TWO HARBORS INVESTMENT (TWO) Q1 2025 Earnings Call Transcript

Executive Summary

Q1 2025 delivered positive comprehensive income per share of $0.62 and a 4.4% economic return on book value, with both Agency RMBS and MSR contributing; book value per share rose to $14.66 from $14.47 in Q4.
Non-GAAP EAD per share was $0.24, below S&P Global consensus of ~$0.40; GAAP EPS was $(0.89), reflecting mark-to-market losses on MSR, swaps and futures offset by RMBS gains. Values retrieved from S&P Global.
Management highlighted wider Agency RMBS spreads increasing levered returns, maintained high liquidity, and expressed comfort with the dividend; they disclosed book value was down ~3.5% through April amid volatility.
Post quarter-end, TWO committed to purchase $1.7B UPB of MSR (expected to settle in Q2), expanding servicing assets; financing remained stable with Agency RMBS repo at ~68 days to maturity and SOFR+~20 bps spreads.

What Went Well and What Went Wrong

What Went Well
- “We delivered a strong first quarter, with both our securities and MSR contributing to positive performance,” said CEO Bill Greenberg.
- Net interest and servicing income improved by $5.2M QoQ due to shifts into higher coupon Agency RMBS and lower borrowing rates; RMBS unrealized gains tightened mark-to-market losses.
- Wider RMBS spreads increased prospective levered returns; MSR portfolio showed low prepayment speeds (3‑month CPR 4.2%) and stable cash flows.
What Went Wrong
- GAAP EPS of $(0.89) reflected mark-to-market losses on MSR, swaps and futures despite RMBS gains; MSR fair value change was $(36.2)M in Q1.
- Street EAD EPS miss vs consensus (~$0.40 vs $0.24 actual), implying downward estimate revisions near term. Values retrieved from S&P Global.
- Management noted continued volatility and policy uncertainty (tariffs/trade/Fed), with book value down ~3.5% through April; convexity costs elevated for hedged mortgage portfolios.

Transcript

Operator (participant)

Good morning. My name is Cynthia, and I will be your conference facilitator. At this time, I would like to welcome everyone to Two Harbors' first quarter 2025 earnings call. All participants will be in a listen-only mode. After the speaker's remarks, there will be a question-and-answer period. I would now like to turn over the call to Maggie Karr. Please go ahead.

Margaret Karr (Head of Investor Relations)

Good morning, everyone, and welcome to our call to discuss Two Harbors' first 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 2inv.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 does not update forward-looking statements and disclaims any obligations to do so. I will now turn the call over to Bill.

Bill Greenberg (CEO)

Thank you, Maggie. Good morning, everyone, and welcome to our first quarter earnings call. Please turn to slide three. We generated a total economic return of 4.4% for the first quarter, with both RMBS and MSR contributing positively to the results. Throughout the changing macroeconomic environment of the first quarter, we kept our risk exposures low, which proved to be prudent. While overall spreads have widened in the second quarter, they have been variable day to day, and we have actively managed the portfolio and our risk to take advantage of any market dislocations and attractive return opportunities. Please turn to slide four. Interest rates across the U.S. Treasury yield curve ended the first quarter lower than at 2024 year-end, with two-year and ten-year notes both decreasing by 36 basis points to finish at 3.88% and 4.21%, respectively, as seen in figure one.

The Fed once again held rates unchanged at their March 19th meeting, but revised lower real GDP growth expectations for this year from 2.1% to 1.7%, while core PCE was revised up from 2.5% to 2.8%, changes which Chairman Powell acknowledged were related to potential changes in trade policies. At the end of March, the market's expectations for cuts for the remainder of 2025 moved from 50 to 75 basis points, as you can see in figure two. However, subsequent data on employment, inflation, and most everything else has largely been overshadowed by growing economic uncertainty driven by proposals from the administration on tariffs, trade policy, and the composition of the Fed and its reaction function. The instability of U.S. policy has, for the first time, raised questions about the status of the dollar as the world's reserve currency, and we are carefully watching developments unfold.

