Earnings call transcript: Two Harbors Q3 2025 reveals unexpected loss

Two Harbors Investment Corp. reported a significant unexpected loss in its Q3 2025 earnings call, with earnings per share (EPS) of -$1.36, starkly missing the forecasted $0.35. The company’s comprehensive loss reached $80.2 million, or $0.77 per share. Following the announcement, Two Harbors’ stock price fell by 1.99% to $9.64 in premarket trading. According to InvestingPro data, the company maintains a significant 14.14% dividend yield despite recent challenges, though dividend growth has declined by 24.44% in the last twelve months.

Key Takeaways

• Two Harbors reported a comprehensive loss of $80.2 million for Q3 2025.
• The company’s EPS of -$1.36 was a substantial miss from the expected $0.35.
• Stock price dropped by 1.99% in premarket trading after the earnings release.
• Two Harbors is expanding its sub-servicing business to approximately $40 billion UPB.

Company Performance

Two Harbors Investment Corp. faced a challenging Q3 2025, reporting a total economic return of -6.3%, which includes expenses from a litigation settlement. Despite these setbacks, the company managed to increase its book value by approximately 1% and achieved marked-to-market gains of $111.3 million. InvestingPro analysis indicates the company’s financial health score is currently rated as ’FAIR’, with a beta of 1.32 suggesting higher volatility than the market. The company continues to focus on expanding its sub-servicing business and leveraging technology to enhance customer experience. For deeper insights into Two Harbors’ financial health and valuation metrics, investors can access the comprehensive Pro Research Report, available exclusively to InvestingPro subscribers.

Financial Highlights

• Revenue: -$23.51 million
• Comprehensive loss: $80.2 million, or $0.77 per share
• Net interest and servicing income increased by $2.8 million
• Book value rose approximately 1%

Earnings vs. Forecast

Two Harbors’ actual EPS of -$1.36 fell short of the forecasted $0.35, marking a surprise of -488.57%. This significant miss represents a deviation from the company’s previous performance trends and suggests potential challenges in its strategic execution.

Market Reaction

Following the earnings announcement, Two Harbors’ stock price declined by 1.99% to $9.64 in premarket trading. This movement reflects investor concerns over the unexpected earnings miss and its implications for the company’s financial health. The stock is trading near its 52-week low of $9.49, indicating a cautious market sentiment.

Outlook & Guidance

Looking ahead, Two Harbors remains optimistic about its mortgage spreads and investment opportunities. The company projects a potential static return on common equity of 9.5% to 15.2%, with a prospective quarterly static return per share of $0.26 to $0.42. Two Harbors is also continuing to grow its direct-to-consumer originations platform, aiming to capitalize on favorable market conditions.

Executive Commentary

CEO Bill Greenberg stated, "We are confident that after all of our portfolio adjustments, we will continue to be well-positioned to execute on our MSR-focused investment strategy." CIO Nick Letica added, "Returns remain attractive and supportive of our core strategy of low mortgage rate MSR paired with agency RMBS."

Risks and Challenges

• Litigation settlement costs impacting financial results.
• Potential volatility in mortgage rates affecting MSR valuations.
• Execution risk in expanding the sub-servicing business.
• Market conditions influencing investment opportunities.
• Competitive pressures in the mortgage servicing sector.

Q&A

During the earnings call, analysts raised questions about Two Harbors’ MSR sales strategy and its approach to coupon positioning and portfolio management. The company also addressed the potential impact of lower interest rates on MSR valuations and highlighted improvements in its technology for recapture capabilities.

Full transcript - Two Harbors Investment Corp (TWO) Q3 2025:

Taryn, Conference Facilitator: Good morning. My name is Taryn, and I will be your conference facilitator. At this time, I would like to welcome everyone to the Two Harbors Investment Corp. third quarter 2025 earnings call. All participants will be in a listen-only mode. After the speakers’ remarks, there will be a question and answer period. I would now like to turn the call over to Margaret Karr.

Margaret Karr, Investor Relations, Two Harbors Investment Corp.: Good morning, everyone, and welcome to our call to discuss Two Harbors Investment Corp. third quarter 2025 financial results. With me on the call this morning are Bill Greenberg, our President and Chief Executive Officer, Nick Letica, our Chief Investment Officer, and William Dellal, our Chief Financial Officer. The earnings press release and presentation associated with today’s call have been filed with the SEC and are available on the SEC’s website, as well as the investor relations page of our website at twoharborsinvestment.com. In our earnings release and presentation, we have provided reconciliations of GAAP to non-GAAP financial measures, and we urge you to review this information in conjunction with today’s call. As a reminder, our comments today will include forward-looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectations.

These are described on page two of the presentation and in our Form 10-K and subsequent reports filed with the SEC. Except as may be required by law, Two Harbors Investment Corp. does not update forward-looking statements and disclaims any obligation to do so. I will now turn the call over to Bill.

