UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________
FORM 10-Q
______________________________
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: March 31, 2013
Commission File Number 001-34506
______________________________
TWO HARBORS INVESTMENT CORP.
(Exact Name of Registrant as Specified in Its Charter)
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| | |
Maryland | | 27-0312904 |
(State or Other Jurisdiction of Incorporation or Organization) | | (I.R.S. Employer Identification No.) |
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601 Carlson Parkway, Suite 1400 Minnetonka, Minnesota | | 55305 |
(Address of Principal Executive Offices) | | (Zip Code) |
(612) 629-2500
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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| | | | | | |
Large accelerated filer x | | Accelerated filer o | | Non-accelerated filer o | | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
As of May 8, 2013 there were 365,252,790 shares of outstanding common stock, par value $.01 per share, issued and outstanding.
TWO HARBORS INVESTMENT CORP.
INDEX
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| PART I - FINANCIAL INFORMATION | |
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| PART II - OTHER INFORMATION | |
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
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| | | | | | | |
| March 31, 2013 | | December 31, 2012 |
ASSETS | (unaudited) | | |
|
Available-for-sale securities, at fair value | $ | 14,963,531 |
| | $ | 13,666,954 |
|
Trading securities, at fair value | 1,002,414 |
| | 1,002,062 |
|
Equity securities, at fair value | 368,970 |
| | 335,638 |
|
Mortgage loans held-for-sale, at fair value | 192,417 |
| | 58,607 |
|
Mortgage loans held-for-investment in securitization trust, at fair value | 434,068 |
| | — |
|
Cash and cash equivalents | 1,140,706 |
| | 821,108 |
|
Restricted cash | 277,428 |
| | 302,322 |
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Accrued interest receivable | 47,089 |
| | 42,613 |
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Due from counterparties | 15,499 |
| | 39,974 |
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Derivative assets, at fair value | 511,749 |
| | 462,080 |
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Other assets | 49,020 |
| | 82,586 |
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Total Assets (1) | $ | 19,002,891 |
| | $ | 16,813,944 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY | |
| | |
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Liabilities | |
| | |
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Repurchase agreements | $ | 13,444,565 |
| | $ | 12,624,510 |
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Collateralized borrowings in securitization trust, at fair value | 397,229 |
| | — |
|
Derivative liabilities, at fair value | 45,423 |
| | 129,294 |
|
Accrued interest payable | 19,348 |
| | 19,060 |
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Due to counterparties | 535,971 |
| | 412,861 |
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Accrued expenses | 9,485 |
| | 13,295 |
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Dividends payable | 485,791 |
| | 164,347 |
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Total liabilities (1) | 14,937,812 |
| | 13,363,367 |
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Stockholders’ Equity | |
| | |
|
Preferred stock, par value $0.01 per share; 50,000,000 shares authorized; no shares issued and outstanding | — |
| | — |
|
Common stock, par value $0.01 per share; 900,000,000 shares authorized and 362,142,394 and 298,813,258 shares issued and outstanding, respectively | 3,621 |
| | 2,988 |
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Additional paid-in capital | 3,774,548 |
| | 2,948,345 |
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Accumulated other comprehensive income | 800,710 |
| | 696,458 |
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Cumulative earnings | 593,074 |
| | 449,358 |
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Cumulative distributions to stockholders | (1,106,874 | ) | | (646,572 | ) |
Total stockholders’ equity | 4,065,079 |
| | 3,450,577 |
|
Total Liabilities and Stockholders’ Equity | $ | 19,002,891 |
| | $ | 16,813,944 |
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____________________
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(1) | The condensed consolidated balance sheets include assets of a consolidated variable interest entity (“VIE”) that can only be used to settle obligations of this VIE and liabilities of the consolidated VIE for which creditors do not have recourse to the Company (Two Harbors Investment Corp.). At March 31, 2013, assets of consolidated the VIE totaled $435,469 and liabilities of the consolidated VIE totaled $398,068. The Company did not consolidate any VIEs as of December 31, 2012. See Note 3 - Variable Interest Entities for additional information. |
The accompanying notes are an integral part of these condensed consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands, except share data)
|
| | | | | | | |
| Three Months Ended |
| March 31, |
| 2013 | | 2012 |
| (unaudited) |
Interest income: | |
| | |
|
Available-for-sale securities | $ | 130,292 |
| | $ | 84,214 |
|
Trading securities | 1,264 |
| | 1,050 |
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Mortgage loans held-for-sale | 1,318 |
| | 69 |
|
Mortgage loans held-for-investment in securitization trust | 1,654 |
| | — |
|
Cash and cash equivalents | 307 |
| | 168 |
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Total interest income | 134,835 |
| | 85,501 |
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Interest expense: | | | |
Repurchase agreements | 23,018 |
| | 11,467 |
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Collateralized borrowings in securitization trust | 818 |
| | — |
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Total interest expense | 23,836 |
| | 11,467 |
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Net interest income | 110,999 |
| | 74,034 |
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Other-than-temporary impairments: | | | |
Total other-than-temporary impairment losses (includes $236 and $4,275, respectively, accumulated other comprehensive income reclassifications for unrealized losses on available-for-sale securities) | (236 | ) | | (4,275 | ) |
Non-credit portion of loss recognized in other comprehensive income | — |
| | — |
|
Net other-than-temporary credit impairment losses | (236 | ) |
| (4,275 | ) |
Other income: | | | |
Gain on investment securities (includes $18,775 and $9,991, respectively, accumulated other comprehensive income reclassifications for unrealized gains on available-for-sale securities) | 26,968 |
| | 9,931 |
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Gain (loss) on interest rate swap and swaption agreements | 18,972 |
| | (16,193 | ) |
Loss on other derivative instruments | (16,662 | ) | | (8,903 | ) |
Gain (loss) on mortgage loans held-for-sale | 14,323 |
| | (32 | ) |
Gain on mortgage loans held-for-investment and collateralized borrowings in securitization trust | 6,289 |
| | — |
|
Total other income (loss) | 49,890 |
| | (15,197 | ) |
Expenses: | | | |
Management fees | 4,761 |
| | 6,743 |
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Securitization deal costs | 2,028 |
| | — |
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Other operating expenses | 6,561 |
| | 3,550 |
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Total expenses | 13,350 |
| | 10,293 |
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Income from continuing operations before income taxes | 147,303 |
| | 44,269 |
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Provision for (benefit from) income taxes | 4,964 |
| | (7,577 | ) |
Net income from continuing operations | 142,339 |
| | 51,846 |
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Income (loss) from discontinued operations | 1,377 |
| | (46 | ) |
Net income attributable to common stockholders | $ | 143,716 |
| | $ | 51,800 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME, continued
(in thousands, except share data)
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| | | | | | | |
| Three Months Ended |
| March 31, |
| 2013 | | 2012 |
| (unaudited) |
Basic earnings per weighted average common share: | | | |
Continuing operations | $ | 0.47 |
| | $ | 0.28 |
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Discontinued operations | — |
| | — |
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Net income | $ | 0.47 |
| | $ | 0.28 |
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Diluted earnings per weighted average common share: | | | |
Continuing operations | $ | 0.47 |
| | $ | 0.28 |
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Discontinued operations | — |
| | — |
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Net income | $ | 0.47 |
| | $ | 0.28 |
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Dividends declared per common share | $ | 0.32 |
| | $ | 0.40 |
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Weighted average number of shares of common stock: | | | |
Basic | 305,284,922 |
| | 186,855,589 |
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Diluted | 306,963,711 |
| | 186,855,589 |
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Comprehensive income: | | | |
Net income | $ | 143,716 |
| | $ | 51,800 |
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Other comprehensive income: | | | |
Unrealized gain on available-for-sale securities, net | 104,252 |
| | 143,910 |
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Other comprehensive income | 104,252 |
