Executive Summary / Key Takeaways

• Strategic Transformation Complete: Two Harbors Investment Corp. ($TWO) has successfully resolved its significant litigation and is now fully focused on its MSR-centric strategy, leveraging its internally-managed RoundPoint platform to drive stable, risk-adjusted returns and enhance shareholder value.
• Operational Platform as a Differentiator: The RoundPoint acquisition and subsequent investments in direct-to-consumer (DTC) originations, second liens, and advanced AI technologies are proving critical. These initiatives are designed to hedge the MSR portfolio against prepayment risk, diversify revenue streams, and significantly reduce operating costs.
• Resilient Portfolio Amidst Market Shifts: Despite recent market volatility and a significant litigation settlement, the company maintains ample liquidity and a portfolio strategically balanced between Mortgage Servicing Rights (MSR) and Agency Residential Mortgage-Backed Securities (RMBS), positioned for attractive returns in various interest rate environments.
• Commitment to Shareholder Value: Management is actively addressing increased structural leverage and expense ratios post-settlement, with clear plans for cost savings and the redemption of convertible notes, reinforcing confidence in the dividend and the stock's long-term undervaluation.
• Technological Moat Deepening: Substantial investments in AI and other technologies within RoundPoint are creating tangible benefits in efficiency, accuracy, and customer experience, providing a competitive edge in the evolving mortgage finance landscape.

The MSR-Centric Evolution: A Story of Strategic Integration and Technological Edge

Two Harbors Investment Corp. ($TWO), founded in 2009, has evolved into a distinctive internally-managed real estate investment trust (REIT) with a core investment thesis centered on the strategic pairing of Mortgage Servicing Rights (MSR) and Agency Residential Mortgage-Backed Securities (RMBS). This foundational strategy aims to deliver more stable performance across diverse market environments compared to portfolios solely focused on RMBS. The company's journey took a pivotal turn with the September 2023 acquisition of RoundPoint Mortgage Servicing LLC, a move designed to internalize MSR servicing, gain greater control over cash flows, and expand its footprint in the broader mortgage finance sector. This integration has been instrumental in shaping Two Harbors' current market positioning and its strategic responses to industry dynamics.

The competitive landscape for mortgage REITs is dynamic, with players like Annaly Capital Management , AGNC Investment Corp. , PennyMac Mortgage Investment Trust (PMT), and Starwood Property Trust (STWD) vying for market share. While NLY and AGNC often boast larger scale and a broader range of mortgage finance assets, Two Harbors differentiates itself through its specialized focus on residential MSR and its integrated operational platform, RoundPoint. This niche expertise allows Two Harbors to potentially achieve stronger customer relationships within the residential segment, offering a unique value proposition. However, larger competitors may exhibit greater financial resilience and operational scale, which can translate to stronger profitability margins and return on equity. Two Harbors' REIT status, emphasizing tax-efficient distributions, also appeals to income-focused investors, providing a competitive moat against rivals.

Technological Differentiation: RoundPoint's AI-Driven Advantage

A critical differentiator for Two Harbors, particularly through its RoundPoint subsidiary, is its aggressive investment in advanced technology and artificial intelligence (AI). This technological push is not merely about incremental improvements; it is a strategic imperative to enhance efficiency, reduce costs, and elevate the homeowner experience, thereby deepening the company's competitive moat.

RoundPoint is actively implementing AI across multiple areas of its platform. Human emulation bots are deployed to automate repetitive tasks and move data across applications, freeing up human capital for more complex interactions. Image recognition, utilizing Optical Character Recognition (OCR) technologies, aids in data validation, improving accuracy and processing speed. Speech recognition applications enable comprehensive analysis of customer service calls, providing valuable insights into borrower needs and service quality. Furthermore, generative AI technology is being used to create automatic call summaries, significantly saving time for contact center employees while enhancing the precision of call documentation. The company is also exploring conversational AI to allow customers to interact more fully with customized AI interfaces for simple inquiries, reserving live agents for more complex problems. On the origination side, AI is being evaluated to automate the application and fulfillment process, promising further efficiencies.

