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Two Harbors Investment Corp. Reports Third Quarter 2011 Financial Results

Strong Underlying Performance of Portfolio Resulting in Core Earnings of $0.40 per Weighted Share, 16.2% Return on Average Equity

NEW YORK--()--Two Harbors Investment Corp. (NYSE: TWO; NYSE Amex: TWO.WS), a real estate investment trust that invests in residential mortgage-backed securities (RMBS), residential mortgage loans and other financial assets, today announced its financial results for the quarter ended September 30, 2011.

Highlights

  • Increased Core Earnings 64.9% on a sequential quarter basis to $51.8 million, or $0.40 per diluted weighted average share.
  • RMBS portfolio generated an aggregate yield of 5.5%, driven by non-Agency portfolio performance of 9.8% in the third quarter of 2011 as compared to 8.8% in the previous quarter.
  • Declared a dividend of $0.40 per common share, or 18.1% annualized dividend yield, based upon September 30, 2011 closing price of $8.83.
  • Completed accretive secondary stock offering in July, which resulted in the issuance of 48.3 million shares for net proceeds of approximately $483.6 million. The deployed proceeds increased the company's investment portfolio to $6.6 billion at September 30, 2011 compared to $4.6 billion at June 30, 2011.
  • Continued development of infrastructure to support asset securitization program.
  • Announced Board of Director authorization for a share repurchase program of up to 10 million shares.

"We are pleased with our investment team's performance against a backdrop of volatile market conditions," said Thomas Siering, Two Harbors' President and Chief Executive Officer. "Our relative portfolio performance this quarter exceeded many indices for the same period and we believe our continued focus on security selection, thoughtful capital allocation and sophisticated hedging strategies distinguishes Two Harbors from its peers."

Operating Performance

The following table summarizes the company's GAAP and non-GAAP earnings measurements and key metrics for the third quarter of 2011:

Two Harbors Operating Performance
(dollars in thousands, except per share data)   Q3-2011   Q3 YTD 2011
Earnings Earnings  

Per diluted
weighted
share

 

Return
(Loss) on
average
equity

Earnings  

Per diluted
weighted
share

 

Return
(Loss) on
average
equity

Core Earnings1 $ 51,801 $ 0.40 16.2 % $ 97,979 $ 1.16 15.7 %
GAAP Net Income $ 54,609 $ 0.42 17.1 % $ 76,002 $ 0.90 12.2 %
Adjusted GAAP Earnings2 $ 71,259 $ 0.55 22.3 % $ 125,188 $ 1.48 20.0 %
Comprehensive (Loss) Income $ (17,964 ) $ (0.14 ) (5.6 )% $ 27,058 $ 0.32 4.3 %
 
Operating Metrics Q3-2011
Dividend per common share $ 0.40
Book value per diluted share at period end $ 9.30
Operating expenses as a percentage of average equity 0.9 %
 
(1) Core Earnings is a non-GAAP measure that the company defines as GAAP net income, excluding impairment losses, gains or losses on sales of securities and termination of interest rate swaps, unrealized gains or losses on trading securities, interest rate swaps and swaptions, certain gains or losses on derivative instruments and non-recurring business combination expenses. As defined, Core Earnings includes interest income associated with the company's inverse interest-only securities ("Agency derivatives") and premium income on credit default swaps.
(2) Adjusted GAAP Earnings is a non-GAAP measure that the company defines as GAAP net income, excluding the unrealized fair value gains and losses associated with the company's interest rate swaps and swaptions utilized to economically hedge interest rate risk associated with the company's short-term LIBOR-based repurchase agreements and available-for-sale securities.

Earnings Summary

Two Harbors reported Core Earnings for the quarter ended September 30, 2011 of $51.8 million, or $0.40 per diluted weighted average common share outstanding, as compared to Core Earnings for the quarter ended June 30, 2011 of $31.4 million, or $0.41 per diluted weighted average common share outstanding.

