Two Harbors Investment Corp. Q3 FY2025 earnings call

Litigation Settlement

• In August, a $375 million settlement was reached with the former external manager, funded by portfolio sales, cash, and borrowing, with ample liquidity remaining.

Portfolio Adjustments

• Sold agency securities, adjusted RMBS and MSR portfolios. Plan to redeem $262 million convertible notes in January 2026 using cash and MSR facilities.

Subservicing Growth

• Signed a term sheet for subservicing, bringing combined subservicing UPB to ~$40 billion, and set to service Ginnie Mae loans.

Originations

• Direct-to-consumer originations platform saw record locks in September, funded $49 million UPB in Q3, with $52 million UPB in pipeline and brokered $60 million UPB second liens in the quarter.

Technology Improvements

• AI and other applications at RoundPoint improve customer and borrower experiences, aiding in cost reduction and scale.

In the third quarter, the RMBS portfolio was adjusted with sales, bringing it to $10.9 billion from $11.4 billion. MSR sales included $19.1 billion UPB and another ~$10 billion UPB settling end of the month. The subservicing business grew to roughly $40 billion of true third-party clients using RoundPoint as a subservicer, and RoundPoint is set to service Ginnie Mae loans, expanding the subservicing business. The RMBS portfolio contribution and MSR contribution in terms of revenue would need detailed financials from the transcript but key absolute figures are as mentioned.

Redemption Plan

• Intend to redeem full $262 million UPB of convertible notes in January 2026, funding with cash and MSR facilities.

Market Outlook

• Optimistic about MSR and MBS opportunities, sees stock undervalued at a discount to book, and mortgage spreads still attractive despite tightening.

MBS Performance Risks

• Symmetrical risks to MBS performance. ### Interest Rate Fluctuations
• Impact of interest rate changes on portfolio value. ### Competition
• Competition in the subservicing market could affect growth.

Q: What are the key drivers of the increase in the EAD in the third quarter relative to the second quarter?

A: On the EAD, it's due to the cost of financing securities coming down while asset yields on EAD are roughly constant.

Q: With short rates coming down 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?

A: 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.

Q: Can you talk about the various risk metrics as you think about the size of the portfolio following the settlement?

A: Economic debt-to-equity did go up while overall spread risk was taken down. Look at returns on asset classes, market mix, leverage, financing rates, and asset yields vs risk.

Q: What stands out to you about the tactical net short the coupon 50 basis points below the coupon where you have the highest concentration?

A: A lot of what drives that coupon exposure is how rates move and current coupon sit relative to risk exposures. It's about managing risk on a bucketed basis around current coupons.

Q: Can you give us a little bit of color in terms of what you're seeing on growth opportunities of the subservicing business?

A: Growing subservicing takes time, opportunities exist to pick up dissatisfied clients or those with concentration risk. Selling MSR to subservicing clients is a tool to manage portfolio and grow business.

Q: Looking at the return estimates on Slide 14, why did the securities portfolio return go up a couple hundred basis points from last quarter even though spreads are tighter?

A: Spreads used are on actual portfolio, varies by coupon stack. Portfolio shifts, includes other sectors like DUS bonds and derivatives, and assumptions like financing, leverage, prepay affect the numbers.

Q: On the direct-to-consumer origination platform, does cost saving strategies impede the ability to ramp up?

A: DTC platform isn't to hedge entire interest rate risk, but helps with faster than expected speeds. Need to invest in technology to scale as rates fall, but recapture rates are higher than modeled.

Q: How do you see MSR valuations responding to a further drop in interest rates?

A: With gross WACC of portfolio at 3.60%, still out of the money. MSR prices go down with rate drops, but demand for low gross WACC MSR remains strong.

Q: What's the valuation of the flow MSRs that you are originating versus your existing portfolio?

A: Portfolio is marked to market price. Cash flows include recapture, but mark doesn't directly include recapture assumption; discount rates adjust for different assumptions.