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Thank you, Maggie. Good morning, everyone, and welcome to our third quarter earnings call. In August, we reached a settlement in the litigation with our former external manager, arising from our internalization in 2020. In particular, we agreed to make a one-time payment of $375 million in exchange for a release of all claims, including ownership claims related to our intellectual property. The settlement payment was funded through a combination of portfolio sales, cash on hand, and available borrowing capacity. Importantly, we continue to have ample liquidity following the payments, and our risk metrics are in line with how we have managed the portfolio historically. With this matter now fully behind us, we are glad to move forward with clarity and certainty of purpose.

During the quarter, we took a number of steps to adjust our portfolio, largely on a pro-rata basis to address our lower capital base and higher structural leverage. We sold some agency securities, bringing the RMBS portfolio to $10.9 billion from $11.4 billion. We also sold $19.1 billion UPB of MSR and another approximately $10 billion of UPB that will settle at the end of this month, in both cases slightly above our marks. Furthermore, these sales were done on a servicing-retained basis with a new sub-servicing client, establishing a significant and important relationship. These transactions validate our efforts to meaningfully grow our third-party sub-servicing business and confirm the thesis that we envisioned when we first acquired RoundPoint, specifically that given our history as MSR investors, we are an ideal sub-servicing partner for other MSR owners.

With those additions, we will have roughly $40 billion of true third-party clients using RoundPoint as a sub-servicer. In addition, RoundPoint will soon be set up to service Ginnie Mae loans too, allowing further growth in our sub-servicing business. Additionally, we intend to redeem the full $262 million UPB of our outstanding convertible notes when they mature in January 2026, which will reduce our structural leverage to be in line with historical levels. We plan to fund this redemption with cash on hand and by drawing down our MSR facilities. If we were to pay down the convertible note today, we would still have in excess of $500 million of cash on our balance sheet. Lastly, the reduction in our capital base has also had the effect of increasing our expense ratio.

While we are always intently focused on improving efficiencies and lowering costs, we are acutely aware of the impact today. We have already undertaken efforts to reduce our cost structure in light of the settlement payments, and we have line of sight into significant amounts of savings already. We will have more to say about this in coming quarters. We are confident that after all of our portfolio adjustments, we will continue to be well-positioned to execute on our MSR-focused investment strategy to enhance and grow our servicing and origination activities and to deliver long-term value for our stockholders. Please turn to slide three. For the third quarter, including the litigation settlement expense of $1.68 per share, we experienced a total economic return of negative 6.3% and a positive 7.6% without the expense.

For the first nine months of the year, this results in a total economic return on book value of negative 15.6% and positive 9.3% excluding the expense. Please turn to slide four. Performance across the fixed income market was positive in the third quarter. Though inflation readings continue to run above the Fed’s target and the full impact of recent increases to tariffs on forward inflation were still unclear, the Fed cut rates by 25 basis points in September, the first cut since November 2024, as Chair Powell cited emerging downside risks in the labor market. The Fed’s own guidance of another 50 basis points of cuts by year-end aligned with the market consensus, as you can see in the blue line in figure one.

Net changes across the yield curve were small over the quarter, as you can see in figure two, with two-year yields lower by 11 basis points to 3.61 and 10-year yields down by 8 basis points to 4.15. Equity markets were also buoyed by Fed cuts, with the S&P 500 up almost 8% by quarter-end after setting all-time record highs early in the quarter. Please turn to slide five. As I mentioned earlier, in the third quarter, we signed a term sheet with a new sub-servicing client, which will bring our combined sub-servicing UPB to approximately $40 billion and will bring the total of our own servicing down to approximately $165 billion. We are particularly encouraged by the robust growth in our direct-to-consumer originations platform, especially since most of our portfolio is not economically incentivized to move or refinance.

Our originations team recorded the most ever locks for the month of September, and in the third quarter, we funded $49 million of UPB in first and second liens, which gives us increasing confidence that our DTC efforts are working as intended and can provide a meaningful pickup in portfolio recapture and economic returns. Indeed, at quarter-end, we had an additional $52 million UPB in our origination pipeline. Additionally, we brokered $60 million UPB in second liens in the quarter, a significant pickup from the $44 million we did in Q2 and also a record high for us at RoundPoint. As interest rates have trended lower post-quarter end, we are very optimistic about the additional value that RoundPoint can bring to shareholders. Lastly, I want to mention again the improvements that we are making in the technology platform at RoundPoint.

AI and other applications continue to allow us to improve customer and borrower experiences and quality. These efforts allow us to achieve more economies of scale and to recognize the benefits of our investments immediately, which are important components of our drive to reduce servicing and corporate costs. Looking ahead, we now have a clean slate to capitalize on opportunities in our MSR and MBS portfolio and to drive growth in servicing and originations. We believe that with our stock trading at a discount to book, it is significantly undervalued. With the uncertainty created by the litigation behind us, with the quality of assets that we hold, and with several of our peers trading at premiums to book, we see no reason why we should trade at an 11% discount to book as we were at quarter ends.

We still see mortgage spreads as being very attractive despite the recent tightening. However, we view the risks to MBS performance as being symmetric and therefore very supportive of our strategy in particular with its large allocation to hedged MSR, which is designed to have less sensitivity to fluctuations in mortgage spreads than portfolios without MSR. We are very optimistic about the attractive investment opportunities available in the market for our strategy. With that, I’d like to hand the call over to William to discuss our financial results.

