two-20210331

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: March 31, 2021


☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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.)


601 Carlson Parkway, Suite 1400
Minnetonka,	Minnesota	55305
(Address of Principal Executive Offices)		(Zip Code)

(612) 453-4100

(Registrant’s Telephone Number, Including Area Code)

Securities Registered Pursuant to Section 12(b) of the Act:

Title of Each Class:

Trading Symbol(s)

Name of Exchange on Which Registered:

Common Stock, par value $0.01 per share

TWO

New York Stock Exchange

8.125% Series A Cumulative Redeemable Preferred Stock

TWO PRA

New York Stock Exchange

7.625% Series B Cumulative Redeemable Preferred Stock

TWO PRB

New York Stock Exchange

7.25% Series C Cumulative Redeemable Preferred Stock

TWO PRC

New York Stock Exchange

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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.


Large accelerated filer	☒	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐

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. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒

As of May 4, 2021, there were 273,723,894 shares of outstanding common stock, par value $0.01 per share, issued and outstanding.

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TWO HARBORS INVESTMENT CORP.

INDEX


		Page
	PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)	1
	Condensed Consolidated Balance Sheets at March 31, 2021 and December 31, 2020	1
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 2021 and 2020	2
	Condensed Consolidated Statements of Stockholders’ Equity for the Three Months Ended March 31, 2021 and 2020	4
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2021 and 2020	5
	Notes to the Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	42
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	65
Item 4.	Controls and Procedures	68
	PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	70
Item 1A.	Risk Factors	70
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	70
Item 3.	Defaults Upon Senior Securities	71
Item 4.	Mine Safety Disclosures	71
Item 5.	Other Information	71
Item 6.	Exhibits	71
Index of Exhibits		72
Signatures		74

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

TWO HARBORS INVESTMENT CORP.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)


	March 31, 2021		December 31, 2020
ASSETS	(unaudited)
Available-for-sale securities, at fair value (amortized cost $11,067,188 and $14,043,175, respectively; allowance for credit losses $18,170 and $22,528, respectively)	$	11,473,390	$	14,650,922

Mortgage servicing rights, at fair value	2,091,761		1,596,153
Cash and cash equivalents	1,159,306		1,384,764
Restricted cash	812,654		1,261,667
Accrued interest receivable	40,527		47,174
Due from counterparties	60,293		146,433
Derivative assets, at fair value	55,145		95,937
Reverse repurchase agreements	76,000		91,525
Other assets	222,839		241,346
Total Assets (1)	$	15,991,915	$	19,515,921
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Repurchase agreements	$	11,676,062	$	15,143,898

Revolving credit facilities	443,458		283,830
Term notes payable	395,891		395,609
Convertible senior notes	423,337		286,183
Derivative liabilities, at fair value	16,162		11,058
Due to counterparties	144,270		135,838
Dividends payable	60,384		65,480
Accrued interest payable	11,906		21,666
Commitments and contingencies (see Note 15)	—		—
Other liabilities	99,729		83,433
Total Liabilities (1)	13,271,199		16,426,995
Stockholders’ Equity:
Preferred stock, par value $0.01 per share; 100,000,000 shares authorized and 29,050,000 and 40,050,000 shares issued and outstanding, respectively ($726,250 and $1,001,250 liquidation preference, respectively)	702,550		977,501
Common stock, par value $0.01 per share; 700,000,000 shares authorized and 273,718,537 and 273,703,882 shares issued and outstanding, respectively	2,737		2,737
Additional paid-in capital	5,165,683		5,163,794
Accumulated other comprehensive income	370,148		641,601
Cumulative earnings	1,265,913		1,025,756
Cumulative distributions to stockholders	(4,786,315)		(4,722,463)
Total Stockholders’ Equity	2,720,716		3,088,926


Total Liabilities and Stockholders’ Equity	$	15,991,915	$	19,515,921

____________________

(1)The condensed consolidated balance sheets include assets and liabilities of consolidated variable interest entities, or VIEs. At March 31, 2021 and December 31, 2020, assets of the VIEs totaled $438,019 and $496,810, and liabilities of the VIEs totaled $432,059 and $477,270, respectively. See Note 3 - Variable Interest Entities for additional information.