| | 143,910 |
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Comprehensive income | $ | 247,968 |
| | $ | 195,710 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share data)
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| Common Stock | | | | | | | | | | |
| Shares | | Amount | | Additional Paid-in Capital | | Accumulated Other Comprehensive Income (Loss) | | Cumulative Earnings | | Cumulative Distributions to Stockholders | | Total Stockholders' Equity |
| | | | | | | (unaudited) | | | | | | |
Balance, December 31, 2011 | 140,596,708 |
| | $ | 1,406 |
| | $ | 1,373,099 |
| | $ | (58,716 | ) | | $ | 157,452 |
| | $ | (203,155 | ) | | $ | 1,270,086 |
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Net income | — |
| | — |
| | — |
| | — |
| | 51,800 |
| | — |
| | 51,800 |
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Other comprehensive income before reclassifications | — |
| | — |
| | — |
| | 149,626 |
| | — |
| | — |
| | 149,626 |
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Amounts reclassified from accumulated other comprehensive income | — |
| | — |
| | — |
| | (5,716 | ) | | — |
| | — |
| | (5,716 | ) |
Net other comprehensive income | — |
| | — |
| | — |
| | 143,910 |
| | — |
| | — |
| | 143,910 |
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Net proceeds from issuance of common stock, net of offering costs | 73,610,638 |
| | 736 |
| | 691,264 |
| | — |
| | — |
| | — |
| | 692,000 |
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Common dividends declared | — |
| | — |
| | — |
| | — |
| | — |
| | (85,683 | ) | | (85,683 | ) |
Non-cash equity award compensation | — |
| | — |
| | 60 |
| | — |
| | — |
| | — |
| | 60 |
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Balance, March 31, 2012 | 214,207,346 |
| | $ | 2,142 |
| | $ | 2,064,423 |
| | $ | 85,194 |
| | $ | 209,252 |
| | $ | (288,838 | ) | | $ | 2,072,173 |
|
| | | | | | | | | | | | | |
Balance, December 31, 2012 | 298,813,258 |
| | $ | 2,988 |
| | $ | 2,948,345 |
| | $ | 696,458 |
| | $ | 449,358 |
| | $ | (646,572 | ) | | $ | 3,450,577 |
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Net income | — |
| | — |
| | — |
| | — |
| | 143,716 |
| | — |
| | 143,716 |
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Other comprehensive income before reclassifications | — |
| | — |
| | — |
| | 122,791 |
| | — |
| | — |
| | 122,791 |
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Amounts reclassified from accumulated other comprehensive income | — |
| | — |
| | — |
| | (18,539 | ) | | — |
| | — |
| | (18,539 | ) |
Net other comprehensive income | — |
| | — |
| | — |
| | 104,252 |
| | — |
| | — |
| | 104,252 |
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Net proceeds from issuance of common stock, net of offering costs | 57,525,457 |
| | 575 |
| | 762,467 |
| | — |
| | — |
| | — |
| | 763,042 |
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Proceeds from issuance of common stock in connection with exercise of warrants | 5,803,679 |
| | 58 |
| | 63,713 |
| | — |
| | — |
| | — |
| | 63,771 |
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Common dividends declared | — |
| | — |
| | — |
| | — |
| | — |
| | (116,821 | ) | | (116,821 | ) |
Special dividends declared | — |
| | — |
| | — |
| | — |
| | — |
| | (343,481 | ) | | (343,481 | ) |
Non-cash equity award compensation | — |
| | — |
| | 23 |
| | — |
| | — |
| | — |
| | 23 |
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Balance, March 31, 2013 | 362,142,394 |
| | $ | 3,621 |
| | $ | 3,774,548 |
| | $ | 800,710 |
| | $ | 593,074 |
| | $ | (1,106,874 | ) | | $ | 4,065,079 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
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| | | | | | | |
| Three Months Ended |
| March 31, |
| 2013 | | 2012 |
| (unaudited) |
Cash Flows From Operating Activities: | |
| | |
|
Net income | $ | 143,716 |
| | $ | 51,800 |
|
Adjustments to reconcile net income to net cash (used in) provided by operating activities: | |
| | |
|
Amortization of premiums and discounts on available-for-sale securities, net | 2,802 |
| | (5,925 | ) |
Other-than-temporary impairment losses | 236 |
| | 4,275 |
|
Realized and unrealized gains on investment securities, net | (26,790 | ) | | (9,931 | ) |
(Gain) loss on mortgage loans held-for-sale | (14,323 | ) | | 32 |
|
Gain on mortgage loans held-for-investment and collateralized borrowings in securitization trust | (6,289 | ) | | — |
|
Loss on termination and option expiration of interest rate swaps and swaptions | 58,692 |
| | 11,265 |
|
Unrealized (gain) loss on interest rate swaps and swaptions | (91,680 | ) | | 212 |
|
Unrealized loss on other derivative instruments | 6,923 |
| | 8,053 |
|
Equity based compensation expense | 23 |
| | 60 |
|
Depreciation of fixed assets | 114 |
| | 33 |
|
Depreciation of real estate | — |
| | 1 |
|
Purchases of mortgage loans held-for-sale | (147,050 | ) | | — |
|
Proceeds from sales of mortgage loans held-for-sale | 25,404 |
| | — |
|
Proceeds from repayment of mortgage loans held-for-sale | 2,284 |
| | 26 |
|
Net change in assets and liabilities: | |
| | |
Increase in accrued interest receivable | (4,476 | ) | | (7,364 | ) |
Decrease in deferred income taxes, net | 4,893 |
| | 638 |
|
Increase in current income tax receivable | (303 | ) | | (7,952 | ) |
(Increase)/decrease in prepaid and fixed assets | (187 | ) | | 5 |
|
Decrease in other receivables | 29,049 |
| | — |
|
Increase in accrued interest payable, net | 288 |
| | 2,858 |
|
Decrease in income taxes payable | — |
| | (3,898 | ) |
(Decrease)/increase in accrued expenses | (3,810 | ) | | 583 |
|
Net cash (used in) provided by operating activities | (20,484 | ) | | 44,771 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
(in thousands)
|
| | | | | | | |
| Three Months Ended |
| March 31, |
| 2013 | | 2012 |
| (unaudited) |
Cash Flows From Investing Activities: | |
| | |
|
Purchases of available-for-sale securities | $ | (2,208,951 | ) | | $ | (3,065,659 | ) |
Proceeds from sales of available-for-sale securities | 796,653 |
| | 170,102 |
|
Principal payments on available-for-sale securities | 235,530 |
| | 130,002 |
|
Purchases of other derivative instruments | (66,277 | ) | | (124,337 | ) |
(Payments for termination) proceeds from sales of other derivative instruments, net | (41,323 | ) | | 14,354 |
|
Purchases of mortgage loans held-for-investment in securitization trust | (442,787 | ) | | — |
|
Proceeds from repayment of mortgage loans held-for-investment in securitization trust | 717 |
| | — |
|
Purchases of investments in real estate | — |
| | (6,108 | ) |
Increase in due to counterparties, net | 147,585 |
| | 349,370 |
|
Decrease in restricted cash | 24,894 |
| | 12,304 |
|
Increase in escrow deposits of discontinued operations | — |
| | (8,496 | ) |
Net cash used in investing activities | (1,553,959 | ) | | (2,528,468 | ) |
Cash Flows From Financing Activities: | |
| | |
|
Proceeds from repurchase agreements | 24,103,888 |
| | 10,564,948 |
|
Principal payments on repurchase agreements | (23,283,833 | ) | | (8,531,340 | ) |
Proceeds from issuance of collateralized borrowings in securitization trust | 412,217 |
| | — |
|
Principal payments on collateralized borrowings in securitization trust | (697 | ) | | — |
|
Proceeds from issuance of common stock, net of offering costs | 763,042 |
| | 692,000 |
|
Proceeds from exercise of warrants | 63,771 |
| | — |
|
Dividends paid on common stock | (164,347 | ) | | (56,239 | ) |
Net cash provided by financing activities | 1,894,041 |
| | 2,669,369 |
|
Net increase in cash and cash equivalents | 319,598 |
| | 185,672 |
|
Cash and cash equivalents at beginning of period | 821,108 |
| | 360,016 |
|
Cash and cash equivalents at end of period | $ | 1,140,706 |
| | $ | 545,688 |
|
Supplemental Disclosure of Cash Flow Information: | |
| | |
Cash paid for interest | $ | 23,548 |
| | $ | 8,609 |
|
Cash paid for taxes | $ | 373 |
| | $ | 3,635 |
|
Noncash Investing Activities: | | | |
Special dividend of Silver Bay common stock declared but not paid at end of period | $ | 368,970 |
| | $ | — |
|
Noncash Financing Activities: | |
| | |
|
Cashless exercise of warrants | $ | 75 |
| | $ | — |
|
Cash dividends declared but not paid at end of period | $ | 116,821 |
| | $ | 85,683 |
|
Reconciliation of mortgage loans held-for-sale: | | | |
Mortgage loans held-for-sale at beginning of period | $ | 58,607 |
| | $ | 5,782 |
|
Purchases of mortgage loans held-for-sale | 147,050 |
| | — |
|
Proceeds from sales of mortgage loans held-for-sale | (25,404 | ) | | — |
|
Proceeds from repayment of mortgage loans held-for-sale | (2,284 | ) | | (26 | ) |
Realized and unrealized gains (losses) on mortgage loans held-for-sale | 14,448 |
| | (45 | ) |
Mortgage loans held-for-sale at end of period | $ | 192,417 |
| | $ | 5,711 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 1. Organization and Operations
Two Harbors Investment Corp., or the Company, is a Maryland corporation focused on investing in, financing and managing residential mortgage-backed securities, or RMBS, residential mortgage loans, and other financial assets. The Company is externally managed and advised by PRCM Advisers LLC, a subsidiary of Pine River Capital Management L.P., or Pine River, a global multi-strategy asset management firm. The Company's common stock is listed on the NYSE and its warrants are listed on the NYSE MKT under the symbols “TWO” and “TWO.WS,” respectively.
The Company was incorporated on May 21, 2009 and commenced operations as a publicly traded company on October 28, 2009, upon completion of a merger with Capitol Acquisition Corp., or Capitol, which became a wholly owned indirect subsidiary as a result of the merger.
