Two Harbors Investment Corp. (TWO) Q2 2025 Earnings Call Transcript
Access earnings results, analyst expectations, report, slides, earnings call, and transcript.
Overview
The earnings call highlights a mix of positive and neutral aspects. The company reported increased book value and comprehensive income, but leverage remains high and economic return is modest. The Q&A section reveals management's cautious approach to leverage and risk, with some uncertainties in litigation timelines. Overall, the sentiment is balanced, leading to a neutral prediction for stock price movement.
Key Financial Performance
Total Economic Return Negative 14.5% including the loss contingency accrual of $1.92 per share, and minus 1.4% without the accrual. The negative return was due to the loss contingency accrual related to ongoing litigation.
Book Value Decreased to $12.14 per share, representing a negative 14.5% quarterly economic return. Excluding the accrual, the total quarterly economic return would have been negative 1.4%.
Comprehensive Loss $221.8 million or $2.13 per share including the loss contingency accrual. Excluding the accrual, the comprehensive loss would have been $21.9 million or $0.21 per share. The loss was driven by unfavorable market movements on MSR, swaps, TBAs, and futures.
Net Interest and Servicing Income Higher by $3.1 million in the second quarter, driven by an increase in the Agency RMBS portfolio and higher float income on MSR. This was partially offset by lower servicing fee income from MSR portfolio runoff and slightly higher financing costs.
Mark-to-Market Gains and Losses Lower by $93.4 million in the quarter, impacted by unfavorable market movements on MSR, swaps, TBAs, and futures, partially offset by positive market movements on Agency RMBS.
First Lien Originations Funded $48 million UPB in first liens, up from $29 million UPB in the first quarter, representing a 68% increase. This growth outpaced the nationwide trend in mortgage originations, which rose 16% quarter-over-quarter.
Second Lien Originations Brokered $44 million UPB in second liens and began originating second liens in the company's name. This activity increased revenue, improved recapture rates, and slowed prepayments for MSR borrowers with second liens.
MSR Portfolio Purchases Purchased $6.4 billion UPB of MSR through 3 bulk purchases in the second quarter. The price multiple of MSR was unchanged quarter-over-quarter at 5.9x.
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Operating Highlights
Direct-to-consumer originations platform: Strengthened at RoundPoint to recapture loans in the portfolio that may refinance.
Second lien originations: Began originating second liens in the company's name, with options to hold, sell, or securitize.
First lien originations: Funded $48 million UPB in first liens, a 68% increase from the previous quarter, outpacing the national trend of 16% growth.
Second lien marketing: Brokered $44 million UPB in second liens and began originating second liens in-house.
AI technology implementation: Invested in AI for contact centers, including human emulation bots, OCR for data validation, speech recognition, and generative AI for call summaries.
Conversational AI: Exploring AI interfaces for customer interactions and automating application and fulfillment processes.
Portfolio strategy: Focused on low coupon MSR paired with Agency RMBS to benefit from stable prepayments and wide agency spreads.
Market outlook: Positioned to leverage opportunities in Agency RMBS and MSR markets amidst geopolitical and market volatility.
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Risk or Challenges
Market Volatility: The company experienced heightened market volatility, particularly in April, which impacted RMBS spreads and overall portfolio performance. This volatility poses a risk to consistent returns.
Litigation Risk: The company took a loss contingency accrual of $199.9 million related to ongoing litigation from the termination of a management agreement in 2020. This has already negatively impacted book value and could lead to further financial losses depending on the trial outcome.
Interest Rate Sensitivity: Fluctuations in interest rates, including potential Federal Reserve rate cuts, could impact RMBS and MSR portfolio performance. While some rate cuts may be beneficial, they could also lead to increased prepayment risks.
Economic Return: The company reported a negative total economic return of 14.5% for the quarter, primarily due to the litigation accrual. Excluding this, the return was still negative at 1.4%, indicating challenges in achieving profitability.
Prepayment Risks: Although prepayment rates are currently low, any significant drop in mortgage rates could increase prepayment speeds, negatively affecting the MSR portfolio.
Supply-Demand Imbalance: The MSR market is experiencing a decline in supply, which could limit future acquisition opportunities and impact portfolio growth.
Geopolitical and Trade Risks: Ongoing tariff threats, trade negotiations, and geopolitical tensions are highlighted as potential sources of market volatility, which could adversely affect portfolio performance.
