Two Harbors Investment Corp. Reports Third Quarter 2016 Financial Results

Two Harbors Investment Corp. Reports Third Quarter 2016 Financial Results

Strong Results Highlighted by Return on Book Value of 4.2%⁽¹⁾

Two Harbors Investment Corp. (NYSE:TWO), a real estate investment trust that invests in residential mortgage-backed securities (RMBS), residential mortgage loans, mortgage servicing rights (MSR), commercial real estate and other financial assets, today announced its financial results for the quarter ended September 30, 2016.

Summary

• Reported book value of $10.01 per common share, representing a 4.2%⁽¹⁾ total return on book value after accounting for a dividend of $0.23 per share.
• Delivered Comprehensive Income of $136.5 million, a return on average equity of 15.7%, or $0.39 per weighted average common share.
• Reported Core Earnings of $82.5 million, or $0.24 per weighted average common share.⁽²⁾
• Added $10.6 billion in unpaid principal balance (UPB) of MSR and secured initial financing facility.
• Increased assets in commercial real estate portfolio; aggregate carrying value of $1.1 billion at September 30, 2016.
• Mortgage loan conduit wind down on track to be substantially complete by year-end 2016.

“We delivered strong results this quarter as smart portfolio management drove healthy increases in both earnings and book value,” stated Thomas Siering, Two Harbors’ President and Chief Executive Officer. “While we are pleased with our recent performance, we are even more enthusiastic about the coming year as the benefits of our efforts to streamline our business and increase our earnings potential are expected to materialize in 2017.”

Operating Performance
The following table summarizes the company’s GAAP and non-GAAP earnings measurements and key metrics for the third quarter of 2016:

Earnings Summary
Two Harbors reported Comprehensive Income of $136.5 million, or $0.39 per weighted average common share outstanding, for the quarter ended September 30, 2016, as compared to a Comprehensive Income of $122.3 million, or $0.35 per weighted average common share outstanding, for the quarter ended June 30, 2016. The company records unrealized fair value gains and losses on the majority of RMBS, classified as available-for-sale, in Other Comprehensive Income. On a Comprehensive Income basis, the company recognized an annualized return on average equity of 15.7% and 14.3% for the quarters ended September 30, 2016 and June 30, 2016, respectively.

The company reported GAAP Net Income of $117.8 million, or $0.34 per weighted average common share outstanding, for the quarter ended September 30, 2016, as compared to GAAP Net Loss of $17.0 million, or $0.05 per weighted average common share outstanding, for the quarter ended June 30, 2016. On a GAAP Net Income (Loss) basis, the company recognized an annualized return on average equity of 13.6% and (2.0%) for the quarters ended September 30, 2016 and June 30, 2016, respectively.

For the third quarter of 2016, the company recognized:

• net realized gains on RMBS and mortgage loans held-for-sale of $35.6 million, net of tax;
• net unrealized losses on certain RMBS and mortgage loans held-for-sale of $6.7 million, net of tax;
• net losses of $75.7 million, net of tax, related to swap and swaption terminations and expirations;
• net unrealized gains of $90.3 million, net of tax, associated with interest rate swaps and swaptions economically hedging its investment portfolio, repurchase agreements and Federal Home Loan Bank (FHLB) of Des Moines advances;
• net realized and unrealized losses on other derivative instruments of approximately $11.1 million, net of tax;
• net realized and unrealized gains on consolidated financing securitizations of $4.3 million, net of tax;
• net realized and unrealized gains of $2.9 million⁽¹⁾ on MSR, net of tax;
• securitization deal costs of $1.4 million, net of tax; and
• restructuring charges of $1.2 million, net of tax.

The company reported Core Earnings for the quarter ended September 30, 2016 of $82.5 million, or $0.24 per weighted average common share outstanding, as compared to Core Earnings for the quarter ended June 30, 2016 of $76.2 million, or $0.22 per weighted average common share outstanding. On a Core Earnings basis, the company recognized an annualized return on average equity of 9.5% and 8.9% for the quarters ended September 30, 2016 and June 30, 2016, respectively.

Other Key Metrics
Two Harbors declared a quarterly cash dividend of $0.23 per common share for the quarter ended September 30, 2016. The annualized dividend yield on the company’s common stock for the quarter, based on the September 30, 2016 closing price of $8.53, was 10.8%.