William Dellal, Chief Financial Officer, Two Harbors Investment Corp.: Thank you, Bill. Please turn to slide six. This quarter, in connection with the settlement agreement with our former external manager, we recorded the $175.1 million litigation settlement expense, or $1.68 per weighted average common share. This expense is the difference between the $375 million cash payment made to our former external manager, less the related loss contingency accrual recorded in the second quarter of $199.9 million. You can see this reflected on this slide in the call-out boxes. Including this expense, our return on book value is a negative 0.63%. Excluding this expense, our return on book value would have been a positive 7.6%. Please turn to slide seven. Including the litigation settlement expense, the company incurred a comprehensive loss of $80.2 million, or $0.77 per share. Excluding the expense, we would have generated comprehensive income of $94.9 million, or $0.91 per share.

Net interest and servicing income, which is the sum of GAAP net interest expense and net servicing income before operating costs, was slightly higher in the third quarter by $2.8 million, driven by higher float and servicing fee income and lower financing costs. This was partially offset by lower interest income on agency RMBS. Marked to market gains and losses were higher in the quarter by $111.3 million. As a reminder, this column represents the sum of investment securities net gains and losses and change in OCI, net swap and other derivative gains and losses, and net servicing asset gains and losses. In the third quarter, we experienced marked to market gains on agency RMBS, TVAs, and swaps, partially offset by marked to market losses on MSR and futures.

You can see the individual components of net interest and servicing income and marked to market gains and losses on appendix slide 21. Please turn to slide eight. On the left-hand side of the slide, you can see a breakdown of our balance sheet at quarter end. After the litigation settlement payment of $375 million and after the sale of $19.1 billion UPB of MSR, we ended the quarter with cash on balance sheet of $770.5 million. As Bill mentioned, we plan to redeem the full $261.9 million of our outstanding convertible notes when they mature on January 15th, 2026. As a reminder, in the second quarter, we defeased part of this maturing debt with the issuance of a baby bond for net proceeds of $110.6 million. Until the maturity of the convertible notes, we will use the cash on balance sheet to lower our MSR borrowings.

RMBS funding markets remained stable and available throughout the quarter, with repurchase spreads at the rate so far plus 20 bps. At quarter end, our weighted average days to maturity for our agency RMBS repo was 88 days. We financed our MSR, including the MSR asset and related servicing advance obligations, across six lenders with $1.7 billion of outstanding borrowings under bilateral facilities. We ended the quarter with a total of $939 million in unused MSR asset financing capacity. Our servicing advances are fully financed, and we have an additional $78 million in available capacity. I will now turn the call over to Nick.

Nick Letica, Chief Investment Officer, Two Harbors Investment Corp.: Thank you, William. Please turn to slide nine. Our portfolio at September 30 was $13.5 billion, including $9.1 billion in settled positions and $4.4 billion in TVAs. After adjusting the portfolio for our lower capital base, we slightly increased our economic debt to equity to 7.2 times. We are comfortable with this current leverage level. Though spreads have contracted, they still look attractive on a levered basis versus swaps, especially in the context of diminished interest rate and spread volatility. Furthermore, positive demand technical, such as robust flows into bond funds and buying by REITs, are likely to persist as the Fed continues to cut interest rates. That said, spreads have normalized quite a bit, and while they are less volatile, we see spread changes to be more two-sided.

Consequently, by quarter end, we reduced the portfolio’s sensitivity to spread changes from 4.2% to 2.3% of common book value if spreads were to tighten by 25 basis points, which you can see in chart three. This quarter, despite leverage increasing, we actually reduced our risk exposure. You can see more details on our risk exposures on appendix slide 18. Please turn to slide 10. Given the stability of rates and broad consensus that the Fed is on a gradual path toward lowering rates further, implied volatility declined to its lowest level since mid-2022. As you can see in figure one, our preferred volatility gauge of two-year options on 10-year swap rates, shown by the green line, closed the quarter at 84 basis points, down 10 basis points, and back to just above its average level over the past 10 years.

If you look back to 2022 when volatility was last here, spreads versus swaps were tighter. We see attractive static returns with volatility at this level between 15% and 19% for the securities portion of our portfolio, which we will see in the return potential slide shortly. RMBS performance was positive across the 30-year coupon stack, with the best performance concentrated in the belly coupons, such as four and a halves and fives. The excess return of the Bloomberg U.S. mortgage-backed securities index was positive 82 basis points, the best performance since Q4 2023. You can see spreads across the curve both nominally and on an option-adjusted basis in figure two. During the quarter, the nominal spread for current coupon RMBS tightened by 26 basis points to 145 basis points to the swap curve, while option-adjusted spreads finished 14 basis points tighter at 67 basis points.