These technological advancements offer tangible benefits. They contribute to significant cost savings by streamlining operations and reducing manual effort, directly impacting the company's operating expense ratio. The improved accuracy and efficiency enhance the customer experience, potentially leading to higher retention rates for the MSR portfolio. For investors, this technological roadmap translates into a stronger competitive position, improved operational leverage, and a pathway to better margins and sustained profitability, particularly as the company scales its servicing and origination activities. This focus on technology allows Two Harbors to achieve economies of scale and recognize the benefits of its investments immediately, a crucial component in its drive to reduce servicing and corporate costs.

Strategic Initiatives and Portfolio Dynamics

The RoundPoint acquisition has enabled several strategic initiatives that are central to Two Harbors' investment thesis. In late 2024, the company launched an in-house, direct-to-consumer (DTC) originations platform. This platform is primarily intended to act as a hedge for the MSR portfolio by retaining or recapturing existing borrowers when they refinance or seek new loan products. Origination activities are generally counter-cyclical to MSR fair value, providing supplementary profitability and hedging against faster-than-expected prepayment speeds. By the third quarter of 2025, the originations team recorded its most-ever locks for September, funding $49 million of UPB in first and second liens, with an additional $52 million UPB in the pipeline. Management is encouraged by the growth and higher-than-modeled recapture rates, even with only a small portion of the portfolio currently refinanceable.

Expanding its offerings, Two Harbors also began brokering second lien loans to its borrowers in late 2024, with $60 million UPB brokered in Q3 2025, a significant increase from $44 million in Q2 2025. The company plans to originate these loans in its own name, providing flexibility to hold, sell, or securitize them based on market opportunities. This not only diversifies revenue but also contributes to slower prepayments for MSR borrowers with second liens. RoundPoint is also preparing to service Ginnie Mae loans, further broadening its subservicing capabilities and market reach.

The company's third-party subservicing business has seen substantial growth, reaching approximately $40 billion in unpaid principal balance (UPB) by Q3 2025. This expansion validates the thesis behind the RoundPoint acquisition, confirming Two Harbors' position as an ideal subservicing partner due to its history as an MSR investor. This growth is expected to continue as consolidation in the subservicing market creates opportunities to attract new clients.

Financial Performance and Capital Management

Two Harbors' financial performance in 2025 has been significantly shaped by market dynamics and a major litigation settlement. For the nine months ended September 30, 2025, the company reported a net loss attributable to common stockholders of $505.77 million, compared to a net income of $13.27 million for the same period in 2024. This substantial loss was primarily driven by a litigation settlement expense of $375 million related to its former external manager, with $175.10 million recognized in Q3 2025 and the remainder accrued in Q2 2025.

Excluding the litigation expense, the company's total economic return for Q3 2025 would have been a positive 7.6%, though it recorded a negative 6.3% including the expense. For the first nine months of 2025, the total economic return was negative 15.6%, or positive 9.3% excluding the litigation expense. Book value per common share stood at $11.04 at September 30, 2025, a decrease from $14.47 at December 31, 2024, primarily due to the litigation settlement, net mark-to-market losses on MSR, and dividends declared. However, management reported a post-quarter update indicating book value was up approximately 1% as of October 25, 2025.

Net interest expense for the nine months ended September 30, 2025, was $63.46 million, an improvement from $122.76 million in the prior year, primarily due to lower overall interest rates and decreased average borrowings. Net servicing income, reflecting RoundPoint's activities, was $472.32 million for the nine months ended September 30, 2025, down from $498.59 million in the prior year, mainly due to lower float income from a reduced interest rate environment and a smaller MSR portfolio from run-off and sales. Operating expenses for the nine months ended September 30, 2025, surged to $509.23 million, largely due to the litigation settlement expense, as well as slightly higher compensation and benefits.

