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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For the Fiscal Year Ended: December 31, 2022
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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Commission File Number 001-34506
TWO HARBORS INVESTMENT CORP.
(Exact Name of Registrant as Specified in Its Charter)
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Maryland |
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27-0312904 |
(State or Other Jurisdiction of
Incorporation or Organization) |
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(I.R.S. Employer
Identification No.) |
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1601 Utica Avenue South, Suite 900 |
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St. Louis Park, |
Minnesota |
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55416 |
(Address of Principal Executive Offices) |
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(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: |
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Trading Symbol(s) |
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Name of Exchange on Which Registered: |
Common Stock, par value $0.01 per share |
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TWO |
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New York Stock Exchange |
8.125% Series A Cumulative Redeemable Preferred Stock |
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TWO PRA |
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New York Stock Exchange |
7.625% Series B Cumulative Redeemable Preferred Stock |
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TWO PRB |
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New York Stock Exchange |
7.25% Series C Cumulative Redeemable Preferred Stock |
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TWO PRC |
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New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes
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No
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Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act.
Yes
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No
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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
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No
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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
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No
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Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated filer,
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 |
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Accelerated filer |
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Non-accelerated filer |
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Smaller reporting company |
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Emerging growth company |
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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.
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Indicate by check mark whether the registrant has filed a report on
and attestation to its management’s assessment of the effectiveness
of its internal control over financial reporting under Section
404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the
registered public accounting firm that prepared or issued its audit
report.
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If securities are registered pursuant to Section 12(b) of the Act,
indicate by check mark whether the financial statements of the
registrant included in the filing reflect the correction of an
error to previously issued financial statements.
☐
Indicate by check mark whether any of those error corrections are
restatements that required a recovery analysis of incentive-based
compensation received by any of the registrant’s executive officers
during the relevant recovery period pursuant to
§240.10D-1(b).
☐
Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Act). Yes
☐
No
☒
As of June 30, 2022, the aggregate market value of the
registrant’s common stock held by non-affiliates of the registrant
was approximately $1.7 billion based on the closing sale price as
reported on the NYSE on that date.
As of February 21, 2023, there were 96,616,279 shares of
common stock, par value $0.01 per share, issued and
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the
2023 Annual Meeting of Stockholders, which will be filed with the
Securities and Exchange Commission under Regulation 14A within 120
days after the end of registrant’s fiscal year covered by this
Annual Report, are incorporated by reference into Part
III.
TWO HARBORS INVESTMENT CORP.
2022 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
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PART I |
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PART II |
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PART III |
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PART IV |
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PART I
Item 1. Business
Overview
Two Harbors Investment Corp. is a Maryland corporation focused on
investing in, financing and managing Agency residential
mortgage-backed securities, or Agency RMBS, mortgage servicing
rights, or MSR, and other financial assets, which we collectively
refer to as our target assets. We operate as a real estate
investment trust, or REIT, as defined under the Internal Revenue
Code of 1986, as amended, or the Code. The terms “Two Harbors,”
“we,” “our,” “us” and the “company” refer to Two Harbors Investment
Corp. and its subsidiaries as a consolidated entity.
We were 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 our
wholly owned indirect subsidiary as a result of the merger. Our
common stock is listed on the New York Stock Exchange, or NYSE,
under the symbol “TWO”.
Our objective is to provide attractive risk-adjusted total return
to our stockholders over the long term, primarily through dividends
and secondarily through capital appreciation. We acquire and manage
an investment portfolio of our target assets, which include the
following:
•Agency
RMBS, meaning RMBS whose principal and interest payments are
guaranteed by a U.S. government agency, such as the Government
National Mortgage Association (or Ginnie Mae), or 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);
•MSR;
and
•Other
financial assets comprising approximately 5% to 10% of the
portfolio.
We seek to deploy moderate leverage as part of our investment
strategy. We generally finance our Agency RMBS through short- and
long-term borrowings structured as repurchase agreements. We also
finance our MSR through revolving credit facilities, repurchase
agreements, term notes payable and convertible senior
notes.
We have elected to be treated as a REIT for U.S. federal income tax
purposes. To qualify as a REIT, we are required to meet certain
investment and operating tests and annual distribution
requirements. We generally will not be subject to U.S. federal
income taxes on our taxable income to the extent that we annually
distribute all of our net taxable income to stockholders, do not
participate in prohibited transactions and maintain our intended
qualification as a REIT. However, certain activities that we may
perform may cause us to earn income which will not be qualifying
income for REIT purposes. We have designated certain of our
subsidiaries as taxable REIT subsidiaries, or TRSs, as defined in
the Code, to engage in such activities, and we may form additional
TRSs in the future. We also operate our business in a manner that
will permit us to maintain our exemption from registration under
the Investment Company Act of 1940, as amended, or the 1940
Act.
Our team of investment professionals has broad experience in
managing our target assets and has demonstrated the ability to
generate attractive risk-adjusted returns under different market
conditions and cycles. We have extensive long-term relationships
with financial intermediaries, including prime brokers, investment
banks, broker-dealers and asset custodians. We believe these
relationships enhance our ability to source, finance, protect and
hedge our investments and, thus, enable us to succeed in various
credit and interest rate environments. We also benefit from our
risk management, accounting, operations, legal, compliance and
information technology teams.
On August 2, 2022, Matrix Financial Services Corporation, or
Matrix, one of our wholly owned subsidiaries, entered into a
definitive stock purchase agreement to acquire RoundPoint Mortgage
Servicing Corporation, or RoundPoint, from Freedom Mortgage
Corporation. In connection with the acquisition, Matrix has 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 will
divest 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. Upon closing, all
servicing licenses and operational capabilities will remain with
RoundPoint, and RoundPoint will become a wholly owned subsidiary of
Matrix. The parties expect to close the transaction in 2023,
subject to the satisfaction of customary closing conditions and the
receipt of required regulatory and GSE approvals.
Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains, or incorporates by
reference, not only historical information, but also
forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, or the Securities Act, and
Section 21E of the Securities Exchange Act of 1934, or the Exchange
Act, and that are subject to the safe harbors created by such
sections. Forward-looking statements involve numerous risks and
uncertainties. Our actual results may differ from our beliefs,
expectations, estimates, and projections and, consequently, you
should not rely on these forward-looking statements as predictions
of future events. Forward-looking statements are not historical in
nature and can be identified by words such as “anticipate,”
“estimate,” “will,” “should,” “expect,” “target,” “believe,”
“intend,” “seek,” “plan,” “goals,” “future,” “likely,” “may,” and
similar expressions or their negative forms, or by references to
strategy, plans, or intentions. These forward-looking statements
are subject to risks and uncertainties, including, among other
things, those described in this Annual Report on Form 10-K under
the caption “Risk Factors.” Other risks, uncertainties, and factors
that could cause actual results to differ materially from those
projected are described below and may be described from time to
time in reports we file with the Securities and Exchange
Commission, or the SEC, including our Quarterly Reports on Form
10-Q and Current Reports on Form 8-K. Forward-looking statements
speak only as of the date they are made, and we undertake no
obligation to update or revise any such forward-looking statements,
whether as a result of new information, future events, or
otherwise.
Important factors, among others, that may affect our actual results
include:
•changes
in interest rates and the market value of our target
assets;
•changes
in prepayment rates of mortgages underlying our target
assets;
•the
state of the credit markets and other general economic conditions,
particularly as they affect the price of earning assets, the credit
status of borrowers and home prices;
•legislative
and regulatory actions affecting our business;
•the
availability and cost of our target assets;
•the
availability and cost of financing for our target assets, including
repurchase agreement financing, revolving credit facilities, term
notes and convertible notes;
•the
impact of any increases in payment delinquencies and defaults on
the mortgages comprising and underlying our target assets,
including additional servicing costs and servicing advance
obligations on the MSR assets we own;
•changes
in liquidity in the market for real estate securities, the
re-pricing of credit risk in the capital markets, inaccurate
ratings of securities by rating agencies, rating agency downgrades
of securities, and increases in the supply of real estate
securities available-for-sale;
•changes
in the values of securities we own and the impact of adjustments
reflecting those changes on our consolidated statements of
comprehensive loss and balance sheets, including our stockholders’
equity;
•our
ability to generate cash flow from our target assets;
•our
ability to effectively execute and realize the benefits of
strategic transactions and initiatives we have pursued or may in
the future pursue;
•our
ability to recognize the benefits of our pending acquisition of
RoundPoint Mortgage Servicing Corporation;
•our
decision to terminate our Management Agreement with PRCM Advisers
LLC and the ongoing litigation related to such
termination;
•changes
in the competitive landscape within our industry, including changes
that may affect our ability to attract and retain
personnel;
•our
exposure to legal and regulatory claims, penalties or enforcement
activities, including those arising from our ownership and
management of MSR and prior securitization
transactions;
•our
exposure to counterparties involved in our MSR business and prior
securitization transactions and our ability to enforce
representations and warranties made by them;
•our
ability to acquire MSR and successfully operate our seller-servicer
subsidiary and oversee the activities of our
subservicers;
•our
ability to manage various operational and regulatory risks
associated with our business;
•interruptions
in or impairments to our communications and information technology
systems;
•our
ability to maintain appropriate internal controls over financial
reporting;
•our
ability to establish, adjust and maintain appropriate hedges for
the risks in our portfolio;
•our
ability to maintain our REIT qualification for U.S. federal income
tax purposes; and
•limitations
imposed on our business due to our REIT status and our status as
exempt from registration under the 1940 Act.
