Two Harbors Investment Corp

Greetings. Welcome to the Two Harbors Investment Corp reports second quarter 2021 financial results. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Paulina Sims. You may begin.

Good morning, everyone, and welcome to our call to discuss Two Harbor's second quarter 2021 financial results. With me on the call this morning are Bill Greenberg, our President, Chief Executive Officer, and Chief Investment Officer, and Mary Riske, our Chief Financial Officer. The press release and the financial tables associated with today's call were filed yesterday with the SEC and are available on both the Two Harbors and SEC websites. In our earnings release and slides, we have provided a reconciliation of GAAP to non-GAAP financial measures. We urge you to review this information in conjunction with today's call. I would also like to mention that this call is being webcast and may be accessed in the investor relations section of our website. As a reminder, Remarks made by management during this conference call and the supporting slides may include forward-looking statements. These statements are based on the current beliefs and expectations of management, and actual results may be materially different because of a variety of risks and other factors. We caution investors not to rely unduly on forward-looking statements. Except as may be required by law, Two Harbors does not update forward-looking statements and expressly disclaims any obligation to do so. I will now turn the call over to Bill.

Thank you, Paulina. Good morning, everyone, and welcome to our second quarter earnings call. Before we begin, I'd like to acknowledge Matt Kepin's departure from the company on June 30th. Matt and I worked very closely together over the last nine years, and we had a very productive partnership. On behalf of the Two Harbors team, I'd like to thank Matt for his years of service to the company, and we wish him good luck in his future endeavors. As we announced a few weeks ago, I have taken on the role of Chief Investment Officer once again, and I look forward to working with the investment team, as well as the rest of the company, to navigate through the complex market environment in front of us. Please turn to slide three. At quarter end, book value was $6.42 per share. representing a negative 9.6% total economic quarterly return. The second quarter performance is almost entirely the result of significantly wider spreads on high coupon RMBS. The stubborn absence of prepayment burnout, along with the introduction of government programs to help borrowers refinance, both contributed to changing market expectations around prepayment speeds in these coupons. The MSR market was very active and we saw 125 billion UPB in bulk deals come to market in the second quarter alone, bringing the year-to-date volumes to approximately 180 billion, which is roughly the volume that we might typically see for a full year. We have been successful in deploying more capital in the MSR space this quarter as we purchased 6.5 billion UPB through bulk transactions and have commitments to add another 17 billion UPB subsequent to quarter end. Additionally, we settled on 16.4 billion UPB in our flow sale program during the quarter. Core earnings were 19 cents per share. However, spread movements generally dominate the portfolio performance relative to core earnings, and this quarter was no exception. In the absence of spread movements, and with more than one quarter in mind, we believe the portfolio can support a dividend of 17 cents, which the Board declared for the second quarter. Post quarter end, we issued approximately $256 million of common equity in a riskless, non-dilutive transaction by selling shares right at our book value. Besides being accretive to EPS by virtue of the expense dilution alone, we felt that it was advantageous to both current and new shareholders to be prepared to invest in our target assets when the opportunity to do so presents itself. We expect that MSR supply will be robust in the second half, and we think that Fed tapering and reduced bank buying will lead to wider, not tighter, RMBS spreads when that finally occurs, either later this year or early next. We have been disciplined in keeping our leverage low, as mortgage spreads have hovered around all-time tight levels. This positioning has not cost us anything in terms of performance thus far, and in fact has saved us from additional losses, as every coupon has underperformed their hedges for the last two quarters. As a result of our new equity and our liquidity positioning, which Mary will discuss further, we have plenty of dry powder to invest at attractive levels. Please turn to slide four, and I will briefly discuss the overall market environment. The second quarter of 2021 was characterized by falling long-term interest rates, a flatter yield curve, and, despite continued buying of current coupon RMBS from the Federal Reserve and large money center banks, wider mortgage spreads. Inflationary pressures have generally increased as the reopening of the economy has highlighted gaps in the supply chain and scarcity of workers, especially in restaurants, travel, and the service sectors in general. As an indication, in mid-July, the CPI index printed at 5.4%, which is the highest it's been in 13 years, and is shown in Figure 1 by the blue line. Compared to two years ago, which removes the base effects from the pandemic, Overall, CPI prices are still up a healthy 2.5%. Interestingly, many market participants have pointed out that prices in the used car and truck sector, shown by the gray line in the figure, increased by more than 40% in the period and was responsible for a large part of the aggregate increase in CPI. The Fed and many economists have insisted that inflation spikes such as these are temporary, although many other market participants aren't so sure. At the June Fed meeting, the Fed surprised the market by moving forward its median expectation for its first two rate hikes to late 2023. Although the initial market reaction was for higher rates, later interpretations focused on whether the Fed, in moving its median rate height expectations, had changed its reaction function and might choke off growth prematurely just as the economy is getting going. Some market participants have pointed to the Delta variant of the COVID virus as being a risk to forward growth, or whether future growth can keep up with the optimistic expectations that are already priced into the equity markets. At the July meeting last week, the Fed confirmed that the labor market has shown significant improvement, but Chairman Powell indicated that multiple strong jobs reports are required before commencing the tapering process. Chairman Powell also clarified that while there is little support to start tapering RMBS before Treasuries, it could possibly reduce RMBS purchases at a faster monthly pace. Whether for the reasons I just described or simply because of positioning and other technical factors, 10-year interest rates ended the quarter 35 basis points lower, retracing a large portion of the increase which occurred during Q1, while shorter-term interest rates were largely unchanged. Despite the fact that the Fed is now clearly talking about tapering, spreads on current coupon RMBS were largely unchanged on the quarter, and still sit at very tight levels, with current coupon OAS at minus 3 basis points, as seen in Figure 3. Compared to other periods of quantitative easing in the past, where the Fed was buying mortgages, these spreads are still at least 10 basis points rich to those periods. And compared to periods where the Fed was not actively buying mortgages, spreads are about 30 basis points lower. The Fed has stated that they are committed to a tapering process which is orderly, methodical, and transparent, we have no reason to doubt the Fed's intentions. However, the picture is further complicated by the large amount of RMBS that has been purchased by the banking sector, which has been fueled by increased deposits and low loan growth. With the news that all the large banks considered passed their Dodd-Frank Act stress tests, it is likely that dividend increases and share buybacks may lessen bank appetite for low yielding RMBS. Indeed, We have already seen signs of decreasing demand from banks as the recent H8 data shows that banks bought $100 billion of RMBS in the second quarter as compared to about $180 billion in the first. In addition, it appears that the second quarter was the first since 2019 where the supply of mortgages was higher than the combined demand from the banks and Fed. Please turn to slide five. Within the backdrop of the transitioning macroeconomic environment, there has been more policy activity in the GSE market than there has been since the onset of the pandemic. Recent leadership appointments at the FHFA and the HUD, along with new programs such as ReFi Now and ReFi Possible, illustrate a shift from the previous administration towards providing continued relief for distressed, low-income, or credit impaired borrowers, supporting affordable housing, and increasing the credit box and the footprint of the GSEs to support the administration's housing goals. On the other side of the ledger, steps have been taken to finally remove some of the accommodation that was provided at the onset of the pandemic, such as the foreclosure moratorium and, for FHA, VA, and HUD borrowers, the ability to enter into forbearance arrangements. Deferral still remains the best option for borrowers to become current again on their loans. As an MSR owner, We are committed to working diligently with our subservicing partners to do everything we can to help keep borrowers in their homes. I will now turn it over to Mary to walk you through a discussion of our financial results.