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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended: September 30, 2023
OR
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☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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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1601 Utica Avenue South, Suite 900 | | |
St. Louis Park, | Minnesota | | 55416 |
(Address of Principal Executive Offices) | | (Zip Code) |
(612) 453-4100
(Registrant’s Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
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Title of Each Class: | | Trading Symbol(s) | | Name of Exchange on Which Registered: |
Common Stock, par value $0.01 per share | | TWO | | New York Stock Exchange |
8.125% Series A Cumulative Redeemable Preferred Stock | | TWO PRA | | New York Stock Exchange |
7.625% Series B Cumulative Redeemable Preferred Stock | | TWO PRB | | New York Stock Exchange |
7.25% Series C Cumulative Redeemable Preferred Stock | | TWO PRC | | New York Stock Exchange |
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer | ☒ | Accelerated filer | ☐ |
Non-accelerated filer | ☐ | Smaller reporting company | ☐ |
| | Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
As of October 26, 2023, there were 96,187,872 shares of outstanding common stock, par value $0.01 per share, issued and outstanding.
TWO HARBORS INVESTMENT CORP.
INDEX
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| PART I - FINANCIAL INFORMATION | |
Item 1. | Financial Statements (unaudited) | |
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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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| September 30, 2023 | | December 31, 2022 |
ASSETS | (unaudited) | | |
Available-for-sale securities, at fair value (amortized cost $9,497,257 and $8,114,627, respectively; allowance for credit losses $4,556 and $6,958, respectively) | $ | 8,830,726 | | | $ | 7,778,734 | |
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Mortgage servicing rights, at fair value | 3,213,113 | | | 2,984,937 | |
Cash and cash equivalents | 644,184 | | | 683,479 | |
Restricted cash | 400,777 | | | 443,026 | |
Accrued interest receivable | 39,038 | | | 36,018 | |
Due from counterparties | 315,467 | | | 253,374 | |
Derivative assets, at fair value | 20,592 | | | 26,438 | |
Reverse repurchase agreements | 282,767 | | | 1,066,935 | |
Other assets | 170,065 | | | 193,219 | |
Total Assets (1) | $ | 13,916,729 | | | $ | 13,466,160 | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | |
Liabilities: | | | |
Repurchase agreements | $ | 9,113,270 | | | $ | 8,603,011 | |
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Revolving credit facilities | 1,410,671 | | | 1,118,831 | |
Term notes payable | 295,025 | | | 398,011 | |
Convertible senior notes | 268,179 | | | 282,496 | |
Derivative liabilities, at fair value | 23,550 | | | 34,048 | |
Due to counterparties | 312,248 | | | 541,709 | |
Dividends payable | 55,675 | | | 64,504 | |
Accrued interest payable | 90,709 | | | 94,034 | |
Commitments and contingencies (see Note 16) | — | | | — | |
Other liabilities | 230,174 | | | 145,991 | |
Total Liabilities (1) | 11,799,501 | | | 11,282,635 | |
Stockholders’ Equity: | | | |
Preferred stock, par value $0.01 per share; 100,000,000 shares authorized and 25,578,232 and 26,092,050 shares issued and outstanding, respectively ($639,456 and $652,301 liquidation preference, respectively) | 618,579 | | | 630,999 | |
Common stock, par value $0.01 per share; 175,000,000 shares authorized and 96,186,425 and 86,428,845 shares issued and outstanding, respectively | 962 | | | 864 | |
Additional paid-in capital | 5,826,133 | | | 5,645,998 | |
Accumulated other comprehensive loss | (660,008) | | | (278,711) | |
Cumulative earnings | 1,782,654 | | | 1,453,371 | |
Cumulative distributions to stockholders | (5,451,092) | | | (5,268,996) | |
Total Stockholders’ Equity | 2,117,228 | | | 2,183,525 | |
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Total Liabilities and Stockholders’ Equity | $ | 13,916,729 | | | $ | 13,466,160 | |
____________________
(1)The condensed consolidated balance sheets include assets and liabilities of consolidated variable interest entities, or VIEs. At September 30, 2023 and December 31, 2022, assets of the VIEs totaled $462,004 and $497,921, and liabilities of the VIEs totaled $453,629 and $453,952, respectively. See Note 4 - 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 LOSS (unaudited)
(in thousands, except share data)
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| | Three Months Ended | | Nine Months Ended |
| | September 30, | | September 30, |
| | 2023 | | 2022 | | 2023 | | 2022 | | |
Interest income: | | | | | | | | |
