UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________
FORM 10-Q
______________________________

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: June 30, 2017

Commission File Number 001-34506
______________________________
TWO HARBORS INVESTMENT CORP.
(Exact Name of Registrant as Specified in Its Charter)

Maryland
 
27-0312904
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
590 Madison Avenue, 36th Floor
New York, New York
 
10022
(Address of Principal Executive Offices)
 
(Zip Code)
(612) 629-2500
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
 
 
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
 
 
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of August 7, 2017 there were 348,972,325 shares of outstanding common stock, par value $.01 per share, issued and outstanding.
 
 
 
 
 


Table of Contents



TWO HARBORS INVESTMENT CORP.
INDEX

 
 
Page
 
PART I - FINANCIAL INFORMATION
 
 
 
 
 
 
 
PART II - OTHER INFORMATION
 


i

Table of Contents



PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
June 30,
2017
 
December 31,
2016
ASSETS
(unaudited)
 
 
Available-for-sale securities, at fair value
$
16,427,710

 
$
13,128,857

Commercial real estate assets
1,782,749

 
1,412,543

Mortgage servicing rights, at fair value
898,025

 
693,815

Residential mortgage loans held-for-investment in securitization trusts, at fair value
3,120,410

 
3,271,317

Residential mortgage loans held-for-sale, at fair value
31,946

 
40,146

Cash and cash equivalents
651,707

 
406,883

Restricted cash
249,728

 
408,312

Accrued interest receivable
74,156

 
62,751

Due from counterparties
39,618

 
60,380

Derivative assets, at fair value
240,502

 
324,182

Other assets
264,482

 
302,870

Total Assets (1)
$
23,781,033

 
$
20,112,056

LIABILITIES AND EQUITY
 
 
 
Liabilities
 
 
 
Repurchase agreements
$
13,316,881

 
$
9,316,351

Collateralized borrowings in securitization trusts, at fair value
2,880,301

 
3,037,196

Federal Home Loan Bank advances
3,238,762

 
4,000,000

Revolving credit facilities
40,000

 
70,000

Convertible senior notes
282,290

 

Derivative liabilities, at fair value
2,580

 
12,501

Due to counterparties
36,858

 
111,884

Dividends payable
95,049

 
83,437

Other liabilities
104,203

 
79,576

Total Liabilities (1)
19,996,924

 
16,710,945

Stockholders’ Equity
 
 
 
Preferred stock, par value $0.01 per share; 50,000,000 shares authorized and 5,750,000 and 0 shares issued and outstanding, respectively (liquidation preference of $143,750)
138,872

 

Common stock, par value $0.01 per share; 900,000,000 shares authorized and 348,977,215 and 347,652,326 shares issued and outstanding, respectively
3,490

 
3,477

Additional paid-in capital
3,654,653

 
3,659,973

Accumulated other comprehensive income
354,617

 
199,227

Cumulative earnings
2,118,636

 
2,038,033

Cumulative distributions to stockholders
(2,681,847
)
 
(2,499,599
)
Total Stockholders’ Equity
3,588,421

 
3,401,111

Noncontrolling interest
195,688

 

Total Equity
3,784,109

 
3,401,111

Total Liabilities and Equity
$
23,781,033

 
$
20,112,056

____________________
(1)
The condensed consolidated balance sheets include assets of consolidated variable interest entities, or VIEs, that can only be used to settle obligations of these VIEs, and liabilities of the consolidated VIEs for which creditors do not have recourse to Two Harbors Investment Corp. At June 30, 2017 and December 31, 2016, assets of the VIEs totaled $3,184,374 and $3,336,292, and liabilities of the VIEs totaled $2,900,344 and $3,058,278, respectively. See Note 3 - Variable Interest Entities for additional information.
The accompanying notes are an integral part of these condensed consolidated financial statements.

1

Table of Contents



TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands, except share data)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2016
 
2017
 
2016
Interest income:
(unaudited)
 
(unaudited)
Available-for-sale securities
$
150,166

 
$
101,512

 
$
285,739

 
$
180,940

Commercial real estate assets
25,840

 
13,300

 
49,410

 
24,372

Residential mortgage loans held-for-investment in securitization trusts
30,826

 
34,499

 
62,454

 
67,270

Residential mortgage loans held-for-sale
503

 
4,960

 
901

 
12,162

Cash and cash equivalents
1,226

 
505

 
1,679

 
795

Total interest income
208,561

 
154,776

 
400,183

 
285,539

Interest expense:
 
 
 
 
 
 
 
Repurchase agreements
49,299

 
22,697

 
86,311

 
38,726

Collateralized borrowings in securitization trusts
24,843

 
25,184

 
50,229

 
44,543

Federal Home Loan Bank advances
11,444

 
6,088

 
20,237

 
12,060

Revolving credit facilities
597

 

 
1,026

 

Convertible senior notes
4,591

 

 
8,412

 

Total interest expense
90,774

 
53,969

 
166,215

 
95,329

Net interest income
117,787

 
100,807

 
233,968

 
190,210

Other-than-temporary impairments:
 
 
 
 

 

Total other-than-temporary impairment losses
(429
)
 
(90
)
 
(429
)
 
(807
)
Other income (loss):
 
 
 
 
 
 
 
Gain (loss) on investment securities
31,249

 
8,331

 
(21,103
)
 
37,805

Loss on interest rate swap and swaption agreements
(76,710
)
 
(12,708
)
 
(66,783
)
 
(138,192
)
Loss on other derivative instruments
(19,540
)
 
(48,051
)
 
(47,404
)
 
(32,036
)
Servicing income
51,308

 
35,816

 
91,081

 
69,949

Loss on servicing asset
(46,630
)
 
(76,535
)
 
(61,195
)
 
(177,975
)
Gain on residential mortgage loans held-for-sale
333

 
7,734

 
1,794

 
18,537

Other income (loss)
2,793

 
(9,561
)
 
10,828

 
(6,734
)
Total other loss
(57,197
)
 
(94,974
)
 
(92,782
)
 
(228,646
)
Expenses:
 
 
 
 
 
 
 
Management fees
11,772

 
11,837

 
23,242

 
23,881

Servicing expenses
11,603

 
7,576

 
17,223

 
15,437

Securitization deal costs

 
429

 

 
4,161

Other operating expenses
19,371

 
17,644

 
35,408

 
32,500

Total expenses
42,746

 
37,486

 
75,873

 
75,979

Income (loss) before income taxes
17,415

 
(31,743
)
 
64,884

 
(115,222
)
Provision for (benefit from) income taxes
8,757

 
(14,762
)
 
(15,759
)
 
(9,311
)
Net income (loss)
8,658

 
(16,981
)
 
80,643

 
(105,911
)
Net income attributable to noncontrolling interest
40

 

 
40

 

Net income (loss) attributable to Two Harbors Investment Corp.
8,618

 
(16,981
)
 
80,603

 
(105,911
)
Dividends on preferred stock
4,285

 

 
4,285

 

Net income (loss) attributable to common stockholders
$
4,333

 
$
(16,981
)
 
$
76,318

 
$
(105,911
)
The accompanying notes are an integral part of these condensed consolidated financial statements.