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

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TWO HARBORS INVESTMENT CORP.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (unaudited)

(in thousands, except share data)


	Three Months Ended
	March 31,
	2021		2020
Interest income:
Available-for-sale securities	$	55,652	$	248,684


Other	457		6,823
Total interest income	56,109		255,507
Interest expense:
Repurchase agreements	8,470		152,605

Revolving credit facilities	4,695		3,531
Term notes payable	3,211		4,804
Convertible senior notes	6,350		4,776
Federal Home Loan Bank advances	—		1,592
Total interest expense	22,726		167,308
Net interest income	33,383		88,199


Other income (loss):
Gain (loss) on investment securities	132,868		(1,081,607)
Servicing income	107,119		130,797
Gain (loss) on servicing asset	327,438		(586,665)
Loss on interest rate swap and swaption agreements	(15,599)		(250,596)
Loss on other derivative instruments	(276,011)		(133,468)
Other (loss) income	(5,742)		798
Total other income (loss)	270,073		(1,920,741)
Expenses:
Management fees	—		14,550
Servicing expenses	24,947		19,905

Compensation and benefits	8,188		8,277
Other operating expenses	7,487		6,801

Restructuring charges	—		719
Total expenses	40,622		50,252
Income (loss) before income taxes	262,834		(1,882,794)
Provision for (benefit from) income taxes	22,677		(13,138)


Net income (loss)	240,157		(1,869,656)


Dividends on preferred stock	17,216		18,950
Net income (loss) attributable to common stockholders	$	222,941	$	(1,888,606)
Basic earnings (loss) per weighted average common share	$	0.81	$	(6.91)
Diluted earnings (loss) per weighted average common share	$	0.74	$	(6.91)
Dividends declared per common share	$	0.17	$	—
Weighted average number of shares of common stock:
Basic	273,710,765		273,392,615
Diluted	311,465,060		273,392,615

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

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TWO HARBORS INVESTMENT CORP.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (unaudited), continued

(in thousands, except share data)


	Three Months Ended
	March 31,
	2021		2020












Comprehensive loss:
Net income (loss)	$	240,157	$	(1,869,656)
Other comprehensive loss, net of tax:
Unrealized loss on available-for-sale securities	(271,453)		(198,070)
Other comprehensive loss	(271,453)		(198,070)
Comprehensive loss	(31,296)		(2,067,726)


Dividends on preferred stock	17,216		18,950
Comprehensive loss attributable to common stockholders	$	(48,512)	$	(2,086,676)

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

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TWO HARBORS INVESTMENT CORP.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (unaudited)

(in thousands)


	Preferred Stock		Common Stock Par Value		Additional Paid-in Capital		Accumulated Other Comprehensive Income (Loss)		Cumulative Earnings		Cumulative Distributions to Stockholders		Total Stockholders’ Equity

















Balance, December 31, 2019	$	977,501	$	2,729	$	5,154,764	$	689,400	$	2,655,891	$	(4,509,819)	$	4,970,466




Net loss	—		—		—		—		(1,869,656)		—		(1,869,656)
Other comprehensive income before reclassifications, net of tax	—		—		—		234,926		—		—		234,926
Amounts reclassified from accumulated other comprehensive income, net of tax	—		—		—		(432,996)		—		—		(432,996)
Other comprehensive loss, net of tax	—		—		—		(198,070)		—		—		(198,070)




Issuance of common stock, net of offering costs	—		—		142		—		—		—		142
Repurchase of common stock	—		(1)		(1,063)		—		—		—		(1,064)
Preferred dividends declared	—		—		—		—		—		—		—
Common dividends declared	—		—		—		—		—		—		—

Non-cash equity award compensation	—		7		2,308		—		—		—		2,315
Balance, March 31, 2020	$	977,501	$	2,735	$	5,156,151	$	491,330	$	786,235	$	(4,509,819)	$	2,904,133