Available-for-sale securities | | $ | 107,827 | | | $ | 88,472 | | | $ | 309,060 | | | $ | 188,518 | | | |
| | | | | | | | | | |
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Other | | 15,781 | | | 5,916 | | | 48,903 | | | 7,719 | | | |
Total interest income | | 123,608 | | | 94,388 | | | 357,963 | | | 196,237 | | | |
Interest expense: | | | | | | | | | | |
Repurchase agreements | | 129,298 | | | 57,868 | | | 350,599 | | | 85,480 | | | |
| | | | | | | | | | |
Revolving credit facilities | | 32,526 | | | 15,178 | | | 87,866 | | | 29,960 | | | |
Term notes payable | | 6,634 | | | 5,427 | | | 22,516 | | | 12,608 | | | |
Convertible senior notes | | 4,636 | | | 4,877 | | | 14,164 | | | 14,720 | | | |
| | | | | | | | | | |
Total interest expense | | 173,094 | | | 83,350 | | | 475,145 | | | 142,768 | | | |
Net interest (expense) income | | (49,486) | | | 11,038 | | | (117,182) | | | 53,469 | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Other income: | | | | | | | | | | |
(Loss) gain on investment securities | | (471) | | | (6,426) | | | 12,499 | | | (256,487) | | | |
Servicing income | | 178,625 | | | 148,833 | | | 507,168 | | | 442,985 | | | |
Gain (loss) on servicing asset | | 67,369 | | | (6,720) | | | 60,969 | | | 489,461 | | | |
Gain on interest rate swap and swaption agreements | | 111,909 | | | 34,806 | | | 86,288 | | | 29,499 | | | |
Gain (loss) on other derivative instruments | | 86,212 | | | 159,044 | | | (22,398) | | | (43,991) | | | |
Other income (loss) | | 2,903 | | | — | | | 5,103 | | | (117) | | | |
Total other income | | 446,547 | | | 329,537 | | | 649,629 | | | 661,350 | | | |
Expenses: | | | | | | | | | | |
| | | | | | | | | | |
Servicing expenses | | 29,903 | | | 21,152 | | | 83,459 | | | 68,847 | | | |
| | | | | | | | | | |
Compensation and benefits | | 8,617 | | | 10,100 | | | 31,568 | | | 33,312 | | | |
Other operating expenses | | 15,984 | | | 10,688 | | | 38,354 | | | 26,465 | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Total expenses | | 54,504 | | | 41,940 | | | 153,381 | | | 128,624 | | | |
Income before income taxes | | 342,557 | | | 298,635 | | | 379,066 | | | 586,195 | | | |
Provision for income taxes | | 36,365 | | | 21,023 | | | 52,237 | | | 95,733 | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Net income | | 306,192 | | | 277,612 | | | 326,829 | | | 490,462 | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Dividends on preferred stock | | (12,115) | | | (13,747) | | | (36,595) | | | (41,242) | | | |
Gain on repurchase and retirement of preferred stock | | — | | | — | | | 2,454 | | | — | | | |
Net income attributable to common stockholders | | $ | 294,077 | | | $ | 263,865 | | | $ | 292,688 | | | $ | 449,220 | | | |
Basic earnings per weighted average common share | | $ | 3.04 | | | $ | 3.04 | | | $ | 3.06 | | | $ | 5.19 | | | |
Diluted earnings per weighted average common share | | $ | 2.81 | | | $ | 2.78 | | | $ | 2.91 | | | $ | 4.80 | | | |
Dividends declared per common share | | $ | 0.45 | | | $ | 0.68 | | | $ | 1.50 | | | $ | 2.04 | | | |
Weighted average number of shares of common stock: | | | | | | | | | | |
Basic | | 96,176,287 | | | 86,252,104 | | | 95,059,856 | | | 86,107,979 | | | |
Diluted | | 105,628,130 | | | 96,132,100 | | | 104,849,018 | | | 96,120,844 | | | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (unaudited), continued
(in thousands, except share data)
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | September 30, | | September 30, |
| | 2023 | | 2022 | | 2023 | | 2022 | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Comprehensive loss: | | | | | | | | | | |
Net income | | $ | 306,192 | | | $ | 277,612 | | | $ | 326,829 | | | $ | 490,462 | | | |
Other comprehensive loss: | | | | | | | | | | |
Unrealized loss on available-for-sale securities | | (350,922) | | | (551,673) | | | (381,297) | | | (887,729) | | | |
Other comprehensive loss | | (350,922) | | | (551,673) | | | (381,297) | | | (887,729) | | | |
Comprehensive loss | | (44,730) | | | (274,061) | | | (54,468) | | | (397,267) | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Dividends on preferred stock | | (12,115) | | | (13,747) | | | (36,595) | | | (41,242) | | | |
Gain on repurchase and retirement of preferred stock | | — | | | — | | | 2,454 | | | — | | | |
Comprehensive loss attributable to common stockholders | | $ | (56,845) | | | $ | (287,808) | | | $ | (88,609) | | | $ | (438,509) | | | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (unaudited)
(in thousands)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Preferred Stock | | Common Stock Par Value | | Additional Paid-in Capital | | Accumulated Other Comprehensive Income (Loss) | | Cumulative Earnings | | Cumulative Distributions to Stockholders | | Total Stockholders’ Equity |
