Exhibit 99.3

 

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

 

On July 31, 2018, Two Harbors Investment Corp., a Maryland corporation (the “Company” or “Two Harbors”) and Eiger Merger Subsidiary LLC, a Maryland limited liability company and an indirect, wholly owned subsidiary of Two Harbors (“Merger Sub”), consummated the transactions contemplated by the Agreement and Plan of Merger (the “Merger Agreement”), dated as of April 25, 2018, with CYS Investments, Inc., a Maryland corporation (“CYS”) pursuant to which Merger Sub merged with and into CYS, with CYS continuing as the surviving corporation, becoming an indirect, wholly owned subsidiary of Two Harbors (the “Merger”).

 

Upon completion of the Merger and under the terms of the Merger Agreement, each outstanding share of common stock, par value $0.01 per share, of CYS (“CYS Common Stock”) (other than shares held by Two Harbors or Merger Sub or by any wholly owned subsidiary of Two Harbors, Merger Sub or CYS, which were automatically cancelled and retired and ceased to exist) was converted into the right to receive from Two Harbors (a) 0.4680 newly issued shares of common stock, par value $0.01 per share, of Two Harbors (the “Two Harbors Common Stock”) and (b) the Per Share Cash Consideration of $0.0965, as specified in the Merger Agreement. No fractional shares of Two Harbors Common Stock were issued in the Merger, and the value of any fractional interests to which a former holder of CYS Common Stock is otherwise entitled was paid in cash.

 

In connection with the Merger, each share of 7.75% Series A Cumulative Redeemable Preferred Stock, par value $0.01 per share, of CYS (the “CYS Series A Preferred Stock”) was converted into the right to receive one share of newly classified 7.75% Series D Cumulative Redeemable Preferred Stock, par value $0.01 per share, of Two Harbors (the “Two Harbors Series D Preferred Stock), and each share of 7.50% Series B Cumulative Redeemable Preferred Stock, par value $0.01 per share, of CYS (the “CYS Series B Preferred Stock”) was converted into the right to receive one share of newly classified 7.50% Series E Cumulative Redeemable Preferred Stock, par value $0.01 per share, of Two Harbors (the “Two Harbors Series E Preferred Stock”). The Two Harbors Series D Preferred Stock has the same rights, preferences, privileges and voting powers as those of the CYS Series A Preferred Stock, and the Two Harbors Series E Preferred Stock has the same rights, preferences, privileges and voting powers as those of the CYS Series B Preferred Stock.

 

The following unaudited pro forma condensed combined financial statements for the year ended December 31, 2017 and the six months ended June 30, 2018 have been prepared as if the Merger occurred on January 1, 2017 for purposes of the unaudited pro forma condensed combined statements of comprehensive income (loss) for the year ended December 31, 2017 and six months ended June 30, 2018. The unaudited pro forma condensed combined statements of comprehensive income (loss) are not necessarily indicative of what the actual operating results would have been had the Merger occurred on January 1, 2017, nor do they purport to represent Two Harbors’ future operating results.

 

The estimated fair values for the assets acquired and liabilities assumed are preliminary and are subject to change during the measurement period as additional information related to the inputs and assumptions used in determining the fair value of the assets and liabilities becomes available and may result in variances to the amounts presented in the unaudited pro forma condensed combined statements of comprehensive income.

 

1

 

The unaudited pro forma condensed combined financial statements are presented for illustrative purposes only and have been prepared on the basis of certain assumptions and adjustments. These assumptions and the estimates underlying the adjustments are described in the accompanying notes to the unaudited pro forma condensed combined financial statements. The adjustments are based on available information and assumptions that management of Two Harbors considered to be reasonable. The unaudited pro forma condensed combined statements of comprehensive income (loss) do not purport to: (i) represent the results of Two Harbors’ operations that would have actually occurred had the Merger occurred on January 1, 2017; or (ii) project Two Harbors’ results of operations for any future period. Future results may vary significantly from the results reflected in unaudited pro forma condensed combined statements because of various factors, including those described in Two Harbors’ 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.”