The Company has elected to be treated as a real estate investment trust, or REIT, for U.S. federal income tax purposes commencing with its initial taxable period ended December 31, 2009. As long as the Company continues to comply with a number of requirements under federal tax law and maintains its qualification as a REIT, the Company generally will not be subject to U.S. federal income taxes to the extent that the Company distributes its taxable income to its stockholders on an annual basis and does not engage in prohibited transactions. However, certain activities that the Company may perform may cause it to earn income which will not be qualifying income for REIT purposes. The Company has designated certain of its subsidiaries as taxable REIT subsidiaries, or TRSs, as defined in the Code, to engage in such activities, and the Company may in the future form additional TRSs.
On December 19, 2012, the Company completed the contribution of its portfolio of single-family rental properties to Silver Bay Realty Trust Corp. ("Silver Bay"), a newly organized Maryland corporation intended to qualify as a REIT and focused on the acquisition, renovation, leasing and management of single-family residential properties for rental income and long-term capital appreciation. The Company contributed its equity interests in its wholly owned subsidiary, Two Harbors Property Investment LLC, to Silver Bay, and in exchange for its contribution, received shares of common stock of Silver Bay. Silver Bay completed its initial public offering, or IPO, of its common stock on December 19, 2012. As the Company will not have any significant continuing involvement in Two Harbors Property Investment LLC, all of the associated operating results were removed from continuing operations and are presented separately as discontinued operations for the three months ended March 31, 2013 and 2012. See Note 4 - Discontinued Operations for additional information.
Note 2. Basis of Presentation and Significant Accounting Policies
Consolidation and Basis of Presentation
The interim unaudited condensed consolidated financial statements of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission, or SEC. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles, or GAAP, have been condensed or omitted according to such SEC rules and regulations. Management believes, however, that the disclosures included in these interim condensed consolidated financial statements are adequate to make the information presented not misleading. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2012. In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at March 31, 2013 and results of operations for all periods presented have been made. The results of operations for the three months ended March 31, 2013 should not be construed as indicative of the results to be expected for the full year.
The condensed consolidated financial statements of the Company have been prepared on the accrual basis of accounting in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires us to make a number of significant estimates and assumptions. These estimates include estimates of fair value of certain assets and liabilities, amount and timing of credit losses, prepayment rates, the period of time during which the Company anticipates an increase in the fair values of real estate securities sufficient to recover unrealized losses in those securities, and other estimates that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities as of the date of the condensed consolidated financial statements and the reported amounts of certain revenues and expenses during the reported period. It is likely that changes in these estimates (e.g., valuation changes due to supply and demand, credit performance, prepayments, interest rates, or other reasons) will occur in the near term. The Company's estimates are inherently subjective in nature and actual results could differ from its estimates and the differences may be material.
The condensed consolidated financial statements of the Company include the accounts of all subsidiaries; inter-company accounts and transactions have been eliminated. Certain prior period amounts have been reclassified to conform to the current period presentation.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The Company's investment in the common stock of Silver Bay was reviewed for consolidation under the applicable consolidation guidance, including voting control and variable interest entities ("VIE") models. The Company concluded that it did not have voting control of Silver Bay nor was Silver Bay considered a VIE and, therefore, consolidation of Silver Bay was not required.
The legal entity used in securitization (i.e., the securitization trust), which is considered a VIE for financial reporting purposes, was also reviewed for consolidation under the applicable consolidation guidance. As the Company has both the power to direct the activities of the securitization trust that most significantly impact the entity's performance, and the obligation to absorb losses or the right to receive benefits of the entity that could be significant, the Company consolidates the trust. The accounting is consistent with a secured financing, where the loans and securitized debt are both carried on the Company's condensed consolidated balance sheets.
Significant Accounting Policies
Securitization and Variable Interest Entities
During the three months ended March 31, 2013, the Company purchased subordinated debt and excess servicing rights from a securitization trust issued by a third party. The securitization trust is considered a VIE for financial reporting purposes and, thus, was reviewed for consolidation under the applicable consolidation guidance. As the Company has both the power to direct the activities of the securitization trust that most significantly impact the entity's performance, and the obligation to absorb losses or the right to receive benefits of the entity that could be significant, the Company consolidates the trust. The underlying loans are classified as mortgage loans held-for-investment in securitization trust and the underlying debt is classified as collateralized borrowings in securitization trust on the condensed consolidated balance sheets. The interest income on mortgage loans held-for-investment and interest expense on collateralized borrowings are recorded on the condensed consolidated statements of comprehensive income. See Note 14 - Fair Value of these notes to the condensed consolidated financial statements for details on fair value measurement.
Mortgage Loans Held-for-Investment in Securitization Trust, at Fair Value
Mortgage loans held-for-investment in securitization trust related to the Company's on-balance sheet securitization are reported at fair value as a result of a fair value option election. These securitized mortgage loans are legally isolated from the Company and have been structured to be beyond the reach of creditors. Fair value is determined under the guidance of ASC 820. The Company determines the fair value of its mortgage loans held-for-investment in securitization trust by type of loan and the determination is generally based on current secondary market pricing or cash flow models using market-based yield requirements. See Note 14 - Fair Value of these notes to the condensed consolidated financial statements for details on fair value measurement.
Interest income on mortgage loans held-for-investment is recognized at the loan coupon rate. Loans are considered past due when they are 30 days past their contractual due date. Interest income recognition is suspended when mortgage loans are placed on nonaccrual status. Generally, mortgage loans are placed on nonaccrual status when delinquent for more than 60 days or when determined not to be probable of full collection. Interest accrued, but not collected, at the date mortgage loans are placed on nonaccrual is reversed and subsequently recognized only to the extent it is received in cash or until it qualifies for return to accrual status. However, where there is doubt regarding the ultimate collectability of loan principal, all cash received is applied to reduce the carrying value of such loans. Mortgage loans are restored to accrual status only when contractually current or the collection of future payments is reasonably assured.
Collateralized Borrowings in Securitization Trust, at Fair Value
Collateralized borrowings in securitization trust related to the Company's on-balance sheet securitization are reported at fair value as a result of a fair value option election. This long-term debt is nonrecourse to the Company beyond the assets held in the trust. Fair value is determined under the guidance of ASC 820. The Company determines the fair value of its collateralized borrowings in securitization trust based on prices obtained from third-party pricing providers, broker quotes received and other applicable market data. See Note 14 - Fair Value of these notes to the condensed consolidated financial statements for details on fair value measurement.
Refer to Note 2 to the Consolidated Financial Statements in the Company's 2012 Annual Report on Form 10-K regarding additional significant accounting policies.
Recently Issued and/or Adopted Accounting Standards
Offsetting Assets and Liabilities
In December 2011, the Financial Accounting Standards Board, or FASB, issued ASU No. 2011-11, which amends ASC 210, Balance Sheet. The amendments in this ASU enhance disclosures required by U.S. GAAP by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with ASC 210, Balance Sheet or
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
ASC 815, Other Presentation Matters or (2) subject to an enforceable master netting arrangement or similar agreement. ASU 2011-11 is effective for the first interim or annual period beginning on or after January 1, 2013. In January 2013, the FASB issued ASU No. 2013-01, which limits the scope of ASU 2011-11 to certain derivatives, repurchase agreements and securities lending arrangements. ASU 2013-01 is also effective for the first interim or annual period beginning on or after January 1, 2013. Adopting both ASU 2011-11 and ASU 2013-01 did not have any impact on the Company's condensed consolidated financial condition or results of operations, but did impact financial statement disclosures.
Comprehensive Income
In February 2013, the FASB issued ASU No. 2013-02, which amends ASC 220, Comprehensive Income. The amendments are intended to make the presentation of items within Other Comprehensive Income (OCI) more prominent. ASU 2013-02 requires reclassification adjustments between OCI and net income to be presented separately on the face of the financial statements. The new guidance does not change the requirement to present items of net income and OCI, and totals for net income, OCI and comprehensive income in a single continuous statement or two consecutive statements. ASU 2013-02 is effective for the first interim or annual period beginning on or after December 15, 2012. Adopting this ASU did not have any impact on the Company's condensed consolidated financial condition or results of operations, but did impact financial statement disclosures.
Note 3. Variable Interest Entities
During the three months ended March 31, 2013, the Company purchased subordinated debt and excess servicing rights from a securitization trust issued by a third party. The securitization trust is considered a VIE for financial reporting purposes and, thus, was reviewed for consolidation under the applicable consolidation guidance. Since the Company has both the power to direct the activities of the securitization trust that most significantly impact the entity's performance, and the obligation to absorb losses or the right to receive benefits of the entity that could be significant, the Company consolidates the trust. As the Company is required to reassess VIE consolidation guidance each quarter, new facts and circumstances may change the Company's determination. This could result in a material impact to the Company's financial statements during subsequent reporting periods.
