrop for our assets.
We've seen our book value continue to strengthen into 2021 and have outearned our dividend for the past few quarters.
We are delivering a dividend yield of over 10%, in line with our historical average while the S&P 500 earnings yield of 2.5% is the lowest it's been in the past decade.
Annaly represents one of few countercyclical or acyclical yield strategies that are less at risk to the pace of economic recovery.
Additionally, we provide equity portfolio diversification without sacrificing returns while money market funds are zero and real treasury yields are at near-record lows.
As unforeseen events will once again shift investors focused to fundamentals, balance sheet strength and earnings stability will be coveted.
Now secondly, we have talked about leading with purpose this year in response to the trying societal and economic climate that marked 2020.
And at Annaly, our mission is to utilize our capital to generate attractive returns and support the American homeowner.
To that end, we have kept our focus on the individual needs of our borrowers and supported government policies to extend forbearance periods.
We have also used our human capital to meaningfully contribute to the communities where we live and work.
Through our corporate philanthropy initiatives, we have focused on partnerships with high-impact programs that seek to combat homelessness, provide food security, and advance women and underrepresented groups in the workforce.
Annaly employees have volunteered their time and energy to serve vulnerable New Yorkers in their hour of need and our culture of responsible investment with respect to where we invest, both our dollars and time is something we're very proud of, and it has undoubtedly yielded considerable impact for our overall stakeholders.
And with that, operator, we can open it up to Q&A.

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q4 gaap earnings per share $0.60.
core earnings (excluding paa) of $0.30 per average common share for quarter.

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