2

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TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME, continued
(in thousands, except share data)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2016
 
2017
 
2016
 
(unaudited)
 
(unaudited)
Basic and diluted earnings (loss) per weighted average common share
$
0.01

 
$
(0.05
)
 
$
0.22

 
$
(0.30
)
Dividends declared per common share
$
0.26

 
$
0.23

 
$
0.51

 
$
0.46

Basic and diluted weighted average number of shares of common stock outstanding
348,946,335

 
347,597,955

 
348,756,189

 
348,516,985

Comprehensive income:
 
 
 
 
 
 
 
Net income (loss)
$
8,658

 
$
(16,981
)
 
$
80,643

 
$
(105,911
)
Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Unrealized gain on available-for-sale securities
81,628

 
139,291

 
155,390

 
160,636

Other comprehensive income
81,628

 
139,291

 
155,390

 
160,636

Comprehensive income
90,286

 
122,310

 
236,033

 
54,725

Comprehensive income attributable to noncontrolling interest
42

 

 
42

 

Comprehensive income attributable to Two Harbors Investment Corp.
90,244

 
122,310

 
235,991

 
54,725

Dividends on preferred stock
4,285

 

 
4,285

 

Comprehensive income attributable to common stockholders
$
85,959

 
$
122,310

 
$
231,706

 
$
54,725

The accompanying notes are an integral part of these condensed consolidated financial statements.


3

Table of Contents



TWO HARBORS INVESTMENT CORP. 
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except share data)
 
Series A
Preferred Stock
 
Common Stock
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares
 
Par Value
 
Shares
 
Par Value
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income
 
Cumulative Earnings
 
Cumulative Distributions to Stockholders
 
Total Stockholders’ Equity
 
Noncontrolling Interest
 
Total Equity
 
 
 
 
 
 
 
 
 
(unaudited)

 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2015

 
$

 
353,906,807

 
$
3,539

 
$
3,705,519

 
$
359,061

 
$
1,684,755

 
$
(2,176,313
)
 
$
3,576,561

 
$

 
$
3,576,561

Net loss

 

 

 

 

 

 
(105,911
)
 

 
(105,911
)
 

 
(105,911
)
Other comprehensive income before reclassifications, net of tax

 

 

 

 

 
184,085

 

 

 
184,085

 

 
184,085

Amounts reclassified from accumulated other comprehensive income, net of tax

 

 

 

 

 
(23,449
)
 

 

 
(23,449
)
 

 
(23,449
)
Net other comprehensive income, net of tax

 

 

 

 

 
160,636

 

 

 
160,636

 

 
160,636

Issuance of common stock, net of offering costs

 

 
29,143

 

 
227

 

 

 

 
227

 

 
227

Repurchase of common stock

 

 
(8,020,000
)
 
(80
)
 
(61,227
)
 

 

 

 
(61,307
)
 

 
(61,307
)
Common dividends declared

 

 

 

 

 

 

 
(159,892
)
 
(159,892
)
 

 
(159,892
)
Non-cash equity award compensation

 

 
1,705,435

 
17

 
7,737

 

 

 

 
7,754

 

 
7,754

Balance, June 30, 2016

 
$

 
347,621,385

 
$
3,476

 
$
3,652,256

 
$
519,697

 
$
1,578,844

 
$
(2,336,205
)
 
$
3,418,068

 
$

 
$
3,418,068

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2016

 
$

 
347,652,326

 
$
3,477

 
$
3,659,973

 
$
199,227

 
$
2,038,033

 
$
(2,499,599
)
 
$
3,401,111

 
$

 
$
3,401,111

Net income

 

 

 

 

 

 
80,603

 

 
80,603

 
40

 
80,643

Other comprehensive income before reclassifications, net of tax

 

 

 

 

 
151,789

 

 

 
151,789

 
2

 
151,791

Amounts reclassified from accumulated other comprehensive income, net of tax

 

 

 

 

 
3,595

 

 

 
3,595

 

 
3,595

Net other comprehensive income, net of tax

 

 

 

 

 
155,384

 

 

 
155,384

 
2

 
155,386

Issuance of Granite Point Mortgage Trust Inc. stock, net of offering costs

 

 

 

 
(13,777
)
 
6

 

 

 
(13,771
)
 
195,646

 
181,875

Issuance of preferred stock, net of offering costs
5,750,000

 
138,872

 

 

 

 

 

 

 
138,872

 

 
138,872

Issuance of common stock, net of offering costs

 

 
26,438

 

 
256

 

 

 

 
256

 

 
256

Preferred dividends declared

 

 

 

 

 

 

 
(4,285
)
 
(4,285
)
 

 
(4,285
)
Common dividends declared

 

 

 

 

 

 

 
(177,963
)
 
(177,963
)
 

 
(177,963
)
Non-cash equity award compensation

 

 
1,298,451

 
13

 
8,201

 

 

 

 
8,214

 

 
8,214

Balance, June 30, 2017
5,750,000

 
$
138,872

 
348,977,215

 
$
3,490

 
$
3,654,653

 
$
354,617

 
$
2,118,636

 
$
(2,681,847
)
 
$
3,588,421

 
$
195,688

 
$
3,784,109

The accompanying notes are an integral part of these condensed consolidated financial statements.


