Two Harbors at RBC Conference: Navigating Mortgage Market Volatility

On Tuesday, 04 March 2025, Two Harbors Investment Corporation (NYSE: TWO) participated in the RBC Capital Markets Global Financial Institutions Conference 2025. The discussion, led by Bill Greenberg, President and CEO of Two Harbors, offered insights into the company’s strategies amidst fluctuating interest rates and evolving mortgage spreads. While the company is optimistic about current market conditions, challenges persist due to ongoing rate volatility.

Key Takeaways

• Two Harbors focuses heavily on agency MBS and MSR portfolios, with a balance sheet of 12 to 13 billion dollars.
• Interest rate volatility is expected to continue, impacting mortgage REITs, but current spreads are viewed as favorable.
• Two Harbors services its own MSR in-house, differentiating it from competitors.
• The company has initiated a direct-to-consumer lending operation and offers second liens to borrowers.

Financial Results

• Two Harbors Investment Corporation:

- Holds approximately 2.2 billion dollars in total stockholder equity.

- Manages a balance sheet of around 12 to 13 billion dollars.

- Allocates more than 60% of its capital to the MSR portfolio, with 38% to agency RMBS strategy.

Operational Updates

• Two Harbors has integrated Roundpoint Mortgage Servicing to handle its MSR in-house, enhancing efficiency and earnings.
• The company has launched a direct-to-consumer lending operation to capture recapture opportunities.
• It has maintained an average annual MSR volume of 200 billion dollars before the last three years.

Future Outlook

• Two Harbors aims to provide stable returns with less volatility through its MSR-focused portfolio.
• The company anticipates maintaining its average annual MSR volume and hopes for stable spreads to support future earnings.
• Interest rate volatility is expected to persist, impacting business strategies.

Q&A Highlights

• MSR Hedging:

- Greenberg noted that MSR prices are driven by mortgage rates and should be hedged accordingly.

• GSE Conservatorship:

- The likelihood of GSEs exiting conservatorship soon is low, due to political and financial hurdles.

For more detailed insights, readers are encouraged to refer to the full transcript.

Full transcript - RBC Capital Markets Global Financial Institutions Conference 2025:

Kenneth Lee, Senior Equity Analyst, RBC Capital Markets: RBC Capital Markets Financial Institutions Conference. My name is Kenneth Lee. I am the senior equity analyst with a firm covering the mortgage REIT sector. And welcome to our industry panel, The Outlook in Mortgage Finance. And I’m very pleased to be joined by my panelist today.

To my immediate right, David Finkelstein, CEO and co CIO of Annaly Capital Management. Dave joined Annaly in 2013. And prior to that, he served as a primary strategist and policy advisor for the MBS purchase program at the Federal Reserve Bank of New York. And then to his right, we have Bill Greenberg, president and CEO of Two Harbors Investment Corporation. Bill previously served as a CIO at Two Harbors and joined the company in 2012.

So welcome both of you.

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: Thanks for having us, Ken. Thank you.

Kenneth Lee, Senior Equity Analyst, RBC Capital Markets: And then before we dive in, why don’t we just give a few minutes, for each of you to give people a view of your companies?

David Finkelstein, CEO and co CIO, Annaly Capital Management: Sure. I’ll start. Thank you, Ken, and thank you to RBC for having us here today. It’s always a pleasure to, do this conference given the the strong attendance, and great guests that you have. So I’m David Finkelstein.

As Ken mentioned, I’m the CEO and co CIO of Annaly Capital Management. We’re a mortgage REIT. We are the oldest or the largest and one of the oldest of the we have approximately 12 and a half billion of capital, and that capital funds are roughly $80,000,000,000 balance sheet. And that balance sheet is allocated across three sectors, all within housing finance. The largest of our businesses is agency MBS, which is approximately a $70,000,000,000 portfolio of largely pass throughs, MBS agency pass throughs that are levered and hedged, whereby we use swaps, futures and swaptions to hedge the vast majority of the interest rate exposure.

And we run about a leverage level on the agency portfolio around seven, seven point five times. The next largest business is our residential credit business, which some of you may know as Onslow Bay Financial. That business is largely a residential whole loan to securitization business. We do own third party securities across resi finance, but the core of the business is acquiring whole loans through our correspondent channel, balance sheeting those loans and then ultimately securitizing and holding the subordinate securities on balance sheet. And then our third business is mortgage servicing rights.