Balance, December 31, 2021 | $ | 702,550 | | | $ | 860 | | | $ | 5,627,758 | | | $ | 186,346 | | | $ | 1,212,983 | | | $ | (4,986,544) | | | $ | 2,743,953 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Net income | — | | | — | | | — | | | — | | | 285,270 | | | — | | | 285,270 | |
Other comprehensive loss before reclassifications | — | | | — | | | — | | | (323,490) | | | — | | | — | | | (323,490) | |
Amounts reclassified from accumulated other comprehensive income | — | | | — | | | — | | | (8,355) | | | — | | | — | | | (8,355) | |
Other comprehensive loss | — | | | — | | | — | | | (331,845) | | | — | | | — | | | (331,845) | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Issuance of common stock, net of offering costs | — | | | — | | | 323 | | | — | | | — | | | — | | | 323 | |
| | | | | | | | | | | | | |
Preferred dividends declared | — | | | — | | | — | | | — | | | — | | | (13,747) | | | (13,747) | |
Common dividends declared | — | | | — | | | — | | | — | | | — | | | (58,811) | | | (58,811) | |
| | | | | | | | | | | | | |
Non-cash equity award compensation | — | | | — | | | 4,161 | | | — | | | — | | | — | | | 4,161 | |
Balance, March 31, 2022 | 702,550 | | | 860 | | | 5,632,242 | | | (145,499) | | | 1,498,253 | | | (5,059,102) | | | 2,629,304 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Net loss | — | | | — | | | — | | | — | | | (72,420) | | | — | | | (72,420) | |
Other comprehensive loss before reclassifications | — | | | — | | | — | | | (141,843) | | | — | | | — | | | (141,843) | |
Amounts reclassified from accumulated other comprehensive income | — | | | — | | | — | | | 137,632 | | | — | | | — | | | 137,632 | |
Other comprehensive loss | — | | | — | | | — | | | (4,211) | | | — | | | — | | | (4,211) | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Issuance of common stock, net of offering costs | — | | | — | | | 82 | | | — | | | — | | | — | | | 82 | |
| | | | | | | | | | | | | |
Preferred dividends declared | — | | | — | | | — | | | — | | | — | | | (13,748) | | | (13,748) | |
Common dividends declared | — | | | — | | | — | | | — | | | — | | | (58,844) | | | (58,844) | |
| | | | | | | | | | | | | |
Non-cash equity award compensation | — | | | 1 | | | 3,460 | | | — | | | — | | | — | | | 3,461 | |
Balance, June 30, 2022 | 702,550 | | | 861 | | | 5,635,784 | | | (149,710) | | | 1,425,833 | | | (5,131,694) | | | 2,483,624 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Net income | — | | | — | | | — | | | — | | | 277,612 | | | — | | | 277,612 | |
Other comprehensive loss before reclassifications | — | | | — | | | — | | | (534,923) | | | — | | | — | | | (534,923) | |
Amounts reclassified from accumulated other comprehensive income | — | | | — | | | — | | | (16,750) | | | — | | | — | | | (16,750) | |
Other comprehensive loss | — | | | — | | | — | | | (551,673) | | | — | | | — | | | (551,673) | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Issuance of common stock, net of offering costs | — | | | 3 | | | 5,354 | | | — | | | — | | | — | | | 5,357 | |
| | | | | | | | | | | | | |
Preferred dividends declared | — | | | — | | | — | | | — | | | — | | | (13,747) | | | (13,747) | |
Common dividends declared | — | | | — | | | — | | | — | | | — | | | (59,051) | | | (59,051) | |
| | | | | | | | | | | | | |
Non-cash equity award compensation | — | | | — | | | 2,355 | | | — | | | — | | | — | | | 2,355 | |
Balance, September 30, 2022 | $ | 702,550 | | | $ | 864 | | | $ | 5,643,493 | | | $ | (701,383) | | | $ | 1,703,445 | | | $ | (5,204,492) | | | $ | 2,144,477 | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (unaudited), continued
(in thousands)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Preferred Stock | | Common Stock Par Value | | Additional Paid-in Capital | | Accumulated Other Comprehensive Income (Loss) | | Cumulative Earnings | | Cumulative Distributions to Stockholders | | Total Stockholders’ Equity |
Balance, December 31, 2022 | $ | 630,999 | | | $ | 864 | | | $ | 5,645,998 | | | $ | (278,711) | | | $ | 1,453,371 | | | $ | (5,268,996) | | | $ | 2,183,525 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Net loss | — | | | — | | | — | | | — | | | (176,808) | | | — | | | (176,808) | |
Other comprehensive income before reclassifications | — | | | — | | | — | | | 62,709 | | | — | | | — | | | 62,709 | |
Amounts reclassified from accumulated other comprehensive income | — | | | — | | | — | | | 63,222 | | | — | | | — | | | 63,222 | |
Other comprehensive income | — | | | — | | | — | | | 125,931 | | | — | | | — | | | 125,931 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Issuance of common stock, net of offering costs | — | | | 102 | | | 177,627 | | | — | | | — | | | — | | | 177,729 | |
| | | | | | | | | | | | | |
Preferred dividends declared | — | | | — | | | — | | | — | | | — | | | (12,365) | | | (12,365) | |
Common dividends declared | — | | | — | | | — | | | — | | | — | | | (58,381) | | | (58,381) | |
| | | | | | | | | | | | | |
