Two Harbors reports non-GAAP loss in 2Q

Two Harbors Investment, while profitable using standard accounting rules, lost $3.7 million or 4 cents per share in the second quarter using earnings available for distribution, because of hedging activities.

EAD is a non-GAAP method common among real estate investment trusts.

So far in the current earnings cycle, PennyMac Financial also noted its results were reduced because of the impact of hedging losses on its servicing portfolio.

For the period Two Harbors had GAAP net income of $187.8 million.

Both are opposite where they were in the first quarter, in which Two Harbors had an EAD profit of $8.3 million but a GAAP loss of $189.2 million.

In the second quarter of 2022, the REIT reported EAD profitability of $75.3 million and a GAAP loss of $86.2 million.

"We see that largely being a function of the company's hedging mix being concentrated in Treasury and SOFR futures, whose [net interest margin] doesn't get picked up in EAD," said Eric Hagen, an analyst at BTIG in a report issued before Two Harbors' earnings call. "We don't see EAD in this case being a strong reflection of the company's ability to maintain its current dividend."

Prior to the second quarter's end, Two Harbors cut its dividend to 45 cents per share from 60 cents. However, on the call, management reiterated its claim that the move was not related to any pressure on earnings.

The company reportedly plans to use the money it is not paying out in dividends to invest in what is now "very attractive" residential mortgage-backed securities and residential mortgage servicing rights, said Bill Greenberg, Two Harbors' president and CEO on the call.

"EAD currently does not reflect our portfolio's earning potential, nor does it drive our dividend decisions," added Mary Riskey, chief financial officer.

Two Harbors has yet to close on its purchase of RoundPoint Mortgage Servicing, although the transaction with Freedom Mortgage was announced almost exactly one year ago.

The REIT is still waiting on regulatory approval from several states, Greenberg said.

Two Harbors has already moved over 63% of its MSR portfolio from three other subservicers to the RoundPoint platform, a move that was planned when the deal was first announced.

"We generally prefer when large servicers perform the operational subservicing in-house versus exporting the function to third-parties, mainly given the control we see around both operating and financial leverage, particularly in cases where the default servicing pipeline may be growing," BTIG's Hagen said.

Two Harbors serviced $222.6 billion as of June 30, up from $212.4 billion three months prior.

RoundPoint could be an entry point for Two Harbors into other segments of the mortgage finance business, Greenberg said.

Spreads are wide for both residential MSRs and mortgage-backed securities. But Two Harbors likes its opportunities with hedged MSRs better than with RMBS, Greenberg said, but the support from investors for securities from recent sales by the Federal Deposit Insurance Corp. was "robust and encouraging."