So that’s been a business that has been growing considerably for us. We’ve been in the MSR sector for about nine years, but we brought it on. We used to own a servicer and then we brought the business on balance sheet in 2021 and started acquiring MSR on balance sheet and that’s about a $3,300,000,000 market value portfolio of about $200,000,000,000 in principal balance of agency MSR that is diversified and relatively low note rate. And that’s the portfolio. Together these three portfolios create a diversified capital allocation that we think has considerable synergies across the businesses, operational, as well as strategic synergies that gives us a lens in all aspects of housing finance, is not correlated with one another and gives us relatively smooth book value in earnings and an earnings stream for the investor.

Okay. Bill?

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: Thanks. I’m Bill Greenberg. I’m the President and CEO of Two Harbors. We’re a little bit smaller than Annaly. We have about $2,200,000,000 of total stockholder equity of balance sheet of around $12,000,000,000 or $13,000,000,000 We started in 02/2009.

I came in 2012. We have two lines of business, not three, like Dave does. We have an agency mortgage backed securities portfolio as well as an MSR portfolio. One of the differences between our companies is the relative size of our MSR. We have roughly more than 60% of our capital is allocated to the hedged MSR strategy, and the other 38% or something like that is allocated to a hedged RMBS strategy.

We have often talked about our portfolios as being paired in certain ways, the MSR providing many interesting risk offsets to the agency MBS position, both in terms of interest rate risk as well as mortgage spread risk. Another one,

Kenneth Lee, Senior Equity Analyst, RBC Capital Markets: one

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: of the differentiators between Venus and Annaly is we service our own MSR in house. We acquired a mortgage servicer in 2023 called Roundpoint Mortgage Servicing. That’s given us some economies of scale and some incremental earnings that we have from that. And, of course, having an operational entity itself has given us the opportunity to be able to do more things in the mortgage finance space. We just started a direct to consumer lending operation to provide recapture for our businesses.

We’re offering our borrowers second liens. And of course, it allows us to do other things in the future as well. So, I think together that again, that provides us with something that two lines that are complementary to one another and provides a benefit to be able to, as I like to say, provide returns in our portfolio that are less volatile than portfolios without MSR.

Kenneth Lee, Senior Equity Analyst, RBC Capital Markets: Okay. Great. Well, before we begin, let me just read a quick disclaimer. Any forward looking statements made during today’s event are subject to certain risks and uncertainties, which are outlined in the risk factors section and annually in Two Harbors’ most recent SEC filings. Actual events and results may differ materially from these forward looking statements.

Both companies encourage you to read the forward looking statements disclaimer in their quarterly and annual filings. Additionally, the comments made during this call may contain time sensitive information that is accurate only as of today’s date. The companies do not undertake or specifically disclaim any obligation to update or revise this information. The companies may discuss both GAAP and non GAAP financial measures. A reconciliation of GAAP to non GAAP measures is included in each company’s most recent filings.

K. That out of the way, we’re gonna keep the discussion relatively interactive, and we will periodically open it up, to the floor for any questions from the audience. In the meantime, I’m gonna start off with a few questions of my own. Let’s start off at a broad level here, and I’ll direct this one to to you, David, first. And both of you guys mentioned this briefly, but given your business models, mortgage REITs has levered bond portfolios, the macro backdrop is always going to be an important consideration.

And I believe that prior to the most recent election, there was a thinking that we can get a little bit more clarity around rates, but there’s been a lot going on. What’s your latest outlook on the macro environment rates and the Fed policy?

David Finkelstein, CEO and co CIO, Annaly Capital Management: Look, it’s changing by the minute. So let’s back up a little bit and talk about where we were when the Fed’s first started cutting rates in September. So coming out of last summer, we started to have some deterioration in the labor market and the Fed was obviously concerned about it. And as a consequence, they cut 50 basis points in September. Now at that time heading into that meeting, there were approximately 10 rate cuts priced into the market, from September ’20 ’20 ’5.

So a pretty meaningful easing cycle was factored in, and the Fed was aggressive on that first move. Fast forward a little bit, we saw some stability in the labor market and we saw economic growth in Q4 start to perform relatively well. We ended up growing at 2.5% on the quarter, 2.8% on the full year. And so momentum started to rematerialize in the economy. And as we progress, we get to the election, all of a sudden it’s a red sweep.