Balance, December 31, 2020	$	977,501	$	2,737	$	5,163,794	$	641,601	$	1,025,756	$	(4,722,463)	$	3,088,926


Net income	—		—		—		—		240,157		—		240,157
Other comprehensive loss before reclassifications, net of tax	—		—		—		(202,888)		—		—		(202,888)
Amounts reclassified from accumulated other comprehensive income, net of tax	—		—		—		(68,565)		—		—		(68,565)
Other comprehensive loss, net of tax	—		—		—		(271,453)		—		—		(271,453)


Redemption of preferred stock	(274,951)		—		—		—		—		—		(274,951)
Issuance of common stock, net of offering costs	—		—		99		—		—		—		99

Preferred dividends declared	—		—		—		—		—		(17,216)		(17,216)
Common dividends declared	—		—		—		—		—		(46,636)		(46,636)

Non-cash equity award compensation	—		—		1,790		—		—		—		1,790
Balance, March 31, 2021	$	702,550	$	2,737	$	5,165,683	$	370,148	$	1,265,913	$	(4,786,315)	$	2,720,716

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

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TWO HARBORS INVESTMENT CORP.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)


	Three Months Ended
	March 31,
	2021		2020
Cash Flows From Operating Activities:
Net income (loss)	$	240,157	$	(1,869,656)
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Amortization of premiums and discounts on investment securities, net	71,955		41,387
Amortization of deferred debt issuance costs on term notes payable and convertible senior notes	642		554

(Reversal of) provision for credit losses on investment securities	(1,135)		45,638
Realized and unrealized (gains) losses on investment securities	(131,733)		1,035,969
(Gain) loss on servicing asset	(327,438)		586,665

Realized and unrealized loss on interest rate swaps and swaptions	17,249		237,980
Unrealized loss on other derivative instruments	43,466		64,589
Equity based compensation	1,790		2,315



Net change in assets and liabilities:
Decrease in accrued interest receivable	6,647		34,780
Decrease (increase) in deferred income taxes, net	24,546		(44,090)
Decrease in accrued interest payable	(9,760)		(70,083)
Change in other operating assets and liabilities, net	257		34,158

Net cash (used in) provided by operating activities	(63,357)		100,206
Cash Flows From Investing Activities:
Purchases of available-for-sale securities	(131,315)		(4,354,636)
Proceeds from sales of available-for-sale securities	2,050,943		15,586,752
Principal payments on available-for-sale securities	1,047,364		1,119,117
Purchases of trading securities	—		(1,052,500)
Proceeds from sales of trading securities	—		1,053,477
Purchases of mortgage servicing rights, net of purchase price adjustments	(168,170)		(180,951)
(Payments for) proceeds from sales of mortgage servicing rights, net	—		(1,433)
(Purchases) short sales of derivative instruments, net	(64)		(3,630)
(Payments for termination and settlement) proceeds from sales and settlement of derivative instruments, net	(14,755)		(58,840)



Payments for reverse repurchase agreements	(304,875)		(1,591,621)
Proceeds from reverse repurchase agreements	320,400		614,756


Increase (decrease) in due to counterparties, net	94,572		(321,110)
Change in other investing assets and liabilities, net	10,000		508

Net cash provided by investing activities	$	2,904,100	$	10,809,889

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

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TWO HARBORS INVESTMENT CORP.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited), continued

(in thousands)




	Three Months Ended
	March 31,
	2021		2020





















Cash Flows From Financing Activities:
Proceeds from repurchase agreements	$	11,976,033	$	35,793,417
Principal payments on repurchase agreements	(15,443,869)		(46,096,150)


Proceeds from revolving credit facilities	164,000		25,000
Principal payments on revolving credit facilities	(4,372)		(72,857)


Proceeds from convertible senior notes	279,912		—
Repurchase of convertible senior notes	(143,118)		—
Proceeds from Federal Home Loan Bank advances	—		585,000
Principal payments on Federal Home Loan Bank advances	—		(745,000)

Redemption of preferred stock	(274,951)		—
Proceeds from issuance of common stock, net of offering costs	99		142