 

The unaudited pro forma condensed combined financial information  have been developed from, and should be read in conjunction with, (i) the consolidated financial statements of Two Harbors and the accompanying notes thereto included in Two Harbors’ Annual Report on Form 10-K for the year ended December 31, 2017 and Quarterly Report on Form 10-Q for the three and six months ended June 30, 2018, (ii) the consolidated financial statements of CYS and the accompanying notes thereto included in CYS’ Annual Report on Form 10-K for the year ended December 31, 2017, (iii) the unaudited consolidated balance sheet of CYS at June 30, 2018 and the related unaudited consolidated statement of operation, consolidated statement of stockholders equity and consolidated statement of cash flows for the six-month period ended June 30, 2018 included in Exhibit 99.2 of this Current Report on Form 8-K/A, and (iv) the accompanying notes to the unaudited pro forma condensed combined financial statements. In Two Harbors’ opinion, all adjustments necessary to reflect the Mergers have been made.

 

2

 

Unaudited Pro Forma Condensed Combined Balance Sheet

As of June 30, 2018

(in thousands, except per share data)

 

		Two Harbors			CYS			Pro Forma					Two Harbors
		Historical			Historical			Adjustments					Pro Forma
ASSETS
Available-for-sale securities, at fair value		$	19,293,354		$	10,426,068		$			A		$	29,719,422
Mortgage servicing rights, at fair value		1,450,261			—								1,450,261
Residential mortgage loans held-for-sale, at fair value		28,813			—								28,813
Cash and cash equivalents		417,515			953			(15,000		)	B		403,468
Restricted cash		564,705			1,735								566,440
Accrued interest receivable		61,108			49,667								110,775
Due from counterparties		35,385			150,241								185,626
Receivable for reverse repurchase agreements		—			779,362								779,362
Derivative assets, at fair value		257,917			307,404								565,321
Other investments		—			8,673								8,673
Other assets		166,930			2,878								169,808
Total Assets		$	22,275,988		$	11,726,981		$	(15,000	)			$	33,987,969
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Repurchase agreements		$	17,205,823		$	9,187,589		$					$	26,393,412
Federal Home Loan Bank advances		865,024			—								865,024
Revolving credit facilities		170,000			—								170,000
Convertible senior notes		283,268			—								283,268
Obligation to return securities borrowed under reverse repurchase agreements, at fair value		—			761,406								761,406
Derivative liabilities, at fair value		39,429			6,094								45,523
Due to counterparties		25,957			284,616								310,573
Dividends payable		96,219			38,607								134,826
Accrued interest payable		84,296			56,394								140,690
Other liabilities		25,727			3,906			19,689			C		49,322
Total liabilities		18,795,743			10,338,612			19,689					29,154,044
Stockholders’ Equity
Preferred stock, par value $0.01 per share; 50,000,000 shares authorized:
8.125% Series A cumulative redeemable: 5,750,000 shares issued and outstanding ($143,750 liquidation preference)		138,872			—								138,872
7.625% Series B cumulative redeemable: 11,500,000 shares issued and outstanding ($287,500 liquidation preference)		278,094			—								278,094
7.25% Series C cumulative redeemable: 11,800,000 shares issued and outstanding ($295,000 liquidation preference)		285,584			—								285,584
7.75% Series D cumulative redeemable: 3,000,000 shares issued and outstanding ($75,000 liquidation preference)		—			—			75,000			D		75,000
7.50% Series E cumulative redeemable: 8,000,000 shares issued and outstanding ($200,000 liquidation preference)		—			—			200,000			D		200,000
Preferred stock, par value $0.01 per share; 50,000,000 shares authorized:
7.75% Series A cumulative redeemable: 3,000,000 shares issued and outstanding ($75,000 liquidation preference)		—			72,369			(72,369		)	D		—
7.50% Series B cumulative redeemable: 8,000,000 shares issued and outstanding ($200,000 liquidation preference)		—			193,531			(193,531		)	D		—
Common stock, par value $0.01 per share; 450,000,000 shares authorized and 175,470,398 and 247,732,927 shares issued and outstanding, respectively		1,755			—			727			E		2,482
Common stock, par value $0.01 per share; 500,000,000 shares authorized and 155,440,829 and zero shares issued and outstanding					1,554			(1,554		)	E		—
Additional paid-in capital		3,678,586			1,977,734			(850,894		)	E		4,805,426
Accumulated other comprehensive loss		(34,933		)	—			(180,002		)	A		(214,935		)
Retained earnings (accumulated deficit)		(867,713		)	(856,819		)	987,933			A, F		(736,599		)
Total Stockholders’ Equity		3,480,245			1,388,369			(34,689		)			4,833,925
Total Liabilities and Stockholders’ Equity		$	22,275,988		$	11,726,981		$	(15,000	)			$	33,987,969