The following table presents a summary of the assets and liabilities of the securitization trust:
|
| | | | | | | |
(in thousands) | March 31, 2013 | | December 31, 2012 |
Mortgage loans held-for-investment in securitization trust | $ | 434,068 |
| | $ | — |
|
Accrued interest receivable | 1,401 |
| | — |
|
Total Assets | $ | 435,469 |
| | $ | — |
|
Collateralized borrowings in securitization trust | 397,229 |
| | — |
|
Accrued interest payable | 744 |
| | — |
|
Accrued expenses | 95 |
| | — |
|
Total Liabilities | $ | 398,068 |
| | $ | — |
|
Note 4. Discontinued Operations
On December 19, 2012, the Company completed the contribution of its equity interests in its wholly owned subsidiary, Two Harbors Property Investment LLC, to Silver Bay. Two Harbors Property Investment LLC previously housed the Company's portfolio of single-family rental properties. As the Company will not have any significant continuing involvement in Two Harbors Property Investment LLC, all of the associated operating results were removed from continuing operations and are presented separately as discontinued operations for the three months ended March 31, 2013 and 2012.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Summarized financial information for the discontinued operations are presented below.
|
| | | | | | | |
| Three Months Ended |
| March 31, |
(in thousands) | 2013 | | 2012 |
Income: | |
| | |
|
Gain on contribution of entity | $ | 1,239 |
| | $ | — |
|
Real estate related revenues | — |
| | 4 |
|
Total income | 1,239 |
| | 4 |
|
Expenses: | | | |
Management fees | — |
| | — |
|
Real estate related expenses | — |
| | 17 |
|
Other operating expenses | (138 | ) | | 33 |
|
Total expenses | (138 | ) | | 50 |
|
Income (loss) from discontinued operations | $ | 1,377 |
| | $ | (46 | ) |
In addition to the gain on contribution of entity that was recorded in 2012 in connection with the closing of the contribution, certain adjustments were agreed to be recognized in 2013. These include an installment sales gain of approximately $4.0 million from Silver Bay, a reduction of 2013 management fees payable to PRCM Advisers of $4.3 million, and an immaterial amount of additional working capital adjustments determined in accordance with the contribution agreement entered into with Silver Bay. Of these amounts, $1.2 million of the installment sales gain was recorded as a gain on contribution of entity within discontinued operations, and the full $4.3 million of the reduction of 2013 management fees payable to PRCM Advisers was recorded within management fees, on the condensed consolidated statement of comprehensive income for the three months ended March 31, 2013. The remaining $0.1 million recorded within discontinued operations on the condensed consolidated statement of comprehensive income for the three months ended March 31, 2013 relates to accrual adjustments for transaction expenses related to the contribution. See Note 21 - Related Party Transactions for additional information.
Note 5. Available-for-Sale Securities, at Fair Value
The following table presents the Company's available-for-sale, or AFS, investment securities by collateral type, which were carried at their fair value as of March 31, 2013 and December 31, 2012:
|
| | | | | | | |
(in thousands) | March 31, 2013 | | December 31, 2012 |
Mortgage-backed securities: | | | |
Agency | | | |
Federal Home Loan Mortgage Corporation | $ | 4,076,454 |
| | $ | 3,608,272 |
|
Federal National Mortgage Association | 5,778,036 |
| | 5,130,965 |
|
Government National Mortgage Association | 2,078,065 |
| | 2,272,866 |
|
Non-Agency | 3,030,976 |
| | 2,654,851 |
|
Total mortgage-backed securities | $ | 14,963,531 |
| | $ | 13,666,954 |
|
At March 31, 2013 and December 31, 2012, the Company pledged investment securities with a carrying value of $13.6 billion and $12.8 billion, respectively, as collateral for repurchase agreements. See Note 15 - Repurchase Agreements.
At March 31, 2013 and December 31, 2012, the Company did not have any securities purchased from and financed with the same counterparty that did not meet the conditions of ASC 860, Transfers and Servicing, to be considered linked transactions and, therefore, classified as derivatives.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following tables present the amortized cost and carrying value (which approximates fair value) of AFS securities by collateral type as of March 31, 2013 and December 31, 2012:
|
| | | | | | | | | | | |
| March 31, 2013 |
(in thousands) | Agency | | Non-Agency | | Total |
Face Value | $ | 13,177,863 |
| | $ | 4,722,060 |
| | $ | 17,899,923 |
|
Unamortized premium | 777,288 |
| | — |
| | 777,288 |
|
Unamortized discount | | | | | |
Designated credit reserve | — |
| | (1,376,693 | ) | | (1,376,693 | ) |
Net, unamortized | (2,164,457 | ) | | (973,240 | ) | | (3,137,697 | ) |
Amortized Cost | 11,790,694 |
| | 2,372,127 |
| | 14,162,821 |
|
Gross unrealized gains | 224,677 |
| | 664,502 |
| | 889,179 |
|
Gross unrealized losses | (82,816 | ) | | (5,653 | ) | | (88,469 | ) |
Carrying Value | $ | 11,932,555 |
| | $ | 3,030,976 |
| | $ | 14,963,531 |
|
|
| | | | | | | | | | | |
| December 31, 2012 |
(in thousands) | Agency | | Non-Agency | | Total |
Face Value | $ | 11,934,492 |
| | $ | 4,503,999 |
| | $ | 16,438,491 |
|
Unamortized premium | 749,252 |
| | — |
| | 749,252 |
|
Unamortized discount | |
| | |
| | |
|
Designated credit reserve | — |
| | (1,290,946 | ) | | (1,290,946 | ) |
Net, unamortized | (1,929,811 | ) | | (996,490 | ) | | (2,926,301 | ) |
Amortized Cost | 10,753,933 |
| | 2,216,563 |
| | 12,970,496 |
|
Gross unrealized gains | 276,293 |
| | 448,403 |
| | 724,696 |
|
Gross unrealized losses | (18,123 | ) | | (10,115 | ) | | (28,238 | ) |
Carrying Value | $ | 11,012,103 |
| | $ | 2,654,851 |
| | $ | 13,666,954 |
|
The following tables present the carrying value of the Company's AFS investment securities by rate type as of March 31, 2013 and December 31, 2012:
|
| | | | | | | | | | | |
| March 31, 2013 |
(in thousands) | Agency | | Non-Agency | | Total |
Adjustable Rate | $ | 181,657 |
| | $ | 2,613,464 |
| | $ | 2,795,121 |
|
Fixed Rate | 11,750,898 |
| | 417,512 |
| | 12,168,410 |
|
Total | $ | 11,932,555 |
| | $ | 3,030,976 |
| | $ | 14,963,531 |
|
|
| | | | | | | | | | | |
| December 31, 2012 |
(in thousands) | Agency | | Non-Agency | | Total |
Adjustable Rate | $ | 188,429 |
| | $ | 2,334,950 |
| | $ | 2,523,379 |
|
Fixed Rate | 10,823,674 |
| | 319,901 |
| | 11,143,575 |
|
Total | $ | 11,012,103 |
| | $ | 2,654,851 |
| | $ | 13,666,954 |
|
When the Company purchases a credit-sensitive AFS security at a significant discount to its face value, the Company often does not amortize into income a significant portion of this discount that the Company is entitled to earn because it does not expect to collect it due to the inherent credit risk of the security. The Company may also record an other-than-temporary impairment, or OTTI, for a portion of its investment in the security to the extent the Company believes that the amortized cost will exceed the present value of expected future cash flows. The amount of principal that the Company does not amortize into
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
income is designated as an off balance sheet credit reserve on the security, with unamortized net discounts or premiums amortized into income over time to the extent realizable.
The following table presents the changes for the three months ended March 31, 2013 and 2012, of the unamortized net discount and designated credit reserves on non-Agency AFS securities.
|
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, |
| 2013 | | 2012 |
(in thousands) | Designated Credit Reserve | | Unamortized Net Discount | | Total | | Designated Credit Reserve | | Unamortized Net Discount | | Total |
Beginning balance at January 1 | $ | (1,290,946 | ) | | $ | (996,490 | ) | | $ | (2,287,436 | ) | | $ | (782,606 | ) | | $ | (540,969 | ) | | $ | (1,323,575 | ) |
Acquisitions | (101,733 | ) | | (41,450 | ) | | (143,183 | ) | | (521,424 | ) | | (437,331 | ) | | (958,755 | ) |
Accretion of net discount | 655 |
| | 34,636 |
| | 35,291 |
| | — |
| | 28,897 |
| | 28,897 |
|
Realized credit losses | 10,901 |
| | — |
| | 10,901 |
| | 3,309 |
| | — |
| | 3,309 |
|
Reclassification adjustment for other-than-temporary impairments | (236 | ) | | — |
| | (236 | ) | | (4,275 | ) | | — |
| | (4,275 | ) |
Transfers from (to) | 1,691 |
| | (1,691 | ) | | — |
| | — |
| | — |
| | — |
|
Sales, calls, other | 2,975 |
| | 31,755 |
| | 34,730 |
| | 243 |
| | 1,030 |
| | 1,273 |
|
Ending balance at March 31 | $ | (1,376,693 | ) | | $ | (973,240 | ) | | $ | (2,349,933 | ) | | $ | (1,304,753 | ) | | $ | (948,373 | ) | | $ | (2,253,126 | ) |
The following table presents the components comprising the carrying value of AFS securities not deemed to be other than temporarily impaired by length of time the securities had an unrealized loss position as of March 31, 2013 and December 31, 2012. At March 31, 2013, the Company held 1,660 AFS securities, of which 519 were in an unrealized loss position for less than twelve consecutive months and 40 were in an unrealized loss position for more than twelve consecutive months. At December 31, 2012, the Company held 1,493 AFS securities, of which 250 were in an unrealized loss position for less than twelve months and 47 were in an unrealized loss position for more than twelve consecutive months.
