Two Harbors Investment Corp. Reports Fourth Quarter 2018 Financial Results

2018 Transformative Year for the Company

NEW YORK--(BUSINESS WIRE)-- Two Harbors Investment Corp. (NYSE: TWO), a leading hybrid mortgage real estate investment trust (REIT) that invests in residential mortgage-backed securities (RMBS), mortgage servicing rights (MSR) and other financial assets, today announced its financial results for the quarter ended December 31, 2018.

Quarterly Summary

• Redeployed capital from CYS Investments, Inc. (CYS) acquisition in accordance with previously announced plan.
• Added $36.1 billion unpaid principal balance (UPB) of MSR through bulk acquisitions and monthly flow-sale arrangements, bringing total holdings to $163.1 billion UPB.
• Incurred a Comprehensive Loss of ($307.9) million, or ($1.24) per weighted average basic common share.
• Generated Core Earnings, including dollar roll income, of $120.7 million, or $0.49 per weighted average basic common share, representing a return on average common equity of 13.8%.⁽¹⁾
• Reported book value of $13.11 per common share, representing a (8.3%) total quarterly return on book value.⁽²⁾

2018 Summary

• Completed the acquisition of CYS, growing the company’s market capitalization and equity base, increasing the liquidity of the company’s stock and driving expenses lower.
• Added $75.9 billion UPB of MSR, growing portfolio by approximately 60% year-over-year.
• Generated strong Core Earnings and competitive average dividend yield of 12.8% in 2018.

“2018 was a transformative year for our company. We acquired CYS, generated strong Core Earnings and a competitive dividend yield, drove our expenses lower, and achieved substantial scale and operating efficiencies in our MSR platform,” stated Thomas Siering, Two Harbors’ President and Chief Executive Officer. “Heading into 2019, we believe that there are attractive opportunities to drive returns in our Rates and Credit strategies and we remain keenly focused on risk management and hedging.”

Operating Performance
The following table summarizes the company’s GAAP and non-GAAP earnings measurements and key metrics for the fourth quarter of 2018:

Earnings Summary
Two Harbors incurred a Comprehensive Loss of ($307.9) million, or ($1.24) per weighted average basic common share, for the quarter ended December 31, 2018, as compared to a Comprehensive Loss of ($102.8) million, or ($0.46) per weighted average basic common share, for the quarter ended September 30, 2018. The company records unrealized fair value gains and losses on the majority of RMBS, classified as available-for-sale, in Other Comprehensive Loss. On a Comprehensive Loss basis, the company recognized an annualized return on average common equity of (35.2%) and (11.9%) for the quarters ended December 31, 2018 and September 30, 2018, respectively.

The company reported a GAAP Net Loss of ($573.5) million, or ($2.31) per weighted average basic common share, for the quarter ended December 31, 2018, as compared to GAAP Net Income of $17.0 million, or $0.08 per weighted average basic common share, for the quarter ended September 30, 2018. On a GAAP Net (Loss) Income basis, the company recognized an annualized return on average common equity of (65.5%) and 2.0% for the quarters ended December 31, 2018 and September 30, 2018, respectively.

For the fourth quarter of 2018, the company recognized non-Core Earnings of:

• net realized losses on RMBS of $248.9 million;
• net unrealized gains on certain RMBS of $2.9 million;
• other-than-temporary impairment loss of $0.1 million;
• net losses of $35.8 million related to swap, cap and swaption terminations and expirations;
• net unrealized losses of $219.1 million associated with interest rate swaps, caps and swaptions economically hedging interest rate exposure (or duration);
• net realized and unrealized losses on other derivative instruments of $35.0 million;
• net realized and unrealized losses on MSR of $113.5 million⁽¹⁾;
• servicing reserve expense of $1.2 million;
• non-cash equity compensation expense of $3.2 million; and
• net provision for income taxes on non-Core Earnings of $6.4 million.