Please turn to slide five. Our focus at RoundPoint this year is fivefold. First, to bring our direct-to-consumer originations platform fully to scale with widespread brand recognition. Second, to increase the velocity and depth of our offerings of second liens to our borrowers, producing additional revenue. Third, to evaluate opportunities and adapt as the mortgage finance landscape evolves. This includes diversifying our portfolio by potentially participating in the Ginnie Mae market, as well as exploring possibilities in the non-agency sectors. Fourth, as a full-service mortgage servicer and originator, to grow our presence in third-party sub-servicing. Fifth and finally, to continue to generate additional cost efficiencies in servicing, primarily through the use of technology and AI applications.

As I just described, we view the RoundPoint platform as an expansion of our opportunity set, providing additional benefits for our shareholders by allowing us to impact our results through our own actions in ways that portfolios without operating platforms cannot. At Two, we have thoughtfully and intentionally built an investment portfolio with MSR at its core that is designed to deliver attractive risk-adjusted returns across a variety of market environments. An investment in Two allows our shareholders to benefit from our team's deep expertise and experience in managing and hedging portfolios of MSR and mortgage-backed securities. I'm very excited about the opportunities ahead for Two. With that, I'd like to hand the call over to William to discuss our financial results.

William Dellal (CFO)

Thank you, Bill. Please turn to slide six. Our book value increased to $14.66 per share at March 31st, compared to $14.47 on December 31st. Including the $0.45 common stock dividend, this resulted in a positive 4.4% quarterly economic return. Please turn to slide seven. The company generated comprehensive income of $64.9 million, or $0.62 per weighted average common share in the first quarter. We slightly amended the chart on this slide to better reflect how we think about changes in values for the assets and the hedges together, rather than in isolation.

Net interest and servicing income, which is the sum of GAAP net interest expense and net servicing income before operating costs, was higher in the first quarter by $5.2 million, driven by portfolio shifts into higher coupon agency RMBS and lower borrowing rates, slightly offset by lower float income due to seasonality and lower rates and lower servicing fee income from MSR portfolio runoff. The next column, mark-to-market gains and losses, represents the sum of investment securities gain and change in OCI, net swap and other derivative losses, and servicing asset losses. The duration of our RMBS and MSR assets was hedged by net long TBA positions in the case of MSR and by net short futures and payer swaps in the case of RMBS.

The $38.4 million difference, quarter over quarter, was driven primarily by unrealized gains on RMBS and TBA positions, offset by MSR portfolio runoff and mark-to-market losses on swaps and futures. Finally, operating expenses increased primarily due to higher non-cash equity compensation expenses, which typically occur in the first quarter of the year. You can see the individual components of net interest and servicing income and mark-to-market gains and losses on appendix slide 21. Please turn to slide eight. RMBS funding markets remained stable and available throughout the quarter, with repurchase spreads normalizing into a tighter historical context at SOFR plus around 20 basis points. At quarter end, our weighted average days to maturity for agency RMBS repo was 68 days. To date, in the second quarter, repo liquidity remains normal, and we've observed no disruptions to our financing.

We finance our MSR, including the MSR asset and related servicing advance obligations across five lenders with $1.7 billion of outstanding borrowings under bilateral facility. We ended the quarter with a total of $950 million in unused MSR asset financing capacity and $47 million in unused capacity for servicing advances. I will now turn the call over to Nick.

Nick Letica (CIO)

Thank you, William. Our portfolio performed well in the first quarter, with both components of our strategy contributing to the positive return. At year-end, we commented that mortgage spread volatility would decline, and that indeed was the case in Q1, helping to drive our positive hedged RMBS return. Our MSR performance was bolstered not only by slower-than-expected speed but also a slight tightening of spreads indicative of the demand for the asset. Jumping back into the deck, please turn to slide nine. Our portfolio at March 31st was $14.6 billion, including $11.6 billion in settled positions and $3 billion in TBAs. Our economic debt to equity decreased to 6.2x . We manage our exposure to rates across the curve very closely, and in the first quarter we lowered our risk to mortgage spreads and interest rates, as you can see in figures two and three.

By quarter end, we had substantially less risk than when we started the quarter. Overall, we decreased our mortgage exposure by 30% and reduced our leverage. You can see more detail on our risk exposures on appendix slide 18. Please turn to slide ten. The performance of agency RMBS securities was net positive over the quarter. RMBS outperformed interest rate hedges in January and February but underperformed in March as equities and fixed income spread products weakened. Performance across the RMBS coupon stack was uneven, with higher coupons both in TBAs and specified pools outperforming longer duration lower coupons. As you can see in figure one, our preferred implied volatility gauge, two-year options on ten-year rates, decreased modestly from 101 to 98 basis points on an annualized basis.