Please turn to slide 11 to review our agency RMBS portfolio. Figure one shows the performance of TVAs and specified pools we owned throughout this quarter. Specified pools outperformed TVAs, led by four and a halves and fives. We rotated the portfolio down in coupon, reducing our six to six and a half position in TVAs and specified pools by approximately $1.8 billion and increased our five to five and a half position by approximately $1.6 billion. We also opportunistically sold approximately $1.3 billion of specified pools versus TVAs across several coupons. You can see this detail on appendix slide 17. We have continued this downward rotation into this quarter as the rally in rates continues. In September, primary mortgage rates dropped to their lowest levels of 2025, finishing the quarter for a sustained period around 6.25%, aided by the drop in U.S.

Treasury rates, as well as a strong performance of current coupon RMBS spreads and firm primary secondary mortgage spreads. We are seeing the effects of the rate drop on refinancing activity, with large month-over-month increases for refinanceable coupons prepayment speeds, as reported in early October. Thus far, the pickup in speeds has followed the pattern seen in recent prepayment episodes, such as when rates dropped about a year ago. With rates remaining about here, we expect to see further pickups in speeds as borrower refinance activity fully works its way through closings. Figure two on the bottom right shows our specified pool prepayment speeds by coupon, which, despite the drop in primary rates, decreased to 8.3% from 8.6% CPR.

This is a result of having the majority of our pool holdings in lower coupons, as well as in call-protected securities that did not experience the large increases seen for generic collateral. Please turn to slide 12. You can see that the volume of MSR in the bulk market has remained lower than in prior years. The market continues to be well-subscribed, with bank and non-bank portfolios continuing to compete for greater scale in MSRs. Figure two is a chart we periodically update, which shows that with mortgage rates at their current level, still only about 3% of our MSR portfolio is considered in the money. If mortgage rates were to drop to 5%, the portion of our portfolio in the money would rise to about 9%.

As Bill highlighted, RoundPoint’s direct-to-consumer originations platform has been growing, consistent with the market opportunity to recapture loans in our portfolio that may refinance. When interest rates dropped in September, we saw the benefits of these efforts, and our platform is poised and ready to do more. Please turn to slide 13, where we will discuss our MSR portfolio. Figure one is an overview of our portfolio at quarter end, further details of which can be found on appendix slide 24. In the second quarter, we settled about $700 million from flow acquisitions. As Bill said, we also committed to sell approximately $30 billion UPB of low-gross WAC MSR on a servicing-retained basis as part of our portfolio reallocation.

Being able to sell it retained with a large new sub-servicing client benefits us not only by being able to leave those loans at RoundPoint and retain the economies of scale, but also gives us an important lever in efficiently managing our assets. Though we like our MSR portfolio, should we want to redeploy capital away from low-gross WAC MSR into, say, high-gross WAC MSR, selling it to a sub-servicing client is ideal. The price multiple of our MSR was down slightly quarter over quarter to 5.8 times, in line with the drop in mortgage rates, and 60-plus-day delinquencies remain low at under 1%. Figure two compares CPRs across implied security coupons in our portfolio of MSR versus TVAs. Quarter over quarter, our MSR portfolio experienced a de minimis pickup in prepayment rates to 6%.

Importantly, prepays have remained below our projections for the majority of our portfolio, which is a positive tailwind for returns. Finally, please turn to slide 14, our return potential and outlook slide. This is a forward-looking projection of our expected portfolio returns, which incorporates all of our recent portfolio adjustments. Please note, while the $262 million convertible note is shown in the table, the projections assume that it is redeemed at its maturity in January. As you can see on this slide, the top half of the table is meant to show what returns we believe are available on the assets in our portfolio. We estimate that about 68% of our capital is allocated to servicing, with a static return projection of 11% to 14%. The remaining capital is allocated to securities, with a static return estimate of 15% to 19%.

With our portfolio allocation shown in the top half of the table and after expenses, the static return estimate for our portfolio would be between 9.1% to 12.6% before applying any capital structure leverage to the portfolio. After giving effect to our unsecured notes and preferred stock, we believe that the potential static return on common equity falls in the range of 9.5% to 15.2%, or a prospective quarterly static return per share of $0.26 to $0.42. With agency securities showing a higher range of prospective static returns than MSR, astute investors might ask the question as to why we don’t sell more MSR and rotate into MBS. One reason is that the marginal cost of owning MSR is lower than its average cost, and so lowering our exposure there would have the effect of increasing costs.

Another reason is that we believe that the quality of the returns on the MSR side is higher, mostly consisting of very low-rate, easy-to-hedge cash flows with lower convexity risk than MBS. While we do think there is a lot of opportunity in MBS, especially given the level of implied volatility, we think our capital allocation is just where we want it to be. To conclude, returns remain attractive and supportive of our core strategy of low mortgage rate MSR paired with agency RMBS. The MSR market continues to benefit from historically high levels of interest and participation from bank and non-bank originators and investors. Though mortgage rates have dropped and prepayment rates for refinanceable coupons are on the rise, our low mortgage rate MSR portfolio remains hundreds of basis points out of the money.