4

Table of Contents



TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
Six Months Ended
 
June 30,
 
2017
 
2016
Cash Flows From Operating Activities:
(unaudited
Net income (loss)
$
80,643

 
$
(105,911
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
Amortization of premiums and discounts on investment securities and commercial real estate assets, net
19,179

 
16,663

Amortization of deferred debt issuance costs on convertible senior notes
176

 

Other-than-temporary impairment losses
429

 
807

Realized and unrealized losses (gains) on investment securities, net
21,103

 
(37,805
)
Loss on servicing asset
61,195

 
177,975

Gain on residential mortgage loans held-for-sale
(1,794
)
 
(18,537
)
(Gain) loss on residential mortgage loans held-for-investment and collateralized borrowings in securitization trusts
(8,077
)
 
9,441

(Gain) loss on termination and option expiration of interest rate swaps and swaptions
(35,949
)
 
24,487

Unrealized loss on interest rate swaps and swaptions
92,254

 
99,859

Unrealized loss on other derivative instruments
35,111

 
48,818

Equity based compensation
8,214

 
7,754

Depreciation of fixed assets
550

 
664

Purchases of residential mortgage loans held-for-sale
(567
)
 
(580,932
)
Proceeds from sales of residential mortgage loans held-for-sale
3,988

 
68,813

Proceeds from repayment of residential mortgage loans held-for-sale
4,252

 
74,025

Net change in assets and liabilities:


 
 
Increase in accrued interest receivable
(11,405
)
 
(13,945
)
Increase in deferred income taxes, net
(16,078
)
 
(7,716
)
Decrease in income taxes receivable
77

 
3,669

(Increase) decrease in prepaid and fixed assets
(756
)
 
102

(Increase) decrease in other receivables
(4,516
)
 
6,267

Decrease (increase) in servicing advances
5,031

 
(19,328
)
Increase in accrued interest payable
26,173

 
6,544

Increase (decrease) in income taxes payable
51

 
(70
)
Decrease in accrued expenses and other liabilities
(2,923
)
 
(6,076
)
Net cash provided by (used in) operating activities
$
276,361

 
$
(244,432
)
The accompanying notes are an integral part of these condensed consolidated financial statements.

5

Table of Contents



TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
(in thousands)
 
Six Months Ended
 
June 30,
 
2017
 
2016
Cash Flows From Investing Activities:
(unaudited
Purchases of available-for-sale securities
$
(8,883,595
)
 
$
(9,964,377
)
Proceeds from sales of available-for-sale securities
5,092,318

 
3,776,295

Principal payments on available-for-sale securities
627,277

 
527,958

(Purchases) short sales of derivative instruments, net
(33,562
)
 
(15,475
)
Proceeds from sales (payments for termination) of derivative instruments, net
15,905

 
44,364

Proceeds from repayment of residential mortgage loans held-for-investment in securitization trusts
181,806

 
407,861

Originations, acquisitions and additional fundings of commercial real estate assets, net of deferred fees
(372,338
)
 
(276,438
)
Proceeds from repayment of commercial real estate assets
6,246

 
14,387

Purchases of mortgage servicing rights, net of purchase price adjustments
(266,003
)
 
(108,006
)
Proceeds from sales of mortgage servicing rights
627

 

Purchases of Federal Home Loan Bank stock

 
(11,206
)
Redemptions of Federal Home Loan Bank stock
33,080

 

(Decrease) increase in due to counterparties, net
(54,264
)
 
197,289

Net cash used in investing activities
(3,652,503
)
 
(5,407,348
)
Cash Flows From Financing Activities:
 
 
 
Proceeds from repurchase agreements
79,096,337

 
30,339,583

Principal payments on repurchase agreements
(75,095,807
)
 
(25,678,009
)
Proceeds from issuance of collateralized borrowings in securitization trusts

 
1,394,312

Principal payments on collateralized borrowings in securitization trusts
(179,717
)
 
(331,110
)
Proceeds from Federal Home Loan Bank advances

 
215,000

Principal payments on Federal Home Loan Bank advances
(761,238
)
 

Proceeds from revolving credit facilities
74,000

 

Principal payments on revolving credit facilities
(104,000
)
 

Proceeds from convertible senior notes
282,469

 

Proceeds from issuance of preferred stock, net of offering costs
138,872

 

Proceeds from issuance of common stock, net of offering costs
256

 
227

Proceeds from issuance of Granite Point Mortgage Trust Inc. stock, net of offering costs
181,875

 

Repurchase of common stock

 
(61,307
)
Dividends paid on common stock
(170,665
)
 
(171,955
)
Net cash provided by financing activities
3,462,382

 
5,706,741

Net increase in cash, cash equivalents and restricted cash
86,240

 
54,961

Cash, cash equivalents and restricted cash at beginning of period
815,195

 
1,000,393

Cash, cash equivalents and restricted cash at end of period
$
901,435

 
$
1,055,354

The accompanying notes are an integral part of these condensed consolidated financial statements.

6

Table of Contents



TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
(in thousands)
 
Six Months Ended
 
June 30,
 
2017
 
2016
Supplemental Disclosure of Cash Flow Information:
(unaudited
Cash paid for interest
$
89,296

 
$
47,088

Cash paid (received) for taxes
$
192

 
$
(5,194
)
Noncash Activities:
 
 
 
Transfers of residential mortgage loans held-for-sale to residential mortgage loans held-for-investment in securitization trusts
$

 
$
641,738

Transfers of residential mortgage loans held-for-sale to other receivables for foreclosed government-guaranteed loans
$
2,292

 
$
12,080

Transfer of fair value of mortgage servicing rights to fair value of Ginnie Mae residential mortgage loans held-for-sale upon buyout
$
9

 
$
3,572

Additions to mortgage servicing rights due to sale of residential mortgage loans held-for-sale
$
20

 
$
522

Dividends declared but not paid at end of period
$
95,049

 
$
79,953

Reconciliation of residential mortgage loans held-for-sale:
 
 
 
Residential mortgage loans held-for-sale at beginning of period
$
40,146

 
$
811,431

Purchases of residential mortgage loans held-for-sale
567

 
580,932

Transfers to residential mortgage loans held-for-investment in securitization trusts

 
(641,738
)
Transfers to other receivables for foreclosed government-guaranteed loans
(2,292
)
 
(12,080
)
Transfer of fair value of mortgage servicing rights to fair value of Ginnie Mae residential mortgage loans held-for-sale upon buyout
(9
)
 
(3,572
)
Proceeds from sales of residential mortgage loans held-for-sale
(3,988
)
 
(68,813
)
Proceeds from repayment of residential mortgage loans held-for-sale
(4,252
)
 
(74,025
)
Realized and unrealized gains on residential mortgage loans held-for-sale
1,774

 
16,925

Residential mortgage loans held-for-sale at end of period
$
31,946

 
$
609,060

The accompanying notes are an integral part of these condensed consolidated financial statements.