You start to think about the fiscal uncertainty and spending rates market. Simultaneously, inflation picked up again in the fourth quarter after pretty calm Q2 and Q3. And so as a consequence, by the time we got to the December meeting, the Fed, after having cut four times, basically went from the direction is clear in September to policy pause in December. And markets no longer priced six cuts for 2025 into the market. They priced effectively two cuts.

And so the range of outcomes at that time period became very narrow. There was concern about inflation, growth was strong and the bar to hike was relatively high. So the market effectively just settled on two cuts throughout 2025. Now fast forward a little bit, the euphoria surrounding the election dissipated. We’re starting to hear a lot of talk about tariffs and immigration.

And so these protectionist and nationalist themes started to erode both consumer and business confidence. Spending in January really lacked on the part of the consumer, very conservative posture. Consumer confidence and business confidence deteriorated, and manufacturing started to soften. So we started to see what we think to be was a meaningful shift in the data. And where we sit today is that we’ve had a rally back across the curve effectively.

The ten year note, it’s bouncing around today, but it’s in the context of 04/20 from a high of $4.80 just two months ago effectively. So the market has been shifting quite a bit and the range of outcomes associated with the economy and markets has widened pretty considerably. Our view is that things are deteriorating. The Fed will begin cutting again likely in June, and we will get three cuts, which is currently priced in the market this year, which generally speaking for agency investors is a good thing. The carry associated with MBS is reentering the equation and it brings banks back in and demand for agency.

And so that’s a healthy thing. Volatility is typically not very healthy, so that’s something we’re concerned about. And what it necessitates is that you maintain a more conservative risk profile associated with both your duration, rate exposure, as well as your leverage. And so entering into the year, we had the lowest level of leverage that we had since 2014 at 5.5 turns, and we are very, very measured with respect to our rate exposure and we feel like that’s the way to play the market in the current environment. On one hand, it feels like things are deteriorating a little bit.

But on the other hand, you could see a scenario where trade issues get resolved at some point, not without a lot of damage being done, but nevertheless things could normalize and we could get back on this growth track with tax cuts and investment and the like, but it’s very uncertain. So we believe the approach is relatively cautious. Now another area as it relates to the macro economy that impacts both of our businesses is the housing market. And housing has been obviously very strong over the past number of years. And even last year with persistently high mortgage rates, HPA was still 2% to 3%, so consistent, kind of growing at a pace of personal income growth.

However, there has been disparity regionally. So for example, areas that ran up a lot in 2020, ’20 ’20 through 2023, started to come off a little bit, mainly in the Southeast and Texas, for example. And so there’s pockets of uncertainty around the housing market. But generally, consumer balance sheets are reasonably strong, unemployment is still low, and we feel pretty good about housing. But you do have to be a little bit more cautious as it relates to evaluating the housing market and protect credit a little bit better.

So overall, I think we’ll be okay in terms of how the market will evolve, but you generally have to take a more conservative approach in the current environment. And the good news is for both, Bill and our business is that returns in the agency market as well as MSR for for Bill and MSR and resi for us are still quite ample. So you can earn really good returns without taking a lot of risk. And that will persist for the time being, we think. And so we’re perfectly comfortable taking a cautious approach because the balance sheet is doing a lot of work to get us the returns we need.

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: I might just add a couple of thoughts to that, Dave. One, I think the history you gave of Fed expectations and so forth was a good one. But I think you can characterize the whole thing as just the last two years, three years has been, right, interest rate volatility caused by markets changing expectations of what the Fed response function is and what it’s going to do. And I think while there have been periods of uncertain responses of what the Fed’s gonna do and more narrow ones, and I think now we may be back to more more uncertainty, not as wide as it was, but there’s still a lot of uncertainty there. And and, you know, I think this administration has shown that, always new ways to surprise us in terms of what’s expected versus what’s what’s not expected.

So, you know, when I think about interest rate volatility and how that impacts our businesses, I I don’t see, the case for falling interest rate volatility really in 2025 very much. Dave mentioned that mortgage spreads could tighten. If interest rates go down, that is likely to bring tighter mortgage spreads and more participants in. I agree with that. I don’t think we need, mortgage spreads to tighten in, in either of our businesses.

I think the spreads that are offered are perfectly fine. We are also operating at what I would call moderate leverage. And, I am hoping for spreads to not tighten, right, because that just means lower forward, earnings potentials as well. So, I and and and where mortgage spreads are today, right, they’re certainly historically wide on a nominal basis. But on an option adjusted basis, they’re more in line with historical norms, right, which is really an indication that volatility is higher than it has been historically.

