Two Harbors Investment Corp. Reports Third Quarter 2014 Financial Results

Delivered Total Return on Book Value of 3.8%⁽¹⁾

NEW YORK--(BUSINESS WIRE)-- Two Harbors Investment Corp. (NYSE: TWO), a real estate investment trust that invests in residential mortgage-backed securities (RMBS), residential mortgage loans, mortgage servicing rights (MSR) and other financial assets, today announced its financial results for the quarter ended September 30, 2014.

Highlights

• Book value was $11.25 per diluted common share, representing a 3.8%⁽¹⁾ total return on book value, after accounting for a dividend of $0.26 per share, bringing the total return on book value for the first nine months of 2014 to 13.9%.⁽²⁾
• Delivered Comprehensive Income of $152.6 million, a return on average equity of 14.9%, or $0.42 per diluted weighted average common share.
• Reported Core Earnings of $82.8 million, or $0.23 per diluted weighted average common share.⁽³⁾
• Generated an aggregate portfolio yield of 4.5% for the quarter ended September 30, 2014, compared to an aggregate yield of 4.6% for the quarter ended June 30, 2014.
• Completed two securitizations, Agate Bay Mortgage Trust 2014-1 and Agate Bay Mortgage Trust 2014-2, issuing securities backed by approximately $642 million unpaid principal balance (UPB) of prime jumbo mortgage loans.

“I’m pleased to report that in the third quarter we delivered a total return on book value of 3.8%⁽¹⁾, resulting in a total return of 13.9%⁽²⁾ for the first nine months of the year,” stated Thomas Siering, Two Harbors’ President and Chief Executive Officer. “In the recent quarter, performance was driven by strong returns in both our Rates and Credit strategies, despite our defensive portfolio positioning and low leverage profile.”

Operating Performance

The following table summarizes the company’s GAAP and non-GAAP earnings measurements and key metrics for the respective periods in 2014:

(1) Please see page 12 of this press release for a reconciliation of GAAP to non-GAAP financial information.

Earnings Summary

Two Harbors reported Core Earnings for the quarter ended September 30, 2014 of $82.8 million, or $0.23 per diluted weighted average common share outstanding, as compared to Core Earnings for the quarter ended June 30, 2014 of $89.7 million, or $0.24 per diluted weighted average common share outstanding. On a Core Earnings basis, the company recognized an annualized return on average equity of 8.1% and 8.9% for the quarters ended September 30, 2014 and June 30, 2014, respectively.

For the third quarter of 2014, the company recognized:

• net realized gains on RMBS, trading securities and mortgage loans held-for-sale of $68.4 million, net of tax;
• unrealized losses on trading securities, mortgage loan forward purchase commitments and mortgage loans held-for-sale of $10.5 million, net of tax;
• net losses of $28.1 million, net of tax, related to swap and swaption terminations and expirations;
• net unrealized gains, net of tax, of $83.6 million associated with its interest rate swaps and swaptions economically hedging its investment portfolio, repurchase agreements and Federal Home Loan Bank of Des Moines (FHLB)advances;
• net realized and unrealized losses on other derivative instruments of approximately $0.7 million, net of tax;
• net realized and unrealized losses on consolidated financing securitizations of $2.2 million, net of tax;
• a net decrease in fair value of $6.7 million⁽²⁾ on MSR, net of tax; and
• representation and warranty expenses of $4.1 million, net of tax.

(2) Decrease in fair value on MSR, net of tax, of $6.7 million is comprised of a increase in fair value of $6.5 million, net of tax, excluded from Core Earnings and $13.2 million, net of tax, of estimated amortization included in Core Earnings.

The company reported GAAP Net Income of $193.6 million, or $0.53 per diluted weighted average common share outstanding, for the quarter ended September 30, 2014, as compared to GAAP Net Income of $39.7 million, or $0.11 per diluted weighted average common share outstanding, for the quarter ended June 30, 2014. On a GAAP basis, the company recognized an annualized return on average equity of 18.9% and 3.9% for the quarters ended September 30, 2014 and June 30, 2014, respectively.

The company reported Comprehensive Income of $152.6 million, or $0.42 per diluted weighted average common share outstanding, for the quarter ended September 30, 2014, as compared to Comprehensive Income of $230.8 million, or $0.63 per diluted weighted average common share outstanding, for the quarter ended June 30, 2014. The company records unrealized fair value gains and losses on RMBS securities, classified as available-for-sale, as Other Comprehensive Income. On a Comprehensive Income basis, the company recognized an annualized return on average equity of 14.9% and 23.0% for the quarters ended September 30, 2014 and June 30, 2014, respectively.

Other Key Metrics

Two Harbors declared a quarterly cash dividend of $0.26 per common share for the quarter ended September 30, 2014. The annualized dividend yield on the company’s common stock for the third quarter of 2014, based on the September 30, 2014 closing price of $9.67, was 10.8%.