As of September 30, 2025, total assets were $10.87 billion, down from $12.20 billion at December 31, 2024. The MSR portfolio was valued at $2.63 billion, and available-for-sale securities (primarily Agency RMBS) at $6.35 billion. The company maintained strong liquidity, ending Q3 2025 with $770.5 million in cash on its balance sheet, even after the $375 million settlement payment. It also reported $939 million in unused MSR asset financing capacity and $78 million for servicing advances. The debt-to-equity ratio increased to 7.2x in Q3 2025, reflecting the reduced capital base. However, management views this as within their historical operating range and is actively working to reduce it, including the planned redemption of $261.9 million UPB of convertible notes maturing in January 2026, which will be funded by cash and MSR facilities.

Competitive Standing and Outlook

Two Harbors' competitive standing is bolstered by its MSR-centric strategy and the operational capabilities of RoundPoint. While larger peers like Annaly Capital Management (NLY) and AGNC Investment Corp. (AGNC) may benefit from greater scale and broader asset diversification, Two Harbors' specialized focus on residential MSR, combined with its in-house servicing and origination platform, provides a unique advantage. The company's investments in AI and technology are particularly noteworthy, as they promise to enhance efficiency and customer experience, potentially leading to lower operating costs and improved recapture rates that could outpace rivals.

The MSR market remains robust, with strong demand from both bank and non-bank originators and investors, despite a decline in bulk acquisition opportunities. Two Harbors' low gross coupon MSR portfolio (3.60% weighted average) remains largely "out of the money" for refinancing, contributing to stable cash flows. The company's ability to sell MSR on a servicing-retained basis, as demonstrated by the $19.1 billion UPB sale in Q3 2025 to a new subservicing client, underscores the value of its RoundPoint platform and its growing third-party subservicing business.

Management is optimistic about the future, expecting mortgage rates to remain above 6% in the intermediate term. They believe the current portfolio construction, with a significant allocation to MSR (approximately 68% of capital in Q3 2025) paired with Agency RMBS, will generate attractive risk-adjusted returns. Static return estimates for the portfolio range from 9.5% to 15.2% on common equity, or $0.26 to $0.42 per share quarterly. Management is comfortable with the current dividend, citing stable spreads and portfolio composition. Efforts to reduce the cost structure post-litigation settlement are underway, with significant savings anticipated, which could further enhance future earnings.

Risks and Challenges

Despite the positive outlook, Two Harbors faces several risks. The recent litigation settlement, while providing clarity, resulted in a substantial one-time cash payment and an increase in structural leverage. Although management is actively managing this, it requires careful capital allocation and cost control. Interest rate volatility remains a perennial risk for mortgage REITs. While the MSR portfolio offers a natural hedge, significant and rapid changes in interest rates can impact asset valuations and hedging effectiveness, leading to convexity costs. The company's reliance on short-term borrowings for long-maturity assets also exposes it to liquidity risk, particularly if pledged asset values decline, triggering margin calls. Credit risk, though low for Agency RMBS, exists for mortgage loans held-for-sale and non-Agency securities.

Conclusion

Two Harbors Investment Corp. is emerging from a period of significant litigation with a clear strategic vision and a robust, MSR-centric business model. The successful integration of RoundPoint and the ongoing investments in advanced technology, particularly AI, are transforming its operational capabilities, providing a distinct competitive edge in efficiency, customer engagement, and risk management. This technological leadership, coupled with a disciplined approach to portfolio construction and capital management, positions Two Harbors to generate stable, attractive risk-adjusted returns for its shareholders.

While challenges such as managing structural leverage and navigating interest rate volatility persist, the company's proactive measures, including cost reduction initiatives and strategic portfolio adjustments, underscore its commitment to long-term value creation. With its stock trading at a discount to book value, management believes Two Harbors is significantly undervalued, presenting a compelling opportunity for discerning investors who recognize the power of its integrated MSR and tech-driven operational platform in the evolving mortgage finance landscape.