Repurchase of common stock	—		(1,064)
Dividends paid on preferred stock	(22,418)		(18,950)
Dividends paid on common stock	(46,530)		(109,175)

Net cash used in financing activities	(3,515,214)		(10,639,637)
Net (decrease) increase in cash, cash equivalents and restricted cash	(674,471)		270,458


Cash, cash equivalents and restricted cash at beginning of period	2,646,431		1,616,826
Cash, cash equivalents and restricted cash at end of period	$	1,971,960	$	1,887,284
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest	$	30,908	$	236,043
Cash paid for taxes, net	$	—	$	119
Noncash Activities:
















Dividends declared but not paid at end of period	$	60,384	$	—

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

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TWO HARBORS INVESTMENT CORP.

Notes to the Condensed Consolidated Financial Statements (unaudited)

Note 1. Organization and Operations

Two Harbors Investment Corp. is a Maryland corporation that, through its wholly owned subsidiaries (collectively, the Company), invests in and manages Agency residential mortgage-backed securities, or Agency RMBS, mortgage servicing rights, or MSR, and other financial assets. The investment portfolio as a whole is managed by the Company’s Chief Investment Officer and resources are allocated and financial performance is assessed on a consolidated basis. The Company’s common stock is listed on the NYSE under the symbol “TWO”.

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.

In the first quarter of 2020, the Company experienced unprecedented market conditions as a result of the global COVID-19 pandemic, including unusually significant spread widening in both Agency RMBS and non-Agency securities. In response, the Company focused its efforts on raising excess liquidity and de-risking its portfolio. On March 25, 2020, the Company sold substantially all of its non-Agency securities in order to eliminate the risks posed by continued margin calls and ongoing funding concerns associated with the significant spread widening on these assets. The Company also sold approximately one-third of its Agency RMBS in order to reduce risk and raise cash to establish a strong defensive liquidity position to weather potential ongoing economic and market instability. Since then, the Company has focused on the composition of its Agency RMBS and MSR portfolio, deploying risk as the market entered a period of stabilization and asset price recovery. Going forward, management expects the Company’s capital to be fully allocated to its strategy of pairing Agency RMBS and MSR.

Through August 14, 2020, the Company was externally managed and advised by PRCM Advisers LLC, a subsidiary of Pine River Capital Management L.P., under the terms of a Management Agreement between the Company and PRCM Advisers. The Company terminated the Management Agreement effective August 14, 2020 for “cause” in accordance with Section 15(a) thereof. On August 15, 2020, the Company completed its transition to self-management and directly hired the senior management team and other personnel who had historically provided services to the Company.

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 condensed consolidated financial statements of the Company include the accounts of all subsidiaries; inter-company accounts and transactions have been eliminated. All trust entities in which the Company holds investments that are considered variable interest entities, or 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. Certain prior period amounts have been reclassified to conform to the current period presentation. 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, 2020. In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at March 31, 2021 and results of operations for all periods presented have been made. The results of operations for the three months ended March 31, 2021 should not be construed as indicative of the results to be expected for future periods or the full year.

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TWO HARBORS INVESTMENT CORP.

Notes to the Condensed Consolidated Financial Statements (unaudited)

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make a number of significant estimates. These include estimates of fair value of certain assets and liabilities, amount and timing of credit losses, prepayment rates, and other estimates that affect the reported amounts of certain 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 in the market, 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.

Significant Accounting Policies

Included in Note 2 to the Consolidated Financial Statements of the Company’s 2020 Annual Report on Form 10-K is a summary of the Company’s significant accounting policies.

Recently Issued and/or Adopted Accounting Standards

Measurement of Credit Losses on Financial Instruments

On January 1, 2020, the Company adopted ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which changed the impairment model for most financial assets and certain other instruments. Allowances for credit losses on AFS debt securities are recognized, rather than direct reductions in the amortized cost of the investments, regardless of whether the impairment is considered to be other-than-temporary. 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.