The company’s book value per diluted share, after taking into account the third quarter 2014 dividend of $0.26 per share, was $11.25 as of September 30, 2014, compared to $11.09 as of June 30, 2014, which represented a total return on book value for the third quarter of 2014 of 3.8%.⁽¹⁾ For the nine months ended September 30, 2014, the company reported a total return on book value of 13.9%.⁽²⁾

Other operating expenses for the third quarter of 2014 were approximately $12.4 million, or 1.2% of average equity, compared to approximately $15.0 million, or 1.5% of average equity, for the second quarter of 2014.

Portfolio Summary

The company’s aggregate portfolio is principally comprised of RMBS available-for-sale securities, inverse interest-only securities (Agency Derivatives), MSR, residential mortgage loans held-for-sale and net economic interests in consolidated securitization trusts. As of September 30, 2014, the total value of the company’s portfolio was $14.3 billion.

The company’s portfolio includes the rates strategy, which consists of $10.4 billion of Agency RMBS, Agency Derivatives and MSR as well as associated notional hedges as of September 30, 2014. The remaining portfolio is invested in the credit strategy, which consists of $3.9 billion of non-Agency RMBS, net economic interests in consolidated securitization trusts, prime jumbo residential mortgage loans and credit sensitive loans, as well as their associated notional hedges as of September 30, 2014.

For the quarter ended September 30, 2014, the annualized yield on the company’s average aggregate portfolio was 4.5% and the annualized cost of funds on the associated average borrowings, which includes net interest rate spread expense on interest rate swaps, was 1.5%. This resulted in a net interest rate spread of 3.0%.

RMBS and Agency Derivatives

For the quarter ended September 30, 2014, the annualized yield on average RMBS securities and Agency Derivatives was 4.3%, consisting of an annualized yield of 3.3% in Agency RMBS and Agency Derivatives and 8.5% in non-Agency RMBS.

The company experienced a three-month average constant prepayment rate (CPR) of 7.9% for Agency RMBS securities and Agency Derivatives held during the quarter ended September 30, 2014, compared to 8.5% for those securities held during the quarter ended June 30, 2014. The weighted average cost basis of the principal and interest Agency portfolio was 108.3% of par for the quarter ended September 30, 2014, compared to 108.4% of par for the quarter ended June 30, 2014. The net premium amortization was $39.5 million and $34.1 million for the quarters ended September 30, 2014 and June 30, 2014, respectively.

The company experienced a three-month average CPR of 4.1% for non-Agency principal and interest RMBS securities held during the quarter ended September 30, 2014, as compared to 3.6% for those securities held during the quarter ended June 30, 2014. The weighted average cost basis of the non-Agency portfolio was 57.2% of par for the quarter ended September 30, 2014, compared to 55.4% of par for the quarter ended June 30, 2014. The discount accretion was $32.8 million for the quarter ended September 30, 2014, compared to $32.3 million for the quarter ended June 30, 2014. The total net discount remaining was $2.0 billion as of September 30, 2014, compared to $2.2 billion as of June 30, 2014, with $1.0 billion designated as credit reserve as of September 30, 2014.

As of September 30, 2014, fixed-rate investments composed 78.1% and adjustable-rate investments composed 21.9% of the company’s RMBS and Agency Derivatives portfolio.

As of September 30, 2014, the company had mortgage loans held-for-investment with a carrying value of $1.4 billion and the company’s collateralized borrowings had a carrying value of $938.5 million, resulting in net economic interests in consolidated securitization trusts of $490.4 million.

Mortgage Servicing Rights

The company held MSR on mortgage loans having $45.5 billion in unpaid principal balance, which had a fair market value of $498.5 million, as of September 30, 2014.

The company does not directly service mortgage loans, but instead contracts with fully licensed subservicers to handle all servicing functions for the loans underlying the company’s MSR. The company recognized $32.3 million of servicing income, $6.1 million of subservicing expense and a $10.7 million decrease in fair market value of MSR during the three months ended September 30, 2014.

Mortgage Loans Held for Sale

As of September 30, 2014, the company held prime jumbo residential mortgage loans with a fair market value of $418.7 million and had outstanding purchase commitments to acquire an additional $326.4 million of mortgage loans, subject to fallout if the loans do not close. For the quarter ended September 30, 2014, the annualized yield on the prime jumbo residential mortgage loan portfolio was 4.1%, consistent with the quarter ended June 30, 2014.

During the quarter, the company completed two securitizations, Agate Bay Mortgage Trust 2014-1 and Agate Bay Mortgage Trust 2014-2. The trusts issued securities backed by approximately $642 million UPB of prime jumbo 30-year fixed residential mortgage loans.