Both nominal spread and OAS tightened slightly, and these metrics, as well as the two-year ten-year implied volatility, finished the quarter close to their six and twelve-month averages. As has been the case, nominal spreads and volatility remain well above longer-term averages, but option-adjusted spreads are close to their long-term average. For this reason, we continue to believe that volatility will need to decline for RMBS spreads to materially tighten to treasuries. Of course, we have seen the opposite, as implied and realized volatility has increased in the second quarter, given the uncertainty around the macroeconomic outlook. Spreads for agency RMBS have widened, and spread volatility itself has increased to pre-election levels. Please turn to slide 11 to review our agency RMBS portfolio. Figure one shows the performance of TBAs compared to the specified pools we own throughout this quarter.

The bull steepening of the swap curve plus strong levels of CMO issuance led to the outperformance of higher coupon RMBS. In terms of coupon stack activity, we started the quarter with an up-in-coupon bias while progressively lowering our risk throughout the quarter. We reduced our exposure in 3%-4.5% seasoned specified pools by approximately $730 million and simultaneously added about $1.7 billion of six and a half percent specified pools, while correspondingly reducing our net TBA position. To maintain our MSR current coupon hedging, we moved our MSR duration-related TBA position down in coupon by selling sixes and buying fives. Primary mortgage rates hovered around 7% for most of the quarter. With winter seasonals at play, prepayment activity was muted. Overall, prepayment rates for the 30-year agency RMBS universe decreased by 1.4 percentage points quarter over quarter to 5.6% CPR.

Figure two on the bottom right shows our specified pool prepayment speeds by coupon. Most of the decline in speeds quarter over quarter came from higher coupons slowing down. Please turn to slide 12 as we discuss the market for investing in MSR. The MSR market remains well-supported given the high demand for the asset class and limited bulk acquisition opportunities. As you can see in figure one, transfer volume appears to have normalized to pre-COVID levels. Borrowers remain as locked in as ever, happy with their low rates. With a current mortgage rate around 6.75%, less than 1% of the UPB of our portfolio has 50 basis points or more of a rate incentive to refinance. As you can see in figure two, prepays have remained low and steady and below our projections for the majority of our portfolio, with only fives and above slightly increasing.

The slow and steady nature of realized prepayment speeds, however, relies on a very interesting characteristic of the structure of the market and of the nature of lock-in. In particular, looking at the blue line, we do not see prepayment speeds asymptotically approaching some base turnover level of payoffs. Historical 12-month prepayment rates for two and a halves are faster than for twos by about 1.2 CPR and faster for threes than for two and a halves by about 0.5 CPR. This shows that even for mortgages that are very deeply out of the money, there is still rate sensitivity to the prepayment function. This has pricing implications for low coupon MSR and explains why the lowest note rate MSR has been able to trade at historically high multiples. Please turn to slide 13, where we will discuss our MSR portfolio.

Figure one is an overview of the portfolio quarter end, further details of which can be found in appendix slide 24. In April, we committed to purchase $1.7 billion UPB of MSR through two bulk purchases, which are expected to settle in the second quarter. The price multiple of our MSR was unchanged quarter over quarter at 5.9x , and 60+ day delinquencies remained low at under 1%. Figure two compares CPRs across those implied security coupons in our portfolio of MSR versus TBAs. The prepayment speed of our MSR portfolio was 4.2 CPR for the first quarter, down 0.7% quarter over quarter. Please turn to slide 14, our return potential and outlook slide. As you can see on this slide, the top half of this table is meant to show what returns we believe are available on the assets in our portfolio.

We estimate that about 65% of our capital is allocated to servicing, with a static return potential of 12%-14%. The remaining capital is allocated to securities, with a static return estimate of 10%-15%. With our portfolio allocation shown in the top half of the table and after expenses, the static return estimate for our portfolio is between 8.7%-12.3% before applying any capital structure leverage to the portfolio. After giving effect to our outstanding convertible notes and preferred stock, we believe that the potential static return on common equity falls in the range of 9.1%-14.7%, or a prospective quarterly static return per share of $0.33-$0.54. Remember, these numbers reflect our portfolio and spreads at quarter end and would be higher today given that spreads are wider.