|
| | | | | | | | | | | | | | | | | | | | | | | |
| Unrealized Loss Position for |
| Less than 12 Months | | 12 Months or More | | Total |
(in thousands) | Estimated Fair Value | | Gross Unrealized Losses | | Estimated Fair Value | | Gross Unrealized Losses | | Estimated Fair Value | | Gross Unrealized Losses |
March 31, 2013 | $ | 5,372,704 |
| | $ | (79,512 | ) | | $ | 60,459 |
| | $ | (8,957 | ) | | $ | 5,433,163 |
| | $ | (88,469 | ) |
December 31, 2012 | $ | 2,548,995 |
| | $ | (18,610 | ) | | $ | 52,689 |
| | $ | (9,628 | ) | | $ | 2,601,684 |
| | $ | (28,238 | ) |
Evaluating AFS Securities for Other-Than-Temporary Impairments
In order to evaluate AFS securities for OTTI, the Company determines whether there has been a significant adverse quarterly change in the cash flow expectations for a security. The Company compares the amortized cost of each security in an unrealized loss position against the present value of expected future cash flows of the security. The Company also considers whether there has been a significant adverse change in the regulatory and/or economic environment as part of this analysis. If the amortized cost of the security is greater than the present value of expected future cash flows using the original yield as the discount rate, an other-than-temporary credit impairment has occurred. If the Company does not intend to sell and is not more likely than not required to sell the security, the credit loss is recognized in earnings and the balance of the unrealized loss is recognized in other comprehensive income. If the Company intends to sell the security or will be more likely than not required to sell the security, the full unrealized loss is recognized in earnings.
The Company recorded a $0.2 million other-than-temporary credit impairment during the three months ended March 31, 2013, on one non-Agency RMBS where the future expected cash flows for each security was less than its amortized cost. As of March 31, 2013, impaired securities had weighted average cumulative losses of 8.8%, weighted average three-month prepayment speed of 2.15%, weighted average 60+ day delinquency of 36.1% of the pool balance, and weighted average FICO
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
score of 626. At March 31, 2013, the Company did not intend to sell the securities and determined that it was not more likely than not that the Company will be required to sell the securities, therefore, only the projected credit loss was recognized in earnings. During the three months ended March 31, 2012, the Company recorded a $4.3 million other-than-temporary credit impairment on 15 non-Agency RMBS where the future expected cash flows for each security was less than its amortized cost.
The following table presents the changes in OTTI included in earnings for three months ended March 31, 2013 and 2012:
|
| | | | | | | |
| Three Months Ended |
| March 31, |
(in thousands) | 2013 | | 2012 |
Cumulative credit loss at beginning of year | $ | (15,561 | ) | | $ | (5,102 | ) |
Additions: | | | |
Other-than-temporary impairments not previously recognized | — |
| | (3,483 | ) |
Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments | (236 | ) | | (792 | ) |
Reductions: | | | |
Decreases related to other-than-temporary impairments on securities paid down | — |
| | — |
|
Decreases related to other-than-temporary impairments on securities sold | 655 |
| | — |
|
Cumulative credit loss at end of year | $ | (15,142 | ) | | $ | (9,377 | ) |
Cumulative credit losses related to OTTI may be reduced for securities sold as well as for securities that mature, pay down, or are prepaid such that the outstanding principal balance is reduced to zero. Additionally, increases in cash flows expected to be collected over the remaining life of the security cause a reduction in the cumulative credit loss.
Gross Realized Gains and Losses
Gains and losses from the sale of AFS securities are recorded as realized gains (losses) within gain on investment securities in the Company's condensed consolidated statements of comprehensive income. For the three months ended March 31, 2013 and 2012, the Company sold AFS securities for $0.8 billion and $0.2 billion with an amortized cost of $0.8 billion and $0.2 billion, for net realized gains of $18.9 million and $11.1 million, respectively.
The following table presents the gross realized gains and losses on sales of AFS securities for the three months ended March 31, 2013 and 2012:
|
| | | | | | | |
| Three Months Ended |
| March 31, |
(in thousands) | 2013 | | 2012 |
Gross realized gains | $ | 23,226 |
| | $ | 11,103 |
|
Gross realized losses | (4,296 | ) | | — |
|
Total realized gains on sales, net | $ | 18,930 |
| | $ | 11,103 |
|
Note 6. Trading Securities, at Fair Value
The Company holds U.S. Treasuries in a taxable REIT subsidiary and classifies these securities as trading instruments due to short-term investment objectives. As of March 31, 2013 and December 31, 2012, the Company held U.S. Treasuries with an amortized cost of $1.0 billion and a fair value of $1.0 billion for both periods classified as trading securities. The unrealized gains included within trading securities were $5.1 million and $5.0 million as of March 31, 2013 and December 31, 2012, respectively.
The Company did not sell any trading securities during the three months ended March 31, 2013 and 2012. For the three months ended March 31, 2013 and 2012, trading securities experienced unrealized gains of $17,133 and unrealized losses of $1.2 million, respectively. Unrealized gains and losses are recorded as a component of gains on investment securities, net in the Company's condensed consolidated statements of comprehensive income.
At March 31, 2013, the Company pledged trading securities with a carrying value of $1.0 billion as collateral for repurchase agreements. See Note 15 - Repurchase Agreements.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 7. Equity Securities, at Fair Value
Equity securities consists of shares of Silver Bay common stock carried at fair value as a result of a fair value option election. In exchange for the contribution of the Company's equity interests in its wholly owned subsidiary, Two Harbors Property Investment LLC, to Silver Bay on December 19, 2012, the Company received 17,824,647 shares of common stock, or 47.7%, of Silver Bay at the initial public offering price of $18.50. The following table presents the carrying value of the Company's equity securities as of March 31, 2013 and December 31, 2012:
|
| | | | | | | |
(in thousands) | March 31, 2013 | | December 31, 2012 |
Initial carrying value | $ | 329,756 |
| | $ | 329,756 |
|
Unrealized gain | 39,214 |
| | 5,882 |
|
Carrying value | $ | 368,970 |
| | $ | 335,638 |
|
On March 18, 2013, the Company declared a special dividend pursuant to which the 17,824,647 shares of Silver Bay common stock would be distributed, on a pro rata basis, to Two Harbors stockholders of record at the close of business on April 2, 2013. As a result, the unrealized gain of $7.8 million included in gain on investment securities on the condensed consolidated statement of comprehensive income for the three months ended March 31, 2013, represents the change in unrealized gain for the period from December 31, 2012 to declaration date, March 18, 2013. The remaining change in unrealized gain for the period from March 18, 2013 to March 31, 2013, was recognized as an adjustment to the dividend payable at March 31, 2013.
Note 8. Mortgage Loans Held-for-Sale, at Fair Value
Mortgage loans held-for-sale consists of residential mortgage loans carried at fair value as a result of a fair value option election. The following table presents the carrying value of the Company's mortgage loans held-for-sale as of March 31, 2013 and December 31, 2012:
|
| | | | | | | |
(in thousands) | March 31, 2013 | | December 31, 2012 |
Unpaid principal balance | $ | 228,840 |
| | $ | 56,976 |
|
Fair value adjustment | (36,423 | ) | | 1,631 |
|
Carrying value | $ | 192,417 |
| | $ | 58,607 |
|
At March 31, 2013, the Company pledged mortgage loans with a carrying value of $25.9 million as collateral for repurchase agreements. See Note 15 - Repurchase Agreements.
Note 9. Mortgage Loans Held-for-Investment in Securitization Trust, at Fair Value
During the three months ended March 31, 2013, the Company purchased subordinated debt and excess servicing rights from a securitization trust issued by a third party. The underlying residential mortgage loans held by the trust, which are consolidated on the Company's condensed consolidated balance sheet, are classified as mortgage loans held-for-investment in securitization trust and carried at fair value as a result of a fair value option election. See Note 3 - Variable Interest Entities for additional information regarding consolidation of the securitization trust. The following table presents the carrying value of the Company's mortgage loans held-for-investment in securitization trust as of March 31, 2013 and December 31, 2012:
|
| | | | | | | |
(in thousands) | March 31, 2013 | | December 31, 2012 |
Unpaid principal balance | $ | 421,485 |
| | $ | — |
|
Fair value adjustment | 12,583 |
| | — |
|
Carrying value | $ | 434,068 |
| | $ | — |
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 10. Restricted Cash
The Company is required to maintain certain cash balances with counterparties for broker activity and collateral for the Company's repurchase agreements in non-interest bearing accounts. The Company has also placed cash in a restricted account pursuant to a letter of credit on an office space lease.