This Annual Report on Form 10-K may contain statistics and other
data that, in some cases, have been obtained or compiled from
information made available by mortgage loan servicers and other
third-party service providers.
Our Business
Our Investment Strategy
Our investment objective is to provide attractive risk-adjusted
total return to our stockholders over the long term, primarily
through dividends and secondarily through capital appreciation. We
intend to achieve this objective by constructing a well-balanced
portfolio consisting of Agency RMBS, MSR and other financial
assets, with a focus on managing various associated risks,
including interest rate, prepayment, credit, mortgage spread and
financing risk. The preservation of book value is of paramount
importance to our ability to generate total return on an ongoing
basis.
Our investment team makes investment decisions based on a rigorous
asset selection process that takes into consideration a variety of
factors, including expected cash yield, risk-adjusted returns,
current and projected credit fundamentals, current and projected
macroeconomic considerations, current and projected supply and
demand, credit and market risk concentration limits, liquidity,
cost of financing and financing availability. It is our intention
to select our assets in such a way as to maintain our REIT
qualification and our exemption from registration under the 1940
Act.
Our Target Assets
Our portfolio includes assets that are primarily sensitive to
changes in interest rates, prepayments and mortgage spreads,
including but not limited to Agency RMBS, MSR and related hedging
transactions. These assets have minimal exposure to the underlying
credit performance of the investments. Our portfolio is managed as
a whole and our resources are allocated and financial performance
is assessed on a consolidated basis. Our target asset classes are
as follows:
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Agency RMBS |
Agency RMBS collateralized by fixed rate mortgage loans,
adjustable-rate mortgage (or ARM) loans or hybrid mortgage loans,
or derivatives thereof, including: |
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mortgage pass-through certificates; |
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collateralized mortgage obligations; |
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uniform mortgage-backed securities; |
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Freddie Mac gold certificates; |
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Fannie Mae certificates; |
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Ginnie Mae certificates; |
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“to-be-announced” forward contracts, or TBAs, which are pools of
mortgages with specific investment terms to be issued by Ginnie
Mae, Fannie Mae or Freddie Mac at a future date; and
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interest-only and inverse interest-only securities. |
MSR |
The right to control the servicing of residential mortgage loans,
receive the servicing income therefrom and the obligation to
service the loans in accordance with relevant standards; the actual
servicing functions are outsourced to appropriately licensed
third-party subservicers, which service the loans in their own
names. |
Other assets may include financial and mortgage-related assets
other than our target assets, including non-Agency securities
(securities that are not issued or guaranteed by Ginnie Mae, Fannie
Mae or Freddie Mac) and certain non-hedging transactions that may
produce non-qualifying income for purposes of the REIT gross income
tests.
Our Investment Activities
Our Agency RMBS portfolio is comprised primarily of fixed rate
mortgage-backed securities backed by single-family and multi-family
mortgage loans. All of our principal and interest Agency RMBS are
Fannie Mae or Freddie Mac mortgage pass-through certificates or
collateralized mortgage obligations, or Ginnie Mae mortgage
pass-through certificates, which are backed by the guarantee of the
U.S. government. The majority of these securities consist of whole
pools in which we own all of the investment interests in the
securities.
One of our wholly owned subsidiaries holds the requisite approvals
from Fannie Mae and Freddie Mac to own and manage MSR, which
represent a contractual right to control the servicing of a
mortgage loan, the obligation to service the loan in accordance
with relevant standards and the right to collect a fee for the
performance of servicing activities, such as collecting principal
and interest from a borrower and distributing those payments to the
owner of the loan. We do not directly service the mortgage loans
underlying the MSR we acquire; rather, we contract with
appropriately licensed third-party subservicers to handle
substantially all servicing functions in the name of the
subservicer for the loans underlying our MSR. As the servicer of
record, however, we remain accountable to the GSEs for all
servicing matters and, accordingly, provide substantial oversight
of each of our subservicers. We believe MSR are a natural fit for
our portfolio over the long term. Our MSR business leverages our
core competencies in prepayment and credit risk analytics and the
MSR assets may provide offsetting risks to our Agency RMBS, hedging
both interest rate and mortgage spread risk.
In making our capital allocation decisions, we take into
consideration a number of factors, including the opportunities
available in the marketplace, the cost and availability of
financing, and the cost of hedging interest rate, prepayment,
credit and other portfolio risks. In the ordinary course of
business, we make investment decisions and allocate capital in
accordance with our views on the changing risk/reward dynamics in
the market and in our portfolio. Going forward, we expect our
capital to be fully allocated to our strategy of pairing Agency
RMBS and MSR. We have expertise in mortgage credit and may choose
to invest again in those assets should the opportunity
arise.
Our Investment Guidelines
Our board of directors has approved the following investment
guidelines:
•no
investment shall be made that would cause us to fail to qualify as
a REIT for U.S. federal income tax purposes;
•no
investment shall be made that would cause us to be regulated as an
investment company under the 1940 Act;
•we
will primarily invest within our target assets, consisting
primarily of Agency RMBS, non-Agency securities, residential
mortgage loans, MSR and certain types of commercial real estate
assets; approximately 5% to 10% of our portfolio may include other
financial assets; and
•until
appropriate investments can be identified, we will invest available
cash in interest-bearing and short-term investments that are
consistent with (i) our intention to qualify as a REIT and (ii) our
exemption from investment company status under the 1940
Act.
These investment guidelines may be changed from time to time by our
board of directors in its discretion without the approval of our
stockholders.
Within the constraints of the foregoing investment guidelines, we
have broad authority to select, finance and manage our investment
portfolio. As a general matter, our investment strategy is designed
to enable us to:
•build
an investment portfolio consisting of Agency RMBS, MSR and other
financial assets that will generate attractive returns while having
a moderate risk profile;
•manage
financing, interest, prepayment rate, credit and similar
risks;
•capitalize
on discrepancies in the relative valuations in the mortgage and
housing markets; and
•provide
regular quarterly dividend distributions to
stockholders.
Within the requirements of the investment guidelines, we make
determinations as to the percentage of our assets that will be
invested in each of our target assets. Our investment decisions
depend on prevailing market conditions and may change over time in
response to opportunities available in different interest rate,
economic and credit environments. As a result, we cannot predict
the percentage of our assets that will be invested in any of our
target asset classes at any given time. We believe that the
diversification of our portfolio of assets and the flexibility of
our strategy, combined with the expertise of our investment team,
will enable us to achieve attractive risk-adjusted total return
under a variety of market conditions and economic
cycles.
Financing Strategy
We deploy moderate leverage to fund the acquisition of our target
assets and increase potential returns to our stockholders. We are
not required to maintain any particular leverage ratio. The amount
of leverage we deploy for particular investments in our target
assets depends upon a variety of factors, including without
limitation: general economic, political and financial market
conditions; the anticipated liquidity and price volatility of our
assets; the gap between the duration of assets and liabilities,
including hedges; the availability and cost of financing our
assets; our opinion of the credit worthiness of financing
counterparties; the health of the U.S. residential mortgage and
housing markets; our outlook for the level, slope and volatility of
interest rates; the credit quality of the loans underlying our
target assets; the rating assigned to securities; and our outlook
for asset spreads relative to the London Interbank Offered Rate, or
LIBOR, curve, the Secured Overnight Financing Rate, or SOFR, curve,
the Overnight Index Swap Rate, or OIS, the U.S. federal funds rate,
and other benchmark rate curves.
Our primary financing sources for Agency RMBS are repurchase
agreements. Repurchase agreements are financings pursuant to which
one party, the seller/borrower, sells assets to the repurchase
agreement counterparty, the buyer/lender, for an agreed price with
the obligation to repurchase the assets from the buyer at a future
date and at a price different than the original purchase price,
with the difference representing the borrowing rate (typically
based on an index plus a spread consistent with those demanded in
the market). The amount of financing available under a repurchase
agreement is limited to a specified percentage of the estimated
market value of the assets. The difference between the sale price
and repurchase price is the interest expense of financing under a
repurchase agreement. Under repurchase agreement financing
arrangements, if the value of the collateral decreases, the buyer
could require the seller to provide additional cash collateral to
re-establish the ratio of value of the collateral to the amount of
borrowing (i.e.,
a margin call). In the current economic climate, lenders under
repurchase agreements generally advance approximately 95% to 97% of
the market value of the Agency RMBS financed (a discount from
market value, generally referred to as a haircut, of 3% to
5%).
To finance MSR assets and related servicing advance obligations, we
may enter into repurchase agreements, revolving credit facilities
and securitization transactions collateralized by the value of the
MSR and/or servicing advances pledged and with borrowing rates
typically based on an index plus a spread consistent with those
demanded in the market. If the value of our MSR and/or servicing
advances pledged as collateral for the agreements decreases, the
respective lender could require us to provide additional collateral
or cash as collateral to re-establish the ratio of value of the
collateral to the amount of the debt outstanding. Due to certain
GSE requirements, we may be restricted as to the frequency in which
we are able to pledge additional MSR and/or servicing advance
collateral to counterparties. As a result, we may choose to
over-collateralize certain financing arrangements in order to avoid
having to provide cash as additional collateral. Lenders generally
advance approximately 60% to 70% of the market value of the MSR
financed (i.e.,
a haircut of 30% to 40%) and 80% to 95% of the value of servicing
advances financed (i.e.,
a haircut of 5% to 20%), depending on the type of advance
(e.g.,
corporate, escrow).
