Two Harbors: The Series B Preferred Shares Offer The Best Value

Company Overview - Two Harbors Investment Corporation specializes in agency residential mortgage-backed securities (RMBS), which constitute 62% of its balance sheet, and mortgage servicing rights (MSR), making up 23% of its asset base [6][31] - As of March 31, 2024, the company has a portfolio valued at $14.7 billion [7] Performance and Returns - The Series B 7.625% preferred shares have significantly outperformed the iShares Preferred and Income Securities ETF (PFF) in 2024, delivering a low double-digit total return compared to the mid-single-digit return of the benchmark ETF [6][33] - The Series B shares offer an approximate 8.27% dividend yield and a capital appreciation potential of 8.46% to par value, which is higher than the Series A shares [30][33] Dividend Coverage - In Q1 2024, the company paid $11.8 million in cumulative preferred dividends, representing only 5.8% of its $203.6 million net income before preferred distributions [26] - The company has maintained strong preferred dividend coverage over the past few years, with coverage ratios of 2.35 times based on equity market capitalization of $1.46 billion [31] Leverage and Debt Ratios - The company has leveraged its common equity 8.25 times, with an economic debt-to-equity ratio of 6.0 when accounting for agency-to-be-announced securities [19][30] - The preferred shares are well-covered by shareholders' equity adjusted for preferred shares, standing at $1.6 billion [31] Interest Rate and Mortgage Spread Exposure - The company is well-hedged against interest rate exposure, with a potential portfolio impact of only -0.2% to -0.3% from a 0.25% move in rates [27] - A 5.3% increase in mortgage spreads could negatively affect the portfolio by 5.3% [27] Outlook on Monetary Policy - The Federal Reserve is projected to lower rates to 3.75-4.00% by July 2025, which would likely enhance the value of RMBS held by the company [36] - The company expects to benefit from lower interest rates through reduced rates on its repurchase agreements, which are tied to the secured overnight financing rate (SOFR) [39]