8-K: Two Harbors Investment Corp. Announces Fourth Quarter 2023 Financial Results

Two Harbors Investment Corp. reported a book value of $15.21 per common share and a quarterly economic return of 2.0% on book value for the fourth quarter of 2023.

Summary

• Two Harbors Investment Corp. reported a book value of $15.21 per common share at the end of the fourth quarter of 2023.
• The company declared a fourth quarter common stock dividend of $0.45 per share.
• The quarterly economic return on book value was 2.0%.
• Comprehensive income for the quarter was $38.9 million, or $0.40 per weighted average basic common share.
• Income Excluding Market-Driven Value Changes (IXM) was $0.39 per weighted average basic common share.
• Two Harbors issued 7.0 million shares of common stock through an at-the-market (ATM) offering program, generating $97.8 million in proceeds.
• The company repurchased 221,806 shares of preferred stock during the quarter.
• They settled $829.1 million unpaid principal balance (UPB) of MSR through flow-sale acquisitions.
• For the full year 2023, the company closed the acquisition of RoundPoint Mortgage Servicing LLC.
• Total dividends declared for 2023 were $1.95 per common share.
• The total economic return on book value for 2023 was (3.2)%.
• The company issued 17.1 million shares of common stock through both an underwritten offering and ATM program during the year.
• They repurchased 735,624 shares of preferred stock, contributing approximately $0.04 to book value per common share.
• Two Harbors settled $27.5 billion UPB of MSR through flow-sale acquisitions and bulk purchases in 2023.

Sentiment

Score: 5

Explanation: The sentiment is neutral to slightly negative. While the company highlights strategic moves and positive aspects of its portfolio, the significant net loss and negative annual economic return on book value temper the overall outlook. The company is navigating a challenging market environment, and the results reflect this.

Positives

• The company successfully navigated interest rate and spread volatility by actively managing its portfolio and increasing its allocation to MSR.
• Two Harbors strategically managed its capital structure through the issuance of common stock and repurchases of preferred stock.
• The acquisition of RoundPoint Mortgage Servicing LLC was completed, and the portfolio of MSR was transferred to their platform.
• The MSR portfolio is well-positioned to benefit from the current and expected market environments due to its lower mortgage spread duration.
• Prepayment speeds on the MSR portfolio slowed by approximately 20% in the fourth quarter.
• The company maintains a neutral leverage exposure.
• The MSR portfolio has low refinance incentive, which should keep prepayment rates low.
• The company remains optimistic about the return potential of its portfolio given the levered returns available in the market.
• The company has a strong balance sheet and diversified financing for both MSR and Agency RMBS.

Negatives

• The company experienced a net loss of $444.7 million attributable to common stockholders for the quarter.
• The annual economic return on book value was negative at (3.2)%.
• The company's GAAP net loss was $(4.56) per weighted average common share.
• Earnings Available for Distribution (EAD) was $(0.11) per weighted average basic common share.
• Operating expenses, excluding non-cash LTIP amortization and certain operating expenses, increased significantly to $40.2 million from $12.6 million in the previous quarter.
• The company's debt-to-equity ratio at period-end was 4.5:1.0, and the economic debt-to-equity ratio was 6.0:1.0.
• The company's comprehensive income was impacted by market-driven value changes.

Risks

• The company is exposed to risks associated with changes in interest rates and the market value of its assets.
• Changes in prepayment rates of mortgages underlying the company's target assets could impact performance.
• The company faces risks related to the rates of default or decreased recovery on the mortgages underlying its target assets.
• Declines in home prices could negatively affect the company's investments.
• The company's ability to establish, adjust, and maintain appropriate hedges for the risks in its portfolio is crucial.
• The availability and cost of target assets and financing are subject to market conditions.
• Changes in the competitive landscape within the industry could impact the company's performance.
• The company's ability to effectively execute and realize the benefits of strategic transactions is a risk.
• The company faces risks associated with operating a mortgage loan servicer following the acquisition of RoundPoint Mortgage Servicing LLC.
• Ongoing litigation related to the termination of the management agreement with PRCM Advisers LLC poses a risk.
• The company is exposed to various operational risks and costs associated with its business.
• Interruptions in or impairments to the company's communications and information technology systems could disrupt operations.
• The company's ability to acquire MSR and maintain its MSR portfolio is subject to market conditions.
• Deficiencies in the servicing or foreclosure practices of third parties and related delays in the foreclosure process could impact the company.
• The company is exposed to legal and regulatory claims.
• Legislative and regulatory actions affecting the business could impact performance.
• The impact of new or modified government mortgage refinance or principal reduction programs is a risk.
• The company's ability to maintain its REIT qualification is crucial.
• Limitations imposed on the business due to its REIT status and exempt status under the Investment Company Act of 1940 are risks.