We made a small update to this table this quarter by expanding the factors that we vary and determining the range of prospective static returns per basic common share. Previously, we had determined the range by varying prepayment rates and funding rates. Today, in addition, we have chosen to vary portfolio leverage rather than only using the spot value, keeping in mind that this slide is meant to be a medium-term estimate of return potential. Post-quarter end, dramatic shifts on tariff policies have triggered speculation on broad global asset allocation shifts away from dollar-based assets and heightened concerns about the effects of stagflation on Fed policy. Predictably, equity and fixed income volatility have spiked. Since April 2nd, the 10-year Treasury yield has traded in a whopping 70 basis point range, and the yield curve between two and 10-year Treasuries has steepened by about 20 basis points.

Good morning.

Can you guys talk a little bit about the big merger or acquisition between Rocket and Mr. Cooper and how you think that sort of impacts the competitive landscape in the servicing market and potentially the bulk MSR purchase market as well? Thanks.

Bill Greenberg (CEO)

Bill Greenberg (CEO)

A tightening of 4.1%. You think that should be higher?

Eric Hagen (Managing Director and CFA)

Maybe a little bit. I mean, just for a 25 basis point move in spreads. That's pretty meaningful, right?

Bill Greenberg (CEO)

Yeah. Yeah. I mean, as you know, if you go back down to slide 14, right, we say that 65% of our capital is allocated to the hedge servicing strategy part of the portfolio, and only 35% is allocated to hedge securities. When MBS spreads do something, the MSR part of the portfolio does not react really at all because that is incorporated quickly and immediately into the MSR values, right? That is the way the MSR market prices itself and works. By definition, right, all else being equal, you would think that our portfolio would have 35% of the spread sensitivity exposure to a portfolio without MSR. Now, there are somewhat differences between capital structures and so forth. There are slight differences. As a base case, that is where I would start.

I'd say whatever spreads do, we would be 35% of what portfolios without MSR would be. That's true when spreads tighten, and that's true when spreads widen. Nick, would you add anything to that?

Nick Letica (CIO)

Yeah, Eric. I would point you to the fact that if you look at our net mortgage exposure, as in my comments, and if you look at it quarter over quarter, our net mortgage exposure, which is on page 17 of the deck, I think was down to about $5.5 billion when you take out the effect of the MSR, which was down significantly. We talked about this before. The amount of spread duration you have in a mortgage with a mortgage portfolio does depend on where you are on the coupon stack too, right? If we had all of that $5 billion in two and a halves or threes as opposed to having the majority of it more up in the stack, you would have more spread exposure there. It's the notional amount and where it's located on the coupon stack that determine that sensitivity.

I think that if you distill down that the net mortgage exposure is lower, number one. Two, we did have a little bit more of a shift up in coupon. Both of those things will decline the amount of spread sensitivity. Again, that was something that we very intentionally did by the end of the quarter because we were sort of hunkering down getting into second quarter with all of these changes flowing through the macroeconomic world.

Eric Hagen (Managing Director and CFA)

Yep. Okay. That's helpful. I think that prompts a follow-up question. I mean, do you feel like the MBS spreads have essentially kind of reset wider as a result of tariffs in this new range for volatility? How do you feel like spreads would maybe respond if the Fed looks more likely to cut rates from this point?

Good morning, Merrill. We maintained our liquidity at very high levels from the end of the year, and we're maintaining a lot of cash and capacity in our borrowing.

Merrill Ross (Senior REIT Research Analyst)

Okay. On the recapture, you referred to the, whatever, $179 million of loans that were flow and recapture, $174 million. What is the nature of that? How much of it was recapture versus flow? Did that meet your expectations relative to the market runoff? Because the portfolio is ever so slightly larger. I am just wondering if you are holding your own against the runoff with the recapture effort.

Nick Letica (CIO)

Yeah. Thanks for that question, Merrill. The organic recapture coming from our direct-to-consumer channel is still very low. It's still in its nascent stages. As Nick said in his remarks, and I could put a finer point on it, only about 0.5% of our portfolio is refinanceable from a rate and term perspective right now, right? There's very little ability to recapture some of those loans. However, we are seeing within that 0.5%, we are seeing some increased activity in our direct-to-consumer channel there. I am very optimistic about what we'll be able to do when we bring the platform fully to scale, right? I think we'll be able to achieve some really good numbers there once we get there.