Non-cash equity award compensation | — | | | 1 | | | 6,051 | | | — | | | — | | | — | | | 6,052 | |
Balance, March 31, 2023 | 630,999 | | | 967 | | | 5,829,676 | | | (152,780) | | | 1,276,563 | | | (5,339,742) | | | 2,245,683 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Net income | — | | | — | | | — | | | — | | | 197,445 | | | — | | | 197,445 | |
Other comprehensive loss before reclassifications | — | | | — | | | — | | | (156,306) | | | — | | | — | | | (156,306) | |
Amounts reclassified from accumulated other comprehensive income | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Other comprehensive loss | — | | | — | | | — | | | (156,306) | | | — | | | — | | | (156,306) | |
| | | | | | | | | | | | | |
Repurchase and retirement of preferred stock | (12,420) | | | — | | | — | | | — | | | 2,454 | | | — | | | (9,966) | |
Issuance of common stock, net of offering costs | — | | | — | | | 149 | | | — | | | — | | | — | | | 149 | |
Repurchase of common stock | — | | | (6) | | | (7,050) | | | — | | | — | | | — | | | (7,056) | |
Preferred dividends declared | — | | | — | | | — | | | — | | | — | | | (12,115) | | | (12,115) | |
Common dividends declared | — | | | — | | | — | | | — | | | — | | | (43,560) | | | (43,560) | |
| | | | | | | | | | | | | |
Non-cash equity award compensation | — | | | 1 | | | 1,734 | | | — | | | — | | | — | | | 1,735 | |
Balance, June 30, 2023 | 618,579 | | | 962 | | | 5,824,509 | | | (309,086) | | | 1,476,462 | | | (5,395,417) | | | 2,216,009 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Net income | — | | | — | | | — | | | — | | | 306,192 | | | — | | | 306,192 | |
Other comprehensive loss before reclassifications | — | | | — | | | — | | | (350,922) | | | — | | | — | | | (350,922) | |
Amounts reclassified from accumulated other comprehensive income | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Other comprehensive loss | — | | | — | | | — | | | (350,922) | | | — | | | — | | | (350,922) | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Issuance of common stock, net of offering costs | — | | | — | | | 48 | | | — | | | — | | | — | | | 48 | |
| | | | | | | | | | | | | |
Preferred dividends declared | — | | | — | | | — | | | — | | | — | | | (12,115) | | | (12,115) | |
Common dividends declared | — | | | — | | | — | | | — | | | — | | | (43,560) | | | (43,560) | |
| | | | | | | | | | | | | |
Non-cash equity award compensation | — | | | — | | | 1,576 | | | — | | | — | | | — | | | 1,576 | |
Balance, September 30, 2023 | $ | 618,579 | | | $ | 962 | | | $ | 5,826,133 | | | $ | (660,008) | | | $ | 1,782,654 | | | $ | (5,451,092) | | | $ | 2,117,228 | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(in thousands)
| | | | | | | | | | | | | | |
| | Nine Months Ended |
| | September 30, |
| | 2023 | | 2022 | | |
Cash Flows From Operating Activities: | | | | | | |
Net income | | $ | 326,829 | | | $ | 490,462 | | | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | |
Amortization of premiums and discounts on investment securities, net | | 21,686 | | | 70,254 | | | |
Amortization of deferred debt issuance costs on term notes payable and convertible senior notes | | 1,940 | | | 1,964 | | | |
(Reversal of) provision for credit losses on investment securities | | (217) | | | 3,048 | | | |
Realized and unrealized (gains) losses on investment securities | | (12,282) | | | 253,439 | | | |
Gain on servicing asset | | (60,969) | | | (489,461) | | | |
| | | | | | |
Realized and unrealized gain on interest rate swaps and swaptions | | (72,374) | | | (34,328) | | | |
Unrealized gains on other derivative instruments | | (49,296) | | | (52,105) | | | |
| | | | | | |
Gain on repurchase of outstanding borrowings | | (5,104) | | | — | | | |
Equity based compensation | | 9,363 | | | 9,977 | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
Net change in assets and liabilities: | | | | | | |
Increase in accrued interest receivable | | (3,020) | | | (11,435) | | | |
Decrease in deferred income taxes, net | | 46,740 | | | 95,647 | | | |
(Decrease) increase in accrued interest payable | | (3,325) | | | 30,210 | | | |
Change in other operating assets and liabilities, net | | 33,799 | | | 19,749 | | | |
| | | | | | |
Net cash provided by operating activities | | 233,770 | | | 387,421 | | | |
Cash Flows From Investing Activities: | | | | | | |
Purchases of available-for-sale securities | | (3,644,567) | | | (9,486,779) | | | |
Proceeds from sales of available-for-sale securities | | 1,694,891 | | | 5,022,894 | | | |
Principal payments on available-for-sale securities | | 507,200 | | | 937,275 | | | |
| | | | | | |
| | | | | | |
Purchases of mortgage servicing rights, net of purchase price adjustments | | (301,594) | | | (599,314) | | | |
Proceeds from sales of mortgage servicing rights | | 134,387 | | | 258,563 | | | |
(Purchases) short sales of derivative instruments, net | | (3,925) | | | (71,133) | | | |