The Company uses a discounted cash flow method to estimate and recognize an allowance for credit losses on AFS securities. The estimated allowance for credit losses is equal to the difference between the prepayment adjusted contractual cash flows with no credit losses and the prepayment adjusted expected cash flows with credit losses, discounted at the effective interest rate on the AFS security that was in effect upon adoption of the standard. The contractual cash flows and expected cash flows are based on management’s best estimate and take into consideration current prepayment assumptions, lifetime expected losses based on past loss experience, current market conditions, and reasonable and supportable forecasts of future conditions. The allowance for credit losses causes an increase in the AFS security amortized cost and recognizes an allowance for credit losses in the same amount. The allowance for credit losses recognized in connection with adopting the guidance in Topic 326 on January 1, 2020 was equal to the present value of the credit reserve in place on December 31, 2019. As a result, no cumulative effect adjustment to opening cumulative earnings was required.

The adoption of this ASU impacts the Company’s accounting for the purchase of certain beneficial interests with purchased credit deterioration or when there is a “significant” difference between contractual cash flows and expected cash flows. For these securities, the Company records an allowance for credit losses with an increase in amortized cost above the purchase price of the same amount. Subsequent adverse or favorable changes in expected cash flows are recognized immediately in earnings as a provision for or reversal of provision for credit losses, respectively. Adverse changes are reflected as an increase to the allowance for credit losses and favorable changes are reflected as a decrease to the allowance for credit losses. The allowance for credit losses is limited to the difference between the beneficial interest’s fair value and its amortized cost, and any remaining adverse changes in these circumstances are reflected as a prospective adjustment to accretable yield. If the allowance for credit losses has been reduced to zero, the remaining favorable changes are reflected as a prospective adjustment to accretable yield. The Company does not adjust the effective interest rate in subsequent periods for prepayment assumption changes or variable-rate changes. Any changes in the allowance for credit losses due to the time-value-of-money are accounted for in the condensed consolidated statements of comprehensive loss as provision for credit losses rather than a reduction to interest income. Any portion of the AFS securities that is deemed uncollectible results in a write-off of the uncollectible amortized cost with a corresponding reduction to the allowance for credit losses. Recoveries of amounts previously written off results in an increase to the allowance for credit losses.

The standard applies to Agency and non-Agency securities that are accounted for as beneficial interests under Accounting Standards Codification (ASC) 325-40, Investments-Other: Beneficial Interests in Securitized Financial Assets, and ASC 310-30, Receivables: Loans and Debt Securities Acquired with Deteriorated Credit Quality, or ASC 310-30. Only beneficial interests that were previously accounted for as purchased credit impaired under ASC 310-30 were accounted for as purchased credit deteriorated under Topic 326 on the transition date.

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TWO HARBORS INVESTMENT CORP.

Notes to the Condensed Consolidated Financial Statements (unaudited)

Upon adoption of this ASU, the Company established an allowance for credit losses on AFS securities accounted for as purchased credit-impaired assets under ASC 310-30 in an unrealized loss position and with no other-than-temporary impairments, or OTTI, recognized in periods prior to transition. The effective interest rates on these debt securities remained unchanged. On January 1, 2020, the $30.7 billion net amortized cost basis of AFS securities was inclusive of a $244.9 million allowance for credit loss.

The Company used a prospective transition approach for debt securities for which OTTI had been recognized prior to January 1, 2020. As a result, the amortized cost basis remained the same before and after the effective date. The effective interest rate on these debt securities also remained unchanged. Amounts previously recognized in accumulated other comprehensive income as of January 1, 2020 relating to improvements in cash flows expected to be collected are accreted into income over the remaining life of the asset. Recoveries of amounts previously written off relating to improvements in cash flows after January 1, 2020 are recorded in earnings when received.

Facilitation of the Effects of Reference Rate Reform on Financial Reporting

In March 2020, the FASB issued ASU No. 2020-04, which provides temporary optional expedients and exceptions on accounting for contract modifications and hedging relationships in anticipation of the replacement of the London Interbank Offered Rate, or LIBOR, with another reference rate. The guidance also provides a one-time election to sell held-to-maturity debt securities or to transfer such securities to the available-for-sale or trading category. The ASU was effective immediately for all entities and expires after December 31, 2022. The Company’s adoption of this ASU did not have an impact on the Company’s financial condition, results of operations or financial statement disclosures.

