Two Harbors leans into MSR profits as bond volatility drives net loss

Two Harbors Investment Corp. recorded a fourth-quarter net loss linked largely to fluctuations in the value of its residential mortgage backed-securities, spurring a shift more toward more profitable servicing investments.

The real estate investment trust, which is in the process of acquiring a servicer through its Matrix Financial Services subsidiary, recorded a net loss of $262.4 million and generated $160.2 million in comprehensive income under standard accounting principles. Those numbers are mostly in line with preliminary results issued earlier, according to analysts at Keefe, Bruyette & Woods. Comprehensive income was inclusive of a $422.7 million unrealized gain on RMBS for the quarter.

Two Harbors had taken a net loss of a little over $15 million a year earlier, and generated nearly $263.9 million in net income during the third quarter. Two Harbors produced a comprehensive loss of $128. 59 million a year ago and of more than $287.2 in the third quarter.

RMBS generated a $263.69 million net loss, while mortgage servicing rights delivered $71.57 million in income under generally accepted accounting principles. Under an alternate, non-GAAP measure introduced by the company with the aim of removing the impact of market-driven changes in valuations, its bonds reflect $96.33 million in income, and its MSRs generated a gain of more than $80 million. 

"Interest rate expectations have leveled off with the market anticipating a Fed funds rate settling in just under 5% by mid-year. However, mortgage spreads have continued to be quite volatile," President and CEO Bill Greenberg noted in an earnings call.

The company forecasts a decline in volatility going forward, and expects to derive more servicing gains as it leans into that business line, Greenberg said. Currently, half the company's capital is allocated to mortgage servicing rights, he added. The company has been a seller of MSRs in the past, and noted that its strategies shift as the market does. Servicing has been characterized as a more of a buyers market recently, with banking giant Wells Fargo planning to sell some MSRs and many lenders across the board under pressure to find ways to raise cash.

"Given all the supply, we may look to opportunistically allocate some capital to bulk MSR purchases in the first half of 2023," said Nick Letica, Two Harbors' chief investment officer, during the call.

In addition to gains from MSRs, Two Harbors brought in another $68.95 million in derivative-related income from sources to-be-announced (forward delivery) securities, futures and other line items related to things like interest in cash and reverse repurchase agreements. 

That income was counterbalanced by expenses from operations totaling $22.95 million. Expenses also came from other sources like convertible debt interest and funding for bonds and servicing rights. 

Two Harbors additionally incurred some costs during the quarter related to following through with its plan to transition some of the operational responsibility for its MSRs to RoundPoint Mortgage Servicing Corp. RoundPoint is the company plans to acquire in the third quarter of this year.

"These expenses will be higher than average for the next several quarters as we continue to transition our servicing portfolio," Chief Financial Officer Mary Riskey said during the call.

During the quarter, the company also generated $20.15 million from the repurchase and retirement of preferred stock. Stock buybacks may be less desirable in the future. President Biden proposed quadrupling the tax on them in his State of the Union speech Wednesday night.