And as I said, I think that’s fine. I don’t think it’s gonna go down, but the spreads are wide and it is supportive of both of our businesses. I think I think all of that all that seems just fine.

Kenneth Lee, Senior Equity Analyst, RBC Capital Markets: Great. And, actually, why don’t we just stay on the topic for for spreads, the mortgage spreads, and and maybe we just brought it out a little bit more in terms of, you know, what’s the outlook there? And more importantly, you know, how do you think about supply demand dynamics over the near term? Do you see a pickup in demand for for MBS from other market participants such as banks, asset managers, you know, what could this mean for spreads? And I’ll address this to

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: you briefly. I think Dave touched on a little bit of falling rates as deepening yield curve improves the carrier of MBS, which brings another market participants, which is generally good for spreads. You know, prepayments, I think, are expected as we’re talking about, I think, for the bulk of the agency universe, unless we’re talking about a very large interest rate rally, which I don’t think we are. Right? Prepayments should remain well contained and well supported.

Of course, on the cusp stuff, I think speeds will be fast. So I think generally, if this plays out, you’ll see more demand on the MBS side. But it should be manageable. I think that will drive spreads marginally tighter over the near term.

Kenneth Lee, Senior Equity Analyst, RBC Capital Markets: Okay. Great. Why don’t we just pivot a little bit towards mortgage servicing rights or MSRs? For both of you, each of your companies have different MSR strategies. Could you talk about the attractiveness of the MSR asset in the current rate environment?

And how are you positioned should rates decline? And I’ll start off with you, Dave. Sure. So, first of

David Finkelstein, CEO and co CIO, Annaly Capital Management: all, I think both Bill and our portfolios are positioned quite well given how low the note rate is on each of our portfolio. So our note rate average note rate on our portfolio is about three twenty. And so we’re really over three fifty basis points out of the money effectively. So it takes a real significant move in the market to introduce prepayment risk with most MSR portfolios just given the universe. The average note rate of the agency universe is around 4.25%.

So we feel really good about the portfolio and we feel good about the sector from that standpoint. Now the vast majority of our portfolio was constructed by providing liquidity to the non bank mortgage community as they’ve sold MSR that they’ve had on balance sheet. Largely that was created in 2020 and 2021 when there was massive refinance boom. And then rates sold off beginning in 2022. And the originator community, you know, business was slowing down.

They wanted liquidity on their balance sheets, and they wanted to monetize their MSR because it had appreciated with higher rates. And so we were there as a capital provider to to provide that liquidity. And we grew the portfolio much quicker than than we anticipated in the years ’22, ’20 ’3, and and ’24. It slowed down a little bit, ’24. But we constructed our portfolio based on largely on the 2020 and 2021, origination, which is the majority of of of the universe out there.

And so it’s a it’s a very good convexity profile. The originators and medium and small, to folks like us and Bill and other participants and banks. And so it is diminishing in terms of the availability of MSR. Last year, there was about $750,000,000,000 in principal balance that changed hands. And this year, we expect about half of that.

To the extent that spreads remain attractive, we will certainly grow the portfolio. It’s about 20% of our capital allocation currently, and we don’t really lever it to any great degree. And we would like to get our portfolio to 20% of capital with about a turn of leverage. So we effectively could could nearly double the size of our holdings of MSR, but we have to be very, very discerning and make sure that we’re buying the asset at a spread that is complementary to the rest of the portfolio from the standpoint of generating strong earnings for the company. So that’s how we feel about it.

We think that the market is shifting a little bit from what was a bulk market to more of a flow market. And so we’re transitioning a lot of our activities to to take a lot more flow out of the market. We don’t have the advantage of an originator like Bill, but we have, a lot of a lot of connectivity to the origination community that enables us to be there on a flow basis by MSR as it’s created.

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: We were, I think, in 2019, ’20 ’20, ’20 ’20 ’1, I think 2022, I think we’re the largest flow participants, flow buyer of MSR in the market during those years. As rates rose, that channel dried up, of course, and we participate in the bulk market in general. Just to expand a little bit on what Dave said, right, there’s $750,000,000,000 or so of MSRPB that changed hands last year. There’s about 700 the year before and about 600 the year before that. Those were record years, the most we’ve ever seen.