Issuer’s Accounting for Debt and Equity Instruments

In August 2020, the FASB issued ASU No. 2020-06 to simplify an issuer’s accounting for convertible instruments and its application of the derivatives scope exception for contracts in its own equity. Under the new guidance, only conversion features associated with a convertible debt instrument issued at a substantial premium and those that are considered embedded derivatives in accordance with derivatives guidance will be accounted for separate from the convertible instrument. Additionally, for contracts in an entity’s own equity, the new guidance eliminates some of the requirements for equity classification. The guidance also addresses how convertible instruments are accounted for in the diluted earnings per share calculation and requires enhanced disclosures about the terms of convertible instruments and contracts in an entity’s own equity. The ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2021, with early adoption permitted. The early adoption of the ASU’s guidance results in the Company accounting for a convertible debt instrument without separately presenting in stockholders’ equity an embedded conversion feature. The Company accounts for a convertible debt instrument wholly as debt unless (1) a convertible instrument contains features that require bifurcation as a derivative under ASC 815, Derivatives and Hedging, or ASC 815, or (2) a convertible debt instrument was issued at a substantial premium. The Company’s early adoption of this ASU did not have an impact on the Company’s financial condition, results of operations or financial statement disclosures.

Note 3. Variable Interest Entities

During the year ended December 31, 2019, the Company formed a trust entity, or the MSR Issuer Trust, for the purpose of financing MSR through securitization, pursuant to which, through two of the Company’s wholly owned subsidiaries, MSR is pledged to the MSR Issuer Trust and in return, the MSR Issuer Trust issues term notes to qualified institutional buyers and a variable funding note, or VFN, to one of the subsidiaries, in each case secured on a pari passu basis. In connection with the transaction, the Company also entered into a repurchase facility that is secured by the VFN issued in connection with the MSR securitization transaction, which is collateralized by the Company’s MSR.

During the year ended December 31, 2020, the Company formed a trust entity, or the Servicing Advance Receivables Issuer Trust, for the purpose of financing servicing advances through a revolving credit facility, pursuant to which the Servicing Advance Receivables Issuer Trust issued a VFN backed by servicing advances pledged to the financing counterparty.

Both the MSR Issuer Trust and the Servicing Advance Receivables Issuer Trust are considered VIEs for financial reporting purposes and, thus, were reviewed for consolidation under the applicable consolidation guidance. As 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. Additionally, in accordance with arrangements entered into in connection with the securitization transaction and the servicing advance revolving credit facility, the Company has direct financial obligations payable to both the MSR Issuer Trust and the Servicing Advance Receivables Issuer Trust, which, in turn, support the MSR Issuer Trust’s obligations to noteholders under the securitization transaction and the Servicing Advance Receivables Issuer Trust’s obligations to the financing counterparty.

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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 March 31, 2021 and December 31, 2020:


(in thousands)	March 31, 2021		December 31, 2020
Note receivable (1)	$	395,891	$	395,609

Restricted cash	15,942		72,530
Accrued interest receivable (1)	226		131
Other assets	25,960		28,540
Total Assets	$	438,019	$	496,810
Term notes payable	$	395,891	$	395,609
Revolving credit facilities	20,000		9,000
Accrued interest payable	286		156
Other liabilities	15,882		72,505
Total Liabilities	$	432,059	$	477,270

____________________

(1)Receivables due from a wholly owned subsidiary of the Company to the trusts are eliminated in consolidation in accordance with U.S. GAAP.

Note 4. Available-for-Sale Securities, at Fair Value

The Company holds both Agency and non-Agency AFS investment securities which are carried at fair value on the condensed consolidated balance sheets. In the first quarter of 2020, the Company experienced unprecedented market conditions as a result of the global COVID-19 pandemic, including unusually significant spread widening in both Agency RMBS and non-Agency securities. In response, the Company focused its efforts on raising excess liquidity and de-risking its portfolio. On March 25, 2020, the Company sold substantially all of its non-Agency securities in order to eliminate the risks posed by continued margin calls and ongoing funding concerns associated with the significant spread widening on these assets. The Company also sold approximately one-third of its Agency RMBS in order to reduce risk and raise cash to establish a strong defensive liquidity position to weather potential ongoing economic and market instability. Since then, the Company has focused on the composition of its Agency RMBS portfolio, deploying risk as the market entered a period of stabilization and asset price recovery.