Thus far, the exposure the portfolio has to higher-rate, newer production servicing has grown very modestly. Given RoundPoint’s capability to refinance and recapture these loans, we look forward to continued growth in this part of our MSR portfolio. We continue to be optimistic that our portfolio construction of MSR paired with agency RMBS should generate attractive risk-adjusted returns for a wide range of market scenarios. Thank you very much for joining us today, and now we will be happy to take any questions you might have.

Taryn, Conference Facilitator: If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speaker phone, please make sure that your mute function is turned off to allow your signal to reach our equipment. Again, you may press star one to ask a question. We’ll pause for just a moment to allow everyone an opportunity to signal. We’ll take our first question from Bose Thomas George with Keefe, Bruyette & Woods. Please go ahead.

Bose George, Analyst, Keefe, Bruyette & Woods: Hey, everyone. Good morning. What are the key drivers of the increase in the EAD in the third quarter relative to the second quarter? Can you just remind us what are the drivers that take you from the low end to the high end of your guided range?

William Dellal, Chief Financial Officer, Two Harbors Investment Corp.: Hi, Boze.

Bose George, Analyst, Keefe, Bruyette & Woods: Sure.

William Dellal, Chief Financial Officer, Two Harbors Investment Corp.: On the EAD, I think it’s the, if we look at the cost of our financing asset, financing securities, that’s what has come down to allow the EAD to go up. The asset yields on EAD are roughly constant, but the financing rates have come down. Of course, there’s no mark to market, so this is just as a result of rejiggering the portfolio.

Bose George, Analyst, Keefe, Bruyette & Woods: Just as a follow-up to that, with short rates coming down, you know, as the Fed cuts, does that trend continue or just in terms of what happens to the EAD over the next, say, quarter or two?

William Dellal, Chief Financial Officer, Two Harbors Investment Corp.: I don’t think it’s a trend that will continue. It’s largely as a result of the change in the mix of the liabilities between TBAs and the financing on TBAs and spec pools.

Bose George, Analyst, Keefe, Bruyette & Woods: Okay. Great. Thanks. Can you give us an update on your book value quarter to date?

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Yeah, sure. Good morning, Bose. As of last Friday, our book value was up about 1%.

Bose George, Analyst, Keefe, Bruyette & Woods: Great. Thanks.

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Thanks, Boze.

Taryn, Conference Facilitator: We’ll take our next question from Douglas Michael Harter with UBS Investment Bank. Please go ahead.

Thanks. I know leverage is just one metric you look at, but can you talk about the various risk metrics as you think about the size of the portfolio, kind of following the settlement?

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Sure. Hey, Doug. This is Nick. Thank you for the question. As you know, we look at a lot of risk metrics in managing the portfolio, and as I said in my prepared remarks, this quarter, our economic debt to equity did go up while we, by quarter end, had taken down our overall spread risk. It’s a slew of things that we look at when we manage a portfolio. It’s clearly first and foremost, the returns that are available on the asset classes that we have in the portfolio and what seems to be the ideal mix in the context of the market that we are in. All of those kind of things come into play, whether it’s the amount of leverage that’s available in the market, the financing rates clearly, but just most importantly, the asset yields versus the risk that each security sector has.

Each quarter and each and every day, we look to maximize the return that we can generate from the portfolio versus the amount of risk that each asset has.

Yeah, I might just add here, Doug, you know, Nick made a comment in his prepared remarks about the difference between, you know, leverage ticking up a little bit while our mortgage spread risk went down. Right? That’s a good example of not being too focused on one metric versus another. Both of those things are important as we look at the overall leverage, the overall liquidity, overall what I will call drawdown risk, different scenario analyses that we look at depending on volatility of interest rates and volatility of spreads and so forth. All of those things get mixed into our decisions about how we manage the risk of the portfolio, especially in the context of the returns available as Nick said.

Thanks. Bill, you mentioned that you were looking at, you know, to try to implement some cost saves on the corporate expense side. On your return potential slide, does that factor in potential cost saves, or is that, you know, kind of where your costs are today?

No, that’s where they are today.

There would be potential upside to that number as those cost saves are realized?

Yes, I think so.

Great. Thank you.

Taryn, Conference Facilitator: We’ll take our next question from Richard Barry Shane with JPMorgan Chase & Co. Your line is now open.

Richard Shane, Analyst, JPMorgan Chase & Co.: Hey, guys. Thanks for taking my question this morning.

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Sure.

Richard Shane, Analyst, JPMorgan Chase & Co.: In looking at chart or slide 17, what stands out to me is that for the third quarter in a row at least, you are tactically net short the coupon 50 basis points below the coupon where you are. You have the highest concentration. Can you help us understand, again, as an equity guy, I’m just trying to understand what’s going on there, what drives that strategy?

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Hey, Rick. Thank you for that question. A lot of what drives that coupon exposure, and we do manage it, of course, but it is how rates move and where the current coupon sits relative to our risk exposures and our MSR and the rest of our portfolio. As rates rally, you can see in that table, we do show what we believe is the effective offset to our mortgage loans by the current coupon exposure of the MSR and other negatively derated assets in our portfolio. As rates rally, that negative number migrates down in coupon, and we manage that through time.

