Two Harbors Investment (US:TWO)2023-10-31 15:07PART I - FINANCIAL INFORMATION Item 1. Financial Statements (unaudited) This section presents Two Harbors Investment Corp.'s unaudited condensed consolidated financial statements, including balance sheets, comprehensive loss, equity, and cash flows, with detailed notes Condensed Consolidated Balance Sheets As of September 30, 2023, total assets increased to $13.92 billion and liabilities to $11.80 billion, while stockholders' equity slightly decreased to $2.12 billion Condensed Consolidated Balance Sheet Highlights (in thousands) | Account | September 30, 2023 (unaudited) | December 31, 2022 | | :--- | :--- | :--- | | Total Assets | $13,916,729 | $13,466,160 | | Available-for-sale securities, at fair value | $8,830,726 | $7,778,734 | | Mortgage servicing rights, at fair value | $3,213,113 | $2,984,937 | | Cash and cash equivalents | $644,184 | $683,479 | | Total Liabilities | $11,799,501 | $11,282,635 | | Repurchase agreements | $9,113,270 | $8,603,011 | | Revolving credit facilities | $1,410,671 | $1,118,831 | | Total Stockholders' Equity | $2,117,228 | $2,183,525 | Condensed Consolidated Statements of Comprehensive Loss For Q3 2023, net income attributable to common stockholders was $294.1 million, or $2.81 per diluted share, but a $350.9 million unrealized loss on available-for-sale securities resulted in a $56.8 million comprehensive loss Key Performance Indicators (in thousands, except per share data) | Metric | Q3 2023 | Q3 2022 | Nine Months 2023 | Nine Months 2022 | | :--- | :--- | :--- | :--- | :--- | | Net Interest (Expense) Income | $(49,486) | $11,038 | $(117,182) | $53,469 | | Total Other Income | $446,547 | $329,537 | $649,629 | $661,350 | | Net Income Attributable to Common Stockholders | $294,077 | $263,865 | $292,688 | $449,220 | | Diluted EPS | $2.81 | $2.78 | $2.91 | $4.80 | | Comprehensive Loss Attributable to Common Stockholders | $(56,845) | $(287,808) | $(88,609) | $(438,509) | Condensed Consolidated Statements of Stockholders' Equity Total stockholders' equity decreased from $2.18 billion at year-end 2022 to $2.12 billion as of September 30, 2023, primarily due to comprehensive loss and dividends, partially offset by common stock issuance Change in Stockholders' Equity (Nine Months Ended Sep 30, 2023, in thousands) | Description | Amount | | :--- | :--- | | Balance, December 31, 2022 | $2,183,525 | | Net Income | $326,829 | | Other Comprehensive Loss | $(381,297) | | Issuance of common stock, net | $177,729 | | Repurchase of common stock | $(7,056) | | Repurchase and retirement of preferred stock | $(9,966) | | Common dividends declared | $(145,501) | | Preferred dividends declared | $(36,595) | | Balance, September 30, 2023 | $2,117,228 | Condensed Consolidated Statements of Cash Flows For the nine months ended September 30, 2023, net cash provided by operating activities was $233.8 million, while investing activities used $973.3 million, and financing activities provided $657.9 million, resulting in an $81.5 million net decrease in cash Cash Flow Summary (Nine Months Ended, in thousands) | Cash Flow Category | Sep 30, 2023 | Sep 30, 2022 | | :--- | :--- | :--- | | Net cash provided by operating activities | $233,770 | $387,421 | | Net cash used in investing activities | $(973,253) | $(3,633,478) | | Net cash provided by financing activities | $657,939 | $2,732,403 | | Net decrease in cash, cash equivalents and restricted cash | $(81,544) | $(513,654) | Notes to the Condensed Consolidated Financial Statements The notes detail the company's accounting policies and activities, including the $44.7 million RoundPoint acquisition, portfolio composition of Agency RMBS and MSR, derivative usage, financing, and equity structure - The company invests in Agency residential mortgage-backed securities (Agency RMBS) and mortgage servicing rights (MSR)29 - On September 30, 2023, the company closed its acquisition of RoundPoint Mortgage Servicing LLC from Freedom Mortgage Corporation. The provisional purchase price was $44.7 million, creating $27.7 million in goodwill314749 - The company uses various derivative instruments, including TBAs, interest rate swaps, and futures, to mitigate interest rate risk. These are not designated as accounting hedges, leading to earnings volatility9395 - During the nine months ended September 30, 2023, the company repurchased 593,453 common shares for $7.1 million and various series of preferred stock for a total cost of $10.0 million199206 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the company's strategy of pairing Agency RMBS with MSR, noting Q3 2023's higher interest rates, wider mortgage spreads, and the RoundPoint acquisition, while maintaining moderate leverage - The company's objective is to provide attractive risk-adjusted total returns by investing in Agency RMBS and MSR, deploying moderate leverage235239 - The acquisition of RoundPoint Mortgage Servicing LLC closed on September 30, 2023, with a provisional purchase price of $44.7 million. This move is intended to bring servicing in-house, reduce costs, and provide greater control over the MSR portfolio237 - Market conditions