Prior to that, if you go back another ten years, the average annual volume was $200,000,000,000 a year. The average quarterly volume of about $50,000,000,000 a year. Right? So I think, Dave, you might be a little bit more optimistic than I am about supply for this year. I’m probably gonna go right back to the to the long term mean of two two hundred to $2.50.

But I still think that’s Apple opportunity for for both of us to enjoy some of the things that we see there. You know, one of the things that that, you know, because we’ve we’ve been in the MSR business a little bit longer, we didn’t necessarily choose this out of the money portfolio. Right? We had been buying servicing, all along, when rates were rising. Yes.

We did buy some low x stuff as rates did rise, but we also had some at the money stuff, which became very deep out of the money, at the time. Our our average WACC is about three three fifty, so a little bit higher than Dave’s, but still miles away from from the refinance window. I I will sometimes call this this product, right, 300 basis point out of the money. Right? We’ve not seen this before in the world with mortgages this this far away from the refinance window.

I’ll sometimes call this a new asset class. Right? And it’s not that it’s so attractive from the nominal yields that are available. Right? Because it’s it’s not a 20% return or something like that.

But on a risk adjusted basis, I think it is unlike, anything we’ve seen before in the in the structured finance markets. And so I think it’s super attractive. And the thing that makes it attractive, right, in particular is that is the prepayment speeds, the turnover speeds that have been realized over the last year, two years, whatever, have been a lot slower than conventional wisdom would have said. I think, right, the textbooks would tell you that you should expect, you know, speeds from turnover, from death, divorce, moving, so forth, should be 6% per year. And we’re coming in in the 3% to 4% range.

Right? So, there’s a lot of of cash flow being thrown off by these assets. It’s not very convex, right, given given how far out of the money it is. If rates fall 50 basis points, a hundred basis points, our portfolios will still be 200 basis points out of the money. In the old days, that would be about as deep out of the money as you could hope to get, and we’re still 100 basis points away from that.

So it’s easy to hedge. It’s easy to extract the value. They’re very high quality loans. Lock in seems to be to be still very strong. And so I think this is going to persist for a long time.

David Finkelstein, CEO and co CIO, Annaly Capital Management: Just to add, in terms of the history, the non bank mortgage community, the transition to the vast majority of origination going from banks to non banks, has introduced a need for participants like us, capital partners that can provide liquidity and has the balance sheet to take on the take the MSR asset. Now originators, they’re operating companies. They’re great at that. Where capital participants were really good at providing liquidity from that standpoint. And when you consider the profitability of the origination model, the net profit is inside of 100 basis points.

And so to really be cash flow positive

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: Which is bound in the MSR. I think you’re about to say that, right?

David Finkelstein, CEO and co CIO, Annaly Capital Management: Yeah. Sell the MSR. Effectively, you got to sell the MSR, and that’s what our role is in the market. And while both volumes will slow down, there’s continuously gonna be a need for folks like us to to be liquidity providers.

Kenneth Lee, Senior Equity Analyst, RBC Capital Markets: Great. No. That’s a great segue to my next question, and I’ll address this one to to you, Bill. Staying on the top of of MSRs, and this is briefly touched upon too.

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: Both of

Kenneth Lee, Senior Equity Analyst, RBC Capital Markets: your firms periodically evaluate bulk MSR packages. What’s your outlook around the potential supply of MSR bulk packages for for this year?

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: 200 two 50, I think.

David Finkelstein, CEO and co CIO, Annaly Capital Management: A little 300 to 4 hundred is what we’d say. Yeah, which is 5,000,000,000 in market value based on maybe a little bit more depending on pricing. So it’s enough. We’ll be okay. So it’s current coupon

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: a little bit. That’s

Kenneth Lee, Senior Equity Analyst, RBC Capital Markets: great. Yeah. We’ll briefly pause here and see if there are any questions out from the audience before we we go along. Right there. So let me just repeat the question before we answer it just for the the question was about MSRs and then how how you think about hedging it.

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: I’ll start. Well, first of all, one thing which I think is maybe underappreciated when hedging MSR is that the primary driver of MSR prices and values is the mortgage rate. Right? And the mortgage rates for people involved in securities markets is also sometimes called the current coupon mortgage. Right?

So those will be the price of the mortgage backed securities whose price is par. Right? And today, that’s Fannie fives or 5 and halves or whatever it is. Right? So even though we have a portfolio which has a gross WACC of 3.5%, which sounds like mortgages which are collateral for Fannie two and a halves, The the theoretical hedge for the MSR is not Fannie 2 and a halfs.