Proceeds from sales and settlement (payments for termination and settlement) of derivative instruments, net | | 120,943 | | | 273,015 | | | |
| | | | | | |
| | | | | | |
| | | | | | |
Payments for reverse repurchase agreements | | (1,822,726) | | | (1,967,693) | | | |
Proceeds from reverse repurchase agreements | | 2,606,894 | | | 1,895,169 | | | |
Acquisition of RoundPoint Mortgage Servicing LLC, net of cash acquired | | 26,798 | | | — | | | |
| | | | | | |
(Decrease) increase in due to counterparties, net | | (291,554) | | | 104,525 | | | |
| | | | | | |
| | | | | | |
Net cash used in investing activities | | $ | (973,253) | | | $ | (3,633,478) | | | |
| | | | | | |
The accompanying notes are an integral part of these condensed consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited), continued
(in thousands)
| | | | | | | | | | | | | | |
| | | | | | |
| | | | | | |
| | Nine Months Ended |
| | September 30, |
| | 2023 | | 2022 | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
Cash Flows From Financing Activities: | | | | | | |
Proceeds from repurchase agreements | | $ | 30,770,899 | | | $ | 29,238,122 | | | |
Principal payments on repurchase agreements | | (30,260,640) | | | (26,860,549) | | | |
| | | | | | |
| | | | | | |
Proceeds from revolving credit facilities | | 349,000 | | | 720,000 | | | |
Principal payments on revolving credit facilities | | (57,160) | | | (9,600) | | | |
| | | | | | |
Repurchase of term notes payable | | (100,970) | | | — | | | |
| | | | | | |
Repurchase/repayment of convertible senior notes | | (13,169) | | | (143,774) | | | |
| | | | | | |
| | | | | | |
| | | | | | |
Repurchase and retirement of preferred stock | | (9,966) | | | — | | | |
Proceeds from issuance of common stock, net of offering costs | | 177,926 | | | 5,762 | | | |
| | | | | | |
| | | | | | |
Repurchase of common stock | | (7,056) | | | — | | | |
Dividends paid on preferred stock | | (36,845) | | | (41,242) | | | |
Dividends paid on common stock | | (154,080) | | | (176,316) | | | |
| | | | | | |
Net cash provided by financing activities | | 657,939 | | | 2,732,403 | | | |
Net decrease in cash, cash equivalents and restricted cash | | (81,544) | | | (513,654) | | | |
| | | | | | |
| | | | | | |
Cash, cash equivalents and restricted cash at beginning of period | | 1,126,505 | | | 2,088,670 | | | |
Cash, cash equivalents and restricted cash at end of period | | $ | 1,044,961 | | | $ | 1,575,016 | | | |
Supplemental Disclosure of Cash Flow Information: | | | | | | |
Cash paid for interest | | $ | 455,678 | | | $ | 92,473 | | | |
Cash paid (received) for taxes, net | | $ | 5,830 | | | $ | (468) | | | |
Noncash Activities: | | | | | | |
| | | | | | |
| | | | | | |
Dividends declared but not paid at end of period | | $ | 55,675 | | | $ | 72,802 | | | |
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. is a Maryland corporation that, through its wholly owned subsidiaries (collectively, the Company), invests in and manages Agency residential mortgage-backed securities, or Agency RMBS, mortgage servicing rights, or MSR, and other financial assets. Agency refers to a U.S. government sponsored enterprise, or GSE, such as the Federal National Mortgage Association (or Fannie Mae) or the Federal Home Loan Mortgage Corporation (or Freddie Mac), or a U.S. government agency such as the Government National Mortgage Association (or Ginnie Mae). The investment portfolio is managed as a whole and resources are allocated and financial performance is assessed on a consolidated basis. The Company’s common stock is listed on the NYSE under the symbol “TWO”.
On August 2, 2022, Matrix Financial Services Corporation, or Matrix, a wholly owned subsidiary of the Company, entered into a definitive stock purchase agreement to acquire RoundPoint Mortgage Servicing LLC (formerly RoundPoint Mortgage Servicing Corporation), or RoundPoint, from Freedom Mortgage Corporation, or Freedom. In connection with the acquisition, Matrix agreed to pay a purchase price upon closing in an amount equal to the tangible net book value of RoundPoint, plus a premium amount of $10.5 million, subject to certain additional post-closing adjustments. In connection with the transaction, RoundPoint divested its retail origination business as well as its RPX servicing exchange platform. Matrix also agreed to engage RoundPoint as a subservicer prior to the closing date and began transferring loans to RoundPoint in the fourth quarter of 2022. Management believes this acquisition will add value for stakeholders of the Company through cost savings achieved by bringing the servicing of its MSR portfolio in-house, greater control over the Company’s MSR portfolio and the associated cash flows, and the ability to participate more fully in the mortgage finance space as opportunities arise.