The company’s book value per share, after taking into account the third quarter 2016 dividend of $0.23 per share, was $10.01 as of September 30, 2016, compared to $9.83 as of June 30, 2016, which represented a total return on book value for the quarter of 4.2%.⁽¹⁾

Other operating expenses for the quarter ended September 30, 2016 were approximately $14.8 million, or 1.7% of average equity, compared to approximately $17.6 million, or 2.1% of average equity, for the quarter ended June 30, 2016.

Portfolio Summary
The company’s aggregate portfolio is principally comprised of RMBS available-for-sale securities, inverse interest-only securities (Agency Derivatives), MSR, residential mortgage loans held-for-sale, net economic interests in consolidated securitization trusts and commercial real estate assets. As of September 30, 2016, the total value of the company’s portfolio was $17.0 billion.

The company’s portfolio includes rates, credit and commercial real estate strategies. The rates strategy consisted of $13.1 billion of Agency RMBS, Agency Derivatives and MSR as well as their associated notional hedges as of September 30, 2016. The credit strategy consisted of $2.8 billion of non-Agency RMBS, net economic interests in consolidated securitization trusts, prime jumbo residential mortgage loans and credit sensitive residential mortgage loans, as well as their associated notional hedges as of September 30, 2016. The commercial strategy consisted of senior and mezzanine commercial real estate assets with an aggregate carrying value of $1.1 billion as of September 30, 2016.

For the quarter ended September 30, 2016, the annualized yield on the company’s average aggregate portfolio was 3.50% and the annualized cost of funds on the associated average borrowings, which includes net interest rate spread expense on interest rate swaps, was 1.08%. This resulted in a net interest rate spread of 2.42%.

RMBS and Agency Derivatives
For the quarter ended September 30, 2016, the annualized yield on average RMBS and Agency Derivatives was 3.4%, consisting of an annualized yield of 2.8% in Agency RMBS and Agency Derivatives and 8.7% in non-Agency RMBS.

The company experienced a three-month average constant prepayment rate (CPR) of 9.7% for Agency RMBS and Agency Derivatives held as of September 30, 2016, compared to 8.6% for those securities held as of June 30, 2016. The weighted average cost basis of the principal and interest Agency portfolio was 105.6% of par as of September 30, 2016 and 105.3% of par as of June 30, 2016. The net premium amortization was $33.0 million and $28.1 million for the quarters ended September 30, 2016 and June 30, 2016, respectively.

The company experienced a three-month average CPR of 7.3% for non-Agency principal and interest RMBS held as of September 30, 2016, as compared to 6.1% for those securities held as of June 30, 2016. The weighted average cost basis of the non-Agency portfolio was 59.1% of par as of September 30, 2016, compared to 58.6% of par as of June 30, 2016. The discount accretion was $18.3 million for the quarter ended September 30, 2016, compared to $15.5 million for the quarter ended June 30, 2016. The total net discount remaining was $1.1 billion as of September 30, 2016, compared to $1.1 billion as of June 30, 2016, with $0.4 billion designated as credit reserve as of September 30, 2016.

As of September 30, 2016, fixed-rate investments composed 88.1% and adjustable-rate investments composed 11.9% of the company’s RMBS and Agency Derivatives portfolio.

As of September 30, 2016, the company had residential mortgage loans held-for-investment with a carrying value of $3.6 billion and the company’s collateralized borrowings had a carrying value of $3.4 billion, resulting in net economic interests in consolidated securitization trusts of $244.1 million.

Mortgage Servicing Rights
As of September 30, 2016, the company held MSR on mortgage loans with UPB totaling $55.1 billion,⁽¹⁾ with a fair market value of $455.6 million. In the quarter, the company sold substantially all of its $8.7 billion Ginnie Mae MSR portfolio. In addition, the company recognized fair value losses of $33.5 million during the quarter ended September 30, 2016.

The company does not directly service mortgage loans, but instead contracts with fully licensed subservicers to handle substantially all servicing functions for the loans underlying the company’s MSR. The company recognized $38.7 million of servicing income, $7.3 million⁽¹⁾ of servicing expenses and $1.1 million in reserve expense for representation and warranty obligations during the quarter ended September 30, 2016.

Commercial Real Estate
The company originates and acquires senior and mezzanine commercial real estate assets. These assets are U.S.-domiciled and are secured by a diverse mix of property types, which includes office, retail, multifamily, hotel and industrial properties. As of September 30, 2016, the company held senior and mezzanine commercial real estate assets with an aggregate carrying value of $1.1 billion. For both of the quarters ended September 30, 2016 and June 30, 2016, the annualized yield on commercial real estate loans was 6.2%.