The company reported Core Earnings, including dollar roll income, for the quarter ended December 31, 2018 of $120.7 million, or $0.49 per weighted average basic common share. The company reported Core Earnings, including dollar roll income, for the quarter ended September 30, 2018 of $107.0 million or $0.48 per weighted average basic common share. On a Core Earnings basis, including dollar roll income, the company recognized an annualized return on average common equity of 13.8% for the quarter ended December 31, 2018, compared to 12.4% for the quarter ended September 30, 2018.

Other Key Metrics
Two Harbors declared a cash dividend of $0.47 per common share for the quarter ended December 31, 2018. The annualized dividend yield on the company’s common stock for the quarter, based on the December 31, 2018 closing price of $12.84, was 14.6%.

Two Harbors declared quarterly dividends of $0.50781 per share on its 8.125% Series A fixed-to-floating rate cumulative redeemable preferred stock, $0.47656 per share on its 7.625% Series B fixed-to-floating rate cumulative redeemable preferred stock, $0.45313 per share of the 7.25% Series C fixed-to-floating rate cumulative redeemable preferred stock, $0.484375 per share of the 7.75% Series D cumulative redeemable preferred stock and $0.46875 per share of the 7.50% Series E cumulative redeemable preferred stock. The Series A, Series B and Series C preferred dividends were paid on January 28, 2019 to the applicable preferred stockholders of record at the close of business on January 11, 2019. The Series D and Series E preferred dividends were paid on January 15, 2019 to the applicable preferred stockholders of record at the close of business on January 1, 2019.

The company’s book value per common share, after taking into account the fourth quarter 2018 common and preferred stock dividends, was $13.11 as of December 31, 2018, compared to $14.81 as of September 30, 2018, which represented a total return on book value for the quarter of (8.3%).⁽²⁾

Other operating expenses, excluding non-cash LTIP amortization, for the quarter ended December 31, 2018 were $12.7 million. The company’s annualized expense ratio was 1.1% of average equity, compared to other operating expenses, excluding non-cash LTIP amortization, of $13.8 million, or 1.3% of average equity, for the quarter ended September 30, 2018. These exclude non-cash equity compensation expense of $3.2 million for both of the quarters ended September 30, 2018 and December 31, 2018.

Portfolio Summary
The company’s aggregate portfolio is principally comprised of RMBS available-for-sale securities, inverse interest-only securities (Agency Derivatives) and MSR. As of December 31, 2018, the total value of the company’s portfolio was $27.6 billion.

The company’s portfolio includes rates and credit strategies. The rates strategy consisted of $23.7 billion of Agency RMBS, Agency Derivatives and MSR as well as their associated notional hedges as of December 31, 2018. Additionally, the company held $6.5 billion notional of net long to-be-announced securities (TBAs) as part of the Rates strategy. The credit strategy consisted of $3.9 billion of non-Agency securities, as well as their associated notional hedges as of December 31, 2018.

For the quarter ended December 31, 2018, the annualized yield on the company’s average aggregate portfolio was 4.14% and the annualized cost of funds on the associated average borrowings, which includes net interest rate spread on interest rate swaps and caps, was 2.53%. This resulted in a net interest rate spread of 1.61%.

RMBS and Agency Derivatives
For the quarter ended December 31, 2018, the annualized yield on average RMBS and Agency Derivatives was 3.9%, consisting of an annualized yield of 3.3% in Agency RMBS and Agency Derivatives and 7.7% in non-Agency securities.

The company experienced a three-month average constant prepayment rate (CPR) of 6.8% for Agency RMBS and Agency Derivatives held as of December 31, 2018, compared to 8.1% as of September 30, 2018. The weighted average cost basis of the principal and interest Agency portfolio was 105.2% of par as of both December 31, 2018 and September 30, 2018. The net premium amortization was $45.0 million and $48.5 million for the quarters ended December 31, 2018 and September 30, 2018, respectively.

The company experienced a three-month average CPR of 5.2% for legacy non-Agency securities held as of December 31, 2018, compared to 6.6% as of September 30, 2018. The weighted average cost basis of the legacy non-Agency securities was 61.9% of par as of December 31, 2018, compared to 61.7% of par as of September 30, 2018. The discount accretion was $24.6 million for the quarter ended December 31, 2018, compared to $19.9 million for the quarter ended September 30, 2018. The total net discount remaining was $1.9 billion as of December 31, 2018, compared to $1.8 billion as of September 30, 2018, with $1.3 billion designated as credit reserve as of December 31, 2018.

