Two Harbors Investment Corp

Greetings and welcome to the Two Harbors Investment Corp. Third Quarter 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief 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. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Maggie Carr, Head of Investor Relations. Thank you, Maggie. You may begin.

Good morning, everyone, and welcome to our call to discuss Two Harbor's third quarter 2023 financial results. With me on the call this morning are Bill Greenberg, our President and Chief Executive Officer, Nick Letica, our Chief Investment Officer, and Mary Riske, our Chief Financial Officer. The press release and presentation associated with today's call have been filed with the SEC and are available on the SEC's website, as well as the investor relations page of our website at TwoHarborsInvestment.com. In our earnings release and presentation, we have provided reconciliations of GAAP to non-GAAP financial measures, and we urge you to review this information in conjunction with today's call. As a reminder, our comments today will include forward-looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These are described on page two of the presentation and in our Form 10-K and subsequent reports filed with the SEC. Except as may be required by law, Two Harbors does not update forward-looking statements and disclaims any obligation to do so. I will now turn the call over to Bill.

Thank you, Maggie. Good morning, everyone, and welcome to our third quarter earnings call. Today, I'll provide an overview of our quarterly performance and the markets. Mary will cover our financial results in detail, and Nick will discuss our portfolio and return outlook. Let's begin with slide three. Our book value at September 30th was $15.36 per share, representing a negative 3.5% total economic return. Income excluding market-driven value changes, or IXM, was 51 cents per share, representing a 12.6% annualized return. This backward-looking metric of realized return is analogous to the forward-looking metrics on slide 14, but includes actual cash flows, actual prepayments, and actual costs incurred in the quarter. Please turn to slide four. Undoubtedly, the highlight of our third quarter was the closing of the acquisition of Round Point Mortgage Servicing, which reinforces our commitment to MSR as a core and essential part of our strategy. When we first envisioned acquiring a servicer, Our goal was to achieve economies of scale, improve MSR economics, and be able to leverage a more expansive set of opportunities in the mortgage finance space. Everything we have seen at Roundpoint at the last year, from the announcement through the closing, has given us confidence that our visions were not misplaced. Let me expand a little more on this topic. A subservicing model works well when you have a small portfolio because the cost to service is a fixed number of dollars per loan. However, when a portfolio gets to a certain size, it becomes more expensive since the marginal cost of service is lower than the average cost. For instance, it costs less to service the one millionth loan than it does the 100,000th loan or the very first loan. Conventional wisdom says that portfolios with approximately 500,000 loans are about break even and this conforms with our own observations and estimates. As a reminder, we are owners of MSR related to more than 850,000 loans. By bringing our servicing in-house, we can enjoy all cash flows related to the asset, whereas previously we only participated in a fraction. Although we were already receiving 100% of the float income associated with holding the principal and interest and taxes and insurance, we only received about 15% of the late fees and other ancillary income, and we did not receive any incentive payments from the GSEs for helping delinquent borrowers. These extra cash flows can be quite meaningful on a large and growing portfolio. In addition to the immediate economics I just described, we intend to grow Roundpoint's third-party subservicing business. Roundpoint currently services approximately 80,000 loans from a total of six true third-party clients. We believe that we can grow this significantly. Furthermore, we will be, as they say, eating our own cooking which means that we can provide the same experience to clients as they tag along with what we will be doing for our own portfolio. To date, we have transferred approximately two-thirds of our MSR portfolio from our sub-servicers to Roundpoint. We have three final transfers remaining and expect the last one to take place in June 2024. At the end of that process, we estimate that Roundpoint will have approximately 930,000 loans on the platform which will make it the eighth largest servicer of conventional loans in the country. The team at Roundpoint has done an excellent job of facilitating these loan transfers. October 1st, 2023 marks one year since our initial servicing transfer. Roundpoint has been able to keep up with the expanding portfolio through successful recruiting, technology refinements, and a commitment to delivering exceptional service to every customer. Since last October, Roundpoint has completed eight reallocation transfers, totaling approximately 600,000 loans. As one measure of the capabilities of the Roundpoint team, the average 30-plus day delinquency rate, 90 days post-transfer, is 16 basis points lower than it was before the transfer. Additionally, with an operating entity, we can also participate more fully in the structured finance housing market. This includes areas like new loan products, reverse mortgages, HELOCs, second liens, and other ancillary products. We have an incredible opportunity to grow RoundPoints and Two Harbors businesses together. Most importantly, this acquisition results in a bottom-line benefit to stockholders. We anticipate that the operation of RoundPoint will be accretive to our 2024 pre-tax earnings by $25 to $30 million. Mary will detail this and the purchase price more fully in her remarks. Turning to slide five, I'd like to engage in a brief discussion on the markets. The fixed income markets fluctuated during the quarter as participants tried to understand potential future Fed action or inaction. The June reading of headline CPI of 3.0% showed good progress coming down from a high of 9.1% a year prior. However, CPI readings in August and September increased back to 3.7%. There are, of course, more factors that go into determining the market's reaction, but it all led to interest rates generally rising over the quarter. With greater acceptance of Fed funds' rates close to their peak and likely higher for longer, along with concerns about greater Treasury supply and spillover effects from overseas central bank tightening, the SOFR interest rate swap market curve materially bear steepened as the quarter progressed. The 10-year swap rate rose 68 basis points from 3.6% to 4.3%, while the 2-year swap rate rose 15 basis points from 4.8% to 5.0%, as you can see in Figure 1. The rate on current coupon MBS increased 60 basis points from 6.7% to 7.3%. Note that these rates are current coupon rates and not primary mortgage rates, which are often 75 to 100 basis points higher. At quarter end, the market's projection for short-term rates was that they should come down moderately through 2024, landing around 4.7% at the end of next year, as seen in Figure 2 on the right-hand side of this slide. Compared to the shape of the front end of the curve in previous periods, current expectations have changed calling for fewer cuts in total and extended out in time. The Fed has been clear that interest rate cuts are not imminent, and it seems that the market has finally taken the Fed at face value. Elevated rate and spread volatility can pose near-term challenges to the sector. But if rate volatility moderates, spreads at this level are very attractive for investing our agency portfolio. Additionally, With our MSR weighted average coupon at 3.4%, it is so far out of the money that we have a very low convexity, low duration asset with stable cash flows. As you will see on our return potential slide, we believe that our combined strategy can generate low to mid-teens returns in this environment. October has seen continued difficulties in the MBS and interest rate markets. While rates have continued their upward trajectory, Geopolitical volatility and its attendant flight to quality have not tempered the upward rise and caused large movements to intraday levels of rates, as well as in mortgage spreads. This is why we believe it remains prudent to maintain a neutral leverage position and low risk exposures. Despite the continued market volatility, this is an exciting time for Two Harbors. We are uniquely positioned to capitalize on opportunities in agency RMBS and MSR, and our size allows us to be nimble enough to do so. The addition of Roundpoint improves our outlook as we expect to realize further operational and cost efficiencies as it becomes fully integrated into Two Harbors. Finally, we posted the first of our conversation series of videos last night. You can find them on our website under Investors and Insights. Each quarter we plan to release videos on special topics in the REIT industry or specific to Two Harbors. We hope that you find these helpful and interesting. And with that, I'd like to hand the call over to Mary to discuss our financial results.