Effective September 30, 2023, the parties had satisfied customary closing conditions and received the required regulatory and GSE approvals to close the transaction. Upon closing, all servicing and origination licenses and operational capabilities remained with RoundPoint, and RoundPoint became a wholly owned subsidiary of Matrix. The provisional purchase price recognized was $44.7 million, with $23.6 million paid upon closing and $21.1 million recognized as a payable to Freedom within the other liabilities line item on the Company’s condensed consolidated balance sheets.
The Company has elected to be treated as a real estate investment trust, or REIT, as defined under the Internal Revenue Code of 1986, as amended, or the Code, for U.S. federal income tax purposes. 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.
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 the SEC. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, have been condensed or omitted according to such SEC rules and regulations. However, management believes that the disclosures included in these interim condensed consolidated financial statements are adequate to make the information presented not misleading.
The condensed consolidated financial statements of the Company include the accounts of all subsidiaries; inter-company accounts and transactions have been eliminated. All trust entities in which the Company holds investments that are considered variable interest entities, or VIEs, for financial reporting purposes were reviewed for consolidation under the applicable consolidation guidance. Whenever the Company has both the power to direct the activities of a trust that most significantly impact the entities’ performance, and the obligation to absorb losses or the right to receive benefits of the entities that could be significant, the Company consolidates the trust. Certain prior period amounts have been reclassified to conform to the current period presentation. All per share amounts, common shares outstanding and common equity-based awards for all prior periods reflect the Company’s one-for-four reverse stock split effected on November 1, 2022 at 5:01 p.m. Eastern Time (refer to Note 17 - Stockholders’ Equity for additional information). 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, 2022. In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at September 30, 2023 and results of operations for all periods presented have been made. The results of operations for the three and nine months ended September 30, 2023 should not be construed as indicative of the results to be expected for future periods or the full year.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make a number of significant estimates. These include estimates of fair value of certain assets and liabilities, amount and timing of credit losses, prepayment rates, and other estimates that affect the reported amounts of certain 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 in the market, 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.
Significant Accounting Policies
Included in Note 2 to the Consolidated Financial Statements of the Company’s 2022 Annual Report on Form 10-K is a summary of the Company’s significant accounting policies. Provided below is a summary of additional accounting policies that are significant to the Company’s financial condition and results of operations for the nine months ended September 30, 2023.
Business Combinations
Under Accounting Standards Codification (ASC) 805, Business Combinations, or ASC 805, an acquisition is considered a business combination when the assets acquired and liabilities assumed constitute a business. The acquisition method prescribed in ASC 805 requires, among other things, that the assets acquired and liabilities assumed be recognized at fair value as of the acquisition date. In a business combination, the initial allocation of the purchase price is considered preliminary and therefore subject to change until the end of the measurement period (up to one year from the acquisition date). Goodwill is calculated as the excess of the consideration transferred over the net assets acquired that meet the criteria for separate recognition and represents the estimated future economic benefits arising from these and other assets acquired that could not be individually identified or do not qualify for recognition as a separate asset. Goodwill is included within the other assets line item on the Company’s condensed consolidated balance sheets. Acquisition-related costs are expensed as incurred. The results of operations of acquired businesses are included from the date of acquisition.
Goodwill and Intangible Assets
On an annual basis, the Company qualitatively assesses its goodwill assigned to each of its reporting units during the fourth quarter of each year. This qualitative assessment evaluates various events and circumstances, such as macro-economic conditions, industry and market conditions, cost factors, relevant events and financial trends, that may impact a reporting unit’s fair value. Using this qualitative assessment, the Company determines whether it is more-likely-than-not that the reporting unit’s fair value exceeds its carrying value. If it is determined that it is not more-likely-than-not that the reporting unit’s fair value exceeds the carrying value, or upon consideration of other factors, including recent acquisition, restructuring or divestiture activity, the Company performs a quantitative, “step one” goodwill impairment analysis. In addition, the Company may test goodwill in between annual test dates if an event occurs or circumstances change that could more-likely-than-not reduce the fair value of a reporting unit below its carrying value. The Company did not recognize any goodwill impairment during the three and nine months ended September 30, 2023.