 

See accompanying notes to the unaudited pro forma condensed combined financial statements

 

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Unaudited Pro Forma Condensed Combined Statement of Comprehensive Income

For the Year Ended December 31, 2017

(in thousands, except per share data)

 

		Two Harbors			CYS			Pro Forma					Two Harbors
		Historical			Historical			Adjustments					Pro Forma
Interest income:
Available-for-sale securities		$	631,853		$	304,421		$					$	936,274
Residential mortgage loans held-for-investment in securitization trusts		102,886			—								102,886
Residential mortgage loans held-for-sale		1,704			—								1,704
Other		8,646			6,362								15,008
Total interest income		745,089			310,783			—					1,055,872
Interest expense:
Repurchase agreements		210,430			114,616								325,046
Collateralized borrowings in securitization trusts		82,573			—								82,573
Federal Home Loan Bank advances		36,911			—								36,911
Revolving credit facilities		2,341			—								2,341
Convertible senior notes		17,933			—								17,933
Total interest expense		350,188			114,616			—					464,804
Net interest income		394,901			196,167			—					591,068
Other-than-temporary impairments:
Total other-than-temporary impairment losses		(789		)	—								(789		)
Other income:
Loss on investment securities		(34,695		)	(20,274		)	(94,463		)	A		(149,432		)
Servicing income		209,065			—								209,065
Loss on servicing asset		(91,033		)	—								(91,033		)
Loss on interest rate swap, swaption and cap agreements		(9,753		)	(29,550		)						(39,303		)
(Loss) gain on other derivative instruments		(70,159		)	57,750								(12,409		)
Other income		30,141			163								30,304
Total other income		33,566			8,089			(94,463		)			(52,808		)
Expenses:
Management fees		40,472			—								40,472
Servicing expenses		35,289			—								35,289
Other operating expenses		54,160			22,995								77,155
Total expenses		129,921			22,995			—					152,916
Income (loss) from continuing operations before income taxes		297,757			181,261			(94,463		)			384,555
Benefit from income taxes		(10,482		)	—								(10,482		)
Net income from continuing operations		308,239			181,261			(94,463		)			395,037
Income from discontinued operations, net of tax		44,146											44,146
Net income		352,385			181,261			(94,463		)			439,183
Income from discontinued operations attributable to noncontrolling interest		3,814											3,814
Net income attributable to the Company		348,571			181,261			(94,463		)			435,369
Dividends on preferred stock		25,122			20,812								45,934
Net income attributable to common stockholders		$	323,449		$	160,449		$	(94,463	)			$	389,435
Basic per common share data:
Net income from continuing operations per weighted average common share		$	1.62		$	1.05		$	(1.26	)			$	1.41
Income from discontinued operations per weighted average common share		0.23			—			(0.07		)			0.16
Net income per weighted average common share		$	1.85		$	1.05		$	(1.32	)			$	1.58
Weighted average number of shares of common stock outstanding		174,433,999			151,757,485			(79,011,177		)			247,180,307
Diluted per common share data:
Net income from continuing operations per weighted average common share		$	1.60		$	1.05		$	(1.24	)			$	1.41
Income from discontinued operations per weighted average common share		0.21			—			(0.06		)			0.15
Net income per weighted average common share		$	1.81		$	1.05		$	(1.31	)			$	1.55
Weighted average number of shares of common stock outstanding		188,133,341			151,757,485			(79,011,177		)			260,879,649
Comprehensive income:
Net income		$	352,385		$	181,261		$	(94,463	)			$	439,183
Other comprehensive income, net of tax:
Unrealized gain on available-for-sale securities		135,586			—			94,463			A		230,049
Other comprehensive income		135,586			—			94,463					230,049
Comprehensive income		487,971			181,261			—					669,232
Comprehensive income attributable to noncontrolling interest		3,814			—								3,814
Comprehensive income attributable to the Company		484,157			181,261			—					665,418
Dividends on preferred stock		25,122			20,812			—					45,934
Comprehensive income attributable to common stockholders		$	459,035		$	160,449		$	—				$	619,484