The following table presents the Company's restricted cash balances as of March 31, 2013 and December 31, 2012:
|
| | | | | | | |
(in thousands) | March 31, 2013 | | December 31, 2012 |
Restricted cash balances held by trading counterparties: | | | |
For securities trading activity | $ | 9,000 |
| | $ | 9,000 |
|
For derivatives trading activity | 138,934 |
| | 208,669 |
|
As restricted collateral for repurchase agreements | 129,148 |
| | 84,307 |
|
| 277,082 |
| | 301,976 |
|
Restricted cash balance pursuant to letter of credit on office lease | 346 |
| | 346 |
|
Total | $ | 277,428 |
| | $ | 302,322 |
|
Note 11. Accrued Interest Receivable
The following table presents the Company's accrued interest receivable by collateral type:
|
| | | | | | | |
(in thousands) | March 31, 2013 | | December 31, 2012 |
Accrued Interest Receivable: | | | |
U.S. Treasuries | $ | 173 |
| | $ | 1,119 |
|
Mortgage-backed securities: | | | |
Agency | | | |
Federal Home Loan Mortgage Corporation | 13,088 |
| | 11,888 |
|
Federal National Mortgage Association | 18,296 |
| | 17,101 |
|
Government National Mortgage Association | 8,910 |
| | 8,962 |
|
Non-Agency | 3,821 |
| | 3,296 |
|
Total mortgage-backed securities | 44,115 |
| | 41,247 |
|
Mortgage loans held-for-sale | 1,400 |
| | 247 |
|
Mortgage loans held-for-investment in securitization trust | 1,401 |
| | — |
|
Total | $ | 47,089 |
| | $ | 42,613 |
|
Note 12. Derivative Instruments and Hedging Activities
The Company enters into a variety of derivative and non-derivative instruments in connection with its risk management activities. The Company's primary objective for executing these derivative and non-derivative instruments is to mitigate the Company's economic exposure to future events that are outside its control. The Company's derivative financial instruments are utilized principally to manage market risk and cash flow volatility associated with interest rate risk (including associated prepayment risk) related to certain assets and liabilities. As part of its risk management activities, the Company may, at times, enter into various forward contracts, including short securities, Agency to-be-announced securities, or TBAs, options, futures, swaps, caps and credit default swaps. In executing on the Company's current risk management strategy, the Company has entered into interest rate swap and swaption agreements and credit default swaps. At times, the Company may use TBAs for risk management or other purposes. The Company has also entered into a number of non-derivative instruments to manage interest rate risk, principally U.S. Treasuries and Agency interest-only securities.
The following summarizes the Company's significant asset and liability classes, the risk exposure for these classes, and the Company's risk management activities used to mitigate certain of these risks. The discussion includes both derivative and non-derivative instruments used as part of these risk management activities. While the Company uses non-derivative and derivative instruments to achieve the Company's risk management activities, it is possible that these instruments will not effectively
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
mitigate all or a substantial portion of the Company's market rate risk. In addition, the Company might elect, at times, not to enter into certain hedging arrangements in order to maintain compliance with REIT requirements.
Balance Sheet Presentation
The following tables present the gross fair value and notional amounts of the Company's derivative financial instruments treated as trading instruments as of March 31, 2013 and December 31, 2012.
|
| | | | | | | | | | | | | | | | |
(in thousands) | | March 31, 2013 |
| | Derivative Assets | | Derivative Liabilities |
Trading instruments | | Fair Value | | Notional | | Fair Value | | Notional |
Inverse interest-only securities | | $ | 313,373 |
| | $ | 1,960,087 |
| | $ | — |
| | $ | — |
|
Interest rate swap agreements | | — |
| | — |
| | (45,267 | ) | | 16,685,000 |
|
Credit default swap agreements | | 47,238 |
| | 437,496 |
| | — |
| | — |
|
Swaptions | | 148,791 |
| | 5,800,000 |
| | — |
| | — |
|
TBAs | | 2,237 |
| | 1,850,000 |
| | (156 | ) | | 300,000 |
|
Forward purchase commitment | | 110 |
| | 8,745 |
| | — |
| | — |
|
Total | | $ | 511,749 |
| | $ | 10,056,328 |
| | $ | (45,423 | ) | | $ | 16,985,000 |
|
|
| | | | | | | | | | | | | | | | |
(in thousands) | | December 31, 2012 |
| | Derivative Assets | | Derivative Liabilities |
Trading instruments | | Fair Value | | Notional | | Fair Value | | Notional |
Inverse interest-only securities | | $ | 304,975 |
| | $ | 1,909,351 |
| | $ | — |
| | $ | — |
|
Interest rate swap agreements | | — |
| | — |
| | (129,055 | ) | | 14,070,000 |
|
Credit default swap agreements | | 52,906 |
| | 438,440 |
| | — |
| | — |
|
Swaptions | | 102,048 |
| | 4,950,000 |
| | — |
| | — |
|
TBAs | | 1,917 |
| | 2,414,000 |
| | (239 | ) | | 139,000 |
|
Forward purchase commitment | | 234 |
| | 56,865 |
| | — |
| | — |
|
Total | | $ | 462,080 |
| | $ | 9,768,656 |
| | $ | (129,294 | ) | | $ | 14,209,000 |
|
The Company has netting arrangements in place with all derivative counterparties pursuant to standard documentation developed by the International Swap and Derivatives Association, or ISDA. The following table presents the gross amounts and amounts offset in accordance with offsetting guidance to determine the net derivative assets and liabilities presented on the condensed consolidated balance sheets:
|
| | | | | | | | | | | | | | | |
(in thousands) | March 31, 2013 | | December 31, 2012 |
| Derivative Assets | | Derivative Liabilities | | Derivative Assets | | Derivative Liabilities |
Gross amount of derivative assets (liabilities) | $ | 514,190 |
| | $ | (50,172 | ) | | $ | 464,483 |
| | $ | (129,658 | ) |
Amounts offset in accordance with offsetting guidance to determine net amounts presented | (2,441 | ) | | 4,749 |
| | (2,403 | ) | | 364 |
|
Net amount of derivative assets (liabilities) | $ | 511,749 |
| | $ | (45,423 | ) | | $ | 462,080 |
| | $ | (129,294 | ) |
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following table provides the average outstanding notional amounts of the Company's derivative financial instruments treated as trading instruments for the three months ended March 31, 2013.
|
| | | | | | | | |
(in thousands) | | Three Months Ended March 31, 2013 |
Trading instruments | | Derivative Assets | | Derivative Liabilities |
Inverse interest-only securities | | $ | 1,922,195 |
| | $ | — |
|
Interest rate swap agreements | | — |
| | 14,854,500 |
|
Credit default swaps | | 437,845 |
| | — |
|
Swaptions | | 5,542,778 |
| | — |
|
TBAs | | 1,213,644 |
| | 326,667 |
|
Forward purchase commitment | | 51,783 |
| | — |
|
Comprehensive Income Statement Presentation
The Company has not applied hedge accounting to its current derivative portfolio held to mitigate the interest rate risk associated with its debt portfolio. As a result, the Company is subject to volatility in its earnings due to movement in the unrealized gains and losses associated with its interest rate swaps and its other derivative instruments.
The following table summarizes the location and amount of gains and losses on derivative instruments reported in the condensed consolidated statements of comprehensive income on its derivative instruments:
|
| | | | | | | | | | |
(in thousands) | | | | | | |
Trading Instruments | | Location of Gain/(Loss) Recognized in Income on Derivatives | | Amount of Gain/(Loss) Recognized in Income on Derivatives |
| | | | Three Months Ended March 31, |
| | | | 2013 | | 2012 |
Risk Management Instruments | | | | | | |
Interest Rate Contracts | | | | | | |
Investment securities - RMBS | | Loss on other derivative instruments | | $ | (12,249 | ) | | $ | (2,637 | ) |
Investment securities - U.S. Treasuries and TBA contracts | | Gain (loss) on interest rate swap and swaption agreements | | (89 | ) | | (1,648 | ) |
Mortgage loans held-for-sale | | Gain (loss) on mortgage loans held-for-sale | | 287 |
| | 13 |
|
Repurchase agreements | | Gain (loss) on interest rate swap and swaption agreements | | 19,061 |
| | (14,545 | ) |
Credit default swaps - Receive protection | | Loss on other derivative instruments | | (5,643 | ) | | (24,301 | ) |
Non-Risk Management Instruments | | | | | | |
Credit default swaps - Provide protection | | Loss on other derivative instruments | | — |
| | 8,220 |
|
Inverse interest-only securities | | Loss on other derivative instruments | | 1,230 |
| | 9,815 |
|
Total | | | | $ | 2,597 |
| | $ | (25,083 | ) |
For the three months ended March 31, 2013 and 2012, the Company recognized $14.0 million and $4.7 million, respectively, of expenses for the accrual and/or settlement of the net interest expense associated with its interest rate swaps. The expenses result from generally paying a fixed interest rate on an average $14.9 billion and $6.4 billion notional, respectively, to economically hedge a portion of the Company's interest rate risk on its short-term repurchase agreements, funding costs, and macro-financing risk and generally receiving LIBOR interest.