One of our subsidiary trust entities, MSR Issuer Trust, was formed
for the purpose of financing MSR through securitization, pursuant
to which, through two of our 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. In connection with the transaction, we also
entered into a repurchase facility that is secured by the VFN
issued in connection with the MSR securitization transaction, which
is collateralized by our MSR.
A significant decrease in the advance rate or an increase in the
haircut could result in us having to sell assets in order to meet
additional margin requirements by the lender. We expect to mitigate
our risk of margin calls under financing arrangements by deploying
leverage at an amount that is below what could be used under
current advance rates.
In order to reduce our exposure to risks associated with lender
counterparty concentration, we generally seek to diversify our
exposure by entering into repurchase agreements with multiple
counterparties. At December 31, 2022, we had $8.6 billion of
outstanding balances under repurchase agreements with 20
counterparties, with a maximum net exposure (the difference between
the amount loaned to us, including interest payable, and the value
of the assets pledged by us as collateral, including accrued
interest receivable on such assets) to any single lender of
$158.3 million, or 7.2% of stockholders’ equity.
Interest Rate Hedging and Risk Management Strategy
We may enter into a variety of derivative and non-derivative
instruments to economically hedge interest rate risk or “duration
mismatch (or gap)” by adjusting the duration of our floating-rate
borrowings into fixed-rate borrowings to more closely match the
duration of our assets. This particularly applies to borrowing
agreements with maturities or interest rate resets of less than six
months. Typically, the interest receivable terms
(i.e.,
LIBOR, OIS or SOFR) of certain derivatives match the terms of the
underlying debt, resulting in an effective conversion of the rate
of the related borrowing agreement from floating to fixed. The
objective is to manage the cash flows associated with current and
anticipated interest payments on borrowings, as well as the ability
to roll or refinance borrowings at the desired amount by adjusting
the duration. To help manage the adverse impact of interest rate
changes on the value of our portfolio as well as our cash flows, we
may, at times, enter into various forward contracts, including
short securities, TBAs, options, futures, swaps, caps, credit
default swaps and total return swaps. In executing on our current
interest rate risk management strategy, we have entered into TBAs,
interest rate swap and swaption agreements, futures and options on
futures. In addition, because MSR are negative duration assets,
they may provide a hedge to interest rate exposure on our Agency
RMBS portfolio. In hedging interest rate risk, we seek to reduce
the risk of losses on the value of our investments that may result
from changes in interest rates in the broader markets, improve
risk-adjusted returns and, where possible, obtain a favorable
spread between the yield on our assets and the cost of our
financing.
Human Capital
We believe that our people are the foundation of our success. We
are dedicated to providing human capital management best practices
that evolve with the needs of our business and our people. We are
committed to attracting and retaining the industry’s top talent by
providing competitive wages and benefits and cultivating a
workplace environment in which all of our employees can thrive and
contribute. As of December 31, 2022, we had 97 full time
equivalent employees based out of our two office locations in
Minneapolis, Minnesota and New York, New York.
Compensation and Benefits.
We use market data to benchmark and guide our compensation
practices to ensure that our compensation program is industry
standard, competitive and rewarding, while at the same time
aligning the interests of our employees with those of our
stockholders. In addition to competitive wages and salaries, our
compensation programs are designed to attract and retain talented
professionals. Our overall package includes cash bonus and equity
incentive compensation opportunities, a 401(k) plan and
profit-sharing contribution, employer-paid health benefits, health
savings and dependent care flexible spending accounts, generous
paid time off, short- and long-term disability insurance, a variety
of personal and family leave options, life-planning financial and
legal resources, and other voluntary supplemental
benefits.
Professional Development.
We encourage the professional development of our people through
regular leadership development training, talent management and
tuition reimbursement programs. We also offer a wide variety of
educational opportunities through our educational platforms, Two
Harbors University and a learning management system. We encourage
collaboration and teamwork to ensure mutual understanding of
responsibilities, priorities and expectations. We thoughtfully plan
for our collective success by aligning individual employee and
company goals.
Health, Safety and Well-being.
We sponsor a number of programs and events that emphasize the
health and well-being of our employees, including relational,
financial, emotional and physical. We promote a culture of health
and well-being through employee assistance program services,
comprehensive health care benefits and resources for preventative
health, such as reduced-fee health club memberships. Throughout the
course of the COVID-19 pandemic, we have put the health and safety
of our employees and their families first, initially supporting
comprehensive work-from-home policies and subsequently implementing
a work-life integration and flexibility policy after our return to
the office in-person. In addition, we established enhanced safety
measures and precautions in both of our offices as recommended by
the federal, state and our local agencies.
Workplace Culture.
We strive to foster a workplace culture where every individual on
our team brings their unique perspectives, abilities and
experiences which contribute to driving our organizational value.
We are committed to supporting the engagement and leadership of a
diverse workforce, with over 50% in aggregate identifying as either
female or racially/ethnically diverse and providing opportunities
for collaboration, development and career growth. We conduct an
annual pulse survey which provides valuable insights from employees
on topics involving culture, diversity and inclusion, education,
benefits and engagement, and pride ourselves on having a strong
participation rate. We also offer a flexible work environment,
providing employees the opportunity to balance their professional
obligations with that of their personal.
Charitable Partnerships.
We are committed to strengthening our local communities through the
support of charitable organizations allied with the housing sector,
and in particular those that provide housing support to families
and children in need. Examples of our support include partnerships
with AEON, Simpson Housing and Habitat for Humanity. In addition,
we match dollar-for-dollar the cash donations made by our employees
to our charitable partnerships.
Operating and Regulatory Structure
Our business is subject to extensive regulation by U.S. federal and
state governmental authorities, and self-regulatory organizations.
We are required to comply with numerous federal and state laws,
including those described below. The laws, rules and regulations
comprising this regulatory framework change frequently, as can the
interpretation and enforcement of existing laws, rules and
regulations. Some of the laws, rules and regulations to which we
are subject are intended primarily to safeguard and protect
consumers, rather than stockholders or creditors. On occasion, we
may receive requests from U.S. federal and state agencies for
records, documents and information regarding our policies,
procedures and practices regarding our business activities. We
incur significant ongoing costs to comply with these
regulations.
REIT Qualification
We elected to be taxed as a REIT under the Code, commencing with
our taxable period ended December 31, 2009. Our qualification as a
REIT depends upon our ability to meet on a continuing basis,
through actual investment and operating results, various complex
requirements under the Code relating to, among other things, the
sources of our gross income, the composition and value of our
assets, our distribution levels and the diversity of ownership of
our shares. We believe that we are organized in conformity with the
requirements for qualification and taxation as a REIT under the
Code, and we conduct our operations in a manner which will enable
us to continue to meet the requirements for qualification and
taxation as a REIT. Certain activities that we may perform may
cause us to earn income that will not be qualifying income for REIT
purposes. We have designated certain of our subsidiaries as TRSs to
engage in such activities, and we may in the future form additional
TRSs.
As long as we continue to qualify as a REIT, we generally will not
be subject to U.S. federal income tax on the REIT taxable income we
distribute currently to our stockholders. If we fail to qualify as
a REIT in any taxable year and do not qualify for certain statutory
relief provisions, we will be subject to U.S. federal income tax at
regular corporate rates and may be precluded from qualifying as a
REIT for the subsequent four taxable years following the year
during which we lost our REIT qualification. Even if we qualify for
taxation as a REIT, we may be subject to certain U.S. federal,
state and local taxes on our income or property.
Investment Company Act of 1940
We conduct our operations so that we are not required to register
as an investment company under the 1940 Act. If we were to fall
within the definition of an investment company, we would be unable
to conduct our business as described in this Annual Report on Form
10-K.
Section 3(a)(1)(A) of the 1940 Act defines an investment company as
any issuer that “is or holds itself out as being engaged primarily
in the business of investing, reinvesting or trading in
securities.” Section 3(a)(1)(C) of the 1940 Act also defines
an investment company as any issuer that “is engaged or proposes to
engage in the business of investing, reinvesting, owning, holding
or trading in securities and owns or proposes to acquire investment
securities having a value exceeding 40% of the value of the
issuer’s total assets (exclusive of U.S. government securities and
cash items) on an unconsolidated basis.” Excluded from the term
“investment securities,” among other things, are U.S. government
securities and securities issued by majority-owned subsidiaries
that are not themselves investment companies and are not relying on
the exclusion from the definition of investment company set forth
in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.
We are organized as a holding company that conducts business
primarily through our subsidiaries. Any business conducted through
our subsidiaries will be conducted in such a manner as to ensure
that we do not meet the definition of “investment company” because
less than 40% of the value of our total assets on an unconsolidated
basis would consist of “investment securities.”
To avoid registration as an investment company, certain of our
subsidiaries rely on certain exemptions from the 1940 Act,
including Section 3(c)(5)(C), which exempts entities that are
“primarily engaged in the business of purchasing or otherwise
acquiring mortgages and other liens on and interests in real
estate.” Under the SEC staff’s current guidance, to qualify for
this exemption, we must maintain (i) at least 55% of our assets in
qualifying interests (referred to as the 55% Test) and (ii) at
least 80% of our assets in qualifying interest plus other real
estate related assets (referred to as the 80% Test). Qualifying
interests for this purpose include mortgage loans and other assets,
such as whole pool Agency and non-Agency RMBS, which are considered
the functional equivalent of mortgage loans for the purposes of the
1940 Act. We expect each of our subsidiaries that may rely on
Section 3(c)(5)(C) to invest at least 55% of its assets in
qualifying interests in accordance with SEC staff guidance, and an
additional 25% of its assets in either qualifying interests or
other types of real estate related assets that do not constitute
qualifying interests. We believe that we conduct our business so
that we are exempt from the 1940 Act under Section 3(c)(5)(C), but
rapid changes in the values of our assets could disrupt prior
efforts to conduct our business to meet the 55% Test and the 80%
Test. Our efforts to comply with the 55% Test and the 80% Test
could require us to acquire or dispose of certain assets at
unfavorable prices and limit our ability to pursue certain
investment opportunities.
Mortgage Industry Regulation
Although we do not originate or service residential mortgage loans,
we must comply with various federal and state laws, rules and
regulations as a result of owning MSR. These rules generally focus
on consumer protection and include, among others, rules promulgated
under the Dodd-Frank Wall Street Reform and Consumer Protection
Act, or the Dodd-Frank Act, and the Gramm-Leach-Bliley Financial
Modernization Act of 1999, or the Gramm-Leach-Bliley Act. We are
also required to maintain qualifications, registrations and
licenses in certain states in order to own certain of our assets.
These requirements can and do change as statutes and regulations
are enacted, promulgated or amended, or as regulatory guidance or
interpretations evolve or change, and the trend in recent years
among federal and state lawmakers and regulators has been toward
increasing laws, regulations and investigative proceedings in
relation to the mortgage industry generally.
The Dodd-Frank Act significantly changed the regulation of
financial institutions and the financial services industry,
including the mortgage industry. The Dodd-Frank Act tasked many
agencies with issuing a variety of new regulations, including rules
related to mortgage origination, mortgage servicing, securitization
transactions and derivatives. The Dodd-Frank Act also created the
Consumer Financial Protection Bureau, or the CFPB, which has broad
rulemaking authority with respect to many of the federal consumer
protection laws applicable to the mortgage industry. In addition to
its rulemaking authority, the CFPB has supervision, examination and
enforcement authority over consumer financial products and services
by certain non-depository institutions, including our company. The
CFPB has issued a series of rules and related guidance as part of
ongoing efforts to enhance consumer protections and create uniform
standards for the mortgage lending and servicing industries. These
rules include requirements addressing how lenders must evaluate a
consumer’s ability to repay a mortgage loan, specific disclosures
and communications that must be made to consumers at various stages
in the mortgage lending and servicing processes, and specific
actions servicers must take at various stages in a loan’s life
cycle, including providing assistance to consumers who encounter
financial hardship and struggle to make their mortgage payment.
These rules have led to increased costs to originate and service
loans across the mortgage industry, greater regulatory scrutiny of
originators, servicers and other mortgage industry participants
from federal and state regulators and increased litigation and
complaints against these participants from both consumers and
government officials.
The Gramm-Leach-Bliley Act imposes obligations on us to safeguard
the information we maintain on mortgage loan borrowers and imposes
restrictions on our ability to share that information with third
parties and affiliates. In addition, a growing number of states
have passed or enhanced laws to further protect borrower
information, including laws that regulate the use and storage of
personally identifiable information, require notifications to
borrowers if the security of their personal information is
breached, or require us to encrypt personal information when it is
transmitted and stored electronically. These evolving federal and
state laws require the ongoing review of our operations, increase
our compliance costs, and affect our ability to use and share
information with third parties as part of our
business.
We have implemented and will continue to implement policies,
procedures and, as applicable, information technology systems in
order to ensure ongoing compliance with the laws, rules and
regulations applicable to our business. We have incurred and expect
to incur ongoing operational costs to comply with such laws, rules
and regulations.
Competition
Our comprehensive income depends, in large part, on our ability to
acquire assets at favorable spreads over our borrowing costs. In
acquiring our target assets, we compete with other REITs, specialty
finance companies, savings and loan associations, banks, mortgage
bankers, insurance companies, mutual funds, institutional
investors, investment banking firms, financial institutions,
governmental agencies, mortgage loan servicers, asset management
firms and other entities. Some of these entities may not be subject
to the same regulatory constraints that we are (e.g.,
REIT compliance or maintaining an exemption under the 1940 Act).
Many of our competitors are significantly larger than us, have
access to greater capital and other resources and may have other
advantages over us. In addition, some of our competitors may have
higher risk tolerances or different risk assessments, which could
allow them to consider a wider variety of investments and establish
different counterparty relationships than us. Further, we may from
time-to-time face competition from government agencies, such as the
Federal Reserve, in connection with initiatives designed to
stimulate the U.S. economy or the mortgage market. Market
conditions may from time to time attract more competitors for
certain of our target assets, which will not only affect the supply
of assets but may also increase the competition for sources of
financing for these assets. An increase in the competition for
sources of funding could adversely affect the availability and cost
of financing, and thereby adversely affect our financial
results.
Available Information
Our website can be found at
www.twoharborsinvestment.com.
We make available, free of charge on our website, our annual report
on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and any amendments to those reports, as are filed or
furnished pursuant to Section 13(a) or 15(d) of the Exchange Act,
as well as our proxy statement with respect to our annual meeting
of stockholders, as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the SEC.
Our Exchange Act reports filed with, or furnished to, the SEC are
also available at the SEC’s website at
www.sec.gov.
The content of any website referred to in this Annual Report on
Form 10-K is not incorporated by reference into this Form 10-K
unless expressly noted.
We also make available, free of charge, the charters for our Audit
Committee, Compensation Committee, Nominating and Corporate
Governance Committee and Risk Oversight Committee, as well as our
Corporate Governance Guidelines, Code of Business Conduct and
Ethics, Whistleblowing Procedures and Stockholder Communications
Policy. Within the time period required by the SEC and the NYSE, we
will post on our website any amendment to the Code of Ethics and
any waiver applicable to any executive officer, director or senior
officer (as defined in the Code of Ethics).
Our Investor Relations Department can be contacted at:
Two Harbors Investment Corp.
Attn: Investor Relations
1601 Utica Ave. S., Suite 900
St. Louis Park, MN 55416
(612) 453-4100
investors@twoharborsinvestment.com
Item 1A. Risk Factors
The following is a summary of the significant risk factors known to
us that we believe could have a material adverse effect on our
business, financial condition and results of operations. In
addition to understanding the key risks described below, investors
should understand that it is not possible to predict or identify
all risk factors and, consequently, the following is not a complete
discussion of all potential risks or uncertainties.
Risks Related to Our Business and Operations
Difficult conditions in the residential mortgage and real estate
markets, the financial markets and the economy generally may
adversely impact our business, results of operations and financial
condition.
Our results of operations are materially affected by conditions in
the residential mortgage and real estate markets, the financial
markets and the economy generally. In past years, concerns about
the COVID-19 pandemic, unemployment, the availability and cost of
credit, rising government debt levels, inflation, energy costs,
global supply chain disruptions, climate change, global economic
lethargy, warfare, geopolitical unrest across various regions
worldwide, European sovereign debt issues, U.S. budget debates,
federal government shutdowns and international trade disputes, have
from time to time contributed to increased volatility and
uncertainty in the economy and financial markets. Adverse
developments with respect to any of these markets may have an
impact on new demand for homes and on homeowners’ ability to make
their mortgage payments, which may compress home ownership rates
and weigh heavily on future home price performance. There is a
strong correlation between home price growth rates (or losses) and
mortgage loan delinquencies. Any stagnation in or deterioration of
the residential mortgage or real estate markets may limit our
ability to acquire our target assets on attractive terms or cause
us to experience losses related to our assets.
The COVID-19 pandemic and government actions to mitigate its spread
and economic impact could have a material adverse effect on our
business, results of operations and financial
condition.
The COVID-19 pandemic caused significant disruptions to the U.S.
and global economies and contributed to volatility and negative
pressure in financial markets. The impact of the pandemic and
measures by governments and other authorities around the world to
prevent its spread have negatively impacted our business, and the
worsening of COVID-19 pandemic conditions, or the occurrence of any
new public health crisis, may in the future negatively impact our
business. The occurrence of any such event may, among other things,
cause volatility in and disrupt the operations of financial
markets, result in elevated delinquencies rates amongst mortgage
loan borrowers, prompt large scale asset purchases by the Federal
Reserve in order to stabilize the mortgage market and lead to the
adoption of new rules and regulations to support impacted
individuals, such as mortgage loan forbearance and modification
programs. There can be no assurance as to how the COVID-19
pandemic, any new public health crisis or actions taken by
governments and other authorities in response thereto may in the
future affect our business or the efficiency, liquidity and
stability of the financial and mortgage markets.
Our business model depends in part upon the continuing viability of
Fannie Mae and Freddie Mac, or similar institutions, and any
changes to their structure or creditworthiness could have an
adverse impact on us.
We purchase Agency RMBS that are protected from the risk of default
on the underlying mortgages by guarantees from Fannie Mae, Freddie
Mac or, in the case of Ginnie Mae securities, the U.S. government.
In 2008, the U.S. government and U.S. Treasury undertook a series
of
actions designed to stabilize these GSEs, including placing them
into a federal conservatorship. In December 2009, the U.S.
government committed virtually unlimited capital to ensure the
continued existence of Fannie Mae and Freddie Mac. There is no
assurance that such capital will continue to be available or that
the GSEs will honor their guarantees or other obligations. If these
GSEs fail to honor their guarantees, the value of any Agency RMBS
guaranteed by the GSEs that we hold would decline.
The continued flow of residential mortgage-backed securities from
the GSEs is essential to the operation of the mortgage markets in
their current form, and crucial to our business model. A number of
legislative proposals have been introduced in recent years that
would phase out or reform the GSEs. It is not possible to predict
the scope and nature of the actions that the U.S. government will
ultimately take with respect to the GSEs. Although any phase out or
reform would likely take several years to implement, if the
structure of Fannie Mae or Freddie Mac were altered, or if they
were eliminated altogether, the amount and type of Agency RMBS and
other mortgage-related assets available for investment would be
significantly affected. A reduction in supply of Agency RMBS and
other mortgage-related assets would result in increased competition
for those assets and likely lead to a significant increase in the
price for our target assets. Additionally, market uncertainty with
respect to the treatment of the GSEs could have the effect of
reducing the actual or perceived quality of, and therefore the
market value for, the Agency RMBS that we currently hold in our
portfolio.
We operate in a highly regulated environment and may be adversely
affected by changes in federal and state laws and
regulations.
We operate in a highly regulated environment and are subject to the
rules, regulations, approvals, licensing, reporting and examination
requirements of various federal, state and local authorities. Any
change in applicable federal, state or local laws, rules and
regulations, or the interpretation or enforcement thereof, could
have a substantial impact on our assets, operating expenses,
business strategies and results of operations. Our inability or
failure to comply with the rules, regulations or reporting
requirements, to obtain or maintain approvals and licenses
applicable to our businesses, or to satisfy annual or periodic
examinations may impact our ability to do business and expose us to
fines, penalties or other claims and, as a result, could harm our
business.
Federal and state regulation of the mortgage industry is complex
and constantly evolving, and changes to applicable rules,
regulations and guidance may adversely impact our
business.
Although we do not originate or service residential mortgage loans,
we must comply with various federal and state rules, regulations
and guidance as a result of owning MSR. These requirements include,
among other things, the Dodd-Frank Act, the Gramm-Leach-Bliley Act
and the CARES Act. We are also required to maintain qualifications,
registrations and licenses in certain states in order to own
certain of our assets. These requirements can and do change as
statutes and regulations are enacted, promulgated or amended, or as
regulatory guidance or interpretations evolve or
change.
The Dodd-Frank Act and its implementing regulations, as well as
other federal and state rules, regulations and guidance that govern
mortgage servicing, combine to create a complex and constantly
evolving regulatory environment, and the failure by us, or our
subservicers, to comply with these requirements may result in fines
or the suspension or revocation of the qualifications,
registrations and licenses necessary to operate as an owner of MSR.
New or modified regulations at the federal or state level to
address concerns on a variety of fronts, including impacts from the
COVID-19 pandemic, potential impacts from climate change, fair and
equitable access to housing and consumer data privacy and security
concerns, could increase our operational expenses or otherwise
enhance regulatory supervision and enforcement
efforts.
Ongoing efforts to enhance cooperation between federal and state
regulators could also contribute to increased industry
scrutiny.
We expect to continue to incur the operational and system costs
necessary to maintain processes to ensure our compliance with
applicable rules and regulations as well as to monitor compliance
by our business partners. Additional rules and regulations
implemented by the CFPB and state regulators, as well as any
changes to existing rules, could lead to changes in the way we
conduct our business and increased costs of
compliance.
We operate in a highly competitive market and we may not be able to
compete successfully.
We operate in a highly competitive market. Our profitability
depends, in large part, on our ability to acquire a sufficient
supply of our target assets at favorable prices. In acquiring
assets, we compete with a variety of investors, including other
mortgage REITs, specialty finance companies, public and private
investment funds, asset managers, commercial and investment banks,
broker-dealers, commercial finance and insurance companies, the
GSEs, mortgage servicers and other financial institutions. In
addition, the Federal Reserve has in the past committed to purchase
unlimited amounts of Agency RMBS and other assets in order to
stabilize the financial markets. Many of our competitors are
substantially larger and may have greater financial, technical,
marketing and other resources than we do. Competition for our
target assets may lead to the price of such assets increasing and
their availability decreasing, which may limit our ability to
generate desired returns, reduce our earnings and, in turn,
decrease the cash available for distribution to our
stockholders.
Our executive officers and other key employees are critical to our
success and the loss of any executive officer or key employee may
materially adversely affect our business.
We operate in a highly specialized industry and our success is
dependent upon the efforts, experience, diligence, skill, and deep
knowledge of our business and historical operations of our
executive officers and key employees, as well as their industry
knowledge and relationships. The departure of any of our executive
officers and/or key employees could have a material adverse effect
on our operations and performance.
We may change any of our strategies, policies or procedures without
stockholder consent.
We may change any of our strategies, policies or procedures with
respect to investments, asset allocation, growth, operations,
indebtedness, financing strategy and distributions at any time
without the consent of stockholders. Changes in strategy could also
result in the elimination of certain investments and business
activities that we no longer view as attractive or in alignment
with our business model. Shifts in strategy may increase our
exposure to credit risk, interest rate risk, financing risk,
default risk, regulatory risk and real estate market fluctuations.
We also cannot assure you that we will be able to effectively
execute on or realize the potential benefits of changes in
strategy. Any such
changes could adversely affect our financial condition, risk
profile, results of operations, the market price of our common
stock and our ability to make distributions to
stockholders.
Our risk management policies and procedures may not be
effective.
We have established and maintain risk management policies and
procedures designed to identify, monitor and mitigate financial
risks, such as credit risk, interest rate risk, prepayment risk and
liquidity risk, as well as operational and compliance risks related
to our business, assets and liabilities. These policies and
procedures may not sufficiently identify all of the risks to which
we are or may become exposed or mitigate the risks we have
identified. Any expansion of our business activities may result in
our being exposed to risks to which we have not previously been
exposed or may increase our exposure to certain types of risks.
Alternatively, any narrowing of our business activities may
increase the concentration of our exposure to certain types of
risk. Any failure to effectively identify and mitigate the risks to
which we are exposed could have an adverse effect on our business,
results of operations and financial condition.
Maintaining our exemptions from registration as an investment
company under the 1940 Act imposes limits on our
operations.
We intend to conduct our operations so as not to become required to
register as an investment company under the 1940 Act. Section
3(a)(1)(A) of the 1940 Act defines an investment company as any
issuer that is or holds itself out as being engaged primarily in
the business of investing, reinvesting or trading in securities. We
are organized as a holding company that conducts its businesses
primarily through our subsidiaries. We intend to conduct the
operations of Two Harbors and its subsidiaries so that they do not
come within the definition of an investment company, either because
less than 40% of the value of their total assets on an
unconsolidated basis will consist of “investment securities” or
because they meet certain other exceptions or exemptions set forth
in the 1940 Act based on the nature of their business purpose and
activities.
Certain of our subsidiaries may rely upon the exemption set forth
in Section 3(c)(5)(C) of the 1940 Act, which is available for
entities “primarily engaged in the business of purchasing or
otherwise acquiring mortgages and other liens on and interests in
real estate.” This exemption generally means that at least 55% of
each such subsidiary’s portfolio must be comprised of qualifying
assets and at least 80% of its portfolio must be comprised of
qualifying assets and real estate-related assets under the 1940
Act. Qualifying assets for this purpose include mortgage loans and
other assets, such as whole pool Agency and non-Agency RMBS, which
are considered the functional equivalent of mortgage loans for the
purposes of the 1940 Act. We expect each of our subsidiaries
relying on Section 3(c)(5)(C) to invest at least 55% of its assets
in whole pool Agency RMBS and other interests in real estate that
constitute qualifying assets in accordance with SEC staff guidance
and an additional 25% of its assets in either qualifying assets and
other types of real estate related assets that do not constitute
qualifying assets.
As a result of the foregoing restrictions, we are limited in our
ability to make or dispose of certain investments. To the extent
the SEC publishes new or different guidance with respect to these
matters, we may be required to adjust our strategy accordingly.
Although we monitor the portfolios of our subsidiaries that may
rely on the Section 3(c)(5)(C) exemption periodically, there can be
no assurance that such subsidiaries will be able to maintain this
exemption.
Loss of our 1940 Act exemptions would adversely affect us, the
market price of shares of our common stock and our ability to
distribute dividends, and could result in the termination of
certain of our financing or other agreements.
As described above, we intend to conduct operations so that we are
not required to register as an investment company under the 1940
Act. Although we monitor our portfolio and our activities
periodically, there can be no assurance that we will be able to
maintain our exemption from investment company registration under
the 1940 Act. Furthermore, any modifications to the 1940 Act
exemption rules or interpretations may require us to change our
business and operations in order for us to continue to rely on such
exemption. If we were no longer able to qualify for exemptions from
registration under the 1940 Act, we could be required to
restructure our activities or the activities of our subsidiaries,
including effecting sales of assets in a manner that, or at a time
when, we would not otherwise choose, which could negatively affect
the value of our common stock, the sustainability of our business
model, and our ability to make distributions. Such sales could
occur during adverse market conditions, and we could be forced to
accept prices below that which we believe are appropriate. The loss
of our 1940 Act exemptions may also result in a default under or
permit certain of our counterparties to terminate the many
repurchase agreements, financing facilities or other agreements we
have in place.
The lack of liquidity of our assets may adversely affect our
business, including our ability to value, finance and sell our
assets.
We have and may in the future acquire assets or other instruments
with limited or no liquidity, including securities, MSR and other
instruments that are not publicly traded. Market conditions could
also significantly and negatively affect the liquidity of our
assets. It may be difficult or impossible to obtain third-party
pricing on such illiquid assets and validating third-party pricing
for illiquid assets may be more subjective than more liquid assets.
Illiquid assets typically experience greater price volatility, as a
ready market may not exist for such assets, and such assets can be
more difficult to value.
Any illiquidity in our assets may make it difficult for us to sell
such assets if the need or desire arises. The ability to quickly
sell certain of our target assets, such as certain securities and
MSR, may be constrained by a number of factors, including a small
number of willing buyers, lack of transparency as to current market
terms and price, and time delays resulting from the buyer’s desire
to conduct due diligence on the assets, negotiation of a purchase
and sale agreement, compliance with any applicable contractual or
regulatory requirements, and for certain assets like MSR,
operational and compliance considerations. Consequently, even if we
identify a buyer
for certain of our securities and MSR, there is no assurance that
we would be able to sell such assets in a timely manner if the need
or desire arises.
Assets that are illiquid are typically more difficult and costly to
finance. As a result, we may be required to finance the assets at
unattractive rates or hold them on our balance sheet without the
use of leverage. Assets tend to become less liquid during times of
financial stress, which is often the time that liquidity is most
needed. To the extent that we use leverage to finance assets that
later become illiquid, we may lose that leverage if the financing
counterparty determines that the collateral is no longer sufficient
to secure the financing, or the counterparty could reduce the
amount of money that it is willing to lend against the
asset.
We use leverage in executing our business strategy, which may
adversely affect the return on our assets and may reduce cash
available for distribution to our stockholders, as well as increase
losses when economic conditions are unfavorable.
We use leverage to finance many of our investments and to enhance
our financial returns. Through the use of leverage, we may acquire
positions with market exposure significantly greater than the
amount of capital committed to the transaction. It is not uncommon
for investors in Agency RMBS to obtain leverage equal to ten or
more times equity through the use of repurchase agreement
financing. Subject to market conditions, we anticipate that we may
deploy, on a debt-to-equity basis, up to ten times leverage on our
Agency RMBS; however, there is no specific limit on the amount of
leverage that we may use.
Leverage will magnify both the gains and the losses of our
positions. Leverage will increase our returns as long as we earn a
greater return on investments purchased with borrowed funds than
our cost of borrowing such funds. However, if we use leverage to
acquire an asset and the value of the asset decreases, the leverage
will increase our losses. Even if the asset increases in value, if
the asset fails to earn a return that equals or exceeds our cost of
borrowing, leverage will decrease our returns.
We may be required to post large amounts of cash as collateral or
margin to secure our leveraged positions, including on our MSR
financing facilities. In the event of a sudden, precipitous drop in
value of our financed assets, we might not be able to liquidate
assets quickly enough to repay our borrowings, further magnifying
losses. Even a small decrease in the value of a leveraged asset may
require us to post additional margin or cash collateral. This may
adversely affect our financial condition and results of operations
and decrease the cash available to us for distributions to
stockholders.
We depend on repurchase agreements and other credit facilities to
execute our business plan and any limitation on our ability to
access funding through these sources could have a material adverse
effect on our results of operations, financial condition and
business.
Our ability to purchase and hold assets is affected by our ability
to secure repurchase agreements and other credit facilities on
acceptable terms. We currently have repurchase agreements,
revolving credit facilities and other credit facilities in place
with numerous counterparties, but we can provide no assurance that
lenders will continue to provide us with sufficient financing
through the repurchase markets or otherwise. In addition, with
respect to MSR financing, there can be no assurance that the GSEs
will consent to such transactions or consent on terms consistent
with prior MSR financing transactions. Because repurchase
agreements and similar credit facilities are generally short-term
commitments of capital, changing conditions in the financing
markets may make it more difficult for us to secure continued
financing during times of market stress.
Our ability to efficiently access financing through our repurchase
agreements or otherwise may be adversely impacted by counterparty
requirements regarding the type of assets that may be sold and the
timing and process for such sales. Counterparty review and approval
processes may delay the timing in which funding may be provided, or
preclude funding altogether. For MSR, delays may also occur due to
the need to obtain GSE approval of the collateral to be posted, the
need for third-party valuations of the MSR collateral or the
agreement of the relevant subservicers to be party to the financing
agreement. Our lenders also may revise their eligibility
requirements for the types of assets they are willing to finance or
the terms of such financings, based on, among other factors, the
regulatory environment and their management of perceived
risk.
Changes in the financing markets could adversely affect the
marketability of the assets in which we invest, and this could
negatively affect the value of our assets. If our lenders are
unwilling or unable to provide us with financing, or if the
financing is only available on terms that are uneconomical or
otherwise not satisfactory to us, we could be forced to sell assets
when prices are depressed. The amount of financing we receive under
our repurchase agreements, revolving credit facilities or other
credit facilities will be directly related to the lenders’
valuation of the assets that secure the outstanding borrowings. If
a lender determines that the value of the assets has decreased, it
typically has the right to initiate a margin call, requiring us to
transfer additional assets to such lender, or repay a portion of
the outstanding borrowings. We may be forced to sell assets at
significantly depressed prices to meet margin calls and to maintain
liquidity at levels satisfactory to the counterparty, which could
cause us to incur losses. Moreover, to the extent that we are
forced to sell assets because of the availability of financing or
changes in market conditions, other market participants may face
similar pressures, which could exacerbate a difficult market
environment and result in significantly greater losses on the sale
of such assets. In an extreme case of market duress, a market may
not exist for certain of our assets at any price.
Although we generally seek to reduce our exposure to lender
concentration-related risk by entering into financing relationships
with multiple counterparties, we are not required to observe
specific diversification criteria, except as may be set forth in
the investment guidelines adopted by our board of directors. To the
extent that the number of or net exposure under our lending
arrangements may become concentrated with one or more lenders, the
adverse impacts of defaults or terminations by such lenders may be
significantly greater.
Our inability to meet certain financial covenants related to our
repurchase agreements, revolving credit facilities or other credit
facilities could adversely affect our financial condition, results
of operations and cash flows.
In connection with certain of our repurchase agreements, revolving
credit facilities and other credit facilities, we are required to
comply with certain financial covenants, the most restrictive of
which are disclosed within Item 7, “Management’s
Discussion and Analysis of Financial Conditions and Results of
Operations”
of this Annual Report on Form 10-K. Compliance with these financial
covenants will depend on market factors and the strength of our
business and operating results. Failure to
comply with our financial covenants could result in an event of
default, termination of the lending facility, acceleration of all
amounts owing under the lending facility, and may give the
counterparty the right to exercise certain other remedies under the
lending agreement, including without limitation the sale of the
asset subject to repurchase at the time of default, unless we were
able to negotiate a waiver. In addition, we may be subject to
cross-default provisions under certain financing facilities that
could cause an event of default under such financing facilities to
be triggered by events of default under other financing
arrangements.
If a counterparty to a repurchase agreement defaults on its
obligation to resell the underlying security back to us at the end
of the repurchase agreement term, or if we default on our
obligations under the repurchase agreement, we may incur
losses.
When we enter into repurchase agreements, we sell the assets to
lenders and receive cash from the lenders. The lenders are
obligated to resell the same assets back to us at the end of the
term of the repurchase agreement. Because the cash that we receive
from the lender when we initially sell the assets to the lender is
less than the value of those assets (the difference being the
“haircut”), if the lender defaults on its obligation to resell the
same assets back to us, we would incur a loss on the repurchase
agreement equal to the amount of the haircut (assuming there was no
change in the value of the securities). Further, if we default on
our obligations under a repurchase agreement, the lender will be
able to terminate the repurchase agreement and may cease entering
into any other repurchase agreements with us. If a default occurs
under any of our repurchase agreements and a lender terminates one
or more of its repurchase agreements, we may need to enter into
replacement repurchase agreements with different lenders. There can
be no assurance that we will be successful in entering into such
replacement repurchase agreements on the same terms as the
repurchase agreements that were terminated or at all.
Our rights under our repurchase agreements are subject to the
effects of bankruptcy laws in the event of the bankruptcy or
insolvency of us or our lenders under the repurchase
agreements.
In the event of our insolvency or bankruptcy, certain repurchase
agreements may qualify for special treatment under the U.S.
Bankruptcy Code, the effect of which, among other things, would be
to allow the lender under the applicable repurchase agreement to
avoid the automatic stay provisions of the U.S. Bankruptcy Code and
to foreclose on the collateral agreement without delay. In the
event of the insolvency or bankruptcy of a lender during the term
of a repurchase agreement, the lender may be permitted, under
applicable insolvency laws, to repudiate the contract, and our
claim against the lender for damages may be treated simply as an
unsecured creditor claim. In addition, if the lender is a broker or
dealer subject to the Securities Investor Protection Act of 1970,
or an insured depository institution subject to the Federal Deposit
Insurance Act, our ability to exercise our rights to recover our
assets under a repurchase agreement or to be compensated for any
damages resulting from the lender's insolvency may be further
limited by those statutes. These claims would be subject to
significant delay and, if and when received, may be substantially
less than the damages we actually incur.
The impairment or negative performance of other financial
institutions could adversely affect us.
We have exposure to and routinely execute transactions with
numerous counterparties in the financial services industry,
including broker-dealers, commercial banks, investment banks,
investment funds and other institutions. The operations of U.S. and
global financial services institutions are highly interconnected
and a decline in the financial condition of one or more financial
services institutions may expose us to credit losses or defaults,
limit our access to liquidity or otherwise disrupt the operation of
our businesses. While we regularly assess our exposure to different
counterparties, the performance and financial strength of specific
institutions are subject to rapid change, the timing and extent of
which cannot be known.
We may not have the ability to raise funds necessary to pay
principal amounts owed upon maturity of our outstanding convertible
senior notes or to purchase such notes upon a fundamental
change.
We have issued and outstanding $287.5 million aggregate principal
amount of 6.25% convertible senior notes due January 2026. To the
extent these notes are not converted into common stock by the
noteholders prior to their maturity date, we will be obligated to
repay the principal amount of all outstanding notes upon maturity.
In addition, if a fundamental change occurs (as described in the
supplemental indenture governing the notes), noteholders have the
right to require us to purchase for cash any or all of their notes.
We may not have sufficient funds available at the time we are
required to repay principal amounts or to purchase the notes upon a
fundamental change, and we may not be able to raise additional
capital or arrange necessary financing in order to make such
payments on terms that are acceptable to us, if at
all.
An increase in our borrowing costs relative to the interest that we
receive on our leveraged assets may adversely affect our
profitability.
As our repurchase agreements and other short-term borrowings
mature, we must enter into new borrowings, find other sources of
liquidity or sell assets. An increase in short-term interest rates
at the time that we seek to enter into new borrowings would reduce
the spread between the returns on our assets and the cost of our
borrowings. This would adversely affect the returns on our assets,
which might reduce earnings and, in turn, cash available for
distribution to stockholders.
We are highly dependent on information technology, and system
failures or security breaches could disrupt our
business.
Our business is highly dependent on information technology. In the
ordinary course of our business, we may store sensitive data,
including our proprietary business information and that of our
business partners, and personally identifiable information of
mortgage borrowers, on our networks. The secure maintenance and
transmission of this information is critical to our
operations.
Computer malware, viruses, ransomware and phishing attacks remain
widespread and are increasingly sophisticated. We are from time to
time the target of attempted cyber threats. We continuously monitor
and develop our information technology networks and infrastructure
to prevent, detect, address and mitigate the risk of unauthorized
access, misuse, computer viruses and other events that could have a
security impact. Despite these security measures, our information
technology and infrastructure may be vulnerable to attacks by
hackers or breached due to employee error, malfeasance or other
disruptions. Any such breach could compromise our networks and the
information stored there could be accessed, publicly disclosed,
lost or stolen. Any such access, disclosure or other loss of
information could result in legal claims or proceedings, liability
under laws that protect the privacy of personal information,
regulatory penalties, disruption to our operations, or disruption
to our trading activities or damage our reputation, which could
have a material adverse effect on our financial results and
negatively affect the market price of our common stock and our
ability to pay dividends to stockholders.
The resources required to protect our information technology and
infrastructure, and to comply with the laws and regulations related
to data and privacy protection, are subject to uncertainty. Even in
circumstances where we are able to successfully protect such
technology and infrastructure from attacks, we may incur
significant expenses in connection with our responses to such
attacks. Government and regulatory scrutiny of the measures taken
by companies to protect against cybersecurity attacks has resulted
in heightened cybersecurity requirements and additional regulatory
oversight. Any of the foregoing may adversely impact our results of
operations and financial condition.
We enter into hedging transactions that expose us to contingent
liabilities in the future, which may adversely affect our financial
results or cash available for distribution to
stockholders.
We engage in transactions intended to hedge against various risks
to our portfolio, including the exposure to changes in interest
rates. The extent of our hedging activity varies in scope based on,
among other things, the level and volatility of interest rates, the
type of assets held and other market conditions. Although these
transactions are intended to reduce our exposure to various risks,
hedging may fail to adequately protect or could adversely affect us
because, among other things: available hedges may not correspond
directly with the risks for which protection is sought; the
duration of the hedge may not match the duration of the related
liability; the amount of income that a REIT may earn from certain
hedging transactions is limited by U.S. federal income tax
provisions; the credit quality of a hedging counterparty may be
downgraded to such an extent that it impairs our ability to sell or
assign our side of the hedging transaction; and the hedging
counterparty may default on its obligations.
Subject to maintaining our qualification as a REIT and satisfying
the criteria for no-action relief from the Commodity Futures
Trading Commission’s commodity pool operator registration rules,
there are no current limitations on the hedging transactions that
we may undertake. Our hedging transactions could require us to fund
large cash payments in certain circumstances (e.g.,
the early termination of the hedging instrument caused by an event
of default or other early termination event, or a demand by a
counterparty that we make increased margin payments).
Our ability to fund these obligations will depend on the liquidity
of our assets and our access to capital at the time. The need to
fund these obligations could adversely affect our financial
condition. Further, hedging transactions, which are intended to
limit losses, may actually result in losses, which would adversely
affect our earnings and could in turn reduce cash available for
distribution to stockholders.
Our financial results may experience greater fluctuations due to
our decision not to elect hedge accounting treatment on our
derivative instruments.
We have elected to not qualify for hedge accounting treatment under
Accounting Standards Codification (ASC) 815,
Derivatives and Hedging,
or ASC 815, for our current derivative instruments. The economics
of our derivative hedging transactions are not affected by this
election; however, our earnings (losses) for
U.S. generally accepted accounting principles,
or U.S.
GAAP, purposes may be subject to greater fluctuations from period
to period as a result of this accounting treatment for changes in
fair value of derivative instruments or for the accounting of the
underlying hedged assets or liabilities in our financial
statements, as it does not necessarily align with the accounting
used for derivative instruments.
We depend on third-party service providers, including mortgage loan
servicers, for a variety of services related to our business. We
are, therefore, subject to the risks associated with third-party
service providers.
We depend on a variety of services provided by third-party service
providers related to our investments in Agency RMBS and MSR, as
well as for general operating purposes. For example, we rely on the
mortgage servicers who service the mortgage loans underlying our
Agency RMBS and MSR to, among other things, collect principal and
interest payments on such mortgage loans and perform loss
mitigation services in accordance with applicable laws and
regulations. Mortgage servicers and other service providers, such
as trustees, bond insurance providers, due diligence vendors and
document custodians, may fail to perform or otherwise not perform
in a manner that promotes our interests.
Recent enhancements have been made to legislation and regulations
intended to assist borrowers struggling to continue making their
contractual mortgage payments. These requirements may delay, reduce
or prevent foreclosures through, among other things, loan
modifications and other loss mitigation measures, but they may also
result in reduced value of the related mortgage loans, including
those underlying our Agency RMBS and MSR. Mortgage servicers may be
required or otherwise incentivized by federal or state governments
to pursue such actions designed to assist mortgagors, including
loan modifications, forbearance plans and other actions intended to
prevent foreclosure. While these actions may be beneficial to
borrowers, they may
not be in the best interests of the beneficial owners of the
mortgage loans. As a consequence of the foregoing, our business,
financial condition and results of operations may be adversely
affected.
In addition, in connection with our ownership of MSR, we possess
personally identifiable information that is shared with third-party
service providers, including our mortgage servicers, as required or
permitted by law. In the event the information technology networks
and infrastructure of our third-party service providers is
breached, we may be liable for losses suffered by individuals whose
personal information is stolen as a result of such breach and any
such liability could be material. Even if we are not liable for
such losses, any breach of these third-party systems could expose
us to material costs related to notifying affected individuals or
other parties and providing credit monitoring services, as well as
to regulatory fines or penalties.
We may be subject to fines, penalties or other enforcement actions
based on the conduct of third-party mortgage loan servicers who
service the loans underlying the MSR we acquire or our failure to
conduct appropriate oversight of these servicers.
We contract with third-party mortgage loan servicers to perform the
actual day-to-day servicing obligations on the mortgage loans
underlying our MSR. We and the mortgage loan servicers operate in a
highly regulated industry and are required to comply with various
federal, state and local laws and regulations, which includes the
obligation to oversee our third-party mortgage servicers to assess
their compliance with these laws and regulations. Although the
servicing activity is conducted primarily in the name of the
mortgage loan servicers, to the extent these servicers fail to
comply with applicable laws and regulations, we could be subject to
governmental actions such as denial, suspension or revocation of
licenses, be fined or otherwise subject to regulatory enforcement
action, or incur losses or be subject to lawsuits.