Future Outlook

The company believes its portfolio, with less mortgage spread duration due to MSR, is well-positioned to benefit from current and expected market environments. They also plan to expand their third-party subservicing business, render cost savings and economies of scale, and develop a direct-to-consumer origination channel.

Management Comments

• We navigated extreme interest rate and spread volatility by actively managing our portfolio and increasing our allocation to MSR, stated Bill Greenberg, Two Harbors President and CEO.
• We also strategically managed our capital structure through the issuance of common stock and repurchases of preferred stock.
• Most notably, we closed the acquisition of RoundPoint Mortgage Servicing LLC, and transferred substantially all of our portfolio of MSR to their platform.
• Looking ahead to 2024, we believe that our portfolio, with less mortgage spread duration than portfolios without MSR, is very well positioned to benefit from the current and expected market environments.
• In a volatile fourth quarter, mortgage spreads and implied volatility remained positively correlated to interest rates, while prepayment speeds on our MSR slowed by approximately 20%, stated Nick Letica, Two Harbors Chief Investment Officer.
• Given the levered returns available in the market for our combined strategies, we remain optimistic about the return potential of our portfolio.

Industry Context

The announcement reflects the current market conditions with high interest rate volatility and the strategic importance of MSR in managing risk. The company's focus on MSR and its operational platform aligns with the trend of REITs seeking stable cash flows and diversified revenue streams in a challenging market environment. The company's comments on agency spreads being at the tighter end of the recent range also reflects the current market conditions.

Comparison to Industry Standards

• Two Harbors' strategy of combining Agency RMBS and MSR is a common approach among mortgage REITs seeking to balance risk and return, similar to companies like AGNC Investment Corp. and Annaly Capital Management.
• The company's focus on managing interest rate risk through hedging is a standard practice in the industry, comparable to how other REITs manage their portfolios.
• The acquisition of RoundPoint Mortgage Servicing LLC is a strategic move to internalize servicing operations, which is similar to what some larger REITs have done to control costs and improve efficiency.
• The reported economic return on book value of 2.0% for the quarter is within the range of what other mortgage REITs have reported, but the annual return of (3.2)% is below average, indicating challenges in the past year.
• The company's debt-to-equity ratio of 4.5:1.0 and economic debt-to-equity ratio of 6.0:1.0 are within the typical range for mortgage REITs, but the economic ratio is on the higher end, indicating a more leveraged position.
• The company's MSR portfolio with a weighted average coupon of 3.45% and low refinance incentive is similar to other REITs that have invested in MSR with the expectation of stable cash flows.
• The company's focus on reducing exposure to mortgage spread sensitivity and migrating to lower coupon RMBS is a common strategy to manage risk in a volatile market, similar to what other REITs have done.

Legal Proceedings

• The company is involved in ongoing litigation related to the termination of its management agreement with PRCM Advisers LLC.

Stakeholder Impact

• Shareholders experienced a decrease in book value per share and a negative annual economic return on book value.
• Employees are impacted by the integration of RoundPoint Mortgage Servicing LLC and changes in operational structure.
• Customers may experience changes in servicing as the company transitions its MSR portfolio to RoundPoint.
• Suppliers and creditors are impacted by the company's financial performance and strategic decisions.

Next Steps

• The company plans to continue actively managing its portfolio and capital structure.
• They will focus on expanding their third-party subservicing business.
• They aim to render cost savings and economies of scale.
• The company intends to develop a direct-to-consumer origination channel.
• The 10th scheduled subservicing transfer of Two Harbors MSR to RoundPoint is planned for February 1, 2024.
• The final clean up transfer of loans is planned for early June 2024.
• The company will host a conference call on January 30, 2024, to discuss the results.

Key Dates

Keywords

Mortgage Servicing Rights, MSR, Agency RMBS, Real Estate Investment Trust, REIT, Mortgage-Backed Securities, Interest Rates, Prepayment Rates, Book Value, Dividends, RoundPoint Mortgage Servicing, Financial Results, Leverage, Derivatives, TBA