It’s Fannie 5 and a halfs. Right? Because that’s the thing that changes the price, changes the mortgage rate, changes the prepay sensitivity of the asset. Now to your real question, you might say that because we’re 300 basis points out of the money, we shouldn’t have to hedge. If rates fall 50 basis points, how is the sensitivity of our portfolio gonna change?

How are prepayments actually gonna change? Right? And there’s and there’s two answers to that. One is, while you wouldn’t think there’s very large sensitivity to that, so you would think, well, maybe I don’t need to hedge it at all, but it’s a continuum. And one day, you are gonna have to hedge it.

And so I always find it better to let’s stick it in in the models. Let’s have it be a continuous function so that we can accumulate the hedge as rates continue to fall so that we can have the right hedge when rates fall a hundred basis points or 200 basis points. Right? While the theoretical hedge is low for 300 basis points out of the money, it’s not zero. The other is is what I think is even sort of more interesting.

One of the thing is that if you look at the prepayment speeds of Fannie two and a halfs and Fannie threes and Fannie three and a halves, right, there’s a prepay curve there. Right? Fannie two and a halves are I don’t know what the numbers are, Dave. Three CPR. Right?

And threes are three and a half, and fours are four CPR. Right? So even there, even though they’re deep out of the money and and prepay and refinances are not kicking in or becoming meaningful, The turnover part of the thing is increasing even for small rate moves for deep out of the money portfolios. And so that does those speed changes impact the value, the prices of the MSR, which should be hedged as well.

David Finkelstein, CEO and co CIO, Annaly Capital Management: Yes. I’ll add a couple of points on that. And that I agree with everything Bill said. As the market has sold off and we own this deep out of the money MSR, we initially think of MSR as a duration hedge for Agency MBS. However, the current portfolios that Bill and I both own have two really important hedges in addition to a little bit of a duration hedge.

Number one is the fact that it’s a turnover hedge for our low coupon MBS that we hold on balance sheet. So for example, if we own UMBS 3s in the portfolio that have a dollar price of $80 or whatever. Our concern is that those don’t accrete to par. They don’t pay down at a fast enough pace and they’re stuck down there in their longer bond and their yield is ultimately lower. So the MSR actually hedges some of that.

If they stay if turnover stays very low on those, at least we are getting good carry on the MSR as well to offset that. Now another hedge that is really critical in the current environment is that the MSR portfolio entails holding balances of the borrower’s taxes and insurance payments that we take those balances and we invest it in short term instruments, SOFR effectively, and banks will pay us SOFR plus something to hold those balances. So that happens to be a hedge for short term interest rates. If the Fed doesn’t cut, short rates stay higher for longer, we’re getting that float income or that higher float income. And so these are a couple of other benefits from a hedging standpoint that MSR entails that are very difficult or at least turnover is an incredibly difficult component of a mortgage to hedge.

That’s really one of the only hedges you can think of for a discount bond. You can hedge short rates obviously, but this is a very eloquent way to do it that gives you positive carry.

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: I always think it’s interesting the floating rate components, right, are not unlike, when you pay fixed on swap on hedging an MBS portfolio Mhmm. In that you receive the floating rate, just the short term rate from that perspective as well. But along those lines, a pure IO that has a 3.5% gross WACC, when it’s 300 basis points out of the money, you might think even has positive duration, that the speeds won’t go down very much more notwithstanding what I was saying. But the floating rate components, a floating rate IO, in fact, right, when rates rise, even if the speeds don’t slow, which they do, that also goes up. So the floating rate components can be thought of, I like to call it a super floater IO.

Right? And so that provides a lot of extra duration to the MSR asset in and of itself. Okay.

Kenneth Lee, Senior Equity Analyst, RBC Capital Markets: Great. Any other questions from the audience before we proceed?

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: Back there? So, Ali, you start with that one.

Kenneth Lee, Senior Equity Analyst, RBC Capital Markets: I’ll repeat your question. Question was about GSEs and potential emergence from conservatorship, implications for housing finance.

David Finkelstein, CEO and co CIO, Annaly Capital Management: Well, first of all, let’s

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: How much time do you have?

David Finkelstein, CEO and co CIO, Annaly Capital Management: Yes. Let’s talk about the issue more broadly. And obviously, there’s been a lot of chatter in the market about the potential exit from conservatorship of the GSEs, which stands to reason given, in the last Trump administration towards the end, that was that was an objective that the administration wanted to achieve, which they obviously didn’t. So it stands to reason that now we’re talking about it again. It is important to note that a lot of the chatter is coming from the common equity holders and junior preferred holders who really are the only ones who benefit from the release of the GSEs from conservatorship.