In anticipation of the potential release of HARP 2.0 combined with the substantially lower interest rate environment, the company repositioned its Agency portfolio during the quarter. This resulted in the company selling RMBS for $681.1 million with an amortized cost of $660.4 million for a net realized gain of $20.7 million, net of tax. The company recognized additional sales of RMBS and U.S. Treasuries for $427.4 million with an amortized cost of $420.3 million for a net realized gain of $6.7 million, net of tax. In unison with the Agency RMBS portfolio adjustment, the company lowered its cost of financing through the termination of certain interest rate swap positions and realized a loss of $19.8 million, net of tax. The company recognized other-than-temporary impairment losses on its non-Agency RMBS securities of $3.4 million, net of tax, and recognized unrealized gains on its U.S. Treasury trading securities of $2.4 million, net of tax. In addition, the company recognized in earnings an unrealized loss, net of tax, of $16.7 million associated with its interest rate swaps and swaptions economically hedging its repurchase agreements and an unrealized gain, net of tax, of $4.7 million associated with its interest rate swaps economically hedging its trading securities and TBA contracts. The third quarter 2011 results also included net gains on other derivative instruments of approximately $8.1 million, net of tax, including $14.3 million of net unrealized gains on inverse interest-only securities, TBA contracts and credit default swaps.

The company reported GAAP Net Income of $54.6 million, or $0.42 per diluted weighted average share outstanding, for the quarter ended September 30, 2011, as compared to GAAP Net Loss of approximately $1.0 million, or negative $0.01 per diluted weighted average share outstanding, for the quarter ended June 30, 2011. This increase in GAAP Net Income, from a quarter ago, is primarily due to strong underlying RMBS performance and favorable hedging gains on TBAs, credit default swaps and U.S. Treasuries combined with higher prior quarter valuation deterioration in the company's swap and swaption hedges, which are recognized in the GAAP income statement. On a GAAP basis, the company earned an annualized return on average equity of 17.1% for the quarter ended September 30, 2011 and negative 0.5% for the quarter ended June 30, 2011.

Two Harbors reported Adjusted GAAP Earnings for the quarter ended September 30, 2011 of $71.3 million, or $0.55 per diluted weighted average common share outstanding, as compared to Adjusted GAAP Earnings for the quarter ended June 30, 2011 of $36.1 million, or $0.47 per diluted weighted average common share outstanding. Included in Adjusted GAAP are unrealized gains on other derivative hedging activity associated with inverse interest-only securities, TBA contracts and credit default swaps. On an Adjusted GAAP Earnings basis, the company recognized an annualized return on average equity of 22.3% and 18.7% for the comparative periods.

The company reported a Comprehensive Loss of $18.0 million, or negative $0.14 per diluted weighted average share outstanding, for the quarter ended September 30, 2011, as compared to Comprehensive Income of $13.5 million, or $0.18 per diluted weighted average share outstanding, for the quarter ended June 30, 2011. The third quarter 2011 was negatively impacted by a net unrealized fair value loss of $89.1 million on the company's non-Agency portfolio. The company records unrealized fair value gains and losses for RMBS, classified as available-for-sale, as Other Comprehensive Income in the Statement of Stockholders' Equity. On a Comprehensive Income basis, the company recognized an annualized loss on average equity of 5.6% and a return of 7.0% for the quarters ended September 30, 2011 and June 30, 2011, respectively.

Other Key Metrics

Two Harbors declared a quarterly dividend of $0.40 per common share for the quarter ended September 30, 2011. The annualized dividend yield on the company's common stock for the quarter ended September 30, 2011, based on the September 30, 2011 closing price of $8.83, was 18.1%.

The company's book value per diluted share, after giving effect to the third quarter 2011 dividend of $0.40, was $9.30 as of September 30, 2011, compared to $9.73 as of June 30, 2011. The company's book value for the third quarter 2011 was significantly impacted by valuation losses as described above on its non-Agency portfolio.

Other operating expenses for the third quarter of 2011 were approximately $2.9 million, or 0.9% of average equity, compared to approximately $2.2 million, or 1.1%, for the second quarter of 2011.

Portfolio Summary

"Our portfolio increased nearly sevenfold from a year ago due to the secondary offerings we completed over the last year,” said Bill Roth, Two Harbors' Co-Chief Investment Officer. "We continued our opportunistic approach in deploying capital, and are pleased with the expansion of our net interest margin as a result of strong performance on both Agency and non-Agency strategies."

For the quarter ended September 30, 2011, the annualized yield on average RMBS and Agency derivatives was 5.5% and the annualized cost of funds on the average borrowings, which includes net interest rate spread expense on interest rate swaps, was 1.3%. This resulted in a net interest rate spread of 4.2%, up from 4.1% in the prior quarter. The company reported debt-to-equity, defined as total borrowings to fund RMBS and Agency derivatives divided by total equity, of 4.4:1.0 and 4.2:1.0 at September 30, 2011 and June 30, 2011, respectively.

