Housing Gridlock Fuels 10% Yielding Two Harbors Preferreds

Company Overview - Two Harbors Investment Corp. (NYSE:TWO) benefits from the current housing market gridlock, which has resulted in low transaction volumes and increased stability from longer duration assets [2][3] - The company operates primarily in two lines of business: Agency RMBS and mortgage servicing rights (MSRs), which constitute the majority of its balance sheet [5] Market Conditions - The housing market is experiencing a gridlock as potential sellers are reluctant to sell due to low existing mortgage rates, leading to frustration among homebuyers [1] - Mortgage rates have risen to around 7%, but existing mortgages are predominantly at lower rates (2%-5%), causing borrowers to hold onto their mortgages longer [8][10] Financial Performance - Two Harbors has a series of fixed-to-floating preferreds that, upon conversion, would yield between 9.6% and 10.5% based on current SOFR [3] - The company has extended the duration of its assets, providing greater visibility into future cash flows, which are sufficient to cover preferred dividends [3][14] Preferred Shares Analysis - The preferred shares of Two Harbors are trading at discounts to par, allowing for potential capital appreciation in addition to high yields [4][20] - The preferreds are seen as stable investments despite the high leverage of the company, which typically implies higher risk [3][4] Prepayment Sources - Prepayment sources such as voluntary early payment, refinancing, and defaults are currently at abnormally low levels, extending the duration of 30-year mortgages [9][12] - The low prepayment rates benefit MSRs, as the company collects fees for a longer duration on serviced mortgages [13] Preferreds Details - The preferreds include TWO-A, TWO-B, and TWO-C, each with different characteristics regarding yield and conversion dates [15][19] - TWO-A has the largest adjustment over SOFR, making it the most incentivized for redemption, while TWO-B offers significant capital appreciation potential due to its large discount to par [17][18] - TWO-C has an earlier conversion date, providing a competitive yield and likely larger dividends in the near term [19]