Residential Mortgage Loans Held for Sale
As of September 30, 2016, the company held prime jumbo residential mortgage loans with a fair market value of $655.8 million and had outstanding purchase commitments to acquire an additional $61.4 million UPB of residential mortgage loans, subject to fallout if the loans do not close. For the quarters ended September 30, 2016 and June 30, 2016, the annualized yield on the prime jumbo residential mortgage loan portfolio was 4.0% and 4.1%, respectively.

During the quarter, the company sponsored a securitization, Agate Bay Mortgage Trust 2016-3, backed by approximately $376.6 million UPB of prime jumbo residential mortgage loans. As previously disclosed, the company is discontinuing its mortgage loan conduit and securitization business. The wind down process is expected to be substantially complete by the end of 2016.

Other Investments and Risk Management Derivatives
The company held $589.0 million notional of net short TBAs as of September 30, 2016, which are accounted for as derivative instruments in accordance with GAAP.

As of September 30, 2016, the company was a party to interest rate swaps and swaptions with a notional amount of $17.2 billion. Of this amount, $7.1 billion notional in swaps were utilized to economically hedge interest rate risk associated with the company’s LIBOR-based repurchase agreements and FHLB advances, $9.8 billion notional in swaps were utilized to economically hedge interest rate risk associated with the company’s investment portfolio, and $0.3 billion net notional in swaptions were utilized as macroeconomic hedges.

The following tables summarize the company’s investment portfolio as of September 30, 2016 and June 30, 2016:

“Favorable market conditions and our portfolio positioning resulted in each strategy contributing to our strong performance,” stated Bill Roth, Two Harbors’ Chief Investment Officer. “Importantly, our conservative risk profile largely insulates both income and book value from changes in interest rates, enhancing the stability of our financial performance.”

Financing Summary
The company reported a debt-to-equity ratio, defined as total borrowings under repurchase agreements, FHLB advances and revolving credit facilities to fund RMBS, Agency Derivatives, residential mortgage loans held-for-sale, commercial real estate assets and MSR divided by total equity, of 4.2:1.0 and 4.0:1.0 as of September 30, 2016 and June 30, 2016, respectively.

As of September 30, 2016, the company had outstanding $10.6 billion of repurchase agreements funding RMBS, Agency Derivatives and commercial real estate assets with 22 different counterparties. Excluding the effect of the company’s interest rate swaps, the repurchase agreements had a weighted average borrowing rate of 1.06% as of September 30, 2016.

The company’s wholly owned subsidiary, TH Insurance Holdings Company LLC (TH Insurance), is a member of the FHLB. As a member of the FHLB, TH Insurance has access to a variety of products and services offered by the FHLB, including secured advances. As of September 30, 2016, TH Insurance had $4.0 billion in outstanding secured advances, with a weighted average borrowing rate of 0.67%, and had no additional available uncommitted capacity for borrowings.

As of September 30, 2016, the company had outstanding $30.0 million of short-term borrowings secured by MSR collateral under revolving credit facilities with a weighted average borrowing rate of 4.27% and remaining maturities of 336 days.

As of September 30, 2016, the company’s aggregate repurchase agreements, FHLB advances and revolving credit facilities funding RMBS, Agency Derivatives, residential mortgage loans held-for-sale, commercial real estate assets and MSR had a weighted average of 3.5 years to maturity.

The following table summarizes the company’s borrowings by collateral type under repurchase agreements, FHLB advances and revolving credit facilities outstanding as of September 30, 2016 and June 30, 2016, and the related cost of funds for the three months ended September 30, 2016 and June 30, 2016:

Conference Call
Two Harbors Investment Corp. will host a conference call on November 3, 2016 at 9:00 a.m. EDT to discuss third quarter 2016 financial results and related information. To participate in the teleconference, please call toll-free (877) 868-1835 (or (914) 495-8581 for international callers), conference code 83689688, approximately 10 minutes prior to the above start time. You may also listen to the teleconference live via the Internet on the company’s website at www.twoharborsinvestment.com in the Investor Relations section under the Events and Presentations link. For those unable to attend, a telephone playback will be available beginning at 12:00 p.m. EDT on November 3, 2016, through 12:00 a.m. EST on November 10, 2016. The playback can be accessed by calling (855) 859-2056 (or (404) 537-3406 for international callers), conference code 83689688. The call will also be archived on the company’s website in the Investor Relations section under the Events and Presentations link.