The company's portfolio is principally composed of RMBS available-for-sale securities and Agency derivatives. As of September 30, 2011, the total value of the portfolio was $6.6 billion, of which approximately $5.3 billion was Agency RMBS and derivatives and $1.3 billion was non-Agency RMBS. As of September 30, 2011, fixed-rate securities composed 78.0% of the company's portfolio and adjustable-rate securities composed 22.0% of the company's portfolio. In addition, the company held $1.5 billion of U.S. Treasuries classified on its balance sheet as trading securities.

Two Harbors was a party to interest rate swaps and swaptions as of September 30, 2011 with an aggregate notional amount of $8.2 billion, of which $6.1 billion was utilized to economically hedge interest rate risk associated with the company's short-term LIBOR-based repurchase agreements.

The following table summarizes the company's portfolio:

Two Harbors Portfolio
(dollars in thousands, except per share data)
 
RMBS and Agency Derivatives Portfolio Composition   As of September 30, 2011
Agency Bonds
Fixed Rate Bonds $ 4,917,465 74.8 %
Hybrid ARMs 239,229   3.6 %
Total Agency 5,156,694 78.4 %
Agency Derivatives 160,473 2.5 %
Non-Agency Bonds
Senior Bonds 994,883 15.1 %
Mezzanine Bonds 261,318   4.0 %
Total Non-Agency 1,256,201 19.1 %
   
Aggregate Portfolio $ 6,573,368  
 
Fixed-rate investment securities as a percentage of aggregate portfolio 78.0 %
Adjustable-rate investment securities as a percentage of aggregate portfolio 22.0 %
 
Portfolio Metrics

For the Quarter Ended
September 30, 2011

Annualized yield on average RMBS and Agency derivatives during the quarter
Agency 4.3 %
Non-Agency 9.8 %
Aggregate Portfolio 5.5 %
Annualized cost of funds on average repurchase balance during the quarter1 1.3 %
Annualized interest rate spread for aggregate portfolio during the quarter 4.2 %
Weighted average cost basis of principal and interest securities
Agency $ 106.28
Non-Agency $ 55.79
Weighted average three month CPR for its RMBS portfolio
Agency 5.0 %
Non-Agency 2.4 %
Debt-to-equity ratio at period-end2

4.4

 
(1) Cost of funds includes interest spread expense associated with the portfolio's interest rate swaps.
(2) Defined as total borrowings to fund RMBS and Agency derivatives divided by total equity.

RMBS Agency securities owned by the company at period end experienced a three-month average Constant Prepayment Rate (CPR) of 5.0% during the second and third quarters of 2011. Including Agency inverse interest-only derivatives, the company experienced a three-month average CPR of 5.5% during the third quarter of 2011, as compared to 5.3% during the second quarter of 2011. The weighted average cost basis of the Agency portfolio was 106.3% of par as of September 30, 2011 and 105.1% of par as of June 30, 2011. The net premium amortization was $15.1 million and $9.3 million for the quarters ended September 30, 2011 and June 30, 2011, respectively.

Non-Agency securities owned by the company at September 30, 2011 experienced a three-month average CPR of 2.4% during the third quarter of 2011 as compared to 3.0% during the second quarter of 2011. The weighted average cost basis of the non-Agency portfolio was 55.8% of par as of September 30, 2011 and 59.3% of par as of June 30, 2011. The discount accretion was $19.9 million and $7.0 million for the quarters ended September 30, 2011 and June 30, 2011, respectively. The total net discount remaining was $1.3 billion and $0.7 billion as of September 30, 2011 and June 30, 2011, respectively.

Share Repurchase Plan Announced

On October 5, 2011, the company announced that its Board of Directors authorized the company to repurchase up to 10 million shares of its common stock. The shares may be repurchased from time to time through privately negotiated transactions or open market transactions, or by any combination of such methods.

Conference Call

Two Harbors Investment Corp. will host a conference call on November 3, 2011 at 9:00 a.m. EDT to discuss third quarter 2011 financial results and related information. To participate in the teleconference, please call toll-free 877-868-1835 (or 914-495-8581 for international callers) approximately 10 minutes prior to the above start time. You may also listen to the teleconference live via the Internet on the company's website at www.twoharborsinvestment.com in the Investor Relations section under the Events and Presentations link. For those unable to attend, a telephone playback will be available beginning at 12 p.m. EDT on November 3, 2011 through 9 p.m. EDT on November 10, 2011. The playback can be accessed by calling 855-859-2056 (or 404-537-3406 for international callers) and providing Confirmation Code 19735201. The call will also be archived on the company's website in the Investor Relations section under the Events and Presentations link.