Now thinking about the likelihood of it, our view is that over the near term, next couple of years, we think it’s relatively low in terms of the likelihood for a few reasons. Number one is that the administration, treasury secretary, others, and including the nominee for FHFA director have said that it’s not a priority, that there is concern over the mortgage rate, which has to be entered into the equation and that suggests you don’t want volatility associated with MBS pricing. And then number three, and this has been stated by not just the treasury secretary, but also members of Congress on the Republican side have stated that taxpayer has to get made whole for the GSEs and for the conservatorship. So from that standpoint, it seems like the bar is relatively high for what we would characterize to be a hasty release of the GSEs. And then the second point I’ll note is that the math associated with releasing the GSEs is incredibly daunting, okay?

The capital rule that the PSPAs or preferred stock purchase agreements prescribe the GSEs to have before they can be released is about $330,000,000,000 that the two Fannie and Freddie need to have to be in a position to be durable outside of conservatorship. They’re half of that right now. And so they need to continue to accumulate capital through retained earnings to get to a point where from a safety and soundness perspective, they could be released. Now that threshold could be reduced If you cared about those things. If you care about those things.

And given the administration’s perceived tolerance for disruption, they may not. However, I choose to think that politically, that the bar is high. Another point to note as it relates to the math is that the GSEs, in addition to getting to that capital level, they owe Treasury three thirty four billion dollars Now that’s the amount that was used to bail them out, dollars 190 odd billion and then another 140 odd billion that the GSEs began to retain from earnings that should have gone to treasury when they effectively turned off the sweep in 2018 or thereabouts. So I don’t think politically it’s palatable for the administration treasury to just forgive that $330,000,000,000 That’s $1,000 for every man, woman, and child in the country. And so there could be some political costs associated with that.

And then the third point I’ll note is that this release of the GSEs is predicated on raising capital in public markets, okay. So now based on the current capital requirements, if you look at the ROEs of the GSEs, it’s mid to upper single digits, okay. Now if you go to market trying to raise capital with those ROEs, those are like utility type returns, right? And these are monoline cyclical businesses is where investors are going to want to get paid. So I don’t think anybody in this room is going to jump toward an IPO with those types of

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: They’re on the largest IPO in history that would be required. Exactly.

David Finkelstein, CEO and co CIO, Annaly Capital Management: Exactly. Now like to Bill, what Bill alluded to, you can’t underestimate the tolerance for disruption. And so as a consequence we have to be very prepared for that eventuality. However, there’s some of the protections in place in the law when they were brought into conservatorship protects legacy bondholders. So one of those factors is that bondholders cannot be made worse off through the exit of conservatorship, which means that there’s a $254,000,000,000 lifeline at treasury, which would go to protect legacy MBS bondholders.

And if that is there and the government ultimately has to provide support and they get to a level where they have to make a decision, you’re more likely to continue to support the GSEs to protect your initial investment. So we feel like from the standpoint of our portfolio, we’re in pretty good shape if there was even a hasty release of the GSEs. But another silver lining in all of this is that at a minimum we expect that the footprint of the GSEs will be reduced with the new administration much like it was in the last Trump administration. And so just to give context to that, roughly 20% of the loans that are guaranteed by the GSEs are what are called non core. So we’re talking about investor properties, second homes, higher loan balance loans and cash out refis and things like that.

So to the extent that they put caps on those loans like they did in the first Trump administration or de emphasize them, price them out of the market, you have a couple of things going on. Number one, it leads to less agency supply, which is good for our portfolios from a technical standpoint. Number two, for our residential credit business, it enables us to compete for those loans. And so we actually think that the adjustments to the GSEs that will be made over the near to intermediate term are actually quite beneficial both for our core agency business as well as for our residential credit business. So hopefully that answers your question.

We’re eyes wide open. Anything can happen, but we feel like we’re taking a measured approach and we’ll be okay.

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: I might add just a few more words to that. I agree with you your assessment, Dave, about the short term prospects. In fact, there was a I thought a very excellent report from one of the primary dealers about a survey that said 11% of market participants thought that you could have prioritization in the next two years and 35% over the next two and then 55% in the next administration or never. Right? So I thought that was good.

