Two Harbors Investment Corp. Reports Fourth Quarter 2017 Financial Results

A Year of Transformation and Increased Earnings Power 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, 2017.

Quarterly Summary

• Generated Comprehensive Income of $65.7 million, or $0.38 per weighted average basic common share.
• Reported book value of $16.31 per common share, representing a 1.6% total quarterly return on book value.⁽¹⁾
• Reported Core Earnings of $81.3 million, or $0.47 per weighted average basic common share.⁽²⁾
• Closed a 2-year, $300 million financing facility with a large banking counterparty to finance Fannie Mae MSR collateral.
• Issued 11,800,000 shares of 7.25% Series C fixed-to-floating rate cumulative redeemable preferred stock for proceeds, net of offering costs, of $285.6 million.

2017 Summary

• Generated Comprehensive Income of $459.0 million, or $2.63 per weighted average basic common share, representing a return on average common equity of 13.6%.
• Grew Core Earnings return on average common equity to 11.3% for the quarter ended December 31, 2017, from 10.0% for the quarter ended December 31, 2016.⁽²⁾
• Enhanced balance sheet and capital structure through one convertible debt and three preferred stock offerings.
• Formed Granite Point Mortgage Trust Inc. (“Granite Point”) (NYSE: GPMT) to continue and expand the company’s commercial real estate business. On November 1, 2017 distributed approximately 33.1 million shares of common stock of Granite Point to Two Harbors’ common stockholders and concurrently effected a one-for-two reverse stock split.

“2017 was a transformative year for Two Harbors, as we implemented our plan to maximize returns for our stockholders through running a more efficient and focused business model,” stated Thomas Siering, Two Harbors’ President and Chief Executive Officer. “The execution on our plan resulted in Core Earnings growth and three dividend increases, reflecting our stronger earnings power. Importantly, we achieved these results while maintaining an acute focus on book value protection and risk management. Our stock price reacted favorably to this and we are pleased to have delivered an annual total stockholder return of 26%.⁽³⁾”

On November 1, 2017, the company distributed to its common stockholders the 33,071,000 shares of Granite Point common stock it had acquired in connection with the contribution of its commercial real estate portfolio to Granite Point. Due to the company’s controlling ownership interest in Granite Point through November 1, 2017, Granite Point’s results of operations and financial condition through such date are included in the company’s financial statements in accordance with U.S. generally accepted accounting principles (GAAP). Because the company no longer has a controlling interest in Granite Point, it has reclassified all of Granite Point’s current and prior period assets, liabilities and results of operations to discontinued operations.

Additionally, on November 1, 2017, the company completed its previously announced one-for-two reverse stock split of its outstanding shares of common stock. In accordance with GAAP, all common share and per common share amounts presented herein have been adjusted on a retroactive basis to reflect the reverse stock split.

Operating Performance
The following table summarizes the company’s GAAP and non-GAAP earnings measurements and key metrics for the fourth quarter of 2017:

Earnings Summary
Two Harbors reported Comprehensive Income of $65.7 million, or $0.38 per weighted average basic common share, for the quarter ended December 31, 2017, as compared to Comprehensive Income of $161.6 million, or $0.93 per weighted average basic common share, for the quarter ended September 30, 2017. The company records unrealized fair value gains and losses on the majority of RMBS, classified as available-for-sale, in Other Comprehensive Income. On a Comprehensive Income basis, the company recognized an annualized return on average common equity of 8.5% and 18.5% for the quarters ended December 31, 2017 and September 30, 2017, respectively.

The company reported GAAP Net Income of $154.0 million, or $0.88 per weighted average basic common share, for the quarter ended December 31, 2017, as compared to GAAP Net Income of $93.2 million, or $0.53 per weighted average basic common share, for the quarter ended September 30, 2017. On a GAAP Net Income basis, the company recognized an annualized return on average common equity of 20.0% and 10.7% for the quarters ended December 31, 2017 and September 30, 2017, respectively.

For the fourth quarter of 2017, the company recognized non-Core Earnings of:

• net realized losses on RMBS and mortgage loans held-for-sale of $9.4 million, net of tax;
• net unrealized losses on certain RMBS, equity securities and mortgage loans held-for-sale of $8.0 million, net of tax;
• other-than-temporary impairment loss of $0.4 million, net of tax;
• net losses of $5.4 million, net of tax, related to swap and swaption terminations and expirations;
• net unrealized gains of $70.9 million, net of tax, associated with interest rate swaps and swaptions economically hedging interest rate exposure (or duration);
• net realized and unrealized losses on other derivative instruments of $6.2 million, net of tax;
• net realized and unrealized gains on previously consolidated financing securitizations of $7.8 million, net of tax;
• net realized and unrealized gains on MSR of $34.9 million⁽¹⁾, net of tax;
• servicing reserve release of $0.1 million, net of tax;
• non-cash equity compensation income (negative amortization) of $0.4 million, net of tax;
• change in tax valuation allowance of $1.5 million;
• tax expense related to a decrease in the future federal statutory tax rate due to recent tax reform of $17.5 million; and
• income from discontinued operations of $3.9 million, net of tax.

The company reported Core Earnings for the quarter ended December 31, 2017 of $81.3 million, or $0.47 per weighted average basic common share outstanding, as compared to Core Earnings for the quarter ended September 30, 2017 of $89.2 million, or $0.51 per weighted average basic common share outstanding. On a Core Earnings basis, for the quarter ended December 31, 2017 the company recognized an annualized return on average common equity, excluding Granite Point equity, of 11.3%, and for the quarter ended September 30, 2017 the company recognized an annualized return on average common equity of 10.2%.

Other Key Metrics
Two Harbors declared a quarterly cash dividend of $0.47 per common share for the quarter ended December 31, 2017. The annualized dividend yield on the company’s common stock for the quarter, based on the December 31, 2017 closing price of $16.26, was 11.6%.

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 and a dividend of $0.30208 per share of the 7.25% Series C fixed-to-floating rate cumulative redeemable preferred stock. Each of the foregoing preferred dividends were paid on January 29, 2018 to the applicable preferred stockholders of record at the close of business on January 12, 2018.

The company’s book value per common share, after taking into account the fourth quarter 2017 common and preferred dividends, was $16.31 as of December 31, 2017, compared to $20.12 as of September 30, 2017, which represented a total return on book value for the quarter of 1.6%.⁽²⁾

Other operating expenses from continuing operations for the quarter ended December 31, 2017 were approximately $9.8 million. The company’s annualized expense ratio was 1.1% of average equity, compared to expenses from continuing operations of approximately $13.1 million, or 1.4% of average equity, for the quarter ended September 30, 2017. These include non-cash equity compensation income (negative amortization) of $0.4 million and non-cash equity compensation expense of $3.5 million, respectively.

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, 2017, the total value of the company’s portfolio was $22.4 billion.

The company’s portfolio includes rates and credit strategies. The rates strategy consisted of $19.4 billion of Agency RMBS, Agency Derivatives and MSR as well as their associated notional hedges as of December 31, 2017. The credit strategy consisted of $3.0 billion of non-Agency securities, as well as their associated notional hedges as of December 31, 2017.

For the quarter ended December 31, 2017, the annualized yield on the company’s average aggregate portfolio was 3.69% and the annualized cost of funds on the associated average borrowings, which includes net interest rate spread expense on interest rate swaps, was 1.72%. This resulted in a net interest rate spread of 1.97%.

RMBS and Agency Derivatives
For the quarter ended December 31, 2017, the annualized yield on average RMBS and Agency Derivatives was 3.7%, consisting of an annualized yield of 3.1% in Agency RMBS and Agency Derivatives and 7.6% in non-Agency securities.

The company experienced a three-month average constant prepayment rate (CPR) of 7.6% for Agency RMBS and Agency Derivatives held as of December 31, 2017, compared to 8.0% as of September 30, 2017. The weighted average cost basis of the principal and interest Agency portfolio was 106.6% of par as of both December 31, 2017 and September 30, 2017. The net premium amortization was $43.0 million and $45.1 million for the quarters ended December 31, 2017 and September 30, 2017, respectively.

The company experienced a three-month average CPR of 6.4% for legacy non-Agency securities held as of both December 31, 2017 and September 30, 2017. The weighted average cost basis of the legacy non-Agency securities was 59.9% of par as of December 31, 2017, compared to 60.0% of par as of September 30, 2017. The discount accretion was $20.8 million for the quarter ended December 31, 2017, compared to $22.9 million for the quarter ended September 30, 2017. The total net discount remaining was $1.3 billion as of both December 31, 2017 and September 30, 2017, with $0.7 billion designated as credit reserve as of December 31, 2017.

As of December 31, 2017, fixed-rate investments composed 87.2% and adjustable-rate investments composed 12.8% of the company’s RMBS and Agency Derivatives portfolio.

In the fourth quarter of 2017 the company sold all of its retained subordinated securities from prior securitization transactions, thereby causing the deconsolidation of the securitization trusts from the company’s consolidated balance sheet. As of December 31, 2017, the remaining retained securities were included as non-Agency available-for-sale securities on the company’s balance sheet.

Mortgage Servicing Rights
As of December 31, 2017, the company held MSR on mortgage loans with UPB totaling $101.3 billion.⁽¹⁾ The MSR had a fair market value of $1.1 billion, as of December 31, 2017, and the company recognized fair value losses of $0.6 million during the quarter ended December 31, 2017.

The company does not directly service mortgage loans, but instead contracts with fully 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 $60.6 million of servicing income, $10.0 million⁽¹⁾ of servicing expenses and $0.1 million in servicing reserve release during the quarter ended December 31, 2017.

Other Investments and Risk Management Derivatives
The company held $0.6 billion notional of net short TBAs as of December 31, 2017, which are accounted for as derivative instruments in accordance with GAAP.

As of December 31, 2017, the company was a party to interest rate swaps and swaptions with a notional amount of $31.1 billion. Of this amount, $28.5 billion notional in swaps were utilized to economically hedge interest rate exposure (or duration), and $2.7 billion net notional in swaptions were utilized as macroeconomic hedges.

The following tables summarize the company’s investment portfolio as of December 31, 2017 and September 30, 2017:

“As we move into 2018, we believe that we are well positioned across our Rates and Credit strategies for continued economic improvement and higher rates,” stated Bill Roth, Two Harbors’ Chief Investment Officer. “Specifically, our MSR and deeply discounted legacy non-Agency RMBS portfolios are distinguishing factors that differentiate us from our peers and drive returns for shareholders.”

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 5.9:1.0 as of December 31, 2017.

As of December 31, 2017, the company had outstanding $19.3 billion of repurchase agreements funding RMBS and Agency Derivatives with 27 different counterparties. Excluding the effect of the company’s interest rate swaps, the repurchase agreements funding RMBS and Agency Derivatives had a weighted average borrowing rate of 1.68% as of December 31, 2017.

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, 2017, TH Insurance had $1.2 billion in outstanding secured advances funding RMBS, with a weighted average borrowing rate of 1.79%.

As of December 31, 2017, the company had outstanding $20.0 million of short-term borrowings secured by MSR collateral under revolving credit facilities with a weighted average borrowing rate of 5.14% and remaining maturities of 351 days. Additionally, the company had outstanding $112.5 million of long-term repurchase agreements for MSR, with additional available capacity of $187.5 million.

As of December 31, 2017, 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 7.8 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, 2017 and September 30, 2017, and the related cost of funds for the three months ended December 31, 2017 and September 30, 2017:

Dividends and Taxable Income
The company declared cash dividends to common stockholders totaling $347.9 million, or $2.01 per share, not inclusive of the special dividend distribution of Granite Point common stock amounting to $616.4 million, or $3.56 per share, for the 2017 taxable year. As a REIT, the company is required to distribute at least 90% of its taxable income to stockholders, subject to certain distribution requirements. The company distributed 100% of its 2017 taxable income to stockholders, excluding the Granite Point common stock dividend. As such, each cash distribution and the distribution of Granite Point common stock will be characterized for Federal income tax purposes as 36.275% ordinary dividends, 0.00% capital gain distributions, and 63.725% nondividend distributions.

Conference Call
Two Harbors Investment Corp. will host a conference call on February 7, 2018 at 9:00 a.m. EST to discuss fourth quarter 2017 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 9173647, 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, 2018, through 12:00 a.m. EST on February 14, 2018. The playback can be accessed by calling (855) 859-2056 (or (404) 537-3406 for international callers), conference code 9173647. 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, 2016, 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 and Core Earnings per basic 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 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: http://www.businesswire.com/news/home/20180206006440/en/

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

Source: Two Harbors Investment Corp.

Released February 6, 2018