We have been active in the bulk market in small size, right, and able to replenish the portfolio somewhat as well as being participating in the flow market. We are confident that we are going to be able to maintain our servicing portfolio or even grow it over time. We think we are going to be using all of the tools that are available to us in both the bulk and flow markets and eventually the DTC once that gets more up to scale and fully formed.

Merrill Ross (Senior REIT Research Analyst)

Great. Thank you. The last one is quite small, but you threw out a mention to being interested in the Ginnie Mae market. Do you see price dislocations there, or is that just sort of a safe harbor for return generation when the GSEs are being recapped and released?

Nick Letica (CIO)

You know what? I think it's many factors. I mean, we're taking the beginning stages in order to get involved in that market. The rationales are number one, just to have the ability to participate in the broader aspect of the servicing market rather than just conventional, the ability to be able to service and sub-service for Ginnie Mae's. It is slightly cheaper. It's a little bit more opportunity there. I think being able to be a more full-service mortgage originator/servicer sort of requires us to be involved in the Ginnie Mae market. We are taking the beginning steps in order to do that.

Merrill Ross (Senior REIT Research Analyst)

Thank you.

Operator (participant)

There are no further questions at this time. I will turn the conference back to Bill Greenberg for any additional or closing remarks.

Bill Greenberg (CEO)

I want to thank everyone for joining us today. Thank you, as always, to our shareholders for your interest. I look forward to talking to you again next quarter.

Operator (participant)

This concludes today's call. Thank you for your participation. You may now disconnect.

Two Harbors Investment - Earnings Call - Q1 2025

Executive Summary

What Went Well and What Went Wrong

Transcript

Operator (participant)

Margaret Karr (Head of Investor Relations)

Bill Greenberg (CEO)

William Dellal (CFO)

Nick Letica (CIO)

Operator (participant)

Doug Harter (Director and Senior Equity Research Analyst)

Bill Greenberg (CEO)

Nick Letica (CIO)

Doug Harter (Director and Senior Equity Research Analyst)

Nick Letica (CIO)

Doug Harter (Director and Senior Equity Research Analyst)

Bill Greenberg (CEO)

Operator (participant)

Bill Greenberg (CEO)

Trevor Cranston (Analyst)

Bill Greenberg (CEO)

Trevor Cranston (Analyst)

Bill Greenberg (CEO)

Trevor Cranston (Analyst)

Operator (participant)

Bose George (Managing Director and Senior Equity Research Analyst)

Nick Letica (CIO)

Bose George (Managing Director and Senior Equity Research Analyst)

Nick Letica (CIO)

Bose George (Managing Director and Senior Equity Research Analyst)

Bill Greenberg (CEO)

Operator (participant)

Bill Greenberg (CEO)

Eric Hagen (Managing Director and CFA)

Bill Greenberg (CEO)

Eric Hagen (Managing Director and CFA)

Bill Greenberg (CEO)

Eric Hagen (Managing Director and CFA)

Bill Greenberg (CEO)

Nick Letica (CIO)

Eric Hagen (Managing Director and CFA)

Bill Greenberg (CEO)

Operator (participant)

Harsh Hemnani (Senior Analyst of Debt Research)

Nick Letica (CIO)

Harsh Hemnani (Senior Analyst of Debt Research)

Nick Letica (CIO)

Harsh Hemnani (Senior Analyst of Debt Research)

Bill Greenberg (CEO)

Operator (participant)

Nick Letica (CIO)

AJ Odene (Global Investment Strategist)

Nick Letica (CIO)

AJ Odene (Global Investment Strategist)

Bill Greenberg (CEO)

Operator (participant)

Merrill Ross (Senior REIT Research Analyst)

Bill Greenberg (CEO)

Merrill Ross (Senior REIT Research Analyst)

Bill Greenberg (CEO)

Merrill Ross (Senior REIT Research Analyst)

Nick Letica (CIO)

Merrill Ross (Senior REIT Research Analyst)

Nick Letica (CIO)

Merrill Ross (Senior REIT Research Analyst)

Operator (participant)

Bill Greenberg (CEO)

Operator (participant)