 

See accompanying notes to the unaudited pro forma condensed comined financial statements

 

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Unaudited Pro Forma Condensed Combined Statement of Comprehensive Income (Loss)

For the Six Months Ended June 30, 2018

(in thousands, except per share data)

 

		Two Harbors			CYS			Pro Forma					Two Harbors
		Historical			Historical			Adjustments					Pro Forma
Interest income:
Available-for-sale securities		$	374,183		$	171,087		$					$	545,270
Residential mortgage loans held-for-sale		656			—								656
Other		6,540			2,906								9,446
Total interest income		381,379			173,993			—					555,372
Interest expense:
Repurchase agreements		184,392			85,956								270,348
Federal Home Loan Bank advances		9,354			—								9,354
Revolving credit facilities		1,803			—								1,803
Convertible senior notes		9,425			—								9,425
Total interest expense		204,974			85,956			—					290,930
Net interest income		176,405			88,037			—					264,442
Other-than-temporary impairments:
Total other-than-temporary impairment losses		(268		)	—								(268		)
Other income (loss):
Loss on investment securities		(52,553		)	(304,620		)	179,685			A		(177,488		)
Servicing income		148,855			—								148,855
Gain on servicing asset		81,660			—								81,660
Gain on interest rate swap, swaption and cap agreements		179,678			6,259								185,937
Gain on other derivative instruments		15,728			115,442								131,170
Other income		1,788			965								2,753
Total other income (loss)		375,156			(181,954		)	179,685					372,887
Expenses:
Management fees		23,161			—								23,161
Servicing expenses		26,093			—								26,093
Other operating expenses		30,007			14,595			(5,996		)	B		38,606
Total expenses		79,261			14,595			(5,996		)			87,860
Income (loss) before income taxes		472,032			(108,512		)	185,681					549,201
Benefit from income taxes		(2,267		)	—								(2,267		)
Net income (loss)		474,299			(108,512		)	185,681					551,468
Dividends on preferred stock		27,494			10,406								37,900
Net income (loss) attributable to common stockholders		$	446,805		$	(118,918	)	$	185,681				$	513,568
Basic per common share data:
Net income (loss) per weighted average common share		$	2.55		$	(0.77	)	$	0.29				$	2.07
Weighted average number of shares of common stock outstanding		175,299,822			155,438,709			(82,846,259		)			247,892,272
Diluted per common share data:
Net income (loss) per weighted average common share		$	2.36		$	(0.77	)	$	0.36				$	1.95
Weighted average number of shares of common stock outstanding		193,016,793			155,438,709			(82,890,663		)			265,564,839
Comprehensive income (loss):
Net income (loss)		$	474,299		$	(108,512	)	$	185,681				$	551,468
Other comprehensive loss, net of tax:
Unrealized loss on available-for-sale securities		(379,664		)	—			(185,681		)	A		(565,345		)
Other comprehensive loss		(379,664		)	—			(185,681		)			(565,345		)
Comprehensive income (loss)		94,635			(108,512		)	—					(13,877		)
Dividends on preferred stock		27,494			10,406			—					37,900
Comprehensive income (loss) attributable to common stockholders		$	67,141		$	(118,918	)	$	—				$	(51,777	)

 

See accompanying notes to the unaudited pro forma condensed combined financial statements.

