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AUGUST 2, 2011

EXECUTIVE INSIGHTS

Opening remarks to Annaly's 2011 second quarter earnings call

The Face that Launched a Thousand Ships, or In This Case, Bankers

The title of this note is taken from the 16th century play "Doctor Faustus" by Christopher Marlowe. It is the iconic story about a man who trades his soul in exchange for power and knowledge. Faust uses this phrase when expressing his desire for the most beautiful woman in history, Helen of Troy.

The legendary Helen, considered a Greek treasure, was so beautiful that wars were fought over her. Homer's Iliad describes the theft of Helen by the Trojan prince, Paris, from the Greek province ruled by her husband, Menelaus. Menelaus and the Greeks tried to get her back during the decade-long Trojan War, one of the greatest organized sieges in history that finally ended with the infamous ruse of the Trojan Horse. The rest is history: Cassandra warned the Trojans not to keep the gift brought by the Greeks, but she was ignored and the soldiers hidden in the belly of the giant wooden horse came out at night, opened up the city gates to let in the soldiers who ransacked the city and massacred the sleeping population. These stories are rich with metaphorical possibilities as it relates to the present-day situation in sovereign credits. I am going to use all of them today. Let's presume that the treasure of Greece is not Helen but its national assets, and the Euro is the Trojan Horse. The promise of the beauty of cheap money and the consumption benefits that emerged from it drew Greece into a siege that may end with the release of its treasure--islands, buildings, national companies, its economic way of life--or risk a long, costly siege from neighboring nations, creditors and rating agencies. The Euro took about 10 years to create this position for Greece, the Trojan War took about 10 years. The only question today is which re-structuring will the diplomats accept. As I write this, economic conditions in Greece are worsening: Interest rates are pricing in a default, companies are not shipping goods to Greek destinations, hospitals are not receiving supplies from big pharma and the requisite strikes are occurring as the bill for the last ten years of cheap money is now being delivered. Marlowe's play suggests a different metaphor. The Euro represents temptation and Doctor Faustus is Europe, so obsessed with the pursuit of knowledge and the power it brings that he calls on Mephistopheles to give him the power to rule, to heal others through science and to resurrect Helen in return for acceptance of eternal damnation.

Michael A.J. Farrell Chairman, CEO and President

As I write this, economic conditions in Greece are worsening: Interest rates are pricing in a default, companies are not shipping goods to Greek destinations, hospitals are not receiving supplies from big pharma and the requisite strikes are occurring as the bill for the last ten years of cheap money is now being delivered.

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Annaly Capital Management, Inc. | Executive Insights 1

The more he bargains the deeper in debt he gets. His desires become so intertwined that he loses the ability to negotiate his grand Faustian bargain and loses his soul. Faust is still obsessed with the power of the Euro and the relative benefit that it has given it in the export markets, and is desperately trying to hold together the Eurozone by throwing more and more debt at the problem. All politicians eventually learn that their people become tired of the monetary and human costs of the bargain and they will lose their souls through revolt either physically or in the voting booth. Just ask the people of Iceland. For over 2000 years, most people believed that the city of Troy was a figment of Homer's imagination and that the story of the Trojan War and Helen were legends linked to Greek mythology. It turns out the legend may be rooted in history. One of the first books I ever read was on archeology and the discovery of Troy in 1871 by a German amateur archaeologist named Heinrich Schliemann. His identification of the city's walls, consistent with Homer's descriptions in the poem, convinced the world that the Iliad might be more than an epic novel; it may actually be a historical document. The city was buried below seven other cities that were built over it after the destruction in Helen's time. Over time, urns and other artifacts describing Helen and Paris have emerged. It seems hardly a coincidence that on June 29th, the day that the Greek Parliament voted on the austerity measures, a lightning bolt-probably thrown in frustration by Zeus--nearly hit the Parthenon. If you do a clockwise turn to look at it from a Y-axis viewpoint, it looks a lot like the Greek yield curve.

It seems hardly a coincidence that on June 29th, the day that the Greek Parliament voted on the austerity measures, a lightening bolt-probably thrown in frustration by Zeus-nearly hit the Parthenon. If you do a counterclockwise turn to look at it from a Y-axis viewpoint, it looks a lot like the Greek yield curve.

Greek Bond Yield Curve

45 40 35 30 25 20 15 10 5 0 10 year 15 year 3 months 6 months 30 year 1 year 2 year 3 year 4 year 5 year 6 year 7 year 8 year 9 year

Source: Bloomberg

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Annaly Capital Management, Inc. | Executive Insights 2

In all seriousness, the point of all this is that history teaches us much, and we are prone to repeat it. The price of mortgaging the future is incredibly transparent in the relatively small economies of Greece, Portugal, Ireland, Italy, Spain. It is a Faustian promise of an easy life, sprinkled liberally with the open-ended debt restructuring. It is much more opaque in the more complex economies of France, Germany, the UK and here in the US, nevertheless, it is still present and creeping towards judgment day. To stay with my metaphors, we have dragged into the front gates of capitalism a Trojan horse of amend, extend and pretend, quantitative easing and austerity promises that cannot be kept. Inside it is the main weapons of capitalism--capitulation, creative destruction and the repricing of risk, and they are just waiting for their moment to be released. Today's metaphorical Trojans will be twice as surprised by the wreckage of their sovereignty. America is hardly immune, as our sovereign credit moves into unknown territory. As we have discussed on prior communications and earnings calls, the mortgage market has been Cassandra: the correction of spreads on asset opportunities has been predicting this outcome since 2008. The evidence of this is offered in the accompanying chart that demonstrates the performance of Agency current coupon mortgages versus the Canadian covered bond market credit. The market has already adjusted the American mortgage market to wider spreads, allowing us to capture lucrative opportunities against funding rates.

Covered Bond

The market has already adjusted the American mortgage market to wider spreads, allowing us to capture lucrative opportunities against funding rates.

5 4.5 4 1.550 3.5 1.350 3 2.5 1.150 1.950

1.750

2

0.950

1.5

11/10/2009 1/25/2011 1/27/2011 3/24/2011 4/14/2010 7/29/2010 10/29/2010 7/27/2011 6/9/2010 7/2/2010

0.750

CC/Cov. Bond

Source: Bloomberg

Cov. Bond Yield

Current Coupon

Like the Cassandra of legend, will the mortgage market suffer the frustration of having her prophecy ignored? I don't think so. I think that the world is figuring out that Cassandra has been correct, and that the mortgage market has already adjusted to the new realities facing America. Informed investors recognize that they should invest in markets that have already corrected and adjusted to the new fundamentals. In closing, I think that maybe the mortgage market is more like Heinrich Schliemann, who dug down through seven layers of history and proved that myths can turn out to be fact.

Annaly Capital Management, Inc. | Executive Insights

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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities, including securities of Annaly Capital Management, Inc. or any other company, or to adopt any investment strategy. All information and opinions contained herein are derived from proprietary and nonproprietary sources believed to be accurate and reliable. However, such information is presented "as is" without warranty of any kind, and we make no representation or warranty, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use, and we do not undertake to advise you of any changes in the views expressed herein. While we have attempted to make the information current at the time of its release, it may be or become outdated, stale or otherwise subject to a variety of legal qualifications as conditions change. No representation is made that we will or are likely to achieve results comparable to those shown if results are shown. Reliance upon information in this material is at the sole discretion of the reader. ©2011 by Annaly Capital Management, Inc./FIDAC/Merganser. All rights reserved. No part of this commentary may be reproduced in any form and/or any medium, without our express written permission. © 2011 by Annaly Capital Management, Inc./FIDAC. All rights reserved.

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