Two Harbors Investment Corp.
Two Harbors Investment Corp., a Maryland corporation, is a real estate investment trust that invests in residential mortgage-backed securities, residential mortgage loans, mortgage servicing rights, commercial real estate and other financial assets. Two Harbors is headquartered in New York, New York, and is externally managed and advised by PRCM Advisers LLC, a wholly owned subsidiary of Pine River Capital Management L.P. Additional information is available at www.twoharborsinvestment.com.

Forward-Looking Statements
This presentation includes “forward-looking statements” within the meaning of the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Actual results may differ from expectations, estimates and projections and, consequently, readers should not rely on these forward-looking statements as predictions of future events. Words such as “expect,” “target,” “assume,” “estimate,” “project,” “budget,” “forecast,” “anticipate,” “intend,” “plan,” “may,” “will,” “could,” “should,” “believe,” “predicts,” “potential,” “continue,” and similar expressions are intended to identify such forward-looking statements. These forward-looking statements involve significant risks and uncertainties that could cause actual results to differ materially from expected results, including, among other things, those described in our Annual Report on Form 10-K for the year ended December 31, 2015, and any subsequent Quarterly Reports on Form 10-Q, under the caption “Risk Factors.” Factors that could cause actual results to differ include, but are not limited to: the state of credit markets and general economic conditions; changes in interest rates and the market value of our assets; changes in prepayment rates of mortgages underlying our target assets; the rates of default or decreased recovery on the mortgages underlying our target assets; the occurrence, extent and timing of credit losses within our portfolio; the concentration of credit risks we are exposed to; declines in home prices; our ability to establish, adjust and maintain appropriate hedges for the risks in our portfolio; the availability and cost of our target assets; the availability and cost of financing; changes in the competitive landscape within our industry; our ability to successfully implement new strategies and to diversify our business into new asset classes; our ability to manage various operational risks and costs associated with our business; interruptions in or impairments to our communications and information technology systems; our ability to successfully securitize or sell mortgage loans; our ability to acquire mortgage servicing rights (MSR) and successfully operate our seller-servicer subsidiary and oversee our subservicers; the impact of any deficiencies in the servicing or foreclosure practices of third parties and related delays in the foreclosure process; our exposure to legal and regulatory claims; legislative and regulatory actions affecting our business; the impact of new or modified government mortgage refinance or principal reduction programs; our ability to maintain our REIT qualification; the state of commercial real estate markets and our ability to acquire or originate commercial real estate loans or related assets; and limitations imposed on our business due to our REIT status and our exempt status under the Investment Company Act of 1940.

Readers are cautioned not to place undue reliance upon any forward-looking statements, which speak only as of the date made. Two Harbors does not undertake or accept any obligation to release publicly any updates or revisions to any forward-looking statement to reflect any change in its expectations or any change in events, conditions or circumstances on which any such statement is based. Additional information concerning these and other risk factors is contained in Two Harbors’ most recent filings with the Securities and Exchange Commission (SEC). All subsequent written and oral forward-looking statements concerning Two Harbors or matters attributable to Two Harbors or any person acting on its behalf are expressly qualified in their entirety by the cautionary statements above.

Non-GAAP Financial Measures
In addition to disclosing financial results calculated in accordance with United States generally accepted accounting principles (GAAP), this press release and the accompanying investor presentation present non-GAAP financial measures, such as Core Earnings and Core Earnings per common share, that exclude certain items. Two Harbors’ management believes that these non-GAAP measures enable it to perform meaningful comparisons of past, present and future results of the company’s core business operations, and uses these measures to gain a comparative understanding of the company’s operating performance and business trends. The non-GAAP financial measures presented by the company represent supplemental information to assist investors in analyzing the results of its operations. However, because these measures are not calculated in accordance with GAAP, they should not be considered a substitute for, or superior to, the financial measures calculated in accordance with GAAP. The company’s GAAP financial results and the reconciliations from these results should be carefully evaluated. See the GAAP to non-GAAP reconciliation table on page 13 of this release.

Additional Information
Stockholders of Two Harbors and other interested persons may find additional information regarding the company at the SEC’s Internet site at www.sec.gov or by directing requests to: Two Harbors Investment Corp., Attn: Investor Relations, 590 Madison Avenue, 36th Floor, New York, NY 10022, telephone (612) 629-2500.

Two Harbors Investment Corp.
Tim Perrott, 612-629-2514
Senior Director of Investor Relations
tim.perrott@twoharborsinvestment.com

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