 

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Notes to Unaudited Pro Forma Condensed Combined Financial Statements

(in thousands, except per share data)

 

1.  Overview

 

For purposes of the unaudited pro forma condensed combined financial statements, Two Harbors has assumed a total preliminary purchase price for the Merger of approximately $1.4 billion, which consists  primarily of Two Harbors Common Stock issued in exchange for shares of CYS Common Stock.  The total preliminary purchase price was calculated based on the closing price of Two Harbors Common Stock on July 31, 2018, which was $15.50.

 

Estimated Purchase Price:

 

Common Stock Exchange:
CYS Common Stock Outstanding		155,440,829
Common Exchange Ratio		0.4680
Two Harbors Common Stock to be issued		72,746,308
Two Harbors Share Price		$	15.50
					$	1,127,568
Per Share Cash Consideration:
CYS Common Stock Outstanding		155,440,829
Per Share Cash Consideration		$	0.0965
Per Share Cash Consideration					$	15,000
		Shares
Preferred Stock Exchange:
Series D Preferred Stock		3,000,000			$	75,000
Series E Preferred Stock		8,000,000			$	200,000
Total Estimated Purchase Price					$	1,417,568

 

The total preliminary estimated purchase price described above has been allocated to the assets acquired and the liabilities assumed for purposes of pro forma condensed combined financial statements, based on their estimated relative fair values, assuming the Merger was completed on June 30, 2018.  The final allocation will be based upon valuations and other analyses for which there is currently insufficient information to make a definitive allocation.  Accordingly, the purchase price allocation adjustments are preliminary and have been made solely for the purpose of providing unaudited pro forma condensed combined financial statements.  The final purchase price allocation will be determined after a complete and thorough analysis has been completed to determine the fair value of CYS’s net assets and liabilities.  As a result, the final acquisition accounting adjustments, including those resulting from conforming CYS’s accounting policies to those of Two Harbors’ could differ materially from the pro forma adjustments presented herein.  The purchase price of CYS (as calculated in the manner described above) is allocated to the assets to be acquired and the liabilities to be assumed on the following preliminary basis:

 

Available-for-sale securities, at fair value		$	10,426,068
Cash and cash equivalents		953
Restricted Cash		1,735
Accrued interest receivable		49,667
Due from counterparties		150,241
Receivable for reverse repurchase agreements		779,362
Derivative assets, at fair value		307,404
Other investments		8,673
Other assets		2,878
Repurchase agreements		(9,187,589		)
Obligation to return securities borrowed under reverse repurchase agreements, at fair value		(761,406		)
Derivative liabilities, at fair value		(6,094		)
Due to counterparties		(284,616		)
Dividends payable		(38,607		)
Accrued interest payable		(56,394		)
Other liabilities		(3,906		)
Retained earnings (accumulated deficit)		29,199
		$	1,417,568

 

The unaudited pro forma condensed combined financial statements have been prepared by accounting for the Merger as an asset acquisition with Two Harbors as the acquiring entity.  The financial assets and liabilities are recorded at fair value, no goodwill is recorded, and the excess consideration (premium) paid and transactions costs are expensed given there are no meaningful non-financial assets  or other intangibles in which to assign value.

 

To the extent identified, certain reclassifications have been reflected in the unaudited pro forma condensed combined financials statements to conform CYS’s financial statement presentation to that of Two Harbors.  However, the unaudited pro forma condensed combined financial statements may not reflect all of the adjustments necessary to conform the accounting policies of CYS to those of Two Harbors.

 

The pro forma adjustments represent Two Harbors management’s preliminary estimates and are subject to change as additional information becomes available and additional analyses are performed.  The unaudited pro forma

 

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condensed combined financial statements do not reflect the impact of possible cost savings from operating efficiencies or synergies.  Also, the unaudited pro forma condensed combined financial statements do not reflect possible adjustments related to restructuring or integration activities that have yet to be determined or transaction or other costs following the Merger that are not expected to have a continuing impact.  Further, non-recurring transaction-related expenses are not included in the unaudited pro forma condensed statements of comprehensive income (loss).