As I said in my prepared remarks, we had gone down in coupon in terms of our mortgage holdings, and a lot of that was just in response to the fact that rates are rallying and we need to offset the current coupon risk in our MSR portfolio as that happens. I will say that we don’t get overly, the word I used, I think the word I typically use is fussed with a 50 basis point coupon swap. There are times when there can be an extreme value difference in 50 basis points, but the truth of the matter is that we sort of look at these risks a little bit on a bucketed basis, and it’s not, there’s not really a, I wouldn’t say that there’s a strong strategic reason why that 50 basis point exposure is the way it is.

It’s just looking at the overall context of where spreads are and where spec pools are for those respective coupons and managing that risk on an overall basis. We try to keep the exposure relatively tight around those current coupons because if tomorrow we walked in and rates were up 25 basis points, that exposure and our MSR would shift up in coupon, and that chart would change to a reasonable degree. We kind of look at it in that sense of nearby coupons rather than just looking at a specific coupon, if that makes sense.

Richard Shane, Analyst, JPMorgan Chase & Co.: It totally does. It’s very helpful, and I have learned two new words to add to my mortgage glossary, derated and fuss. I appreciate all of that, and thank you for taking my questions this morning.

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Thank you.

Thanks, Rick.

Taryn, Conference Facilitator: We’ll take our next question from Trevor John Cranston with Citizens JMP Securities. Your line is now open.

Hey, thanks. Good morning. Can you guys give us a little bit of color in terms of what you’re seeing on growth opportunities of the sub-servicing business? In particular, I guess I’m curious if you think further growth in sub-servicing is likely to be in combination with MSR sales like we saw this quarter, or if you’re seeing other opportunities beyond that. Thanks.

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Yes, thanks very much for the question. I think growing a sub-servicing business typically takes a long time. These are pretty sticky relationships that people have with their sub-servicers. We’ve been doing the hard work of maintaining and developing relationships and explaining to the world why we are an ideal partner for this sort of thing. I think as other consolidation has occurred in the sub-servicing market, there are opportunities for us to pick up either some clients that are dissatisfied with their current sub-servicer or people who might feel that they have too much concentration risk as the number of sub-servicers in the world has decreased.

We’re out there trying to attract those customers with the value proposition that, as investors ourselves, as MSR owners, as someone who can be more nimble with the portfolio and who knows where the money is contained in sub-servicing and can extract that for the benefit of owners. I think that’s a story that’s resonating and starting to resonate with other sub-servicing clients. We sold $30 billion of MSR to a client to seed a relationship like this. That was good. We sold the amount of servicing that we wanted to sell at this time. That’s not to say that we wouldn’t be open in the future for other sorts of opportunities to seed other sub-servicing relationships.

One way that we can effectuate being able to modify our servicing portfolio, say if we wanted to move up in coupon from low-gross WAC to high-gross WAC, one very good way to do that would be to seed another sub-servicing relationship and then recycle that capital into new servicing that’s higher WAC that gives us different opportunities or might be cheaper in some ways. It’s another tool in our tool belt in order to be able to manage the portfolio and to grow the business together.

Got it. Okay, that’s helpful. Looking at the return estimate on slide 14, I was just curious specifically on the securities portfolio. It looks like it went up a couple hundred basis points from last quarter, even though spreads are tighter. I was wondering if you could just sort of walk us through the math on why that went up. Thanks.

Sure, Trevor. I’m happy to do that, and that’s a very good question. I just want to remind everyone that the spreads that we use in that calculation are actually on our actual portfolio at quarter end, as opposed to a stylized version of a levered spread that you see elsewhere in the market. As you know, there’s a wide variation of mortgage spreads available, and for mortgage-backed securities, it depends where you are in the coupon stack. Obviously, lower coupons have tighter static returns. Higher coupons have higher static returns generally. From quarter to quarter, as the portfolio shifts around and spreads shift around, even if spreads move in one direction or another, those numbers can go in opposite directions. It does include, as I said, everything we have in our portfolio.

Our portfolio is predominantly mortgage-backed security pools, TVAs, things of that nature, but we do have other things in our portfolio like DUS bonds. We have derivatives like IOs or inverse IOs, for example, and that’s a sector that we have added to in the last six months, still a small portion of the portfolio, but have added to that. All of those things mix in to generate those yields from quarter to quarter. We also have assumptions that we apply to generate those ranges, as we’ve said before. We have some financing assumptions up and down. We have some leverage assumptions up and down and some prepay assumptions up and down. All of those things go into that mix to generate that return estimate that you see on that page.

Okay, that makes sense. Thank you.

Taryn, Conference Facilitator: We’ll take our next question from Harsh Hemnani with Green Street Advisors. Please go ahead.

Thank you. Maybe on the direct-to-consumer originations platform, right, originations have been growing, and I think the strategic story there is as prepayment speeds rise, the origination business could be a good hedge to MSRs. Given sort of the cost-saving strategies you’ve highlighted, does that impede the ability at all of the origination business to ramp up at the right time to be able to provide that hedge?