7

Table of Contents



TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

Note 1. Organization and Operations
Two Harbors Investment Corp., or the Company, is a Maryland corporation investing in, financing and managing residential mortgage-backed securities, or RMBS, mortgage servicing rights, or MSR, commercial real estate and other financial assets. The Company is externally managed and advised by PRCM Advisers LLC, or PRCM Advisers, which is a subsidiary of Pine River Capital Management L.P., or Pine River, a global multi-strategy asset management firm. The Company’s common stock is listed on the NYSE under the symbol “TWO”.
The Company was incorporated on May 21, 2009, and commenced operations as a publicly traded company on October 28, 2009, upon completion of a merger with Capitol Acquisition Corp., or Capitol, which became a wholly owned indirect subsidiary of the Company as a result of the merger.
The Company has elected to be treated as a real estate investment trust, or REIT, as defined under the Internal Revenue Code of 1986, as amended, or the Code, for U.S. federal income tax purposes. As long as the Company continues to comply with a number of requirements under federal tax law and maintains its qualification as a REIT, the Company generally will not be subject to U.S. federal income taxes to the extent that the Company distributes its taxable income to its stockholders on an annual basis and does not engage in prohibited transactions. However, certain activities that the Company may perform may cause it to earn income which will not be qualifying income for REIT purposes. The Company has designated certain of its subsidiaries as taxable REIT subsidiaries, or TRSs, as defined in the Code, to engage in such activities, and the Company may in the future form additional TRSs.
On June 28, 2017, the Company completed the contribution of its portfolio of commercial real estate assets to Granite Point Mortgage Trust Inc., or Granite Point, a newly organized Maryland corporation intended to qualify as a REIT, externally managed and advised by Pine River, and focused on directly originating, investing in and managing senior commercial mortgage loans and other debt and debt-like commercial real estate investments. The Company contributed its equity interests in its wholly owned subsidiary, TH Commercial Holdings LLC, to Granite Point and, in exchange for its contribution, received approximately 33.1 million shares of common stock of Granite Point, which represents approximately 76.5% of the outstanding stock of Granite Point upon completion of the initial public offering, or IPO, of its common stock on June 28, 2017. The Company’s shares in Granite Point are subject to a 120 day lock-up period, after which the Company anticipates that it will distribute the shares to its stockholders by means of a special pro rata dividend, subject to the discretion and approval of its Board of Directors and in compliance with applicable securities laws.

Note 2. Basis of Presentation and Significant Accounting Policies
Consolidation and Basis of Presentation
The interim unaudited condensed consolidated financial statements of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission, or SEC. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, have been condensed or omitted according to such SEC rules and regulations. However, management believes that the disclosures included in these interim condensed consolidated financial statements are adequate to make the information presented not misleading. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at June 30, 2017 and results of operations for all periods presented have been made. The results of operations for the three and six months ended June 30, 2017 should not be construed as indicative of the results to be expected for future periods or the full year.
The condensed consolidated financial statements of the Company have been prepared on the accrual basis of accounting in accordance with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires us to make a number of significant estimates and assumptions. These estimates include estimates of fair value of certain assets and liabilities, amount and timing of credit losses, prepayment rates, the period of time during which the Company anticipates an increase in the fair values of real estate securities sufficient to recover unrealized losses in those securities, and other estimates that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities as of the date of the condensed consolidated financial statements and the reported amounts of certain revenues and expenses during the reported period. It is likely that changes in these estimates (e.g., valuation changes due to supply and demand, credit performance, prepayments, interest rates, or other reasons) will occur in the near term. The Company’s estimates are inherently subjective in nature and actual results could differ from its estimates and the differences may be material.

8

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TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

The condensed consolidated financial statements of the Company include the accounts of all subsidiaries; inter-company accounts and transactions have been eliminated. Certain prior period amounts have been reclassified to conform to the current period presentation. The Company’s Chief Investment Officer manages the investment portfolio as a whole and resources are allocated and financial performance is assessed on a consolidated basis.
All trust entities in which the Company holds investments that are considered VIEs for financial reporting purposes were reviewed for consolidation under the applicable consolidation guidance. Whenever the Company has both the power to direct the activities of a trust that most significantly impact the entities’ performance, and the obligation to absorb losses or the right to receive benefits of the entities that could be significant, the Company consolidates the trust.
Due to its controlling ownership interest in Granite Point, the Company consolidates Granite Point on its financial statements and reflects noncontrolling interest for the portion of equity and comprehensive income not attributable to the Company. During the consolidation period (until the Granite Point shares are distributed to the Company’s stockholders), the Company’s financial condition and results of operations will reflect all of Granite Point’s commercial real estate investments and financing. No other subsidiary of the Company invests in, finances or manages commercial real estate debt and related instruments.
Significant Accounting Policies
Included in Note 2 to the Consolidated Financial Statements of the Company’s 2016 Annual Report on Form 10-K is a summary of the Company’s significant accounting policies. Provided below is a summary of additional accounting policies that are significant to the Company’s consolidated financial condition and results of operations for the six months ended June 30, 2017.
Convertible Senior Notes
Convertible senior notes include unsecured convertible debt that are carried at their unpaid principal balance, net of any unamortized deferred issuance costs, on the Company’s condensed consolidated balance sheet. Interest on the notes is payable semiannually until such time the notes mature or are converted into shares of the Company’s common stock.
Noncontrolling Interest
Due to its controlling ownership interest in Granite Point, the Company consolidates Granite Point on its financial statements and reflects noncontrolling interest for the portion of Granite Point equity and comprehensive income not attributable to the Company. Noncontrolling interest is presented as a separate component of equity on the condensed consolidated balance sheets. In addition, the presentation of both net income and comprehensive income on the condensed consolidated statements of comprehensive income attributes earnings (losses) to the Company’s stockholders (controlling interest) and noncontrolling interests.
Pursuant to Accounting Standards Codification (ASC) 810, Consolidation, changes in a parent’s ownership interest (and transactions with noncontrolling interest stockholders in the subsidiary) while the parent retains its controlling interest in its subsidiary should be accounted for as equity transactions. The carrying amount of the noncontrolling interest shall be adjusted to reflect the change in its ownership interest in the subsidiary, with the offset to equity attributable to the parent. The Company’s ownership interest percentage in Granite Point did not change during the period from the completion of Granite Point’s IPO on June 28, 2017 to June 30, 2017. However, noncontrolling interest on the Company’s condensed consolidated balance sheet was impacted by the portion of comprehensive income not attributable to the Company for the period from the completion of Granite Point’s IPO on June 28, 2017 through June 30, 2017.
Earnings Per Share
Basic and diluted earnings (loss) per share are computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares and potential common shares outstanding during the period. For both basic and diluted per share calculations, potential common shares represents issued and unvested shares of restricted stock, which have full rights to the common stock dividend declarations of the Company. If the assumed conversion of convertible notes into common shares is dilutive, diluted earnings (loss) per share is adjusted by adding back the periodic interest expense (net of any tax effects) associated with dilutive convertible notes to net income (loss) attributable to common stockholders and adding the shares issued in an assumed conversion to the diluted weighted average share count.