As of December 31, 2018, fixed-rate investments composed 86.1% and adjustable-rate investments composed 13.9% of the company’s RMBS and Agency Derivatives portfolio.

Mortgage Servicing Rights
As of December 31, 2018, the company held MSR on mortgage loans with UPB totaling $163.1 billion.⁽¹⁾ The MSR had a fair market value of $2.0 billion, as of December 31, 2018, and the company recognized fair value losses of $171.3 million during the quarter ended December 31, 2018.

The company does not directly service mortgage loans, but instead contracts with appropriately licensed subservicers to handle substantially all servicing functions in the name of the subservicer for the loans underlying the company’s MSR. The company recognized $104.6 million of servicing income, $17.4 million⁽¹⁾ of servicing expenses and $1.2 million in servicing reserve expense during the quarter ended December 31, 2018.

Other Investments and Risk Management Derivatives
As previously described, the company held $6.5 billion notional of net long TBAs as of December 31, 2018, compared to $9.3 billion notional of net long TBAs as of September 30, 2018, which are accounted for as derivative instruments in accordance with GAAP.

As of December 31, 2018, the company was a party to interest rate swaps, caps and swaptions with a notional amount of $32.1 billion. Of this amount, $32.0 billion notional in swaps and caps were utilized to economically hedge interest rate exposure (or duration), and $0.1 billion net notional in swaptions were utilized as macroeconomic hedges.

The following tables summarize the company’s investment portfolio, excluding the net TBA positions, as of December 31, 2018 and September 30, 2018:

“The redeployment of capital from CYS unfolded according to our plan in the second half of 2018, as we allocated capital from Agency RMBS into MSR and non-Agency securities,” stated Bill Roth, Two Harbors’ Chief Investment Officer. “The widening of spreads in the fourth quarter, while impactful to book value, provides attractive investment opportunities in 2019.”

Financing Summary
The company reported a debt-to-equity ratio, defined as total borrowings under repurchase agreements, FHLB advances, revolving credit facilities and convertible senior notes to fund RMBS, Agency Derivatives and MSR divided by total equity, of 5.8:1.0 as of December 31, 2018. The company reported an economic debt-to-equity ratio, defined as total borrowings under repurchase agreements, FHLB advances, revolving credit facilities and convertible senior notes to fund RMBS, Agency Derivatives and MSR, plus the implied debt on net TBA positions, divided by total equity, of 7.2:1.0 as of December 31, 2018.

As of December 31, 2018, the company had outstanding $22.8 billion of repurchase agreements funding RMBS and Agency Derivatives with 30 different counterparties. Excluding the effect of the company’s interest rate swaps and caps, the repurchase agreements funding RMBS and Agency Derivatives had a weighted average borrowing rate of 2.65% as of December 31, 2018.

The company’s wholly owned subsidiary, TH Insurance Holdings Company LLC (TH Insurance), is a member of the FHLB. As a member of the FHLB, TH Insurance has access to a variety of products and services offered by the FHLB, including secured advances. As of December 31, 2018, TH Insurance had $865.0 million in outstanding secured advances funding RMBS, with a weighted average borrowing rate of 2.79%.

As of December 31, 2018, the company had outstanding $310.0 million of short and long-term borrowings secured by MSR collateral under revolving credit facilities with a weighted average borrowing rate of 5.60% and remaining maturities of 4.3 years and an additional $60.0 million of available capacity for borrowings. Additionally, the company had outstanding $300.0 million of long-term repurchase agreements for MSR, with a weighted average borrowing rate of 4.51%, with additional available capacity of $100.0 million.

As of December 31, 2018, the company’s aggregate repurchase agreements, FHLB advances, revolving credit facilities and convertible senior notes funding RMBS, Agency Derivatives and MSR had a weighted average of 3.7 months to maturity.