Other Investments and Risk Management Derivatives

The company held $2.0 billion of U.S. Treasuries classified on its balance sheet as trading securities as of September 30, 2014. The company also held $690.0 million notional of net short TBAs as of September 30, 2014, which are accounted for as derivative instruments in accordance with GAAP.

As of September 30, 2014, the company was a party to interest rate swaps and swaptions with a notional amount of $35.4 billion. Of this amount, $15.6 billion notional in swaps were utilized to economically hedge interest rate risk associated with the company’s LIBOR-based repurchase agreements and FHLB advances, $12.1 billion notional in swaps were utilized to economically hedge interest rate risk associated with the company’s investment portfolio, and $7.7 billion notional in swaptions were utilized as macro-economic hedges.

The following table summarizes the company’s investment portfolio:

“During the third quarter our mortgage loan conduit continued to gain momentum,” stated Bill Roth, Two Harbors’ Chief Investment Officer. “Specifically, we completed two securitizations and, subsequent to quarter-end, expanded our program to include a wider range of products that we believe improves the availability of mortgage credit.”

Financing Summary

The company reported a debt-to-equity ratio, defined as total borrowings under repurchase agreements and FHLB advances to fund RMBS securities, Agency Derivatives and mortgage loans held-for-sale divided by total equity, of 2.9 to 1.0 as of both September 30, 2014 and June 30, 2014.

As of September 30, 2014, the company had outstanding $12.3 billion of repurchase agreements funding RMBS securities, Agency Derivatives, mortgage loans held-for-sale and U.S. Treasuries with 25 different counterparties. Excluding the debt associated with the company’s U.S. Treasuries and the effect of the company’s interest rate swaps, the repurchase agreements had a weighted average borrowing rate of 0.70% and weighted average remaining maturity of 100 days as of September 30, 2014.

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 September 30, 2014, TH Insurance had $1.5 billion in outstanding secured advances with a weighted average borrowing rate of 0.4% and a weighted average of 44 months to maturity, and had an additional $1.0 billion of available uncommitted credit for borrowings. To the extent TH Insurance Holdings has unused capacity, it may be adjusted at the sole discretion of the FHLB.

As of September 30, 2014, the company’s aggregate repurchase agreements and FHLB advances funding RMBS securities, Agency Derivatives and mortgage loans held-for-sale had 256 weighted average days to maturity.

The following table summarizes the company’s borrowings by collateral type under repurchase agreements and FHLB advances, excluding borrowings on U.S. Treasuries, and related cost of funds:

Conference Call

Two Harbors Investment Corp. will host a conference call on November 5, 2014 at 9:00 a.m. EST to discuss third quarter 2014 financial results and related information. To participate in the teleconference, please call toll-free (877) 868-1835 (or (914) 495-8581 for international callers), Conference Code 11730830, 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 November 5, 2014, through 12:00 a.m. EST on November 12, 2014. The playback can be accessed by calling (855) 859-2056 (or (404) 537-3406 for international callers), Conference Code 11730830. 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, residential mortgage loans, 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 the company’s Annual Report on Form 10-K for the year ended December 31, 2013, 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, higher than expected operating costs, changes in prepayment speeds of mortgages underlying the company’s residential mortgage-backed securities, the rates of default or decreased recovery on the mortgages underlying our non-Agency securities, failure to recover credit losses in our portfolio, changes in interest rates and the market value of our assets, the availability of financing, the availability of target assets at attractive prices, the company’s ability to manage various operational risks associated with the business, the company’s ability to maintain our REIT qualification, limitations imposed on the business due to our REIT status and the company’s exempt status under the Investment Company Act of 1940, the impact of new legislation or regulatory changes on the company’s operations, the impact of any deficiencies in the servicing or foreclosure practices of third parties and related delays in the foreclosure process, the company’s ability to acquire mortgage loans or securitize the mortgage loans the company acquires, the company’s involvement in securitization transactions, the timing and profitability of the company’s securitization transactions, the risks associated with the company’s securitization transactions, the company’s ability to acquire MSR, the impact of new or modified government mortgage refinance or principal reduction programs, unanticipated changes in overall market and economic conditions, and the company’s exposure to claims and litigation, including litigation arising from its involvement in securitization transactions and its investments in MSR.

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 and Core Earnings per common share, 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 12 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, 590 Madison Avenue, 36th Floor, New York, NY 10022, telephone (612) 629-2500.

(1) Amortization refers to the portion of change in fair value of MSR primarily attributed to the realization of expected cash flows (runoff) of the portfolio. This amortization has been deducted from Core Earnings. Amortization of MSR is deemed a non-GAAP measure due to the company’s decision to account for MSR at fair value.

Two Harbors Investment Corp.
July Hugen, 612-629-2514
Director of Media and Investor Relations
July.Hugen@twoharborsinvestment.com

Source: Two Harbors Investment Corp.

Released November 4, 2014