 

The unaudited pro forma condensed combined statements of comprehensive income (loss) for the year ended December 31, 2017 and for the six months ended June 30, 2018 combine the historical consolidated statements of comprehensive income (loss) of Two Harbors and CYS, giving effect to the Merger as if it occurred on January 1, 2017, the beginning of the earliest period presented.  The unaudited pro forma condensed combined balance sheet combines the historical consolidated balance sheets of Two Harbors and CYS as of June 30, 2018, giving effect to the Merger as if it occurred on June 30, 2018.

 

2. Adjustments to the Unaudited Pro Forma Condensed Combined Balance Sheet

 

The unaudited pro forma condensed combined balance sheet as of June 30, 2018 reflects the following adjustments:

 

A. Reclassification adjustments

 

Certain reclassifications have been made to the historical presentation of CYS to conform to the financial statement presentation of Two Harbors.  Two Harbors classifies its Agency RMBS and non-Agency securities, excluding inverse interest-only Agency securities classified as derivatives for purposes of U.S. GAAP, as available-for-sale securities and all associated changes in unrealized gains and losses are included in accumulated other comprehensive income, on an after-tax basis.  Therefore, the CYS Agency RMBS unrealized gains and losses, which have been accounted for historically under the fair value election pursuant to ASC 825 — Financial Instruments, have been reclassified from retained earnings (accumulated deficit) to accumulated other comprehensive income in the condensed combined balance sheet to conform to the presentation and  the accounting policies of Two Harbors.

 

The cumulative adjustment to reflect this reclassification in the condensed combined balance sheet:

 

Accumulated other comprehensive loss		$	(180,002	)
Retained earnings (accumulated deficit)		$	180,002

 

B. Cash

 

The pro forma adjustment represents the cash consideration of $15.0 million payable to CYS stockholders at the effective time of the Merger.

 

C. Other Liabilities

 

Non-recurring transaction costs include those costs to be paid by Two Harbors or CYS that are directly attributable to the Merger.  These transaction costs, consisting primarily of executive compensation for change of control provisions and fees for bankers, legal, accounting, tax and other professional services, are estimated to be approximately $40.7 million.  These costs are non-recurring in nature and directly related to the Merger and, therefore, are reflected as a reduction to retained earnings and not included in the unaudited pro forma condensed combined statements of comprehensive income (loss).

 

In connection with the Merger, PRCM Advisers LLC, Two Harbors ‘ external manager has agreed to make a one-time downward adjustment of $15.0 million to the management fees payable by Two Harbors  for the quarter in which the Merger closes.

 

Non-recurring transaction costs		$	40,685
Back-out non-recurring transaction costs already recorded		(5,996		)
		34,689
Reduction in management fee		(15,000		)
Adjustment to other liabilities		$	19,689

 

D. Preferred Stock

 

The pro forma adjustments represent the conversion of (A) CYS’s 7.75% Series A Cumulative Redeemable Preferred Stock, $0.01 par value per share, issued and outstanding immediately prior to the Effective Time into the right to receive one newly classified share of Two Harbors Series D Preferred stock and (B) CYS’s 7.5% Series B Cumulative Preferred Stock, $0.01 par value per share, issued and outstanding immediately prior to the Effective Time into the right to receive one newly classified share of Two Harbors Series E Preferred Stock. All shares of CYS’s Series A and Series B Cumulative Redeemable Preferred Stock, when so converted, shall automatically be cancelled and cease to exist.

 

Two Harbors Series D Preferred Stock to be issued		$	75,000
Less: CYS Series A Preferred Stock - historical basis		(72,369		)
Two Harbors Series E Preferred Stock to be issued		200,000
Less: CYS Series B Preferred Stock - historical basis		(193,531		)

 

E. Common Stock and Additional Paid-in Capital

 

The pro forma adjustments represent the issuance of Two Harbors Common Stock with a par value of $0.01 per share and a market price of $15.50 as of July 31, 2018. Each share of CYS Common Stock was converted into 0.4680 shares of Two Harbors Common Stock at the effective

 

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time of the Merger.