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Good morning, Harsh. Thanks for the question. I have two thoughts about your question. The first is that, you know, we’ve always said that the DTC platform isn’t meant to hedge the entire interest rate risk of the MSR portfolio, but only to hedge that part of it which is faster than expected speeds, right? We all know that when rates go lower, prepayments are going to go up and originations are going to go up and MSR values are going to go down, and we hedge that with financial instruments. It’s only the part where speeds are faster than expected that we are expecting the DTC origination business in order to be able to add materially.

Certainly, I’m well aware that you can’t cut costs and you can’t cut your way to growth, and we have to be very smart about how we’re going to invest in technology and our ability to scale as mortgage rates go lower. That’s why it’s not a simple exercise of just cutting a certain amount across the board. Technology investments and improvements are going to be key to being able to maintain or retain that ability in order to get those benefits as rates fall. We’re going to be careful about that and continue to make the investments that we need to make as well.

One thing I will say about the DTC platform and the recapture rates that we’ve seen so far, while it is small, Nick said in his prepared remarks that only 3% of our portfolio is refinanceable from a rate and term perspective with mortgage rates here, but we’ve already seen recapture rates, not just record amounts and absolute levels, as I said in my prepared remarks, but also the recapture rates are higher than we have been modeling into our cash flows for these levels of rates and for the portfolio composition that we have. We’re real excited and optimistic about the benefits that that program is already producing.

That’s excellent. Thank you. Maybe as I look at the coupon positioning, it seems like the higher coupons, you mentioned this in the prepared remarks, there seems to be a spread trade there where you’re long specified pools and short TVAs to be able to capitalize on differences in prepay speeds there. It seems like it’s not necessarily the opposite, but somewhat flipped in sort of the intermediate coupons at the fives and the five and a half where exposure to TVA is higher. Can I maybe read into that as assuming that where current mortgage rates are, you feel like for the next quarter or so they hang out around you?

Hey, Harsh. No, I don’t think you should read into that conclusion. The TVAs, as I mentioned, rates have moved a reasonable amount, and we did rehedge with rates going down. We did migrate our exposure down along with our MSR and current coupon exposure. As far as the TVA concentration in those 5, 5.5s, it’s a mix of the fact of adjusting the portfolio at a moment in time and also just how we see where specified pools are relative to TVAs at that juncture. We do employ a lot of TVAs to hedge our current coupon risk because it’s easy to transact, easy and fast, and just allows us maximum flexibility with that stuff. It’s not necessarily a long-term commitment or a statement to how we feel about those specific trade-offs between spec pools and TVAs and those coupons. It’s a moment in time.

As we see value in specified pools and depending on how roles are trading, we’ll make the determination as to whether we want that exposure in one or the other. We do typically leave a fair amount of TVA exposure in those current coupon-esque type securities so we have that flexibility.

All right. Thanks.

Taryn, Conference Facilitator: We’ll take our next question from Meryl Ross with Compass Point Research. Please go ahead.

Good morning. Thank you. I wanted to talk about the MSR sales. First, it seems like that was broken into 19 in the third quarter, and the balance that’ll be transacted or has been transacted in the fourth quarter here. Is that right?

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: That other $10 billion is scheduling the end of this month.

Right. Okay. What were the characteristics of those MSRs? I look at it, it seems like this is a financial investor, right? That makes sense. They’re looking for very low coupons. Is that correct?

These were low coupon sales. Our entire portfolio is really centered around the low coupon portfolio. This was in that part of the portfolio for sure. Yes.

Right. It just seems that the ones that you added on a flow basis can’t be that low because mortgage rate’s not that low anymore. You’ve got a little bit of a rotation from these sales into slightly higher coupons. It seems from what you said you’re willing to do that because the DTC is a better hedge against that high MSR value that you spoke about. Is that right?

That’s correct. I mean, in fact, if you look at slide 13, you can see the gross coupon rate of our portfolio increased from 3.53% to 3.59%. Right?

Right.

This is a small change given that the additions that we’ve added weren’t that big. It also speaks a little bit to the fact that we sold generally stuff that was on average lower than the average, right, at no rate. That was the impact, a six basis point rise in the gross coupon. Given what I said about the DTC thing, this is something that we are totally comfortable with and desirous of because we think that that higher coupon part of the MSR curve can be attractive to us given the recapture rates that we’re seeing on the portfolio that we have.

Right. Right. The sales that are going to settle would be pretty similar and have a smaller but directionally correct impact.

Yeah.

On the gross coupon. Right.

Yeah.

Okay, thank you.

Thanks, Meryl.

Taryn, Conference Facilitator: We’ll move to our next question from Eric Hagen with BTIG. Please go ahead.

Hey, thanks. Good morning. Maybe following up a little bit there. How do you see MSR valuations responding to a further drop in interest rates? MSR valuations seem to be really strong right now. Do you see the same sources of demand holding up in a refi event? How would you guys potentially respond to even higher MSR valuations at lower interest rates?