The following table presents the Company’s AFS investment securities by collateral type as of March 31, 2021 and December 31, 2020:


(in thousands)	March 31, 2021		December 31, 2020
Agency:
Federal National Mortgage Association	$	8,604,120	$	11,486,658
Federal Home Loan Mortgage Corporation	2,578,406		2,837,103
Government National Mortgage Association	281,645		314,130
Non-Agency	9,219		13,031
Total available-for-sale securities	$	11,473,390	$	14,650,922

At March 31, 2021 and December 31, 2020, the Company pledged AFS securities with a carrying value of $11.5 billion and $14.6 billion, respectively, as collateral for repurchase agreements. See Note 11 - Repurchase Agreements.

At March 31, 2021 and December 31, 2020, the Company did not have any securities purchased from and financed with the same counterparty that did not meet the conditions of ASC 860, Transfers and Servicing, to be considered linked transactions and, therefore, classified as derivatives.

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TWO HARBORS INVESTMENT CORP.

Notes to the Condensed Consolidated Financial Statements (unaudited)

The Company is not required to consolidate variable interest entities, or 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 all non-Agency securities, which are classified within available-for-sale securities, at fair value on the condensed consolidated balance sheets. As of March 31, 2021 and December 31, 2020, the carrying value, which also represents the maximum exposure to loss, of all non-Agency securities in unconsolidated VIEs was $9.2 million and $13.0 million, respectively.

The following tables present the amortized cost and carrying value of AFS securities by collateral type as of March 31, 2021 and December 31, 2020:


	March 31, 2021
(in thousands)	Principal/ Current Face		Un-amortized Premium		Accretable Purchase Discount		Amortized Cost		Allowance for Credit Losses		Unrealized Gain		Unrealized Loss		Carrying Value
Agency:
Principal and interest	$	10,170,349	$	456,318	$	(13)	$	10,626,654	$	—	$	393,005	$	(32,355)	$	10,987,304
Interest-only	4,381,919		423,461		—		423,461		(16,699)		78,836		(8,731)		476,867
Total Agency	14,552,268		879,779		(13)		11,050,115		(16,699)		471,841		(41,086)		11,464,171



Non-Agency	1,600,877		15,313		(1,783)		17,073		(1,471)		1,446		(7,829)		9,219
Total	$	16,153,145	$	895,092	$	(1,796)	$	11,067,188	$	(18,170)	$	473,287	$	(48,915)	$	11,473,390


	December 31, 2020
(in thousands)	Principal/ Current Face		Un-amortized Premium		Accretable Purchase Discount		Amortized Cost		Allowance for Credit Losses		Unrealized Gain		Unrealized Loss		Carrying Value
Agency:
Principal and interest	$	13,103,355	$	605,253	$	(14)	$	13,708,594	$	—	$	629,079	$	(420)	$	14,337,253
Interest-only	3,649,556		315,876		—		315,876		(17,889)		15,680		(13,029)		300,638
Total Agency	16,752,911		921,129		(14)		14,024,470		$	(17,889)	644,759		(13,449)		14,637,891



Non-Agency	2,095,365		16,408		(36)		18,705		(4,639)		109		(1,144)		13,031
Total	$	18,848,276	$	937,537	$	(50)	$	14,043,175	(22,528)		$	644,868	$	(14,593)	$	14,650,922

The following table presents the Company’s AFS securities according to their estimated weighted average life classifications as of March 31, 2021:


	March 31, 2021
(in thousands)	Agency		Non-Agency		Total
< 1 year	$	5,155	$	1,236	$	6,391
≥ 1 and < 3 years	92,963		7,983		100,946
≥ 3 and < 5 years	1,482,174		—		1,482,174
≥ 5 and < 10 years