 

CYS Common Stock outstanding as of June 30, 2018		155,440,829
Exchange ratio		0.4680
Two Harbors Common Stock to be issued		72,746,308
Par value per share of Two Harbors Common Stock		$	0.01
Par value of Two Harbors Common Stock to be issued		$	727
Less: Par value of CYS Common Stock - historical basis		(1,554		)
Adjustment to Two Harbors Common Stock		$	(827	)
Two Harbors Common Stock to be issued		72,746,308
Additional paid-in capital per share ($15.50-$0.01 par value)		$	15.49
Additional paid-in capital of Two Harbors Common Stock to be issued		$	1,126,840
Less: CYS additional paid-in capital - historical basis		(1,977,734		)
Adjustment to additional paid-in capital		$	(850,894	)

 

F. Retained Earnings (accumulated deficit)

 

The pro forma adjustments represent the elimination of CYS’s accumulated deficit of $857 million as of June 30, 2018, an adjustment of $29.2 million to decrease retained earnings for the excess consideration (the amount that the cost of the acquisition of CYS exceeds the gross assets acquired less liabilities assumed - see allocattion of purchase price to assets acquired and liabilities assumed in the Overview section), an adjustment of $34.7 million to decrease retained earnings for non-recurring transaction costs  directly attributable to the Merger that have not yet been expensed in the historical consolidated statements of comprehensive income (loss) (See Note C above), and an adjustment of $15.0 million to increase retained earnings for the one-time downward adjustment to management fees payable by Two Harbors for the quarter in which the merger closes.

 

Elimination of CYS’s accumulated deficit		$	856,819
Adjustment for excess consideration		(29,199		)
Adjustment for non-recurring transaction costs		(34,689		)
Adjustment for reduction in management fee		15,000
Adjustment to retained earnings (accumulated deficit)		$	807,931

 

3. Adjustments to the Unaudited Pro Forma Condensed Combined Statements of Comprehensive Income (Loss) for the year ended December 31, 2017 and the six months ended June 30, 2018

 

The historical amounts include Two Harbors’ and CYS’s actual operating results for the periods presented.  The pro forma adjustements to the historical amounts are presented in the unaudited pro forma condensed combined statements of comprehensive income (loss) for the year ended December 31, 2017 and the six months ended June 30, 2018, assuming the Merger occurred on January 1, 2017.  Noted below are the explanations for the adjustments included in the unaudited pro forma condensed combined statements of comprehensive income (loss) for the year ended December 31, 2017 and the six months ended June 30, 2018:

 

A. Reclassification adjustments

 

Certain reclassifications have been made to the historical presentation of CYS to conform to the financial statement presentation of Two Harbors.  Two Harbors classifies its Agency RMBS and non-Agency securities, excluding inverse interest-only Agency securities classified as derivatives for purposes of U.S. GAAP, as available-for-sale securities and all associated changes in unrealized gains and losses are included in accumulated other comprehensive income, on an after-tax basis.  Therefore, the CYS Agency RMBS unrealized gains and losses, which have been accounted for historically under the fair value election pursuant to ASC 825 — Financial Instruments, have been reclassified from other income (loss) to other comprehensive income (loss) in the Statement of Compehensive Income (Loss) to conform to the presentation and  the accounting policies of Two Harbors.

 

The cumulative adjustment to reflect this reclassification in the Statements of Comprehensive Income (Loss):

 

		Year ended			Six months
		December 31,			ended June 30,
		2017			2018
Loss on investment securities		$	94,463		$	(179,685	)

 

B. Transaction Costs

 

CYS incurred certain merger-related transaction costs during the six months ended June 30, 2018. The pro forma adjustment represents the reversal of these costs, which were directly related to the Merger and will not have a continuing impact on the operating results of Two Harbors.

 

		Year ended			Six months
		December 31,			ended June 30,
		2017			2018
Other operating expenses		$	—		$	(5,996	)

 

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