9

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TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

Offsetting Assets and Liabilities
Certain of the Company’s repurchase agreements are governed by underlying agreements that provide for a right of setoff in the event of default by either party to the agreement. The Company also has netting arrangements in place with all derivative counterparties pursuant to standard documentation developed by the International Swap and Derivatives Association, or ISDA, or central clearing exchange agreements, in the case of centrally cleared interest rate swaps. Additionally, the Company and the counterparty or clearing agency are required to post cash collateral based upon the net underlying market value of the Company’s open positions with the counterparty.
Under U.S. GAAP, if the Company has a valid right of setoff, it may offset the related asset and liability and report the net amount. The Company presents repurchase agreements subject to master netting arrangements or similar agreements on a gross basis, and derivative assets and liabilities subject to such arrangements on a net basis, based on derivative type and counterparty, in its condensed consolidated balance sheets. Separately, the Company presents cash collateral subject to such arrangements on a net basis, based on counterparty, in its condensed consolidated balance sheets. However, the Company does not offset financial assets and liabilities with the associated cash collateral on its condensed consolidated balance sheets.
The following tables present information about the Company’s assets and liabilities that are subject to master netting arrangements or similar agreements and can potentially be offset on the Company’s condensed consolidated balance sheets as of June 30, 2017 and December 31, 2016:
 
June 30, 2017
 
 
 
 
 
 
 
Gross Amounts Not Offset with Financial Assets (Liabilities) in the Condensed Consolidated Balance Sheets (1)
 
 
(in thousands)
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts of Assets (Liabilities) Presented in the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Net Amount
Assets
 
 
 
 
 
 
 
 
 
 
 
Derivative assets
$
275,943

 
$
(35,441
)
 
$
240,502

 
$
(2,580
)
 
$

 
$
237,922

Total Assets
$
275,943

 
$
(35,441
)
 
$
240,502

 
$
(2,580
)
 
$

 
$
237,922

Liabilities
 
 
 
 
 
 
 
 
 
 
 
Repurchase agreements
$
(13,316,881
)
 
$

 
$
(13,316,881
)
 
$
13,316,881

 
$

 
$

Derivative liabilities
(38,021
)
 
35,441

 
(2,580
)
 
2,580

 

 

Total Liabilities
$
(13,354,902
)
 
$
35,441

 
$
(13,319,461
)
 
$
13,319,461

 
$

 
$


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Table of Contents

TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

 
December 31, 2016
 
 
 
 
 
 
 
Gross Amounts Not Offset with Financial Assets (Liabilities) in the Condensed Consolidated Balance Sheets (1)
 
 
(in thousands)
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts of Assets (Liabilities) Presented in the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Net Amount
Assets
 
 
 
 
 
 
 
 
 
 
 
Derivative assets
$
388,522

 
$
(64,340
)
 
$
324,182

 
$
(12,501
)
 
$

 
$
311,681

Total Assets
$
388,522

 
$
(64,340
)
 
$
324,182

 
$
(12,501
)
 
$

 
$
311,681

Liabilities
 
 
 
 
 
 
 
 
 
 
 
Repurchase agreements
$
(9,316,351
)
 
$

 
$
(9,316,351
)
 
$
9,316,351

 
$

 
$

Derivative liabilities
(76,841
)
 
64,340

 
(12,501
)
 
12,501

 

 

Total Liabilities
$
(9,463,192
)
 
$
64,340

 
$
(9,398,852
)
 
$
9,398,852

 
$

 
$

____________________
(1)
Amounts presented are limited in total to the net amount of assets or liabilities presented in the condensed consolidated balance sheets by instrument. Excess cash collateral or financial assets that are pledged to counterparties may exceed the financial liabilities subject to a master netting arrangement or similar agreement, or counterparties may have pledged excess cash collateral to the Company that exceed the corresponding financial assets. These excess amounts are excluded from the table above, although separately reported within restricted cash, due from counterparties, or due to counterparties in the Company’s condensed consolidated balance sheets.

Recently Issued and/or Adopted Accounting Standards
Revenue from Contracts with Customers
In May 2014, the Financial Accounting Standards Board, or FASB, issued ASU No. 2014-09, which is a comprehensive revenue recognition standard that supersedes virtually all existing revenue guidance under U.S. GAAP. The standard’s core principle is that an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. As a result of the issuance of ASU No. 2015-14 in August 2015 deferring the effective date of ASU No. 2014-09 by one year, the ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2017, with early adoption prohibited. The Company has evaluated the new guidance and determined that interest income, gains and losses on financial instruments and income from servicing residential mortgage loans are outside the scope of ASC 606, Revenues from Contracts with Customers. For income from servicing residential mortgage loans, the Company considered that the FASB Transition Resource Group members generally agreed that an entity should look to ASC 860, Transfers and Servicing, to determine the appropriate accounting for these fees and ASC 606 contains a scope exception for contracts that fall under ASC 860. As a result, the Company has determined that the adoption of this ASU will not have a material impact on the Company's financial condition, results of operations or financial statement disclosures.
Recognition and Measurement of Financial Assets and Financial Liabilities
In January 2016, the FASB issued ASU No. 2016-01, which changes how entities measure certain equity investments and present changes in the fair value of financial liabilities measured under the fair value option that are attributable to their own credit. The ASU requires certain recurring disclosures and is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2017, with early adoption permitted. Early adoption of this ASU did not have an impact on the Company’s financial condition, results of operations or financial statement disclosures.

11

Table of Contents

TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

Lease Classification and Accounting
In February 2016, the FASB issued ASU No. 2016-02, which requires lessees to recognize on their balance sheets both a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term. The ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2018, with early adoption permitted. The Company has determined this ASU will not have a material impact on the Company’s financial condition, results of operations or financial statement disclosures.
Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued ASU No. 2016-13, which changes the impairment model for most financial assets and certain other instruments. Allowances for credit losses on AFS debt securities will be recognized, rather than direct reductions in the amortized cost of the investments. The new model also requires the estimation of lifetime expected credit losses and corresponding recognition of allowance for losses on trade and other receivables, held-to-maturity debt securities, loans, and other instruments held at amortized cost. The ASU requires certain recurring disclosures and is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2019, with early adoption permitted for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2018. The Company is evaluating the adoption of this ASU to determine the impact it may have on its condensed consolidated financial statements, which at the date of adoption, is expected to increase the allowance for credit losses with a resulting negative adjustment to retained earnings, with offsetting impacts to accumulated other comprehensive income.
Classification of Certain Cash Receipts and Cash Payments and Restricted Cash
In August 2016, the FASB issued ASU No. 2016-15, which clarifies how entities should classify certain cash receipts and cash payments and how the predominance principle should be applied on the statement of cash flows. Additionally, in November 2016, the FASB issued ASU No. 2016-18, which requires entities to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents, but no longer present transfers between cash and cash equivalents and restricted cash and cash equivalents in the statement of cash flows. Both ASUs are effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2017, with early adoption permitted. Early adoption of these ASUs did not impact the Company’s financial condition or results of operations but impacted the presentation of the statements of cash flows and related footnote disclosures. The Company included restricted cash of $249.7 million, $408.3 million, $363.2 million and $262.6 million as of June 30, 2017, December 31, 2016, June 30, 2016 and December 31, 2015, respectively, with cash and cash equivalents, as shown on the condensed consolidated statements of cash flows.