The following table summarizes the company’s borrowings by collateral type under repurchase agreements, FHLB advances, revolving credit facilities and convertible senior notes outstanding as of December 31, 2018 and September 30, 2018, and the related cost of funds for the three months ended December 31, 2018 and September 30, 2018:

Dividends and Taxable Income
The company declared dividends totaling $444.0 million for the 2018 taxable year. The company is required to distribute at least 90% of its taxable income to maintain its REIT status, and must distribute 100% to avoid federal income tax. The company distributed 90.6% of its 2018 taxable income to stockholders during 2018, and intends to distribute the remaining 9.4% during the 2019 calendar year. In addition, the tax characterization of each cash distribution made during 2018 will be treated as ordinary income to stockholders.

Conference Call
Two Harbors Investment Corp. will host a conference call on February 7, 2019 at 9:00 a.m. EST to discuss fourth quarter 2018 financial results and related information. To participate in the teleconference, please call toll-free (800) 239-9838 (or for international callers), conference code 3860780, approximately 10 minutes prior to the above start time. You may also listen to the teleconference live via the Internet on the company’s website at www.twoharborsinvestment.com in the Investor Relations section under the Events and Presentations link. For those unable to attend, a telephone playback will be available beginning at 12:00 p.m. EST on February 7, 2019, through 12:00 a.m. EST on February 14, 2019. The playback can be accessed by calling (888) 203-1112 (or for international callers), conference code 3860780. The call will also be archived on the company’s website in the Investor Relations section under the Events and Presentations link.

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

Forward-Looking Statements
This presentation includes “forward-looking statements” within the meaning of the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Actual results may differ from expectations, estimates and projections and, consequently, readers should not rely on these forward-looking statements as predictions of future events. Words such as “expect,” “target,” “assume,” “estimate,” “project,” “budget,” “forecast,” “anticipate,” “intend,” “plan,” “may,” “will,” “could,” “should,” “believe,” “predicts,” “potential,” “continue,” and similar expressions are intended to identify such forward-looking statements. These forward-looking statements involve significant risks and uncertainties that could cause actual results to differ materially from expected results, including, among other things, those described in our Annual Report on Form 10-K for the year ended December 31, 2017, and any subsequent Quarterly Reports on Form 10-Q, under the caption “Risk Factors.” Factors that could cause actual results to differ include, but are not limited to: the state of credit markets and general economic conditions; changes in interest rates and the market value of our assets; changes in prepayment rates of mortgages underlying our target assets; the rates of default or decreased recovery on the mortgages underlying our target assets; the occurrence, extent and timing of credit losses within our portfolio; the concentration of credit risks we are exposed to; declines in home prices; our ability to establish, adjust and maintain appropriate hedges for the risks in our portfolio; the availability and cost of our target assets; the availability and cost of financing; changes in the competitive landscape within our industry; our ability to effectively execute and to realize the benefits of strategic transactions and initiatives we have pursued or may in the future pursue; our ability to manage various operational risks and costs associated with our business; interruptions in or impairments to our communications and information technology systems; our ability to acquire MSR and successfully operate our seller-servicer subsidiary and oversee our subservicers; the impact of any deficiencies in the servicing or foreclosure practices of third parties and related delays in the foreclosure process; our exposure to legal and regulatory claims; legislative and regulatory actions affecting our business; the impact of new or modified government mortgage refinance or principal reduction programs; our ability to maintain our REIT qualification; and limitations imposed on our business due to our REIT status and our exempt status under the Investment Company Act of 1940.

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

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

Additional Information
Stockholders of Two Harbors and other interested persons may find additional information regarding the company at the SEC’s Internet site at www.sec.gov or by directing requests to: Two Harbors Investment Corp., Attn: Investor Relations, 575 Lexington Avenue, Suite 2930, New York, NY 10022, telephone (612) 629-2500.

View source version on businesswire.com: https://www.businesswire.com/news/home/20190206005737/en/

Margaret Field, Investor Relations, Two Harbors Investment Corp., (212) 364-3663 or margaret.field@twoharborsinvestment.com

Source: Two Harbors Investment Corp.

Released February 6, 2019