For the three months ended March 31, 2013 and 2012, the Company terminated, had agreements mature or had options expire on a total of 69 and 11 interest rate swap and swaption positions of $8.2 billion and $0.9 billion notional, respectively.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Upon settlement of the early terminations, contractual maturities and option expirations, the Company paid $17.2 million and $0.5 million in full settlement of its net interest spread liability and recognized $58.7 million and $11.3 million in realized losses on the swaps and swaptions, respectively, including early termination penalties.
For the three months ended March 31, 2013, the Company did not terminate any credit default swap positions. For the three months ended March 31, 2012, the Company terminated a total of 4 credit default swap positions totaling $85.0 million notional. Upon settlement of the early terminations, the Company received $10,492 in full settlement of its net interest spread receivable and recognized $1.6 million in realized losses for the three months ended March 31, 2012, on the credit default swaps, including early termination penalties.
Cash flow activity related to derivative instruments is reflected within the operating activities and investing activities sections of the condensed consolidated statements of cash flows. Derivative fair value adjustments are reflected within the unrealized (gain) loss on interest rate swaps and swaptions, unrealized loss on other derivative instruments, and (gain) loss on mortgage loans held-for-sale line items within the operating activities section of the condensed consolidated statements of cash flows. Realized losses on interest rate swap and swaption agreements are reflected within the loss on termination of interest rate swaps and swaptions line item within the operating activities section of the condensed consolidated statements of cash flows. The remaining cash flow activity related to derivative instruments is reflected within the purchases of other derivative instruments, proceeds from sales of other derivative instruments, and increase in due to counterparties, net line items within the investing activities section of the condensed consolidated statements of cash flows.
Interest Rate Sensitive Assets/Liabilities
Available-for-sale Securities - The Company's RMBS investment securities are generally subject to change in value when mortgage rates decline or increase, depending on the type of investment. Rising mortgage rates generally result in a slowing of refinancing activity, which slows prepayments and results in a decline in the value of the Company's fixed-rate Agency pools. To mitigate the impact of this risk, the Company maintains a portfolio of financial instruments, primarily fixed-rate interest-only securities, which increase in value when interest rates increase. In addition, the Company has initiated TBA positions to further mitigate its exposure to increased prepayment speeds. The objective is to reduce the risk of losses to the portfolio caused by interest rate changes and changes in prepayment speeds.
As of March 31, 2013 and December 31, 2012, the Company had outstanding fair value of $72.3 million and $77.3 million, respectively, of interest-only securities in place to economically hedge its investment securities. These interest-only securities are included in AFS securities, at fair value, in the condensed consolidated balance sheets. In addition, the Company held TBA positions with $2.2 billion and $1.8 billion in long notional as of March 31, 2013 and December 31, 2012, respectively, and an additional $800.0 million in short notional as of December 31, 2012. At March 31, 2013, $900.0 million of the Company's long notional TBA positions were held as a means to mitigate exposure to increased prepayment speeds, while the remaining $1.3 billion were held for non-risk management purposes (see "Non-Risk Management Activities" section). The Company discloses these on a gross basis according to the unrealized gain or loss position of each TBA contract regardless of long or short notional position. These contracts had a fair market value of $2.2 million and $1.9 million, included in derivative assets, at fair value, and $0.2 million and $0.2 million, included in derivative liabilities, at fair value, in the condensed consolidated balance sheet as of March 31, 2013 and December 31, 2012, respectively.
Commitments to Purchase and/or Sell Mortgage Loans Held-for-Sale - Prior to a mortgage loan purchase, the Company may enter into forward purchase commitments with counterparties whereby the Company commits to purchasing the loans at a particular interest rate, provided the borrower elects to close the loan. These commitments to purchase mortgage loans have been defined as derivatives and are, therefore, recorded on the balance sheet as assets or liabilities and measured at fair value. Subsequent changes in fair value are recorded on the balance sheet as adjustments to the carrying value of these assets or liabilities with a corresponding adjustment recognized in current period earnings. As of March 31, 2013 and December 31, 2012, the Company had entered into commitments to purchase $8.7 million and $56.9 million of mortgage loans, subject to fallout if the loans do not close, with a fair value of $0.1 million and $0.2 million at March 31, 2013 and December 31, 2012, respectively.
The Company is exposed to interest rate risk on mortgage loans from the time it commits to purchase the mortgage loan until it acquires the loan from the originator and subsequently sells the loan to a third party. Changes in interest rates impact the market price for the mortgage loans. For example, as market interest rates decline, the value of mortgage loans held-for-sale increases, and vice versa. To mitigate the impact of this risk, the Company may from time to time enter into a forward sale commitment under the Forward AAA Securities Agreement, or the Forward Agreement, with Barclays Bank PLC, or Barclays, pursuant to which Barclays would purchase certain securities issued in connection with a potential securitization transaction involving mortgage loans subject to the Forward Agreement. As of March 31, 2013, the Company had did not have any trades under the Forward Agreement. The Company may also enter into other derivative contracts to hedge the interest rate risk related to the commitments to purchase mortgage loans, such as interest rate swaps, swaptions or TBAs.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Repurchase Agreements - The Company monitors its repurchase agreements, which are generally floating rate debt, in relationship to the rate profile of its investment securities. When it is cost effective to do so, the Company may enter into interest rate swap arrangements to align the interest rate composition of its investment securities and debt portfolios, specifically repurchase agreements with maturities of less than 6 months. Typically, the interest receivable terms (i.e., LIBOR) of the interest rate swaps match the terms of the underlying debt, resulting in an effective conversion of the rate of the related repurchase agreement from floating to fixed.
As of March 31, 2013 and December 31, 2012, the Company had the following outstanding interest rate swaps that were utilized as economic hedges of interest rate risk associated with the Company's short-term repurchase agreements:
|
| | | | | | | | | | | | | |
(notional in thousands) | | | | | | |
March 31, 2013 |
Swaps Maturities | | Notional Amounts | | Average Fixed Pay Rate | | Average Receive Rate | | Average Maturity (Years) |
2013 | | $ | 500,000 |
| | 0.523 | % | | 0.288 | % | | 0.40 |
|
2014 | | 900,000 |
| | 0.316 | % | | 0.304 | % | | 0.79 |
|
2015 | | 4,000,000 |
| | 0.386 | % | | 0.305 | % | | 1.78 |
|
2016 | | 2,550,000 |
| | 0.583 | % | | 0.298 | % | | 2.92 |
|
2017 and Thereafter | | 7,735,000 |
| | 0.975 | % | | 0.294 | % | | 4.81 |
|
Total | | $ | 15,685,000 |
| | 0.709 | % | | 0.298 | % | | 3.36 |
|
|
| | | | | | | | | | | | | |
(notional in thousands) | | | | | | |
December 31, 2012 |
Swaps Maturities | | Notional Amount | | Average Fixed Pay Rate | | Average Receive Rate | | Average Maturity (Years) |
2013 | | $ | 2,275,000 |
| | 0.713 | % | | 0.315 | % | | 0.56 |
|
2014 | | 1,675,000 |
| | 0.644 | % | | 0.311 | % | | 1.57 |
|
2015 | | 2,770,000 |
| | 0.908 | % | | 0.313 | % | | 2.43 |
|
2016 | | 1,940,000 |
| | 0.874 | % | | 0.323 | % | | 3.46 |
|
2017 and Thereafter | | 3,910,000 |
| | 0.960 | % | | 0.313 | % | | 4.72 |
|
Total | | $ | 12,570,000 |
| | 0.850 | % | | 0.315 | % | | 2.85 |
|
The Company has also entered into interest rate swaps in combination with U.S. Treasuries to economically hedge funding cost risk. As of March 31, 2013 and December 31, 2012, the Company held $1.0 billion in fair value of U.S. Treasuries classified as trading securities and the following outstanding interest rate swaps:
|
| | | | | | | | | | | | | |
(notional in thousands) | | | | | | |
March 31, 2013 |
Swaps Maturities | | Notional Amounts | | Average Fixed Pay Rate | | Average Receive Rate | | Average Maturity (Years) |
2015 | | $ | 1,000,000 |
| | 0.799 | % | | 0.305 | % | | 2.03 |
|
Total | | $ | 1,000,000 |
| | | | | | |
|
| | | | | | | | | | | | | |
(notional in thousands) | | | | | | |
December 31, 2012 |
Swaps Maturities | | Notional Amounts | | Average Fixed Pay Rate | | Average Receive Rate | | Average Maturity (Years) |
2015 | | $ | 1,000,000 |
| | 0.799 | % | | 0.350 | % | | 2.28 |
|
Total | | $ | 1,000,000 |
| | | | | | |
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
As of December 31, 2012, the Company had the following outstanding interest rate swaps that were entered into in combination with TBA contracts to economically hedge mortgage interest rate exposure (or duration):
|
| | | | | | | | | | | | | |
(notional in thousands) | | | | | | |
December 31, 2012 |
Swaps Maturities | | Notional Amounts | | Average Fixed Pay Rate | | Average Receive Rate | | Average Maturity (Years) |
2014 | | $ | 500,000 |
| | 0.399 | % | | 0.356 | % | | 1.78 |
|
Total | | $ | 500,000 |
| | | | | | |
The Company did not hold any interest rate swaps entered into in combination with TBA contracts to economically hedge mortgage interest rate exposure (or duration) at March 31, 2013.