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Yeah. First of all, I would say that, you know, with our gross WAC of our portfolio at 3.60, right, that is still, you know, almost 300 basis points out of the money. Right? At these level mortgages, even 50 lower, 100 lower, this is still not going to have large impacts on the refinanceability of that portfolio. I mean, certainly the way the MSR market and mortgage market works is that when rates decline, you know, prepayment expectations do go up, even, even albeit slightly given the gross WAC of the portfolio, but the MSR prices will go down. We all know that. That’s in our models, in our estimates, it’s in the way that we hedge the asset. That seems to be something that I’m not worried about at the moment. Right?

If you’re asking about how I think supply will or demand will function in that, you know, in a 50 lower, 100 lower, I don’t see it particularly changing given the, what I said, the low gross WAC nature of it. The cash flows are still slow and stable and easy to hedge. Typically, what you see in refinance environments is that originators are able to hold their MSR as they’re originating it. The supply-demand switch really only reverses once rates start to rise after refi waves. I think we’re a long way from that. There continues to be, you know, very strong demand from various market participants for the low gross WAC MSR that we hold.

Yeah, I’ll follow up with what Bill said, Eric. If you look at the progression of technology and the ability to reach mortgage holders and be able to recapture, I think that there have been substantial improvements in that across the industry. I think there’s a greater ability by servicer holders of servicing to recapture and retain the value of MSR compared to other points in the last 20 years of refi events. Not that it’s perfect, but it is definitely better. I completely agree with everything Bill said. I think that the hands that the MSR are in are very solid.

Yep. That’s helpful. Hey, on that point about kind of market evolution, a question about the MSR repo financing. It feels like the MSR market has matured a lot. The size and the scale for you guys has improved considerably. Can you remind us the maturity on that MSR repo and the revolving credit facility? Do you think there’s going to be any opportunities to maybe optimize the financing there next year?

William Dellal, Chief Financial Officer, Two Harbors Investment Corp.: Our maturities are roughly in the range from one to two years. They do roll. When they roll closer, we do renew them. We will look for opportunities to see if we can improve the yield on the MSR. It seems to be static right now.

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Yeah. To follow up on that, we continue to field incoming calls from people wanting to enter the space and provide financing on the asset. I agree with your comment there, Eric, that the market has matured a lot since the financing on the asset really opened up in 2018, 2019. There continues to be more and more participants wanting to participate and spread. Are well supported. I wouldn’t say that they’re really going down a lot here, but they’re well supported and stable at the levels that we’re at.

I appreciate you guys. Thank you.

Appreciate you, Eric.

Taryn, Conference Facilitator: As a reminder, if you would like to ask a question, you may press star one on your telephone keypad to join the queue. We’ll move to Bose George with Keefe, Bruyette & Woods for our next question.

Bose George, Analyst, Keefe, Bruyette & Woods: I just wanted to follow up on.

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Hey, Boze.

Bose George, Analyst, Keefe, Bruyette & Woods: I wanted to follow up on the MSR discussion. What’s the valuation of the flow MSRs that you’re originating versus your existing portfolio? Also, can you remind us, can you reflect the value of recapture in the value of the originated MSR, and how does that differ for originated versus bulk MSR that you purchase?

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: I’m not sure I understood the second part of the question about whether we include recapture in our valuations. You know, we mark our portfolio to the market price, to where we think the thing would transact in the market. Whether the cash flows include recapture cash flows or not is something that impacts the yield or the perspective return of the thing. It doesn’t impact the price or the mark, if that makes sense.

Bose George, Analyst, Keefe, Bruyette & Woods: Yeah, it does. I guess there’s not a specific recapture assumption that goes in there. There’s a broader cash flow assumption that has an embedded recapture feature. Is that the way to think about it?

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: I would just reiterate that that doesn’t impact the mark that we value the asset at, because if we had a different assumption, we would have other different assumptions, typically in discount rates, which would get us to the same market price estimate.

Bose George, Analyst, Keefe, Bruyette & Woods: Yeah. Okay. No, that makes sense. In terms of the valuation, is there, yeah, where’s sort of the originated MSR valued at now versus sort of the lower coupon stuff?

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: Yeah. I mean, we don’t, if you look at the price multiple that we have on the whole portfolio, it’s 5.8 times on a weighted average basis for the whole portfolio. There’s a whole curve of prices, of price multiples as coupons change. Certainly, as the WAC, as the note rate increases, that multiple on those servicing levels will go down, right? High WAC stuff, over long periods of time, you can look at the money servicing, typically trades on average between 4.5 and 5 multiple, depending on lots of things. As a base rule of thumb, that’s something where at the money servicing always trades, and this market is not inconsistent with that level.

Bose George, Analyst, Keefe, Bruyette & Woods: Okay, great. Thanks.

Taryn, Conference Facilitator: There are no further questions at this time. I’d like to turn the conference back over to Bill for any additional or closing remarks.

Bill Greenberg, President and Chief Executive Officer, Two Harbors Investment Corp.: I’d just like to thank you, everyone, for joining us today, and thank you, as always, for your interest in Two Harbors Investment Corp.

Taryn, Conference Facilitator: This concludes today’s call. Thank you again for your participation. You may now disconnect and have a great day.

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