Two Harbors reported mixed results in 3Q, sold $20B in servicing

Two Harbors Investment Corp. was profitable in the third quarter using standard accounting principles but under another metric reflecting gains or losses on financial instruments, it posted a loss due to market volatility.

The real estate investment trust’s GAAP earnings were nearly $263.9 million, which compared favorably to a loss of nearly $86.2 million the previous quarter and net income of nearly $52.6 million a year earlier. 

However, Two Harbors also recorded a comprehensive loss of more than $287.8 million. That compared unfavorably to a comprehensive loss of $90.4 million in the second quarter. During the third quarter a year ago, Two Harbors reported a comprehensive income of $45.2 million.

The third quarter was “one of the most challenging market environments in decades,” CEO Bill Greenberg said during the company’s earnings call, referring to what was a common concern for REITs with mortgage-backed securities holdings during the fiscal period.

Two Harbors sold $20 billion of mortgage servicing rights as part of a portfolio rebalancing that also included a shift in the company’s hedging strategy to Treasury and Eurodollar futures from swaps, some analysts noted.

“We think it’s an indication for the preference and necessity for lower-margin hedging products as the company prioritizes keeping liquidity and a pool of unencumbered collateral to support margin calls,” researchers at BTIG said in a report.

At the end of the quarter, mortgage servicing rights made up roughly 18% of the company’s investment portfolio. Around 57% was invested in agency MBS and approximately 25% was invested in net positions in “to be announced” (future delivery) securitizations.

After the quarter closed, the REIT also effected a one-for-four reverse stock split and a stock buyback involving 2.9 million preferred shares. Management characterized the latter as a way to deploy the company’s capital in a relatively less risky way.

“We felt this was a good use of capital given that the prefs have a low to mid-teen yield with zero convexity risk, zero prepayment risk, and zero credit or market risk,” Greenberg said.

The BTIG analysts called the strategy a differentiator for investors when it comes to Two Harbors, but noted that its upside may only go so far.

“It’s one of the first mortgage REITs we’ve seen recently make a bid for preferred instead of common. We support the effort to control the shape of the capital structure, although we see somewhat limited flexibility to buy back a lot more stock given its leverage,” the researchers said.

Two Harbors’ capital structure includes $1.4 billion of common equity, $650 million of preferred stock, and $287.5 million of convertible notes maturing in 2026, the BTIG analysts noted.

“We estimate it has around $1 billion of capital supporting the MSR (including prefs and unsecured), leaving around $1.3 billion to support the RMBS portfolio and other hedges. We think it’s highly levered for this environment, and we don’t see a lot of room to comfortably raise leverage further,” the researchers said.

Two Harbors executives said they’ve taken a more moderate approach to leverage recently, but could raise it if monetary policymakers were to provide clearer guidance on the path interest rates will take.

“Then probably we see a decline of volatility that gives a little bit more of a green light, and take leverage up,” said Nick Letica, Two Harbors’ chief investment officer.

Other post-quarter developments flagged by management Wednesday included confirmation that the pending acquisition of RoundPoint Servicing by Two Harbors’ Matrix Financial Services subsidiary is on track to close roughly a year from now.

The purchase “is still expected to close sometime in the third quarter of 2023,” Letica said.