As a result of the RoundPoint acquisition, the Company identified intangible assets in the form of state licenses, GSE approvals and trade names. Intangible assets are included within the other assets line item on the Company’s condensed consolidated balance sheets. The Company recorded the intangible assets at fair value at the acquisition date and amortizes the value of finite-lived intangibles into expense over the expected useful life. Amortization of acquired intangible assets is included within the other operating expenses line item in the Company’s condensed consolidated statements of comprehensive loss. If impairment events occur, they could accelerate the timing of acquired intangible asset charges. Licenses and approvals acquired are deemed to have an indefinite useful life and are evaluated for impairment annually during the fourth quarter and in interim periods if indicators of impairment exist. The Company did not recognize any impairment on its intangible assets during the three and nine months ended September 30, 2023.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Recently Issued and/or Adopted Accounting Standards
Facilitation of the Effects of Reference Rate Reform on Financial Reporting
The London Interbank Offered Rate, or LIBOR, has been used extensively in the U.S. and globally as a “benchmark” or “reference rate” for various commercial and financial contracts, including corporate and municipal bonds and loans, floating rate mortgages, asset-backed securities, consumer loans, and interest rate swaps and other derivatives. On March 5, 2021, Intercontinental Exchange Inc. announced that ICE Benchmark Administration Limited, the administrator of LIBOR, intended to stop publication of the majority of USD-LIBOR tenors on June 30, 2023. In the U.S., the Alternative Reference Rates Committee, or ARRC, has identified the Secured Overnight Financing Rate, or SOFR, and, in some cases, the forward-looking term rate based on SOFR published by CME Group Benchmark Administration Limited, or Term SOFR, plus, in each case, a recommended spread adjustment, as its preferred alternative rates for U.S. dollar-based LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. Numerous industry wide and company-specific transitions as it relates to derivatives and cash markets exposed to LIBOR were completed in connection with its phase-out on June 30, 2023.
In March 2020, the FASB issued Accounting Standards Update (ASU) No. 2020-04, which provides temporary optional expedients and exceptions on accounting for contract modifications and hedging relationships for the purpose of the replacement of LIBOR with another reference rate. The guidance also provides a one-time election to sell held-to-maturity debt securities or to transfer such securities to the available-for-sale or trading category. The Company’s material contracts that are or were indexed to USD-LIBOR have been amended to transition to an alternative benchmark, where necessary. Any other unmodified agreements that incorporate LIBOR as the referenced rate either (i) already had provisions in place that provide for an alternative to LIBOR upon its phase-out or that are governed by the Adjustable Interest Rate (LIBOR) Act, or the LIBOR Act, (ii) matured or (iii) were terminated prior to June 30, 2023. The ASU was effective immediately for all entities and expires after December 31, 2024. The Company’s adoption of this ASU did not have an impact on the Company’s financial condition, results of operations or financial statement disclosures.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 3. Acquisition of RoundPoint Mortgage Servicing LLC
Effective September 30, 2023, the Company acquired RoundPoint from Freedom after the completion of customary closing conditions and receiving the required regulatory and GSE approvals. The provisional purchase price recognized was $44.7 million, with $23.6 million paid upon closing and $21.1 million recognized as a payable to Freedom within the other liabilities line item on the Company’s condensed consolidated balance sheets. The Company has performed a provisional allocation of the total consideration of $44.7 million to RoundPoint’s assets and liabilities, as set forth below. The final amount and allocation of total consideration may differ from the amounts included herein to reflect new information, assets acquired and liabilities assumed and the fair value of intangible assets that existed as of the acquisition date. The estimate of fair value of assets and liabilities required the use of significant assumptions and estimates. Significant estimates included, but were not limited to, future expected cash flows, including projected revenues and expenses, and discount rates. These estimates were based on assumptions that management believes to be reasonable as well as a third party-prepared valuation analysis; however, actual results may differ from these estimates. No measurement period adjustments were made during the three months ended September 30, 2023.
| | | | | | | | | | | | | | | | | |
| September 30, 2023 |
(in thousands) | Acquisition Date Amounts Recognized | | Subsequent Measurement Period Adjustments | | Acquisition Date Amounts Recognized, as adjusted |
Total Consideration | $ | 44,732 | | | $ | — | | | $ | 44,732 | |
Assets | | | | | |
Cash and cash equivalents | $ | 50,366 | | | $ | — | | | $ | 50,366 | |
| | | | | |
Intangible assets | 786 | | | — | | | 786 | |
Other assets | 29,148 | | | — | | | 29,148 | |
Total Assets Acquired | $ | 80,300 | | | $ | — | | | $ | 80,300 | |
Liabilities | | | | | |
Accrued expenses | $ | 4,483 | | | $ | — | | | $ | 4,483 | |
Other liabilities | 58,739 | | | — | | | 58,739 | |
Total Liabilities Assumed | $ | 63,222 | | | $ | — | | | $ | 63,222 | |
Net Assets | $ | 17,078 | | | $ | — | | | $ | 17,078 | |
Goodwill | $ | 27,654 | | | $ | — | | | $ | 27,654 | |
As a result of the RoundPoint acquisition, the Company identified intangible assets in the form of mortgage servicing and origination state licenses, insurance state licenses, GSE servicing approvals and trade names. The Company recorded the intangible assets at fair value at the acquisition date and amortizes the value of finite-lived intangibles into expense over the expected useful life. Trade names, with a total acquisition date fair value of $0.2 million, will be amortized straight-line over a finite life of six months based on the Company’s determination of the time to change a trade name. The Company determined the licenses and approvals, with a total acquisition date fair value of $0.6 million, have indefinite useful lives and will be periodically evaluated for impairment given there are no legal, regulatory, contractual, competitive, or economic factors that would limit their useful lives.