Operational Risks: The company is investing heavily in AI and technology to improve efficiency and customer experience. However, the success of these initiatives is uncertain and could pose operational risks if not implemented effectively.
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Guidance & Outlook
Interest Rate Cuts: Several members of the FOMC have suggested 1 to 2 rate cuts likely occurring later this year, and the market similarly projects 50 to 75 basis points of cuts in the second half of 2025. If the Fed does indeed cut rates in the latter half of this year, the company expects RMBS and MSR portfolios to respond positively.
Mortgage Rates and Housing Activity: Mortgage rates are expected to remain below their 2023 peak levels, which has helped housing activity remain reasonably well supported. The company anticipates that a few cuts in the front end of the yield curve will not materially alter mortgage rates or prepayments.
Direct-to-Consumer Originations Platform: The company is strengthening its direct-to-consumer originations platform at RoundPoint to recapture loans in its portfolio that may refinance. This includes originating second liens in its own name, which can be held, sold, or securitized.
AI Technology Investments: The company is making significant investments in AI technologies to increase efficiencies, reduce costs, and improve homeowner experiences. This includes implementing AI in contact centers, using human emulation bots, OCR technologies, speech recognition, and generative AI for call summaries. Future plans include applying AI to automate the origination process.
MSR Portfolio and Prepayment Rates: The MSR market remains well supported, with prepayment rates expected to remain very slow on a historical basis, providing a tailwind for the portfolio. The company projects that only 0.7% of its MSR portfolio is currently in the money, with limited impact even if rates drop to 5%.
Portfolio Returns: The company estimates a static return projection of 11% to 14% for servicing capital and 12% to 17% for securities capital. After expenses, the static return estimate for the portfolio is projected to be between 8.8% to 12.1%, with a potential static return on common equity in the range of 9.4% to 15.3%.
Market Conditions and Opportunities: The company believes that ongoing tariff threats, trade negotiations, and geopolitical tensions will weigh on the market but also present opportunities. Agency RMBS spreads, particularly when hedged with interest rate swaps, remain historically wide and offer good relative value. The company is confident in its portfolio construction to drive attractive risk-adjusted returns across a range of market conditions.
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Shareholder Return Plan
The selected topic was not discussed during the call.
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Key Q&A
Q:Your leverage increased this quarter due to the litigation reserve. Is this the new level of leverage we should expect, or will there be portfolio actions to bring it back to the prior range?
A:The leverage ended the quarter at 7x, within the target range of 5 to 8. The increase was due to favorable market conditions for mortgages versus swaps. Adjusting for the $200 million loss reserve, leverage would be 6.3%. Management is comfortable with the current leverage and will adjust based on market opportunities.
Q:Can you provide an update on economic return performance so far in July?
A:Quarter-to-date, through last Friday, economic return was up about 1.5%.
Q:What are the main differences between the expected returns on Slide 15 and the EAD metric?
A:EAD is based on historical purchase yields, while the return outlook reflects forward-looking mark-to-market yields. The differences arise from timing and market prices used in yield calculations. Slide 15 also accounts for potential fluctuations in prepayment speeds, funding spreads, and leverage.
Q:Does the EAD trend below the economic return in the back half of the year?
A:Yes, because spreads have widened recently, and the EAD of older securities does not reflect the change in market value.
Q:Does your view on leverage change once the reserved capital is paid out?
A:No, the view on leverage does not change. The portfolio will be managed based on the available capital, but the overall approach to leverage remains consistent.
Q:Are you interested in building second liens into the investment portfolio, or will they be sold off?
A:It depends on risk and reward. If yields are attractive, they will be held; otherwise, they may be sold in bulk, on flow, or securitized. The decision will be made in real-time based on opportunities.
Q:Can you elaborate on your increased exposure to mortgage derivatives this quarter?
A:The company added a team member to focus on derivatives, primarily growing inverse IO exposure. About $50 million was allocated to this sector, which remains under 5% of securities capital. It is a small but growing component of the portfolio.
Q:What is the thought process behind moving part of the financing from repo to unsecured this quarter?
A:The issuance of the unsecured baby bond was to prefinance the maturity of the convertible. Some warehouse lines were also adjusted, but the main change was the baby bond issuance.
Q:What is the potential impact of a steepening yield curve on the portfolio, particularly on MSRs?