As of March 31, 2013 and December 31, 2012, the Company had the following outstanding interest rate swaptions (agreements to enter into interest rate swaps in the future for which the Company would pay a fixed rate) that were utilized as macro-economic hedges:
|
| | | | | | | | | | | | | | | | | | | | | | | | |
March 31, 2013 |
(notional and dollars in thousands) | | Option | | Underlying Swap |
Swaption | | Expiration | | Cost | | Fair Value | | Average Months to Expiration | | Notional Amount | | Average Fixed Pay Rate | | Average Receive Rate | | Average Term (Years) |
Payer | | < 6 Months | | $ | 28,970 |
| | $ | 382 |
| | 4.90 | | $ | 2,300,000 |
| | 3.77 | % | | 3M Libor | | 9.5 |
|
Payer | | ≥ 6 Months | | 133,710 |
| | 148,409 |
| | 53.03 | | 3,500,000 |
| | 3.94 | % | | 3M Libor | | 10.0 |
|
Total Payer | | | | $ | 162,680 |
| | $ | 148,791 |
| | 52.94 | | $ | 5,800,000 |
| | 3.87 | % | | 3M Libor | | 9.8 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2012 |
(notional and dollars in thousands) | | Option | | Underlying Swap |
Swaption | | Expiration | | Cost | | Fair Value | | Average Months to Expiration | | Notional Amount | | Average Fixed Pay Rate | | Average Receive Rate | | Average Term (Years) |
Payer | | < 6 Months | | $ | 3,983 |
| | $ | 30 |
| | 5.38 | | $ | 300,000 |
| | 4.00 | % | | 3M Libor | | 10.0 |
|
Payer | | ≥ 6 Months | | 129,925 |
| | 102,018 |
| | 53.38 | | 4,650,000 |
| | 3.74 | % | | 3M Libor | | 9.7 |
|
Total Payer | | | | $ | 133,908 |
| | $ | 102,048 |
| | 53.38 | | $ | 4,950,000 |
| | 3.75 | % | | 3M Libor | | 9.8 |
|
The Company has not applied hedge accounting to its current derivative portfolio held to mitigate the interest rate risk associated with its debt portfolio. As a result, the Company is subject to volatility in its earnings due to movement in the unrealized gains and losses associated with its interest rate swaps and its other derivative instruments.
Foreign Currency Risk
In compliance with the Company's REIT requirements, the Company does not have exposure to foreign denominated assets or liabilities. As such, the Company is not subject to foreign currency risk.
Credit Risk
The Company's exposure to credit losses on its U.S. Treasuries and Agency portfolio of investment securities is limited because these securities are issued by the U.S. Department of the Treasury or government sponsored entities, or GSEs. The payment of principal and interest on the Freddie Mac and Fannie Mae mortgage-backed securities are guaranteed by those respective agencies, and the payment of principal and interest on the Ginnie Mae mortgage-backed securities are backed by the full faith and credit of the U.S. Government.
For non-Agency investment securities, the Company may enter into credit default swaps to hedge credit risk. In future periods, the Company could enhance its credit risk protection, enter into further paired derivative positions, including both long and short credit default swaps, and/or seek opportunistic trades in the event of a market disruption (see "Non-Risk Management
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Activities" section). The Company also has processes and controls in place to monitor, analyze, manage and mitigate its credit risk with respect to non-Agency RMBS.
As of March 31, 2013, the Company held credit default swaps whereby the Company receives credit protection for a fixed premium. The maximum payouts for these credit default swaps are limited to the current notional amounts of each swap contract. Maximum payouts for credit default swaps do not represent the expected future cash requirements, as the Company's credit default swaps are typically liquidated or expire and are not exercised by the holder of the credit default swaps.
The following tables present credit default swaps whereby the Company is receiving protection held as of March 31, 2013 and December 31, 2012:
|
| | | | | | | | | | | | | | | | | | | | |
(notional and dollars in thousands) | | | | | | | | |
March 31, 2013 |
Protection | Maturity Date | | Average Implied Credit Spread | | Current Notional Amount | | Fair Value | | Upfront Payable | | Unrealized Gain/(Loss) |
Receive | 9/20/2013 | | 460.00 |
| | $ | (45,000 | ) | | $ | (183 | ) | | $ | (3,127 | ) | | $ | (3,310 | ) |
| 12/20/2013 | | 181.91 |
| | (105,000 | ) | | (167 | ) | | (3,225 | ) | | (3,392 | ) |
| 6/20/2016 | | 105.50 |
| | (100,000 | ) | | (2,091 | ) | | (260 | ) | | (2,351 | ) |
| 12/20/2016 | | 496.00 |
| | (25,000 | ) | | 41 |
| | (4,062 | ) | | (4,021 | ) |
| 5/25/2046 | | 297.60 |
| | (162,496 | ) | | 49,638 |
| | (71,114 | ) | | (21,476 | ) |
| Total | | 253.96 |
| | $ | (437,496 | ) | | $ | 47,238 |
| | $ | (81,788 | ) | | $ | (34,550 | ) |
|
| | | | | | | | | | | | | | | | | | | | |
(notional and dollars in thousands) | | | | | | | | |
December 31, 2012 |
Protection | Maturity Date | | Average Implied Credit Spread | | Current Notional Amount | | Fair Value | | Upfront Payable | | Unrealized Gain/(Loss) |
Receive | 9/20/2013 | | 460.00 |
| | $ | (45,000 | ) | | $ | (264 | ) | | $ | (3,127 | ) | | $ | (3,391 | ) |
| 12/20/2013 | | 181.91 |
| | (105,000 | ) | | (198 | ) | | (3,225 | ) | | (3,423 | ) |
| 6/20/2016 | | 105.50 |
| | (100,000 | ) | | (1,940 | ) | | (260 | ) | | (2,200 | ) |
| 12/20/2016 | | 496.00 |
| | (25,000 | ) | | 527 |
| | (4,062 | ) | | (3,535 | ) |
| 5/25/2046 | | 297.60 |
| | (163,440 | ) | | 54,781 |
| | (71,114 | ) | | (16,333 | ) |
| Total | | 254.06 |
| | $ | (438,440 | ) | | $ | 52,906 |
| | $ | (81,788 | ) | | $ | (28,882 | ) |
Derivative financial instruments contain an element of credit risk if counterparties are unable to meet the terms of the agreements. Credit risk associated with derivative financial instruments is measured as the net replacement cost should the counterparties that owe the Company under such contracts completely fail to perform under the terms of these contracts, assuming there are no recoveries of underlying collateral, as measured by the market value of the derivative financial instruments. As of March 31, 2013, the fair value of derivative financial instruments as an asset and liability position was $511.7 million and $45.4 million, respectively.
The Company mitigates the credit risk exposure on derivative financial instruments by limiting the counterparties to those major banks and financial institutions that meet established credit guidelines; the Company also seeks to transact with several different counterparties in order to reduce the exposure to any single counterparty. Additionally, the Company reduces credit risk on the majority of its derivative instruments by entering into agreements that permit the closeout and netting of transactions with the same counterparty upon occurrence of certain events. To further mitigate the risk of counterparty default, the Company maintains collateral agreements with certain of its counterparties. The agreements require both parties to maintain cash deposits in the event the fair values of the derivative financial instruments exceed established thresholds. As of March 31, 2013, the Company has received cash deposits from counterparties of $160.7 million and placed cash deposits of $143.7 million in accounts maintained by counterparties, of which the amounts are netted on a counterparty basis and classified within restricted cash, due from counterparties, or due to counterparties on the condensed consolidated balance sheet.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
In accordance with ASC 815, as amended and interpreted, the Company records derivative financial instruments on its condensed consolidated balance sheet as assets or liabilities at fair value. Changes in fair value are accounted for depending on the use of the derivative instruments and whether they qualify for hedge accounting treatment. Due to the volatility of the credit markets and difficulty in effectively matching pricing or cash flows, the Company has elected to treat all current derivative contracts as trading instruments.
Non-Risk Management Activities
The Company has entered into certain financial instruments that are considered derivative contracts under ASC 815 that are not for purposes of hedging. These contracts are currently limited to inverse interest-only RMBS, credit default swaps and TBAs. As of March 31, 2013, we held $1.3 billion notional TBAs as a means of deploying capital until targeted investments are available, and to take advantage of temporary displacements in the marketplace.
Inverse interest-only securities with a carrying value of $313.4 million, including accrued interest receivable of $3.6 million, are accounted for as derivative financial instruments in the condensed consolidated financial statements. The following table presents the amortized cost and carrying value (which approximates fair value) of inverse interest-only securities as of March 31, 2013 and December 31, 2012: