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: June 30, 2013

Commission File Number 001-34506
______________________________
TWO HARBORS INVESTMENT CORP.
(Exact Name of Registrant as Specified in Its Charter)

Maryland
 
27-0312904
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)

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):

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 August 7, 2013 there were 365,742,864 shares of outstanding common stock, par value $.01 per share, issued and outstanding.
 
 
 
 
 

Table of Contents



TWO HARBORS INVESTMENT CORP.
INDEX

 
 
Page
 
PART I - FINANCIAL INFORMATION
 
 
 
 
 
 
 
PART II - OTHER INFORMATION
 


i
Table of Contents



PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
TWO HARBORS INVESTMENT CORP.  
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
June 30,
2013
 
December 31,
2012
ASSETS
  (unaudited)
 
  

Available-for-sale securities, at fair value
$
14,892,315

 
$
13,666,954

Trading securities, at fair value
1,001,172

 
1,002,062

Equity securities, at fair value
—

 
335,638

Mortgage loans held-for-sale, at fair value
958,201

 
58,607

Mortgage loans held-for-investment in securitization trust, at fair value
401,347

 
—

Cash and cash equivalents
917,224

 
821,108

Restricted cash
685,965

 
302,322

Accrued interest receivable
54,080

 
42,613

Due from counterparties
17,210

 
39,974

Derivative assets, at fair value
699,351

 
462,080

Other assets
13,886

 
82,586

Total Assets (1)
$
19,640,751

 
$
16,813,944

LIABILITIES AND STOCKHOLDERS’ EQUITY
   

 
   

Liabilities
   

 
   

Repurchase agreements
$
14,903,155

 
$
12,624,510

Collateralized borrowings in securitization trust, at fair value
363,012

 
—

Derivative liabilities, at fair value
46,028

 
129,294

Accrued interest payable
17,510

 
19,060

Due to counterparties
340,043

 
412,861

Dividends payable
113,378

 
164,347

Other liabilities
23,502

 
13,295

Total liabilities (1)
15,806,628

 
13,363,367

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 365,733,931 and 298,813,258 shares issued and outstanding, respectively
3,657

 
2,988

Additional paid-in capital
3,803,013

 
2,948,345

Accumulated other comprehensive income
265,997

 
696,458

Cumulative earnings
981,711

 
449,358

Cumulative distributions to stockholders
(1,220,255
)
 
(646,572
)
Total stockholders’ equity
3,834,123

 
3,450,577

Total Liabilities and Stockholders’ Equity
$
19,640,751

 
$
16,813,944

____________________
(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 June 30, 2013, assets of consolidated the VIE totaled $402,775 and liabilities of the consolidated VIE totaled $363,819. 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.

1
Table of Contents



TWO HARBORS INVESTMENT CORP.  
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(in thousands, except share data)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2013
 
2012
 
2013
 
2012
 
(unaudited)
 
(unaudited)
Interest income:
 
 
 
 
  

 
   

Available-for-sale securities
$
134,651

 
$
104,319

 
$
264,943

 
$
188,533

Trading securities
1,261

 
1,250

 
2,525

 
2,300

Mortgage loans held-for-sale
4,794

 
126

 
6,112

 
195

Mortgage loans held-for-investment in securitization trust
4,369

 
—

 
6,023

 
—

Cash and cash equivalents
250

 
209

 
557

 
377

Total interest income
145,325

 
105,904

 
280,160

 
191,405

Interest expense:
 
 
 
 
 
 
 
Repurchase agreements
22,553

 
15,527

 
45,571

 
26,994

Collateralized borrowings in securitization trust
2,169

 
—

 
2,987

 
—

Total interest expense
24,722

 
15,527

 
48,558

 
26,994

Net interest income
120,603

 
90,377

 
231,602

 
164,411

Other-than-temporary impairments:
 
 
 
 
 
 
 
Total other-than-temporary impairment losses
(1,426
)
 
(4,476
)
 
(1,662
)
 
(8,751
)
Non-credit portion of loss recognized in other comprehensive (loss) income
—

 
—

 
—

 
—

Net other-than-temporary credit impairment losses
(1,426
)
 
(4,476
)
 
(1,662
)

(8,751
)
Other income:
 
 
 
 
 
 
 
Gain on investment securities
50,863

 
1,789

 
77,831

 
11,720

Gain (loss) on interest rate swap and swaption agreements
259,826

 
(61,014
)
 
278,798

 
(77,207
)
Gain (loss) on other derivative instruments
62,283

 
(7,577
)
 
45,621

 
(16,480
)
(Loss) gain on mortgage loans held-for-sale
(35,142
)
 
10

 
(20,819
)
 
(22
)
Other income
1,810

 
—

 
8,099

 
—

Total other income (loss)
339,640

 
(66,792
)
 
389,530

 
(81,989
)
Expenses:
 
 
 
 
 
 
 
Management fees
12,591

 
7,610

 
17,352

 
14,353

Securitization deal costs
—

 
—

 
2,028

 
—

Other operating expenses
9,486

 
3,919

 
16,047

 
7,470

Total expenses
22,077

 
11,529

 
35,427

 
21,823

Income from continuing operations before income taxes
436,740

 
7,580

 
584,043

 
51,848

Provision for (benefit from) income taxes
49,119

 
(16,605
)
 
54,083

 
(24,183
)
Net income from continuing operations
387,621

 
24,185

 
529,960

 
76,031

Income (loss) from discontinued operations
1,016

 
(181
)
 
2,393

 
(227
)
Net income attributable to common stockholders
$
388,637

 
$
24,004

 
$
532,353

 
$
75,804

The accompanying notes are an integral part of these condensed consolidated financial statements.

2
Table of Contents



TWO HARBORS INVESTMENT CORP.  
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME, continued
(in thousands, except share data)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2013
 
2012
 
2013
 
2012
 
(unaudited)
 
(unaudited)
Basic earnings per weighted average common share:
 
 
 
 
 
 
 
Continuing operations
$
1.06

 
$
0.11

 
$
1.58

 
$
0.38

Discontinued operations
—

 
—

 
0.01

 
—

Net income
$
1.06

 
$
0.11

 
$
1.59

 
$
0.38

Diluted earnings per weighted average common share:
 
 
 
 
 
 
 
Continuing operations
$
1.06

 
$
0.11

 
$
1.57

 
$
0.38

Discontinued operations
—

 
—

 
0.01

 
—

Net income
$
1.06

 
$
0.11

 
$
1.58

 
$
0.38

Dividends declared per common share
$
0.31

 
$
0.40

 
$
0.63

 
$
0.80

Weighted average number of shares of common stock:
 
 
 
 
 
 
 
Basic
365,589,300

 
214,810,579

 
335,603,697

 
200,833,084

Diluted
366,057,203

 
214,810,579

 
336,677,044

 
200,833,084

Comprehensive (loss) income:
 
 
 
 
 
 
 
Net income
$
388,637

 
$
24,004

 
$
532,353

 
$
75,804

Other comprehensive (loss) income:
 
 
 
 
 
 
 
Unrealized (loss) gain on available-for-sale securities, net
(534,713
)
 
117,604

 
(430,461
)
 
261,514

Other comprehensive (loss) income
(534,713
)
 
117,604

 
(430,461
)
 
261,514

Comprehensive (loss) income
$
(146,076
)
 
$
141,608

 
$
101,892

 
$
337,318

The accompanying notes are an integral part of these condensed consolidated financial statements.


3
Table of Contents



TWO HARBORS INVESTMENT CORP. 
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share data)
 
Common Stock
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares
 
Amount
 
Additional Paid-in Capital
 
Receivable from Issuance of Common Stock
 
Accumulated Other Comprehensive Income (Loss)
 
Cumulative Earnings
 
Cumulative Distributions to Stockholders
 
Total Stockholders' Equity
 
 
 
 
 
 
 
 
 
(unaudited)
 
 
 
 
 
 
Balance, January 1, 2012
140,596,708

 
$
1,406

 
$
1,373,099

 
$
—

 
$
(58,716
)
 
$
157,452

 
$
(203,155
)
 
$
1,270,086

Net income
—

 
—

 
—

 
—

 
—

 
75,804

 
—

 
75,804

Other comprehensive income before reclassifications
—

 
—

 
—

 
—

 
259,908

 
—

 
—

 
259,908

Amounts reclassified from accumulated other comprehensive income
—

 
—

 
—

 
—

 
1,606

 
—

 
—

 
1,606

Net other comprehensive income
—

 
—

 
—

 
—

 
261,514

 
—

 
—

 
261,514

Issuance of common stock, net of offering costs
79,058,754

 
790

 
769,022

 
—

 
—

 
—

 
—

 
769,812

Increase in receivable from issuance of common stock
—

 
—

 
—

 
(22,248
)
 
—

 
—

 
—

 
(22,248
)
Common dividends declared
—

 
—

 
—

 
—

 
—

 
—

 
(172,744
)
 
(172,744
)
Non-cash equity award compensation
—

 
—

 
433

 
—

 
—

 
—

 
—

 
433

Balance, June 30, 2012
219,655,462

 
$
2,196

 
$
2,142,554

 
$
(22,248
)
 
$
202,798

 
$
233,256

 
$
(375,899
)
 
$
2,182,657

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, January 1, 2013
298,813,258

 
$
2,988

 
$
2,948,345

 
$
—

 
$
696,458

 
$
449,358

 
$
(646,572
)
 
$
3,450,577

Net income
—

 
—

 
—

 
—

 
—

 
532,353

 
—

 
532,353

Other comprehensive loss before reclassifications
—

 
—

 
—

 
—

 
(368,205
)
 
—

 
—

 
(368,205
)
Amounts reclassified from accumulated other comprehensive loss
—

 
—

 
—

 
—

 
(62,256
)
 
—

 
—

 
(62,256
)
Net other comprehensive loss
—

 
—

 
—

 
—

 
(430,461
)
 
—

 
—

 
(430,461
)
Issuance of common stock, net of offering costs
57,541,664

 
575

 
762,651

 
—

 
—

 
—

 
—

 
763,226

Issuance of common stock in connection with exercise of warrants
9,321,705

 
93

 
101,517

 
—

 
—

 
—

 
—

 
101,610

Repurchase of common stock
(1,000,000
)
 
(10
)
 
(10,488
)
 
—

 
—

 
—

 
—

 
(10,498
)
Common dividends declared
—

 
—

 
—

 
—

 
—

 
—

 
(230,202
)
 
(230,202
)
Special dividends declared
—

 
—

 
—

 
—

 
—

 
—

 
(343,481
)
 
(343,481
)
Non-cash equity award compensation
1,057,304

 
11

 
988

 
—

 
—

 
—

 
—

 
999

Balance, June 30, 2013
365,733,931

 
$
3,657

 
$
3,803,013

 
$
—

 
$
265,997

 
$
981,711

 
$
(1,220,255
)
 
$
3,834,123

The accompanying notes are an integral part of these condensed consolidated financial statements.


4
Table of Contents



TWO HARBORS INVESTMENT CORP.  
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
Six Months Ended
 
June 30,
 
2013
 
2012
Cash Flows From Operating Activities:
(unaudited)
Net income
$
532,353

 
$
75,804

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
12,406

 
(9,058
)
Other-than-temporary impairment losses
1,662

 
8,751

Realized and unrealized gains on investment securities, net
(77,653
)
 
(11,720
)
Loss on mortgage loans held-for-sale
20,819

 
22

Gain on mortgage loans held-for-investment and collateralized borrowings in securitization trust
(7,847
)
 
—

Unrealized loss on mortgage servicing rights
45

 
—

Loss on termination and option expiration of interest rate swaps and swaptions
62,675

 
18,540

Unrealized (gain) loss on interest rate swaps and swaptions
(374,884
)
 
46,296

Unrealized gain on other derivative instruments
(8,131
)
 
(4,799
)
Equity based compensation expense
999

 
433

Depreciation of fixed assets
256

 
46

Depreciation of real estate
—

 
32

Purchases of mortgage loans held-for-sale
(954,027
)
 
(6,618
)
Proceeds from sales of mortgage loans held-for-sale
25,404

 
—

Proceeds from repayment of mortgage loans held-for-sale
9,649

 
1,026

Net change in assets and liabilities:
   

 
 
Increase in accrued interest receivable
(11,467
)
 
(12,517
)
Decrease/(increase) in deferred income taxes, net
52,692

 
(19,720
)
Decrease/(increase) in current income tax receivable
4,323

 
(4,465
)
Increase in prepaid and fixed assets
(557
)
 
(600
)
Decrease in other receivables
28,437

 
—

Increase in servicing advances
(4,881
)
 
—

(Decrease)/increase in accrued interest payable, net
(1,550
)
 
5,089

Increase/(decrease) in income taxes payable
1,320

 
(3,632
)
Increase in accrued expenses and other liabilities
379

 
2,252

Net change in assets and liabilities due to purchase of entity
3,306

 
—

Net cash (used in) provided by operating activities
(684,272
)
 
85,162

The accompanying notes are an integral part of these condensed consolidated financial statements.

5
Table of Contents



TWO HARBORS INVESTMENT CORP.  
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
(in thousands)
 
Six Months Ended
 
June 30,
 
2013
 
2012
Cash Flows From Investing Activities:
(unaudited)
Purchases of available-for-sale securities
$
(3,142,095
)
 
$
(4,696,861
)
Proceeds from sales of available-for-sale securities
986,357

 
197,714

Principal payments on available-for-sale securities
556,549

 
295,829

Purchases of other derivative instruments
(49,526
)
 
(205,440
)
Proceeds from sales of other derivative instruments, net
47,890

 
69,699

Purchases of trading securities
—

 
(996,016
)
Proceeds from sales of trading securities
—

 
1,001,904

Purchases of mortgage loans held-for-investment in securitization trust
(442,788
)
 
—

Proceeds from repayment of mortgage loans held-for-investment in securitization trust
16,684

 
—

Purchases of investments in real estate
—

 
(71,758
)
Purchase of entity
(6,404
)
 
—

(Decrease)/increase in due to counterparties, net
(50,054
)
 
72,932

(Increase)/decrease in restricted cash
(383,643
)
 
28,251

Increase in escrow deposits of discontinued operations
—

 
(28,693
)
Net cash used in investing activities
(2,467,030
)
 
(4,332,439
)
Cash Flows From Financing Activities:
   

 
   

Proceeds from repurchase agreements
73,388,331

 
23,100,723

Principal payments on repurchase agreements
(71,109,686
)
 
(19,322,430
)
Proceeds from issuance of collateralized borrowings in securitization trust
412,216

 
—

Principal payments on collateralized borrowings in securitization trust
(16,600
)
 
—

Proceeds from issuance of common stock, net of offering costs
763,226

 
769,812

Proceeds from exercise of warrants
101,600

 
—

Increase in receivable from issuance of common stock
—

 
(22,248
)
Repurchase of common stock
(10,498
)
 
—

Dividends paid on common stock
(281,171
)
 
(141,922
)
Net cash provided by financing activities
3,247,418

 
4,383,935

Net increase in cash and cash equivalents
96,116

 
136,658

Cash and cash equivalents at beginning of period
821,108

 
360,016

Cash and cash equivalents at end of period
$
917,224

 
$
496,674

The accompanying notes are an integral part of these condensed consolidated financial statements.

6
Table of Contents



TWO HARBORS INVESTMENT CORP.  
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
(in thousands)
 
Six Months Ended
 
June 30,
 
2013
 
2012
Supplemental Disclosure of Cash Flow Information:
(unaudited)
Cash paid for interest
$
50,108

 
$
10,438

Cash (received) paid for taxes
$
(4,252
)
 
$
3,635

Noncash Investing and Financing Activities:
 
 
 
Distribution of Silver Bay common stock
$
343,481

 
$
—

Cashless exercise of warrants
$
75

 
$
—

Cash dividends declared but not paid at end of period
$
113,378

 
$
87,061

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
954,027

 
6,618

Proceeds from sales of mortgage loans held-for-sale
(25,404
)
 
—

Proceeds from repayment of mortgage loans held-for-sale
(9,649
)
 
(1,026
)
Realized and unrealized (losses) gains on mortgage loans held-for-sale
(19,380
)
 
4

Mortgage loans held-for-sale at end of period
$
958,201

 
$
11,378

The accompanying notes are an integral part of these condensed consolidated financial statements.

7
Table of Contents



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., or 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 and six months ended June 30, 2013 and 2012. See Note 4 - Discontinued Operations for additional information.
On April 30, 2013, one of the Company's wholly-owned subsidiaries acquired a company that has seller-servicer approvals from the Federal National Mortgage Association, or Fannie Mae, the Federal Home Loan Mortgage Corporation, or Freddie Mac, and the Government National Mortgage Association, or Ginnie Mae, to hold and manage mortgage servicing rights, or MSRs. The MSRs acquired in conjunction with the acquisition of this entity, or the MSR subsidiary, represent the right to service mortgage loans. The Company and its subsidiaries do not originate or directly service mortgage loans, and instead contract with fully licensed subservicers to handle all servicing functions for the loans underlying the Company's MSRs. See Note 13 - Other Assets 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 June 30, 2013 and results of operations for all periods presented have been made. The results of operations for the three and six months ended June 30, 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

8
Table of Contents

TWO HARBORS INVESTMENT CORP.  
Notes to the Condensed Consolidated Financial Statements (unaudited)

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.
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
Mortgage Servicing Rights, at Fair Value
The MSRs acquired in conjunction with the acquisition of the Company's MSR subsidiary represent the right to service mortgage loans. As of June 30, 2013, the Company and its subsidiaries do not originate or directly service mortgage loans, and instead contract with fully licensed subservicers to handle all servicing functions for the loans underlying the Company's MSRs. However, as an owner and manager of MSRs, the Company may be obligated to fund advances of principal and interest payments due to third party owners of the loans, but not yet received from the individual borrowers. These advances are reported as servicing advances within the other assets line item on the condensed consolidated balance sheets.
MSRs are reported at fair value within the other assets line item on the condensed consolidated balance sheets. Changes in the fair value of MSRs as well as servicing fee income are reported within other income on the condensed consolidated statements of comprehensive (loss) income. The related subservicing expenses are recorded in other operating expenses on the condensed consolidated statements of comprehensive (loss) income.
See Note 13 - Other Assets for further discussion on MSRs.
Equity Incentive Plan
The Company adopted an equity incentive plan in 2009 which provides incentive compensation to attract and retain qualified directors, officers, advisors, consultants and other personnel, including PRCM Advisers LLC and its affiliates. The 2009 equity incentive plan is administered by the compensation committee of the Company's board of directors. The 2009 equity incentive plan permits the granting of restricted shares of common stock, phantom shares, dividend equivalent rights and other equity-based awards.
On May 21, 2013, the Company’s stockholders approved the restated 2009 equity incentive plan, which effectuated, among other changes, an increase in the number of shares available for issuance under the restated 2009 equity incentive plan by 2,800,000 shares of common stock. Other amendments provide for the possibility of making grants of equity-based compensation to the Company’s executive officers and other key employees of the Company’s external manager, PRCM Advisers LLC, upon a determination by the compensation committee, and the implementation of certain best practices of equity-based compensation.
The cost of equity-based compensation awarded to employees of our manager is determined using fair value liability accounting in accordance with ASC 718, Compensation - Stock Compensation, or ASC 718, and amortized over the vesting term.
Offsetting Assets and Liabilities
Certain of the Company's repurchase agreements are governed by underlying agreements that provide for a right of setoff in the event of default of either party to the agreement. The Company also has netting arrangements in place with all derivative counterparties pursuant to standard documentation developed by the International Swap and Derivatives Association, or ISDA. Additionally, the Company and the counterparty are required to post cash collateral based upon the net underlying market value of the Company's open positions with the counterparty.

9
Table of Contents

TWO HARBORS INVESTMENT CORP.  
Notes to the Condensed Consolidated Financial Statements (unaudited)

Under GAAP, if the Company has a valid right of setoff, it may offset the related asset and liability and report the net amount. The Company presents repurchase agreements subject to master netting arrangements or similar agreements on a gross basis, and derivative assets and liabilities subject to such arrangements on a net basis, based on derivative type and counterparty, in its condensed consolidated balance sheets. Separately, the Company presents cash collateral subject to such arrangements on a net basis, based on counterparty, in its condensed consolidated balance sheets. However, the Company does not offset financial assets and liabilities with the associated cash collateral on its condensed consolidated balance sheets.
The following tables present information about the Company's assets and liabilities that are subject to master netting arrangements or similar agreements and can potentially be offset on the Company's condensed consolidated balance sheets as of June 30, 2013 and December 31, 2012:
 
June 30, 2013
 
 
 
 
 
 
 
Gross Amounts Not Offset with Financial Assets (Liabilities) in the Condensed Consolidated Balance Sheets (1)
 
 
(in thousands)
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts of Assets (Liabilities) Presented in the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Net Amount
Assets
 
 
 
 
 
 
 
 
 
 
 
Derivative assets
$
723,246

 
$
(23,895
)
 
$
699,351

 
$
(46,028
)
 
$
(189,927
)
 
$
463,396

Total Assets
$
723,246

 
$
(23,895
)
 
$
699,351

 
$
(46,028
)
 
$
(189,927
)
 
$
463,396

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
Repurchase agreements
$
(14,903,155
)
 
$
—

 
$
(14,903,155
)
 
$
14,903,155

 
$
—

 
$
—

Derivative liabilities
(69,923
)
 
23,895

 
(46,028
)
 
46,028

 
—

 
—

Total Liabilities
$
(14,973,078
)
 
$
23,895

 
$
(14,949,183
)
 
$
14,949,183

 
$
—

 
$
—


10
Table of Contents

TWO HARBORS INVESTMENT CORP.  
Notes to the Condensed Consolidated Financial Statements (unaudited)

 
December 31, 2012
 
 
 
 
 
 
 
Gross Amounts Not Offset with Financial Assets (Liabilities) in the Condensed Consolidated Balance Sheets (1)
 
 
(in thousands)
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts of Assets (Liabilities) Presented in the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Net Amount
Assets
 
 
 
 
 
 
 
 
 
 
 
Derivative assets
$
463,027

 
$
(947
)
 
$
462,080

 
$
(129,294
)
 
$
85,798

 
$
418,584

Total Assets
$
463,027

 
$
(947
)
 
$
462,080

 
$
(129,294
)
 
$
85,798

 
$
418,584

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
Repurchase agreements
$
(12,624,510
)
 
$
—

 
$
(12,624,510
)
 
$
12,624,510

 
$
—

 
$
—

Derivative liabilities
(130,241
)
 
947

 
(129,294
)
 
129,294

 
—

 
—

Total Liabilities
$
(12,754,751
)
 
$
947

 
$
(12,753,804
)
 
$
12,753,804

 
$
—

 
$
—

____________________
(1)
Amounts presented are limited in total to the net amount of assets or liabilities presented in the condensed consolidated balance sheets by instrument. Excess cash collateral or financial assets that are pledged to counterparties may exceed the financial liabilities subject to a master netting arrangement or similar agreement, or counterparties may have pledged excess cash collateral to the Company that exceed the corresponding financial assets. These excess amounts are excluded from the table above, although separately reported within restricted cash, due from counterparties, or due to counterparties in the Company's condensed consolidated balance sheets.
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 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 six months ended June 30, 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,

11
Table of Contents

TWO HARBORS INVESTMENT CORP.  
Notes to the Condensed Consolidated Financial Statements (unaudited)

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)
June 30,
2013
 
December 31,
2012
Mortgage loans held-for-investment in securitization trust
$
401,347

 
$
—

Accrued interest receivable
1,428

 
—

Total Assets
$
402,775

 
$
—

Collateralized borrowings in securitization trust
363,012

 
—

Accrued interest payable
715

 
—

Accrued expenses
92

 
—

Total Liabilities
$
363,819

 
$
—


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 and six months ended June 30, 2013 and 2012.
Summarized financial information for the discontinued operations are presented below.
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(in thousands)
2013
 
2012
 
2013
 
2012
Income:
  

 
   

 
  

 
   

Gain on contribution of entity
$
1,016

 
$
—

 
$
2,255

 
$
—

Real estate related revenues
—

 
83

 
—

 
87

Total income
1,016

 
83

 
2,255

 
87

Expenses:
 
 
 
 
 
 
 
Management fees
—

 
—

 
—

 
—

Real estate related expenses
—

 
181

 
—

 
198

Other operating expenses
—

 
83

 
(138
)
 
116

Total expenses
—

 
264

 
(138
)
 
314

Income (loss) from discontinued operations
$
1,016

 
$
(181
)
 
$
2,393

 
$
(227
)

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, $1.0 million and $2.3 million of the installment sales gain was recorded as a gain on contribution of entity within discontinued operations for the three and six months ended June 30, 2013, 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 statements of comprehensive (loss) income for the six months ended June 30, 2013, respectively. The remaining $0.1 million recorded within discontinued operations on the condensed consolidated statements of comprehensive (loss)

12
Table of Contents

TWO HARBORS INVESTMENT CORP.  
Notes to the Condensed Consolidated Financial Statements (unaudited)

income for the six months ended June 30, 2013 relates to accrual adjustments for transaction expenses related to the contribution. See Note 23 - 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 June 30, 2013 and December 31, 2012:
(in thousands)
June 30,
2013
 
December 31,
2012
Mortgage-backed securities:
 
 
 
Agency
 
 
 
Federal Home Loan Mortgage Corporation
$
4,056,456

 
$
3,608,272

Federal National Mortgage Association
5,867,736

 
5,130,965

Government National Mortgage Association
2,016,636

 
2,272,866

Non-Agency
2,951,487

 
2,654,851

Total mortgage-backed securities
$
14,892,315

 
$
13,666,954


At June 30, 2013 and December 31, 2012, the Company pledged investment securities with a carrying value of $14.2 billion and $12.8 billion, respectively, as collateral for repurchase agreements. See Note 16 - Repurchase Agreements.
At June 30, 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.
The following tables present the amortized cost and carrying value (which approximates fair value) of AFS securities by collateral type as of June 30, 2013 and December 31, 2012:
 
June 30, 2013
(in thousands)
Agency
 
Non-Agency
 
Total
Face Value
$
13,791,266

 
$
4,994,692

 
$
18,785,958

Unamortized premium
809,226

 
—

 
809,226

Unamortized discount
 
 
 
 
 
Designated credit reserve
—

 
(1,386,607
)
 
(1,386,607
)
Net, unamortized
(2,359,641
)
 
(1,222,618
)
 
(3,582,259
)
Amortized Cost
12,240,851

 
2,385,467

 
14,626,318

Gross unrealized gains
101,471

 
577,151

 
678,622

Gross unrealized losses
(401,494
)
 
(11,131
)
 
(412,625
)
Carrying Value
$
11,940,828

 
$
2,951,487

 
$
14,892,315

 
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


13
Table of Contents

TWO HARBORS INVESTMENT CORP.  
Notes to the Condensed Consolidated Financial Statements (unaudited)


The following tables present the carrying value of the Company's AFS investment securities by rate type as of June 30, 2013 and December 31, 2012:
 
June 30, 2013
(in thousands)
 Agency
 
 Non-Agency
 
 Total
Adjustable Rate
$
170,682

 
$
2,543,467

 
$
2,714,149

Fixed Rate
11,770,146

 
408,020

 
12,178,166

Total
$
11,940,828

 
$
2,951,487

 
$
14,892,315

 
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 income is designated as a 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 six months ended June 30, 2013 and 2012, of the unamortized net discount and designated credit reserves on non-Agency AFS securities.
 
Six Months Ended June 30,
 
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
(158,955
)
 
(365,348
)
 
(524,303
)
 
(553,552
)
 
(479,435
)
 
(1,032,987
)
Accretion of net discount
886

 
71,625

 
72,511

 
250

 
62,768

 
63,018

Realized credit losses
22,658

 
—

 
22,658

 
17,908

 
—

 
17,908

Reclassification adjustment for other-than-temporary impairments
(1,662
)
 
—

 
(1,662
)
 
(8,751
)
 
—

 
(8,751
)
Transfers from (to)
30,883

 
(30,883
)
 
—

 
—

 
—

 
—

Sales, calls, other
10,529

 
98,478

 
109,007

 
4,653

 
13,338

 
17,991

Ending balance at June 30
$
(1,386,607
)
 
$
(1,222,618
)
 
$
(2,609,225
)
 
$
(1,322,098
)
 
$
(944,298
)
 
$
(2,266,396
)


14
Table of Contents

TWO HARBORS INVESTMENT CORP.  
Notes to the Condensed Consolidated Financial Statements (unaudited)

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 June 30, 2013 and December 31, 2012. At June 30, 2013, the Company held 1,732 AFS securities, of which 863 were in an unrealized loss position for less than twelve consecutive months and 35 were in an unrealized loss position for more than twelve consecutive months. Of the $8.5 billion and $2.5 billion of AFS securities in an unrealized loss position for less than twelve consecutive months as of June 30, 2013 and December 31, 2012, $8.2 billion, or 97.5%, and $2.4 billion, or 95.8%, respectively, were Agency AFS securities, whose principal and interest are guaranteed by government sponsored entities, or GSEs. 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
June 30, 2013
$
8,461,815

 
$
(405,056
)
 
$
62,024

 
$
(7,569
)
 
$
8,523,839

 
$
(412,625
)
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 (loss) 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 $1.4 million and a $1.7 million other-than-temporary credit impairment during the three and six months ended June 30, 2013, respectively, on a total of four non-Agency RMBS where the future expected cash flows for each security was less than its amortized cost. As of June 30, 2013, impaired securities had weighted average cumulative losses of 10.9%, weighted average three-month prepayment speed of 6.7%, weighted average 60+ day delinquency of 35.6% of the pool balance, and weighted average FICO score of 626. At June 30, 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 and six months ended June 30, 2012, the Company recorded a $4.5 million and an $8.8 million other-than-temporary credit impairment on a total of 27 non-Agency RMBS where the future expected cash flows for each security was less than its amortized cost.

15
Table of Contents

TWO HARBORS INVESTMENT CORP.  
Notes to the Condensed Consolidated Financial Statements (unaudited)

The following table presents the changes in OTTI included in earnings for three and six months ended June 30, 2013 and 2012:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(in thousands)
2013
 
2012
 
2013
 
2012
Cumulative credit loss at beginning of period
$
(15,142
)
 
$
(9,377
)
 
$
(15,561
)
 
$
(5,102
)
Additions:
 
 
 
 
 
 
 
Other-than-temporary impairments not previously recognized
—

 
(2,644
)
 
—

 
(6,128
)
Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments
(1,426
)
 
(1,832
)
 
(1,662
)
 
(2,623
)
Reductions:
 
 
 
 
 
 
 
Decreases related to other-than-temporary impairments on securities paid down
231

 
250

 
231

 
250

Decreases related to other-than-temporary impairments on securities sold
1,291

 
—

 
1,946

 
—

Cumulative credit loss at end of period
$
(15,046
)
 
$
(13,603
)
 
$
(15,046
)
 
$
(13,603
)

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 (loss) income. For the three and six months ended June 30, 2013, the Company sold AFS securities for $189.7 million and $986.4 million with an amortized cost of $137.3 million and $915.0 million, for net realized gains of $52.4 million and $71.4 million, respectively.
The following table presents the gross realized gains and losses on sales of AFS securities for the three and six months ended June 30, 2013 and 2012:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(in thousands)
2013
 
2012
 
2013
 
2012
Gross realized gains
$
52,439

 
$
560

 
$
75,665

 
$
11,663

Gross realized losses
(1
)
 
(1,629
)
 
(4,297
)
 
(1,629
)
Total realized gains on sales, net
$
52,438

 
$
(1,069
)
 
$
71,368

 
$
10,034


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 June 30, 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 $3.5 million and $5.0 million as of June 30, 2013 and December 31, 2012, respectively.
The Company did not sell any trading securities during the three and six months ended June 30, 2013. For both the three and six months ended June 30, 2013, trading securities experienced change in unrealized losses of $1.6 million. Unrealized gains and losses are recorded as a component of gains on investment securities in the Company's condensed consolidated statements of comprehensive (loss) income.
At June 30, 2013, the Company pledged trading securities with a carrying value of $1.0 billion as collateral for repurchase agreements. See Note 16 - Repurchase Agreements.

16
Table of Contents

TWO HARBORS INVESTMENT CORP.  
Notes to the Condensed Consolidated Financial Statements (unaudited)


Note 7. Equity Securities, at Fair Value
At December 31, 2012, equity securities consisted 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 initial carrying value of the Company's equity securities was $329.8 million and the carrying value as of December 31, 2012 was $335.6 million, which included $5.9 million in unrealized gains.
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. The dividend was payable on or about April 24, 2013. As a result, the Company recognized $13.7 million of realized gains on distribution as well as $13.7 million and $5.9 million of change in unrealized losses within gain on investment securities on the condensed consolidated statements of comprehensive (loss) income for the three and six months ended June 30, 2013, respectively. As the shares were distributed to Two Harbors stockholders during the six months ended June 30, 2013, equity securities are no longer recognized on the condensed consolidated balance sheet as of June 30, 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 June 30, 2013 and December 31, 2012:
(in thousands)
June 30,
2013
 
December 31,
2012
Unpaid principal balance
$
1,101,389

 
$
56,976

Fair value adjustment
(143,188
)
 
1,631

Carrying value
$
958,201

 
$
58,607


At June 30, 2013 and December 31, 2012, the Company pledged mortgage loans with a carrying value of $475.0 million and $52.5 million, respectively, as collateral for repurchase agreements. See Note 16 - Repurchase Agreements.

Note 9. Mortgage Loans Held-for-Investment in Securitization Trust, at Fair Value
During the six months ended June 30, 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 June 30, 2013 and December 31, 2012:
(in thousands)
June 30,
2013
 
December 31,
2012
Unpaid principal balance
$
405,519

 
$
—

Fair value adjustment
(4,172
)
 
—

Carrying value
$
401,347

 
$
—


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.

17
Table of Contents

TWO HARBORS INVESTMENT CORP.  
Notes to the Condensed Consolidated Financial Statements (unaudited)

The following table presents the Company's restricted cash balances as of June 30, 2013 and December 31, 2012:
(in thousands)
June 30,
2013
 
December 31,
2012
Restricted cash balances held by trading counterparties:
 
 
 
For securities trading activity
$
9,000

 
$
9,000

For derivatives trading activity
80,140

 
208,669

As restricted collateral for repurchase agreements
596,479

 
84,307

 
685,619

 
301,976

Restricted cash balance pursuant to letter of credit on office lease
346

 
346

Total
$
685,965

 
$
302,322


Note 11. Accrued Interest Receivable
The following table presents the Company's accrued interest receivable by collateral type:
(in thousands)
June 30,
2013
 
December 31,
2012
Accrued Interest Receivable:
 
 
 
U.S. Treasuries
$
1,101

 
$
1,119

Mortgage-backed securities:
 
 
 
Agency
 
 
 
Federal Home Loan Mortgage Corporation
13,660

 
11,888

Federal National Mortgage Association
19,732

 
17,101

Government National Mortgage Association
8,880

 
8,962

Non-Agency
3,926

 
3,296

Total mortgage-backed securities
46,198

 
41,247

Mortgage loans held-for-sale
5,353

 
247

Mortgage loans held-for-investment in securitization trust
1,428

 
—

Total
$
54,080

 
$
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 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.

18
Table of Contents

TWO HARBORS INVESTMENT CORP.  
Notes to the Condensed Consolidated Financial Statements (unaudited)

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 June 30, 2013 and December 31, 2012.
(in thousands)
 
June 30, 2013
 
 
Derivative Assets
 
Derivative Liabilities
Trading instruments
 
Fair Value
 
Notional
 
Fair Value
 
Notional
Inverse interest-only securities
 
$
245,195

 
$
1,798,972

 
$
—

 
$
—

Interest rate swap agreements
 
142,317

 
18,485,000

 
—

 
—

Credit default swap agreements
 
—

 
—

 
(8,198
)
 
1,630,404

Swaptions
 
225,810

 
6,250,000

 
—

 
—

TBAs
 
61,156

 
2,813,000

 
(22,568
)
 
2,892,000

Put and call options for TBAs
 
24,873

 
210,000

 
—

 
—

Constant maturity swaps
 
—

 
—

 
(14,058
)
 
19,000,000

Forward purchase commitment
 
—

 
—

 
(1,204
)
 
29,229

Total
 
$
699,351

 
$
29,556,972

 
$
(46,028
)
 
$
23,551,633

(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 following table provides the average outstanding notional amounts of the Company's derivative financial instruments treated as trading instruments for the three and six months ended June 30, 2013.
(in thousands)
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
Trading instruments
 
Derivative Assets
 
Derivative Liabilities
 
Derivative Assets
 
Derivative Liabilities
Inverse interest-only securities
 
$
1,895,789

 
$
—

 
$
1,908,919

 
$
—

Interest rate swap agreements
 
17,655,220

 
—

 
16,267,624

 
—

Credit default swaps
 
—

 
764,914

 
—

 
602,283

Swaptions
 
5,748,352

 
—

 
5,646,133

 
—

TBAs
 
1,959,495

 
1,234,769

 
1,588,630

 
783,227

Put and call options for TBAs
 
130,901

 
—

 
65,812

 
—

Constant maturity swaps
 
—

 
5,532,967

 
—

 
2,781,768

Short treasuries
 
—

 
26,703

 
—

 
13,425

Forward purchase commitment
 
—

 
297,207

 
—

 
174,920



19
Table of Contents

TWO HARBORS INVESTMENT CORP.  
Notes to the Condensed Consolidated Financial Statements (unaudited)

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 (loss) 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 June 30,
 
Six Months Ended June 30,
 
 
 
 
2013
 
2012
 
2013
 
2012
Risk Management Instruments
 
 
 
 
 
 
 
 
 
 
Interest Rate Contracts