Two Harbors Investment Corp (TWO) is a Maryland-based real estate investment trust (REIT) that invests in, finances, and manages mortgage servicing rights (MSR) and Agency residential mortgage-backed securities (Agency RMBS). The company has established itself as a leading player in the mortgage finance space, leveraging its core competencies in managing interest rate and prepayment risk to deliver more stable performance compared to RMBS portfolios without MSR.
Business Overview A Decade of Growth and Innovation
Two Harbors was founded in 2009 and has since grown into a well-diversified mortgage REIT with a focus on risk-managed investing. The company's investment strategy revolves around pairing its MSR portfolio with Agency RMBS, allowing it to generate more consistent returns across changing market environments.
In 2009, Two Harbors elected to be taxed as a REIT for U.S. federal income tax purposes. This decision requires the company to meet specific investment and operating tests, as well as annual distribution requirements. By complying with REIT regulations, Two Harbors generally avoids U.S. federal income taxes on its taxable income, provided it distributes at least 90% of its net taxable income to stockholders annually.
A significant milestone in the company's history occurred in 2010 when TH MSR Holdings LLC, a wholly-owned subsidiary of Two Harbors, obtained the necessary approvals from Fannie Mae and Freddie Mac to own and manage MSR. This development enabled the company to acquire MSR from third-party originators through both flow and bulk purchases, as well as through the recapture of MSR on loans in its portfolio that refinance.
Throughout its history, Two Harbors has faced challenges common to mortgage REITs, such as managing interest rate, prepayment, and market value risks. The company has successfully navigated these challenges by actively hedging its portfolio and focusing on its MSR strategy, which provides offsetting risks to its Agency RMBS holdings.
One of Two Harbors' key strategic moves was the 2023 acquisition of RoundPoint Mortgage Servicing LLC, a leading mortgage servicer. This vertically integrated platform has enabled the company to bring servicing in-house, improve economics, and enhance its ability to recapture loans from its own servicing portfolio. In 2024, Two Harbors further strengthened its mortgage capabilities by launching a direct-to-consumer origination platform, which serves as a hedge to its MSR assets by allowing the company to retain or recapture existing borrowers.
Financial Performance Weathering Market Volatility
Financials
Two Harbors' financial results have demonstrated the resilience of its hedged MSR-centric strategy. For the full year of 2024, the company generated a 7.0% total economic return on book value, despite navigating a challenging market environment characterized by rising interest rates and volatile mortgage spreads.
As of December 31, 2024, Two Harbors reported a book value of $14.47 per common share, down from $14.93 per share at the end of the third quarter. This flat quarterly economic return was achieved through prudent risk management and the diversification benefits of the company's MSR and Agency RMBS portfolio.
Net interest expense for the fourth quarter of 2024 decreased by $7.4 million compared to the previous quarter, primarily due to lower RMBS borrowing balances and a shift in MSR financing from credit facilities to VFN repurchase agreements, which carry lower floating-rate spreads.
The company's net servicing income remained strong at $163 million for the fourth quarter, though it was slightly lower compared to the third quarter due to a decline in float income. Two Harbors' servicing operations continue to generate stable cash flows, with the MSR portfolio experiencing a 4.9% constant prepayment rate (CPR) in the fourth quarter, down from 5.3% in the prior quarter.
For the most recent fiscal year, Two Harbors reported annual revenue of $450.15 million and annual net income of $298.17 million. The company's annual operating cash flow was $201 million, with annual free cash flow of $86.88 million. In the most recent quarter, revenue was $103.77 million, with net income of $264.95 million. The decrease in revenue and net income in the most recent quarter compared to the prior year was primarily driven by lower interest income on the investment portfolio, increased interest expense, and lower servicing income, partially offset by gains on the servicing asset and derivatives.
Liquidity
Two Harbors maintains a strong liquidity position to support its operations and investment activities. The company's liquidity management strategy includes maintaining cash reserves, access to various financing sources, and a diverse portfolio of high-quality assets that can be easily liquidated if needed.
As of December 31, 2024, Two Harbors reported a debt-to-equity ratio of 0.60x and cash holdings of $504.61 million. The company has access to $70.10 million in unused committed capacity and $795 million in unused uncommitted capacity on MSR financing facilities. Additionally, Two Harbors has $59.70 million in unused committed capacity on servicing advance financing facilities and $30.90 million in unused committed capacity on warehouse facilities. The company's current ratio and quick ratio both stand at 1.21x, indicating a healthy short-term liquidity position.
Outlook Positioning for Continued Success
Looking ahead, Two Harbors remains optimistic about the opportunities in the mortgage market. The company believes that its unique hedged MSR-centric strategy will continue to generate attractive levered returns in 2025 and beyond, driven by the stability of its MSR portfolio and the potential for further improvements in servicing operations and origination activities.
Despite the challenges posed by rising interest rates, Two Harbors is well-positioned to navigate the current market environment. The company's MSR portfolio, with a weighted average coupon of just 3.46%, is largely insulated from the impact of higher rates, as only 0.2% of its customers would currently benefit from a rate-and-term refinance.
Moreover, Two Harbors' direct-to-consumer origination platform, which began operations in 2024, is expected to serve as a valuable hedge to the MSR portfolio, allowing the company to recapture loans and maintain the stability of its servicing assets. The company also plans to expand its second-lien loan offerings, further diversifying its revenue streams.
Two Harbors has provided a static return estimate for their portfolio between 9.8% to 12.1%, before applying any capital structure leverage. After accounting for outstanding convertible notes and preferred stock, the company believes the potential static return on common equity falls in the range of 10.8% to 14.4%, or a prospective quarterly static return per share of $0.39 to $0.52.
The company expects mortgage rates to remain above 6% in 2025, which should help keep housing activity muted and prepayments low, benefiting the value of their MSR portfolio. Two Harbors aims to continue generating additional cost efficiencies in servicing, especially through the use of technology and AI applications at their RoundPoint mortgage servicing platform.
Risks and Challenges
While Two Harbors' strategy has proven resilient, the company is not immune to the risks inherent in the mortgage finance industry. Factors such as changes in interest rates, mortgage spreads, and prepayment speeds, as well as regulatory and competitive pressures, could impact the company's performance.
Additionally, the ongoing litigation with PRCM Advisers, the company's former external manager, represents a potential overhang that could affect Two Harbors' operations and financial results. The outcome of this legal dispute remains uncertain. On July 15, 2020, the company provided PRCM Advisers LLC with a notice of termination of the Management Agreement for cause. PRCM Advisers subsequently filed a complaint against the company alleging misappropriation of trade secrets, breach of contract, and other claims. The company's board believes the complaint is without merit and that the company has complied with the terms of the Management Agreement.
Conclusion A Compelling Mortgage REIT with a Proven Strategy
Two Harbors Investment Corp has established itself as a leading mortgage REIT, leveraging its expertise in MSR and Agency RMBS to deliver more stable performance across market cycles. The company's vertically integrated platform, which now includes mortgage origination capabilities, positions it well to capitalize on opportunities in the evolving mortgage finance landscape.
As of December 31, 2024, Two Harbors had $2.99 billion in MSR assets, representing the right to service a portfolio of approximately 803,000 loans with an unpaid principal balance of $200.32 billion. The company's MSR portfolio had a weighted average gross coupon rate of 3.50% and a weighted average loan age of 53 months. During the year ended December 31, 2024, the company recognized $681.65 million in servicing income, including servicing fee income, ancillary and other fee income, and float income, offset by $20.07 million in servicing costs, resulting in net servicing income of $661.58 million.
Two Harbors' Agency RMBS portfolio had a carrying value of $7.37 billion as of December 31, 2024, with a weighted average coupon rate of 5.70% and a weighted average loan age of 37 months. During the year ended December 31, 2024, the company recognized $450.15 million in interest income from its Agency RMBS portfolio, offset by $607.81 million in interest expense, resulting in net interest expense of $157.65 million. The company also recognized $40.04 million in losses on its investment securities, which included $39.30 million in realized losses on sales of AFS securities and a $259 million reversal of provision for credit losses.
In the second quarter of 2024, Two Harbors' wholly owned subsidiary, RoundPoint, began operating an in-house, direct-to-consumer residential mortgage loan originations platform. This platform was established primarily to benefit the company's MSR portfolio through the retention or recapture of existing borrowers by providing them with competitive refinance and purchase mortgage options. During the year ended December 31, 2024, Two Harbors recognized $558,000 in gains on its mortgage loans held-for-sale, which included gains on interest rate lock commitments and forward mortgage loan sale commitments related to the origination activities.
Despite the challenges posed by the current market environment, Two Harbors' unique hedged strategy, prudent risk management, and focus on enhancing its servicing and origination operations suggest that the company is well-equipped to continue generating favorable returns for its shareholders in the years ahead. The company's diversified investment strategy of pairing MSR and Agency RMBS, along with the addition of the mortgage loan origination platform, is designed to generate more stable performance across changing market environments and create sustainable stockholder value over the long term.