A:The portfolio is hedged across the yield curve, so there is no strong view on curve risks. A steeper yield curve could tighten mortgage spreads due to increased bank participation. For MSRs, a steeper curve has counterbalancing effects: lower float income and reduced prepayment assumptions, which affect MSR pricing.
Q:What is your risk appetite in the current market?
A:Risk exposure is virtually unchanged quarter-over-quarter. The company likes current mortgage spreads, which are historically generous. Spread volatility has declined, and the market is well-supported with low rate volatility and strong MSR performance.
Q:What is your outlook for the mortgage origination market and its impact on MSR appetite and competitive landscape?
A:The mortgage origination effort remains small, with only 0.7% of the portfolio eligible for refinance. The company is balancing costs and opportunities, scaling efforts cautiously, and preparing to react to market changes.
Q:Can you provide clarity on the timeline for the PRCM litigation and claims against IP?
A:A trial date has not been set, and no further details can be provided at this time.
Q:Can you explain the expense structure, particularly with AI investments?
A:Most AI-related expenses will be expensed rather than capitalized due to strict capitalization rules. The expense ratio may remain constant or slightly increase. The company will primarily use third-party AI solutions with some customization.
Q:What is the timeline for expenses in the second half of the year?
A:The combined expense for servicing costs, compensation, and OpEx was $45 million in Q2, which is a reasonable estimate for the second half.
Q:What is the approach to AI development in your business?
A:The company will primarily use third-party AI solutions with some bespoke developments for specific needs. Customization will be minimal, focusing on efficiency and borrower experience.
Q:Is there a possibility of retaining POS as production ramps on the core business?
A:Yes, retaining POS is a possibility, depending on economic return hurdles and strategic considerations. The portfolio will remain primarily agency-focused, with non-agency exposure as a minority interest.
Q:Review of Unclear Management Responses
A:Management avoided providing a direct answer regarding the timeline for the PRCM litigation and claims against IP, stating only that a trial date has not been set and updates will be provided when available.
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Earnings Word Cloud
The most frequently occurring keywords in this quarter's earning call
AI technology
Division Jason
Greenberg President
Harbors
LLC Research
Officer Dellal
RMBS MSR
Research Division
Slide loss
UPB lien
VP Chief
accrual
agreement
application
contact center
contingency share
experience
gain loss
income MSR
increase
interest servicing
loss contingency
loss market
loss share
low
market gain
market movement
order
proceeds
rate prepayment
recognition
share return
standard
sum
tariff
termination
treasury rate
TWO Transcript
Two Harbors Investment Corp. (TWO) Q1 2026 Earnings Call Transcript
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The earnings call showed a mixed financial performance with a 10% revenue increase but a decline in net income and EPS. The book value per share increased, indicating some positive portfolio movement. However, the lack of strategic insights, operational updates, and unclear management responses in the Q&A section contribute to a neutral sentiment. Given the company's mid-cap status, the market reaction is likely to remain within a neutral range (-2% to 2%) over the next two weeks.
Two Harbors Investment Corp. (TWO) Q4 2025 Earnings Call Transcript
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The earnings call presents mixed signals. Positive aspects include a strong direct-to-consumer origination growth, increased book value, and a declared dividend. However, the lack of a share repurchase program, reduced servicing portfolio, and negative annual return due to litigation expenses temper the outlook. The Q&A reveals cautious management with no major changes in strategy or leverage, and some vague responses. Despite technology enhancements and market undervaluation, the overall sentiment remains balanced, leading to a neutral prediction for the stock price movement.
Two Harbors Investment Corp. (TWO) Q3 2025 Earnings Call Transcript
Positive10-28
The earnings call presents a positive outlook with strong financial performance, strategic investments in AI, and a direct-to-consumer platform. The Q&A reveals cautious optimism with a slight increase in book value and strategic portfolio management. Despite some unclear responses, the overall sentiment is positive due to projected static returns, potential cost savings, and gradual growth in subservicing. The market cap suggests moderate volatility, aligning with a positive stock price prediction.
Two Harbors Investment Corp. (TWO) Q2 2025 Earnings Call Transcript
Unknown7-29
The earnings call highlights a mix of positive and neutral aspects. The company reported increased book value and comprehensive income, but leverage remains high and economic return is modest. The Q&A section reveals management's cautious approach to leverage and risk, with some uncertainties in litigation timelines. Overall, the sentiment is balanced, leading to a neutral prediction for stock price movement.
TWO Slides
TWO Report
Frequently Asked Questions
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