The total goodwill of $27.7 million was calculated as the excess of the consideration transferred over the net assets acquired and primarily includes the existence of an assembled workforce, synergies and benefits expected to result from combining operations with RoundPoint and adding in-house servicing. The full amount of goodwill for tax purposes of $29.0 million is expected to be deductible. The Company will assess the goodwill annually during the fourth quarter and in interim periods whenever events or circumstances make it more likely than not that an impairment may have occurred.
Acquisition-related costs are expensed in the period incurred and included within the other operating expenses line item in the Company’s condensed consolidated statements of comprehensive loss. During the three and nine months ended September 30, 2023, the Company recognized $1.1 million and $1.2 million, respectively, of acquisition-related costs. During both the three and nine months ended September 30, 2022, the Company recognized $0.8 million of acquisition-related costs.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
As discussed above, the acquisition of RoundPoint closed effective September 30, 2023. Accordingly, RoundPoint’s consolidated balance sheet is included within the Company’s consolidated balance sheet as of September 30, 2023; however, RoundPoint’s results of operations are not included within the Company’s results of operations for the periods presented. Beginning October 1, 2023, RoundPoint’s results of operations will be consolidated with the Company’s in accordance with U.S. GAAP. The following table presents unaudited pro forma combined revenues and income before income taxes for the three and nine months ended September 30, 2023 prepared as if the RoundPoint acquisition had been consummated on January 1, 2022.
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, | | September 30, |
(in thousands) | 2023 | | 2022 | | 2023 | | 2022 | | |
Revenue (1) | $ | 585,641 | | | $ | 435,563 | | | $ | 1,044,039 | | | $ | 979,098 | | | |
Income before income taxes | $ | 339,009 | | | $ | 271,426 | | | $ | 357,636 | | | $ | 540,740 | | | |
____________________
(1)The Company’s revenue is defined as the sum of the total interest income and total other income line items on the condensed consolidated statements of comprehensive loss.
The above unaudited supplemental pro forma financial information has not been adjusted for transactions that are now considered inter-company as a result of the acquisition, the conforming of accounting policies, nor the divestiture of RoundPoint’s retail origination business and RPX servicing exchange platform, as required by the stock purchase agreement. The unaudited supplemental pro forma financial information also does not include any anticipated synergies or other anticipated benefits of the RoundPoint acquisition and, accordingly, the unaudited supplemental pro forma financial information is not necessarily indicative of either future results of operations or results that might have been achieved had the acquisition been consummated on January 1, 2022.
Note 4. Variable Interest Entities
The Company enters into transactions with subsidiary trust entities that are established for limited purposes. One of the Company’s subsidiary trust entities, MSR Issuer Trust, was formed for the purpose of financing MSR through securitization, pursuant to which, through two of the Company’s wholly owned subsidiaries, MSR is pledged to MSR Issuer Trust and in return, MSR Issuer Trust issues term notes to qualified institutional buyers and a variable funding note, or VFN, to one of the subsidiaries, in each case secured on a pari passu basis. The Company has one repurchase facility that is secured by the VFN, which is collateralized by the Company’s MSR.
Another of the Company’s subsidiary trust entities, Servicing Advance Receivables Issuer Trust, was formed for the purpose of financing servicing advances through a revolving credit facility, pursuant to which Servicing Advance Receivables Issuer Trust issued a VFN backed by servicing advances pledged to the financing counterparty.
Both MSR Issuer Trust and Servicing Advance Receivables Issuer Trust are considered VIEs for financial reporting purposes and were reviewed for consolidation under the applicable consolidation guidance. As the Company has both the power to direct the activities of the trusts that most significantly impact the entities’ performance, and the obligation to absorb losses or the right to receive benefits of the entities that could be significant, the Company is the primary beneficiary and, thus, consolidates the trusts. Additionally, in accordance with arrangements entered into in connection with the securitization transaction and the servicing advance revolving credit facility, the Company has direct financial obligations payable to both MSR Issuer Trust and Servicing Advance Receivables Issuer Trust, which, in turn, support MSR Issuer Trust’s obligations to noteholders under the securitization transaction and Servicing Advance Receivables Issuer Trust’s obligations to the financing counterparty.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following table presents a summary of the assets and liabilities of all consolidated trusts as reported on the condensed consolidated balance sheets as of September 30, 2023 and December 31, 2022:
| | | | | | | | | | | |
(in thousands) | September 30, 2023 | | December 31, 2022 |
Note receivable (1) | $ | 398,985 | | | $ | 398,011 | |
| | | |
Restricted cash | 19,795 | | | 31,691 | |
Accrued interest receivable (1) | 549 | | | 400 | |
Other assets | 42,675 |