in Q3 2023 saw rising interest rates and wider mortgage spreads. The 10-year Treasury yield rose 73 bps to 4.57%. Despite challenges, management believes the combination of wide spreads and slow prepayment rates presents an attractive return potential for its paired RMBS and MSR strategy257258264 Key Financial Metrics | Metric | September 30, 2023 | June 30, 2023 | December 31, 2022 | | :--- | :--- | :--- | :--- | | Book Value Per Common Share | $15.36 | $16.39 | $17.72 | | Debt-to-Equity Ratio | 5.2:1.0 | 5.0:1.0 | 4.4:1.0 | | Economic Debt-to-Equity Ratio | 6.3:1.0 | 6.4:1.0 | 6.3:1.0 | Item 3. Quantitative and Qualitative Disclosures About Market Risk The company is exposed to market risks including interest rate, prepayment, market value, and liquidity risks, which are managed through derivatives and non-derivative instruments, with sensitivity analysis performed - The company's primary market risks are interest rate risk, prepayment risk, market value risk, liquidity risk, and credit risk337356359362364 - To manage interest rate risk, the company uses derivatives (TBAs, swaps, futures) and non-derivatives (MSR) to hedge its portfolio and adjust the duration of its floating-rate borrowings341 Interest Rate Sensitivity Analysis (as of Sep 30, 2023) | Change in Interest Rates | -50 bps | -25 bps | +25 bps | +50 bps | | :--- | :--- | :--- | :--- | :--- | | Change in Annualized Net Interest Income | +$11.1M (+7.4%) | +$5.5M (+3.7%) | -$5.6M (-3.7%) | -$11.1M (-7.4%) | | Change in Total Net Assets (% of common equity) | -2.8% | -0.9% | 0.0% | -0.7% | - Prepayment risk impacts both Agency RMBS (through premium amortization) and MSR (by shortening the servicing income stream). An increase in prepayment rates generally reduces the value of MSR356358 Item 4. Controls and Procedures Management concluded that the company's disclosure controls and procedures were effective as of September 30, 2023, with no material changes to internal control over financial reporting during the quarter - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of September 30, 2023365 - No changes occurred during the quarter ended September 30, 2023, that materially affected, or are reasonably likely to materially affect, the company's internal control over financial reporting366 PART II - OTHER INFORMATION Item 1. Legal Proceedings The company is involved in ongoing litigation with its former external manager, PRCM Advisers, following a 'for cause' termination, with counterclaims filed and an uncertain outcome - The company is in a legal dispute with its former manager, PRCM Advisers, following a 'for cause' termination of the management agreement in July 2020368 - The complaint by PRCM Advisers includes allegations of trade secret misappropriation and breach of contract. The company believes the complaint is without merit and has filed counterclaims368 Item 1A. Risk Factors This section introduces new risk factors related to the RoundPoint Mortgage Servicing LLC acquisition, including the potential failure to realize expected benefits and exposure to new in-house mortgage servicing operational risks - The company may fail to realize the expected benefits of the RoundPoint acquisition, or realization may take longer than anticipated370 - The acquisition exposes the company to new and more direct risks associated with in-house mortgage servicing, including compliance with laws and GSE guidelines, impacts of delinquencies, and IT system failures372 - Future expansion into new products or services through RoundPoint could expose the company to new or increased risks373 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds The company provides an update on its share repurchase programs, noting no repurchases of common or preferred stock during the three months ended September 30, 2023 - The company did not repurchase any common or preferred shares during the three months ended September 30, 2023374375 Cumulative Share Repurchase Program Status (as of Sep 30, 2023) | Security Type | Shares Repurchased | Total Cost | | :--- | :--- | :--- | | Preferred Stock | 3,471,768 | $61.4 million | | Common Stock | 3,637,028 | $208.5 million | Item 3. Defaults Upon Senior Securities The company reported no defaults upon its senior securities during the period - None376 Item 4. Mine Safety Disclosures This item is not applicable to the company - None377 Item 5. Other Information During the third quarter of 2023, certain directors and executive officers, including Chief Legal Officer Rebecca Sandberg and Chairman Stephen Kasnet, adopted or terminated Rule 10b5-1 trading plans - On August 3, 2023, Chief Legal Officer Rebecca Sandberg adopted a Rule 10b5-1 plan to sell shares to cover tax liabilities from future equity vesting379 - On August 10, 2023, Chairman Stephen Kasnet adopted a Rule 10b5-1 plan to sell 40% of shares vesting from future equity compensation380 Item 6. Exhibits This section provides a list of all exhibits filed with the Quarterly Report on Form 10-Q, including certifications by the CEO and CFO, and the financial statements formatted in Inline XBRL - A list of exhibits filed with the Form 10-Q is provided383