Dave Dave highlighted well, I thought, some of the some of the numbers behind, you know, the financial numbers of what’s required in order to do that. But the the other risks just associated to the overall housing finance system, I think, are significant. And we all thought this was really hard to do four years ago. We thought it was really hard to do ten years ago. And I think that’s still true.

If privatization comes with any changes in, what do you call it, risk ratios, what are they called?

David Finkelstein, CEO and co CIO, Annaly Capital Management: Yeah. Bank capital.

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: Bank capital rules or LCR rules or something like that, that could, you know, the banks own a trillion 8, I wanna say, of agency MBS. There’s a trillion 3 held overseas. You know, if you change something in in in the privatization that breaks all of that, that that could have a a very detrimental effect on on on the overall financial system, really. That same survey that I that I referred to said that that up to 75% of banks’ insurance companies aren’t sure whether they will need to sell MBS, whether they will be allowed to based on their investment guidelines and and rules if if the if the GSE debt is downgraded or if they change the rules in some way. Again, the impact of that is is unknowable.

I read some again, that same report said that it’s unclear whether the Fed could buy MBS if they’re no longer an agency of the government, however that has been defined and so forth. So that would tie the hands of of the Fed for the next downturn in terms of being able to buy, buy MBS and provide support.

David Finkelstein, CEO and co CIO, Annaly Capital Management: I can assure you, they would not they would not buy MBS through q QE if they were not in conservatorship or there wasn’t a guarantee.

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: Right. Right. So

David Finkelstein, CEO and co CIO, Annaly Capital Management: They could hold the existing portfolio, but they would not So

Bill Greenberg, President and CEO, Two Harbors Investment Corporation: so besides all the things that you said about the the the protections in place and the largest IPO in history and all of that, I think the system is just so interconnected and there’s so much risk. And I know no one wants to hear this necessarily, but it’s mostly working. The mortgage market is working reasonably well, and there’s lots of unintended consequences and downsides to bringing this thing out. And I think there is an element. I think that’s understood by the officials who are thinking about this, that if you break it, you own it.

And it’s unclear what the real upside is. So so I I I think the likelihood is is low in the near term, but all you gotta do is read the news newspaper to know that anything can happen.

David Finkelstein, CEO and co CIO, Annaly Capital Management: So Yeah. And one more point, if the administration is looking for a pay for for tax reform, for example, sweeping the capital from the GSEs, which they could do of $150,000,000,000 and then taking the retained earnings on an ongoing basis over the next decade, that’s SEK 400,000,000,000 potentially to offset your tax bill.

Kenneth Lee, Senior Equity Analyst, RBC Capital Markets: Okay. That’s great. Any other questions before we proceed from the audience? Okay. Let’s proceed then.

Next one is for you, Dave, for Annalie, and you briefly alluded to this in your prepared remarks. The company derives some benefit from the Onslow Bay platform, specifically the ability to manufacture proprietary assets. And this kind of aspect may be underappreciated by investors. Can you talk more about the platform and what’s your outlook on

David Finkelstein, CEO and co CIO, Annaly Capital Management: the potential contribution? Sure. Sure. So just by way of background, our residential credit business, Onslow Bay Financial, has been involved in the non QM loan sector since 2016. We were one of the original purchasers or acquirers of Non QM loans after the rule was put in place, and we developed a bit of a first mover advantage in the sector.

Now backing up, during that time period, we are actually members of the Federal Home Loan Bank system, and we were able to finance those assets, at quite inexpensive levels. So it was a very, very accretive trade for us at the time. However, we did start to begin a securitization effort in 2018 as the business started to grow. And we were one of the first securitizers in non QM loans and became quite significant in the sector as the residential credit securitization market redeveloped post financial crisis. And in 2021, we launched a correspondent channel.

So effectively, what that entails is we face currently about two sixty different mortgage originators throughout the country that we send daily pricing to and they take that pricing and they lock loans with their loan officers throughout the day and we guarantee them certainty of execution effectively. And that business has really grown over the past couple of years as the Non QM market has taken off. Last year we closed about $13,000,000,000 in whole loans on the year, $12,000,000,000 roughly of which were originated or came through our correspondent channel. What we’ve done over the past number of years is we’ve provided white glove service to these small originators. We’ve provided them liquidity at times of market volatility such that they rely on us and as a consequence they pay a bit of a premium to be able to do business with us and there’s an attachment that enables us to extract what we believe to be better returns than other channels of

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