About Two Harbors Investment Corp.

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

Forward-Looking Statements

This press release includes “forward-looking statements” within the meaning of the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Actual results may differ from expectations, estimates and projections and, consequently, readers should not rely on these forward-looking statements as predictions of future events. Words such as “expect,” “target,” “assume,” “estimate,” “project,” “budget,” “forecast,” “anticipate,” “intend,” “plan,” “may,” “will,” “could,” “should,” “believe,” “predicts,” “potential,” “continue,” and similar expressions are intended to identify such forward-looking statements. These forward-looking statements involve significant risks and uncertainties that could cause actual results to differ materially from expected results. Factors that could cause actual results to differ include, but are not limited to, higher than expected operating costs, changes in prepayment speeds of mortgages underlying the company's RMBS, the rates of default or decreased recovery on the mortgages underlying its non-Agency securities, failure to recover certain losses that are expected to be temporary, changes in interest rates or the availability of financing, the impact of new legislation or regulatory changes on its operations, the impact of any deficiencies in the servicing or foreclosure practices of third parties and related delays in the foreclosure process, the impact of new or modified government mortgage refinance or principal reduction programs, and unanticipated changes in overall market and economic conditions.

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

Non-GAAP Financial Measures

In addition to disclosing financial results calculated in accordance with United States generally accepted accounting principles (GAAP), this press release and the accompanying investor presentation present non-GAAP financial measures that exclude certain items. Two Harbors' management believes that these non-GAAP measures enable it to perform meaningful comparisons of past, present and future results of the company's core business operations, and uses these measures to gain a comparative understanding of the company's operating performance and business trends. The non-GAAP financial measures presented by the company represent supplemental information to assist investors in analyzing the results of Two Harbors' operations; however, as these measures are not in accordance with GAAP, they should not be considered a substitute for, or superior to, the financial measures calculated in accordance with GAAP. Our GAAP financial results and the reconciliations from these results should be carefully evaluated. See the GAAP to Non-GAAP reconciliation table on page 9 of this release.

Additional Information

Stockholders and warrant holders of Two Harbors, and other interested persons, may find additional information regarding the company at the SEC's Internet site at www.sec.gov or by directing requests to: Two Harbors Investment Corp., Attn: Investor Relations, 601 Carlson Parkway, Suite 150, Minnetonka, MN 55305, telephone 612-629-2500.

TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
 
September 30, 2011 December 31, 2010
(unaudited)
ASSETS
Available-for-sale securities, at fair value $ 6,412,895 $ 1,354,405
Trading securities, at fair value 1,526,330 199,523
Cash and cash equivalents 409,947   163,900  
Total earning assets 8,349,172 1,717,828
Restricted cash 164,276 22,548
Accrued interest receivable 25,510 5,383
Due from counterparties 33,918 12,304
Derivative assets, at fair value 245,314 38,109
Other assets 619   1,260  
Total Assets $ 8,818,809   $ 1,797,432  
 
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Repurchase agreements $ 7,300,613 $ 1,169,803
Derivative liabilities, at fair value 46,182 158
Accrued interest payable 5,442 785
Due to counterparties 90,880 231,724
Accrued expenses and other liabilities 7,747 2,063
Dividends payable 56,235 10,450
Other liabilities 4,579   1  
Total Liabilities 7,511,678 1,414,984
 
Stockholders' Equity

Preferred stock, par value $0.01 per share; 50,000,000 shares authorized; no shares issued

and outstanding
Common stock, par value $0.01 per share; 450,000,000 shares authorized and 140,586,736
and 40,501,212 shares issued and outstanding, respectively 1,406 405
Additional paid-in capital 1,372,944 366,974
Accumulated other comprehensive income (26,325 ) 22,619
Cumulative earnings 106,022 30,020
Cumulative distributions to stockholders (146,916 ) (37,570 )
Total stockholders' equity 1,307,131   382,448  
Total Liabilities and Stockholders' Equity $ 8,818,809   $ 1,797,432  
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(dollars in thousands, except per share data)
 