Note 3. Variable Interest Entities
The Company retains subordinated debt and excess servicing rights purchased from securitization trusts sponsored by either third parties or the Company’s subsidiaries. Additionally, the Company is the sole certificate holder of a trust entity that holds a commercial real estate loan. All of these trusts are considered VIEs for financial reporting purposes and, thus, were reviewed for consolidation under the applicable consolidation guidance. Because the Company has both the power to direct the activities of the trusts that most significantly impact the entities’ performance, and the obligation to absorb losses or the right to receive benefits of the entities that could be significant, the Company consolidates the trusts. As the Company is required to reassess VIE consolidation guidance each quarter, new facts and circumstances may change the Company’s determination. A change in the Company’s determination could result in a material impact to the Company’s condensed consolidated financial statements during subsequent reporting periods.

12

Table of Contents

TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

The following table presents a summary of the assets and liabilities of all consolidated trusts as reported on the condensed consolidated balance sheets as of June 30, 2017 and December 31, 2016:
(in thousands)
June 30,
2017
 
December 31,
2016
Residential mortgage loans held-for-investment in securitization trusts
$
3,120,410

 
$
3,271,317

Commercial real estate assets
45,888

 
45,885

Accrued interest receivable
18,076

 
19,090

Total Assets
$
3,184,374

 
$
3,336,292

Collateralized borrowings in securitization trusts
$
2,880,301

 
$
3,037,196

Accrued interest payable
8,190

 
8,708

Other liabilities
11,853

 
12,374

Total Liabilities
$
2,900,344

 
$
3,058,278


The Company is not required to consolidate VIEs for which it has concluded it does not have both the power to direct the activities of the VIEs that most significantly impact the entities’ performance, and the obligation to absorb losses or the right to receive benefits of the entities that could be significant. The Company’s investments in these unconsolidated VIEs include non-Agency RMBS, which are classified within available-for-sale securities, at fair value on the condensed consolidated balance sheets. As of June 30, 2017 and December 31, 2016, the carrying value, which also represents the maximum exposure to loss, of all non-Agency RMBS in unconsolidated VIEs was $2.3 billion and $1.9 billion, respectively.

Note 4. Available-for-Sale Securities, at Fair Value
The Company holds AFS investment securities which are carried at fair value on the condensed consolidated balance sheets. AFS securities exclude the retained interests from the Company’s on-balance sheet securitizations, as they are eliminated in consolidation in accordance with U.S. GAAP. The following table presents the Company’s AFS investment securities by collateral type as of June 30, 2017 and December 31, 2016:
(in thousands)
June 30,
2017
 
December 31,
2016
Agency
 
 
 
Federal National Mortgage Association
$
10,177,588

 
$
8,274,507

Federal Home Loan Mortgage Corporation
3,508,298

 
2,742,630

Government National Mortgage Association
485,382

 
209,337

Non-Agency
2,256,442

 
1,902,383

Total available-for-sale securities
$
16,427,710

 
$
13,128,857


At June 30, 2017 and December 31, 2016, the Company pledged AFS securities with a carrying value of $16.4 billion and $13.1 billion, respectively, as collateral for repurchase agreements and advances from the Federal Home Loan Bank of Des Moines, or the FHLB. See Note 15 - Repurchase Agreements and Note 17 - Federal Home Loan Bank of Des Moines Advances.
At June 30, 2017 and December 31, 2016, the Company did not have any securities purchased from and financed with the same counterparty that did not meet the conditions of ASC 860, to be considered linked transactions and, therefore, classified as derivatives.

13

Table of Contents

TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

The following tables present the amortized cost and carrying value (which approximates fair value) of AFS securities by collateral type as of June 30, 2017 and December 31, 2016:
 
June 30, 2017
(in thousands)
Agency
 
Non-Agency
 
Total
Face Value
$
16,212,860

 
$
3,077,412

 
$
19,290,272

Unamortized premium
827,000

 

 
827,000

Unamortized discount
 
 
 
 
 
Designated credit reserve

 
(433,736
)
 
(433,736
)
Net, unamortized
(2,813,604
)
 
(806,264
)
 
(3,619,868
)
Amortized Cost
14,226,256

 
1,837,412

 
16,063,668

Gross unrealized gains
84,781

 
422,884

 
507,665

Gross unrealized losses
(139,769
)
 
(3,854
)
 
(143,623
)
Carrying Value
$
14,171,268

 
$
2,256,442

 
$
16,427,710

 
December 31, 2016
(in thousands)
Agency
 
Non-Agency
 
Total
Face Value
$
13,571,417


$
2,732,139

 
$
16,303,556

Unamortized premium
571,749



 
571,749

Unamortized discount
 
 
 
 
 
Designated credit reserve


(367,437
)
 
(367,437
)
Net, unamortized
(2,758,445
)

(808,975
)
 
(3,567,420
)
Amortized Cost
11,384,721


1,555,727

 
12,940,448

Gross unrealized gains
79,040


353,358

 
432,398

Gross unrealized losses
(237,287
)

(6,702
)
 
(243,989
)
Carrying Value
$
11,226,474

 
$
1,902,383

 
$
13,128,857


The following tables present the carrying value of the Company’s AFS securities by rate type as of June 30, 2017 and December 31, 2016:
 
June 30, 2017
(in thousands)
 Agency
 
 Non-Agency
 
 Total
Adjustable Rate
$
26,735

 
$
1,949,041

 
$
1,975,776

Fixed Rate
14,144,533

 
307,401

 
14,451,934

Total
$
14,171,268

 
$
2,256,442

 
$
16,427,710

 
December 31, 2016
(in thousands)
Agency
 
Non-Agency
 
Total
Adjustable Rate
$
30,463

 
$
1,574,850

 
$
1,605,313

Fixed Rate
11,196,011

 
327,533

 
11,523,544

Total
$
11,226,474

 
$
1,902,383

 
$
13,128,857



14

Table of Contents

TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

The following table presents the Company’s AFS securities according to their estimated weighted average life classifications as of June 30, 2017:
 