  Three Months Ended   Nine Months Ended
September 30, September 30,
2011   2010 2011   2010
Interest income:
Available-for-sale securities $ 65,919 $ 11,823 $ 125,413 $ 27,064
Trading securities 1,706 15 2,783 15
Cash and cash equivalents 114   27   241   70  
Total interest income 67,739 11,865 128,437 27,149
Interest expense 7,218   1,395   13,580   2,777  
Net interest income 60,521 10,470 114,857 24,372
Other-than-temporary impairments:
Total other-than-temporary impairments losses (3,371 ) (3,665 )
Non-credit portion of loss recognized in other comprehensive income (loss)        
Net other-than-temporary credit impairment losses (3,371 ) (3,665 )
Other income:
Gain on investment securities, net 31,432 2,577 36,159 4,608
Loss on interest rate swap and swaption agreements (39,311 ) (4,436 ) (88,180 ) (10,037 )
Gain on other derivative instruments 22,361   3,098   37,474   4,197  
Total other income (loss) 14,482 1,239 (14,547 ) (1,232 )
Expenses:
Management fees 4,785 862 9,063 2,068
Other operating expenses 2,850   1,213   6,516   3,332  
Total expenses 7,635   2,075   15,579   5,400  
Net income before income taxes 63,997 9,634 81,066 17,740
Income tax (expense) benefit (9,388 ) 246   (5,064 ) 1,555  
Net income attributable to common stockholders $ 54,609   $ 9,880   $ 76,002   $ 19,295  
 
Net income available per share to common stockholders:
Basic and Diluted $ 0.42 $ 0.38 $ 0.90 $ 0.93
 
Weighted average shares outstanding:
Basic and Diluted 130,607,566 26,126,212 84,751,854 20,691,461
 
Comprehensive (loss) income:
 
Net income $ 54,609 $ 9,880 $ 76,002 $ 19,295
Other comprehensive (loss) income
Net unrealized (loss) gain on available-for-sale securities (72,573 ) 14,229   (48,944 ) 17,001  
Other comprehensive (loss) income (72,573 ) 14,229   (48,944 ) 17,001  
Comprehensive (loss) income $ (17,964 ) $ 24,109   $ 27,058   $ 36,296  
TWO HARBORS INVESTMENT CORP.
RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL INFORMATION
(UNAUDITED)
(dollars in thousands, except per share data)
 
  Three Months Ended   Nine Months Ended
September 30, September 30,
2011   2010 2011   2010
 
Reconciliation of net income attributable to common stockholders
to Core Earnings:
 
Net income attributable to common stockholders 54,609 9,880 76,002 19,295
 
Adjustments for non-core earnings:
Gain on sale of securities, net of tax (27,422 ) (2,494 ) (29,584 ) (4,525 )
Other-than-temporary impairment loss 3,371 3,665
Unrealized gain on trading securities, net of tax (2,422 ) (3,953 )

Unrealized loss, net of tax, on interest rate swap and swaptions economically
hedging repurchase agreements and available-for-sale securities

16,650 361 49,186 3,795

Unrealized gain, net of tax, on interest rate swaps economically hedging
trading securities and TBA contracts

(4,686 ) (3,429 )
Realized loss on termination of swaps, net of tax 19,834 2,486 19,983 2,486
Gain on other derivative instruments, net of tax (8,133 ) (1,213 ) (13,891 ) (1,765 )
       
Core Earnings 51,801   9,020   97,979   19,286  
 
Weighted average shares outstanding - basic and diluted 130,607,566 26,126,212 84,751,854 20,691,461
 
Core Earnings per weighted average share outstanding - basic and diluted $ 0.40 $ 0.35 $ 1.16 $ 0.93
 
 
Three Months Ended Nine Months Ended
September 30, September 30,
2011 2010 2011 2010
 
 
Reconciliation of net income attributable to common stockholders
to Adjusted GAAP Earnings:
 
Net gain income attributable to common stockholders $ 54,609 $ 9,880 $ 76,002 $ 19,295
 
Adjustments to GAAP Net Income:

Unrealized loss, net of tax, on interest rate swap and swaptions
economically hedging repurchase agreements and available-for-sale
securities

16,650 361 49,186 3,795
       
Adjusted GAAP Earnings $ 71,259   $ 10,241   $ 125,188   $ 23,090  
 
Weighted average shares outstanding - basic and diluted 130,607,566 26,126,212 84,751,854 20,691,461
 

Adjusted GAAP Earnings per weighted avg. share outstanding - basic and
diluted

$ 0.55 $ 0.39 $ 1.48 $ 1.12

Contacts

Two Harbors Investment Corp.
Christine Battist, Investor Relations
612-629-2507

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