June 30, 2017
(in thousands)
 Agency
 
 Non-Agency
 
 Total
≤ 1 year
$
557

 
$
40,890

 
$
41,447

> 1 and ≤ 3 years
48,271

 
194,999

 
243,270

> 3 and ≤ 5 years
2,127,292

 
312,203

 
2,439,495

> 5 and ≤ 10 years
11,973,466

 
889,262

 
12,862,728

> 10 years
21,682

 
819,088

 
840,770

Total
$
14,171,268

 
$
2,256,442

 
$
16,427,710


When the Company purchases a credit-sensitive AFS security at a significant discount to its face value, the Company often does not amortize into income a significant portion of this discount that the Company is entitled to earn because the Company does not expect to collect the entire discount due to the inherent credit risk of the security. The Company may also record an other-than-temporary impairment, or OTTI, for a portion of its investment in the security to the extent the Company believes that the amortized cost will exceed the present value of expected future cash flows. The amount of principal that the Company does not amortize into income is designated as a credit reserve on the security, with unamortized net discounts or premiums amortized into income over time to the extent realizable.
The following table presents the changes for the three and six months ended June 30, 2017 and 2016 of the unamortized net discount and designated credit reserves on non-Agency AFS securities.
 
Six Months Ended June 30,
 
2017
 
2016
(in thousands)
Designated Credit Reserve
 
Unamortized Net Discount
 
Total
 
Designated Credit Reserve
 
Unamortized Net Discount
 
Total
Beginning balance at January 1
$
(367,437
)
 
$
(808,975
)
 
$
(1,176,412
)
 
$
(409,077
)
 
$
(707,021
)
 
$
(1,116,098
)
Acquisitions
(100,558
)
 
(88,807
)
 
(189,365
)
 
(16,217
)
 
(74,039
)
 
(90,256
)
Accretion of net discount

 
44,301

 
44,301

 

 
32,287

 
32,287

Realized credit losses
8,424

 

 
8,424

 
(2,371
)
 

 
(2,371
)
Reclassification adjustment for other-than-temporary impairments
(429
)
 

 
(429
)
 
(211
)
 

 
(211
)
Transfers from (to)
22,676

 
(22,676
)
 

 
59,453

 
(59,453
)
 

Sales, calls, other
3,588

 
69,893

 
73,481

 
32,562

 
67,121

 
99,683

Ending balance at June 30
$
(433,736
)
 
$
(806,264
)
 
$
(1,240,000
)
 
$
(335,861
)
 
$
(741,105
)
 
$
(1,076,966
)


15

Table of Contents

TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

The following table presents the components comprising the carrying value of AFS securities not deemed to be other than temporarily impaired by length of time that the securities had an unrealized loss position as of June 30, 2017 and December 31, 2016. At June 30, 2017, the Company held 1,306 AFS securities, of which 233 were in an unrealized loss position for less than twelve consecutive months and 131 were in an unrealized loss position for more than twelve consecutive months. At December 31, 2016, the Company held 1,239 AFS securities, of which 252 were in an unrealized loss position for less than twelve consecutive months and 125 were in an unrealized loss position for more than twelve consecutive months. Of the $5.9 billion and $6.4 billion of AFS securities in an unrealized loss position for less than twelve consecutive months as of June 30, 2017 and December 31, 2016, $5.7 billion, or 97.2%, and $6.1 billion, or 95.8%, respectively, were Agency AFS securities, whose principal and interest are guaranteed by the GSEs.
 
Unrealized Loss Position for
 
Less than 12 Months
 
12 Months or More
 
Total
(in thousands)
Estimated Fair Value
 
Gross Unrealized Losses
 
Estimated Fair Value
 
Gross Unrealized Losses
 
Estimated Fair Value
 
Gross Unrealized Losses
June 30, 2017
$
5,911,117

 
$
(80,353
)
 
$
1,046,174

 
$
(63,270
)
 
$
6,957,291

 
$
(143,623
)
December 31, 2016
$
6,416,820

 
$
(204,034
)
 
$
504,978

 
$
(39,955
)
 
$
6,921,798

 
$
(243,989
)

Evaluating AFS Securities for Other-Than-Temporary Impairments
In evaluating AFS securities for OTTI, the Company determines whether there has been a significant adverse quarterly change in the cash flow expectations for a security. The Company compares the amortized cost of each security in an unrealized loss position against the present value of expected future cash flows of the security. The Company also considers whether there has been a significant adverse change in the regulatory and/or economic environment as part of this analysis. If the amortized cost of the security is greater than the present value of expected future cash flows using the original yield as the discount rate, an other-than-temporary credit impairment has occurred. If the Company does not intend to sell and will not be more likely than not required to sell the security, the credit loss is recognized in earnings and the balance of the unrealized loss is recognized in either other comprehensive income, net of tax, or gain (loss) on investment securities, depending on the accounting treatment. If the Company intends to sell the security or will be more likely than not required to sell the security, the full unrealized loss is recognized in earnings.
During both the three and six months ended June 30, 2017, the Company recorded $0.4 million in other-than-temporary credit impairments on one non-Agency RMBS where the future expected cash flows for the security were less than its amortized cost. During the three and six months ended June 30, 2016, the Company recorded $0.1 million and $0.8 million, respectively, in other-than-temporary credit impairments on three non-Agency RMBS where the future expected cash flows for each security were less than its amortized cost. As of June 30, 2017, impaired securities with a carrying value of $117.6 million had actual weighted average cumulative losses of 5.2%, weighted average three-month prepayment speed of 5.2%, weighted average 60+ day delinquency of 21.4% of the pool balance, and weighted average FICO score of 659. At June 30, 2017, the Company did not intend to sell the securities and determined that it was not more likely than not that the Company will be required to sell the securities; therefore, only the projected credit loss was recognized in earnings.

16

Table of Contents

TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

The following table presents the changes in OTTI included in earnings for the three and six months ended June 30, 2017 and 2016:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Cumulative credit loss at beginning of period
$
(5,606
)
 
$
(6,620
)
 
$
(5,606
)
 
$
(6,499
)
Additions:
 
 
 
 
 
 
 
Other-than-temporary impairments not previously recognized
(429
)
 

 
(429
)
 
(292
)
Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments

 
(90
)
 

 
(515
)
Reductions:
 
 
 
 
 
 
 
Decreases related to other-than-temporary impairments on securities paid down

 

 

 

Decreases related to other-than-temporary impairments on securities sold

 

 

 
596

Cumulative credit loss at end of period
$
(6,035
)
 
$
(6,710
)
 
$
(6,035
)
 
$
(6,710
)

Cumulative credit losses related to OTTI may be reduced for securities sold as well as for securities that mature, are paid down, or are prepaid such that the outstanding principal balance is reduced to zero. Additionally, increases in cash flows expected to be collected over the remaining life of the security cause a reduction in the cumulative credit loss.
Gross Realized Gains and Losses
Gains and losses from the sale of AFS securities are recorded as realized gains (losses) within gain (loss) on investment securities in the Company’s condensed consolidated statements of comprehensive income. For the three and six months ended June 30, 2017, the Company sold AFS securities for $2.7 billion and $5.1 billion with an amortized cost of $2.6 billion and $5.1 billion for net realized gains of $33.3 million and losses of $17.1 million, respectively. For the three and six months ended June 30, 2016, the Company sold AFS securities for $1.5 billion and $3.8 billion with an amortized cost of $1.5 billion and $3.7 billion for net realized gains of $9.9 million and $31.6 million, respectively.
The following table presents the gross realized gains and losses on sales of AFS securities for the three and six months ended June 30, 2017 and 2016:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Gross realized gains
$
47,994

 
$
10,700

 
$
56,725

 
$
45,894

Gross realized losses
(14,649
)
 
(830
)
 
(73,783
)
 
(14,323
)
Total realized gains (losses) on sales, net
$
33,345

 
$
9,870

 
$
(17,058
)
 
$
31,571


Note 5. Commercial Real Estate Assets
The Company originates and purchases commercial real estate debt and related instruments generally to be held as long-term investments. These assets are classified as commercial real estate assets on the condensed consolidated balance sheets. Additionally, the Company is the sole certificate holder of a trust entity that holds a commercial real estate loan. The underlying loan held by the trust is consolidated on the Company’s condensed consolidated balance sheet and classified as commercial real estate assets. See Note 3 - Variable Interest Entities for additional information regarding consolidation of the trust. Commercial real estate assets are reported at cost, net of any unamortized acquisition premiums or discounts, loan fees and origination costs as applicable, unless the assets are deemed impaired.

17

Table of Contents

TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

The following tables summarize the Company’s commercial real estate assets by asset type, property type and geographic location as of June 30, 2017 and December 31, 2016:
 
June 30,
2017
(dollars in thousands)
First Mortgages
 
Mezzanine Loans
 
B-Notes
 
Total
Unpaid principal balance
$
1,648,342

 
$
132,969

 
$
14,936

 
$
1,796,247

Unamortized (discount) premium
(178
)
 
(12
)
 

 
(190
)
Unamortized net deferred origination fees
(13,179
)
 
(129
)
 

 
(13,308
)
Carrying value
$
1,634,985


$
132,828

 
$
14,936

 
$
1,782,749

Unfunded commitments
$
213,703

 
$
1,580

 
$

 
$
215,283

Number of loans
39

 
6

 
1

 
46

Weighted average coupon
5.6
%
 
9.0
%
 
8.0
%
 
5.8
%
Weighted average years to maturity (1)
2.6

 
2.0

 
9.6

 
2.6


 
December 31,
2016
(dollars in thousands)
First Mortgages
 
Mezzanine Loans
 
B-Notes
 
Total
Unpaid principal balance
$
1,286,200

 
$
138,245

 
$

 
$
1,424,445

Unamortized (discount) premium
(185
)
 
(15
)
 

 
(200
)
Unamortized net deferred origination fees
(11,481
)
 
(221
)
 

 
(11,702
)
Carrying value
$
1,274,534

 
$
138,009

 
$

 
$
1,412,543

Unfunded commitments
$
170,890

 
1,580

 
$

 
$
172,470

Number of loans
30

 
6

 

 
36

Weighted average coupon
5.1
%
 
8.6
%
 
%
 
5.4
%
Weighted average years to maturity (1)
2.9

 
1.5

 
0.0

 
2.8

____________________
(1)
Based on contractual maturity date. Certain loans are subject to contractual extension options which may be subject to conditions as stipulated in the loan agreement. Actual maturities may differ from contractual maturities stated herein as certain borrowers may have the right to prepay with or without paying a prepayment penalty. The Company may also extend contractual maturities in connection with loan modifications.

(in thousands)
 
June 30,
2017
 
December 31,
2016
Property Type
 
Carrying Value
 
% of Commercial Portfolio
 
Carrying Value
 
% of Commercial Portfolio
Office
 
$
939,961

 
52.7
%
 
$
718,780

 
50.9
%
Multifamily
 
264,920

 
14.9
%
 
260,683

 
18.5
%
Retail
 
246,710

 
13.8
%
 
237,414

 
16.8
%
Hotel
 
186,854

 
10.5
%
 
90,585

 
6.4
%
Industrial
 
144,304

 
8.1
%
 
105,081

 
7.4
%
Total
 
$
1,782,749

 
100.0
%
 
$
1,412,543

 
100.0
%

18

Table of Contents

TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

(in thousands)
 
June 30,
2017
 
December 31,
2016
Geographic Location
 
Carrying Value
 
% of Commercial Portfolio
 
Carrying Value
 
% of Commercial Portfolio
Northeast
 
$
655,248

 
36.8
%
 
$
578,762

 
41.0
%
West
 
389,311

 
21.8
%
 
250,044

 
17.7
%
Southwest
 
340,094

 
19.1
%
 
267,944

 
19.0
%
Southeast
 
319,609

 
17.9
%
 
239,194

 
16.9
%
Midwest
 
78,487

 
4.4
%
 
76,599

 
5.4
%
Total
 
$
1,782,749

 
100.0
%
 
$
1,412,543

 
100.0
%
 
At June 30, 2017 and December 31, 2016, the Company pledged commercial real estate assets with a carrying value of $1.6 billion and $1.4 billion, respectively, as collateral for repurchase agreements and FHLB advances. See Note 15 - Repurchase Agreements and Note 17 - Federal Home Loan Bank of Des Moines Advances.
The following table summarizes activity related to commercial real estate assets for the three and six months ended June 30, 2017 and 2016.
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Balance at beginning of period
$
1,548,603

 
$
744,259

 
$
1,412,543

 
$
660,953

Originations, acquisitions and additional fundings
238,664

 
193,181

 
378,048

 
280,447

Repayments
(2,437