Our ability to own and manage MSR is subject to terms and
conditions established by the GSEs, which are subject to
change.
Our subsidiary’s continued approval from the GSEs to own and manage
MSR is subject to compliance with each of their respective selling
and servicing guidelines, minimum capital requirements and other
conditions they may impose from time to time at their discretion.
Failure to meet such guidelines and conditions could result in the
unilateral termination of our subsidiary’s approved status by one
or more GSEs or result in the acceleration and termination of our
MSR financing facilities. In addition, the implementation of more
restrictive or operationally intensive guidance may increase the
costs associated with owning and managing MSR as well as our
ability to finance MSR.
Our securitization activities expose us to risk of litigation,
which may materially and adversely affect our business and
financial condition.
In connection with our securitization transactions, we prepare
disclosure documentation, including term sheets and offering
memorandums, which contain disclosures regarding the securitization
transactions and the assets securitized. If our disclosure
documentation is alleged or found to contain inaccuracies or
omissions, we may be liable under federal securities laws, state
securities laws or other applicable laws for damages to third
parties that invest in these securitization transactions, including
in circumstances in which we relied on a third party in preparing
accurate disclosures, or we may incur other expenses and costs in
connection with disputing these allegations or settling
claims.
We may be subject to representation and warranty risk in our
capacity as an owner of MSR as well as in connection with our prior
securitization transactions and our sales of MSR and other
assets.
The MSR we acquire may be subject to existing representations and
warranties made to the applicable investor (including, without
limitation, the GSEs) regarding, among other things, the
origination and prior servicing of those mortgage loans, as well as
future servicing practices following our acquisition of such MSR.
If such representations and warranties are inaccurate, we may be
obligated to repurchase certain mortgage loans or indemnify the
applicable investor for any losses suffered as a result of the
origination or prior servicing of the mortgage loans. As such, the
applicable investor will have direct recourse to us for such
origination and/or prior servicing issues.
In connection with our prior securitization transactions and with
the sales of our MSR and other assets from time to time, we may
have been or may be required to make representations and warranties
to the purchasers of the assets regarding certain characteristics
of those assets. If our representations and warranties are
inaccurate, we may be obligated to repurchase the assets or
indemnify the applicable purchaser, which may result in a loss.
Even if we obtain representations and warranties from the parties
from whom we acquired the asset, as applicable, they may not
correspond with the representations and warranties we make or may
otherwise not protect us from losses. Additionally, the loan
originator or other parties from whom we acquired the MSR may be
insolvent or otherwise unable to honor their respective
indemnification or repurchase obligations for breaches of
representation and warranties.
Completion of the proposed acquisition of RoundPoint Mortgage
Servicing Corporation remains subject to conditions that we cannot
control.
Our proposed acquisition of RoundPoint Mortgage Servicing
Corporation, or RoundPoint, is subject to various closing
conditions, including the receipt of certain regulatory and GSE
approvals. There are no assurances that all of the conditions
necessary to complete the acquisition of RoundPoint will be
satisfied or that the conditions will be satisfied within the
anticipated time frame.
We may fail to realize all of the expected benefits of the proposed
acquisition of RoundPoint or those benefits may take longer to
realize than expected.
The full benefits of the proposed acquisition of RoundPoint may not
be realized as expected or may not be achieved within the
anticipated time frame, or at all. Failure to achieve the
anticipated benefits of the acquisition of RoundPoint could
adversely affect our business, results of operations and financial
condition.
In addition, we have devoted and expect to continue to devote
significant attention and resources prior to closing to prepare for
the post-closing operation of the combined company. Following the
closing, we will be required to devote significant attention and
resources to successfully integrate RoundPoint’s operations into
our existing business operations. This integration process may
disrupt our business and, if ineffective, would limit the
anticipated benefits of the acquisition of RoundPoint.
Legal matters related to the termination of our Management
Agreement with PRCM Advisers may adversely affect our business,
results of operations, and/or financial condition.
On August 14, 2020, our Management Agreement with PRCM Advisers
terminated and we thereafter became a self-managed company. In
connection with the termination of our Management Agreement, PRCM
Advisers filed a complaint in federal court that alleges, among
other things, the misappropriation of trade secrets in violation of
both the Defend Trade Secrets Act and New York common law, breach
of contract, breach of the implied covenant of good faith and fair
dealing, unfair competition and business practices, unjust
enrichment, conversion, and tortious interference with contract.
The complaint seeks, among other things, an order enjoining the
company from making any use of or disclosing PRCM Advisers’ trade
secret, proprietary, or confidential information; damages in an
amount to be determined at a hearing and/or trial; disgorgement of
the company’s wrongfully obtained profits; and fees and costs
incurred by PRCM Advisers in pursuing the action. Our board of
directors believes the complaint is without merit and that the
company has complied with the terms of the Management Agreement.
However, the results of litigation are inherently uncertain. It is
possible that a court could enjoin us from using certain
intellectual property. In addition, any damages or costs and fees
that may be awarded to PRCM Advisers related to the litigation may
be significant. While we dispute and intend to vigorously defend
against the claims set forth in the complaint, it is possible that
the results of the litigation with PRCM Advisers may adversely
affect our business, results of operations, and/or financial
condition.
Risks Related To Our Assets
Declines in the market values of our assets may adversely affect
our results of operations and financial condition.
A substantial portion of our assets are classified for accounting
purposes as “available-for-sale.” Changes in the market values of
those assets will be directly charged or credited to stockholders’
equity. As a result, a decline in values may result in connection
with factors that are out of our control and adversely affect our
book value. Moreover, if the decline in value of an
available-for-sale security is other than temporary, such decline
will reduce our earnings.
In addition, some of the assets in our portfolio are not publicly
traded. The fair value of securities and other assets that are not
publicly traded may not be readily determinable. We value these
assets quarterly at fair value, as determined in accordance with
ASC 820,
Fair Value Measurements and Disclosures,
which may include unobservable inputs. Because such valuations are
subjective, the fair value of certain of our assets may fluctuate
over short periods of time and our determinations of fair value may
differ materially from the values that would have been used if a
ready market for these securities existed. We may be adversely
affected if our determinations regarding the fair value of these
assets are materially higher than the values that we ultimately
realize upon their disposal.
Changes in mortgage prepayment rates may adversely affect the value
of our assets.
The value of our assets is affected by prepayment rates on mortgage
loans, and our investment strategy includes making investments
based on our expectations regarding prepayment rates. A prepayment
rate is the measurement of how quickly borrowers pay down the
unpaid principal balance of their loans or how quickly loans are
otherwise brought current, modified, liquidated or charged
off.
With respect to our securities portfolio, typically the value of a
mortgage-backed security includes market assumptions regarding the
speed at which the underlying mortgages will be prepaid. Faster
than expected prepayments could adversely affect our profitability,
including in the following ways:
•We
may purchase securities that have a higher interest rate than the
market interest rate at the time. In exchange for this higher
interest rate, we may pay a premium over the par value to acquire
the security. In accordance with U.S. GAAP, we may amortize this
premium over the estimated term of the security. If the security is
prepaid in whole or in part prior to its maturity date, however, we
may be required to expense the premium that was prepaid at the time
of the prepayment.
•A
substantial portion of our adjustable-rate Agency RMBS may bear
interest rates that are lower than their fully indexed rates, which
are equivalent to the applicable index rate plus a margin. If an
adjustable-rate security is prepaid prior to or soon after the time
of adjustment to a fully-indexed rate, we will have held that
security while it was least profitable and lost the opportunity to
receive interest at the fully indexed rate over the remainder of
its expected life.
•If
we are unable to acquire new Agency RMBS similar to the prepaid
security, our financial condition, results of operations and cash
flows could suffer.
Changes in prepayment rates also significantly affect the value of
MSR because such rights are priced on an assumption of a stable
repayment rate. If the prepayment rate is significantly greater
than expected, the fair value of the MSR could decline and we may
be required to record a non-cash charge, which would have a
negative impact on our financial results. Furthermore, a
significant increase in the prepayment rate could materially reduce
the ultimate cash flows we receive from MSR, and we could
ultimately receive substantially less than what we paid for such
assets.
Prepayment rates may be affected by a number of factors including
mortgage rates, the availability of mortgage credit, the relative
economic vitality of the area in which the related properties are
located, the remaining life of the loans, the size of the remaining
loans, the servicing of mortgage loans, changes in tax laws, other
opportunities for investment, homeowner mobility and other
economic, social, geographic, demographic and legal factors.
Consequently, prepayment rates cannot be predicted with certainty.
If we make erroneous assumptions regarding prepayment rates in
connection with our investment decisions, we may experience
significant losses.
Our delayed delivery transactions, including TBAs, subject us to
certain risks, including price risks and counterparty
risks.
We may purchase Agency RMBS through
delayed delivery transactions, including TBAs. In a delayed
delivery transaction, we enter into a forward purchase agreement
with a counterparty to purchase either (i) an identified Agency
RMBS, or (ii) a to-be-issued (or “to-be-announced”) Agency RMBS
with certain terms. As with any forward purchase contract, the
value of the underlying Agency RMBS may decrease between the
contract date and the settlement date. Furthermore, a transaction
counterparty may fail to deliver the underlying Agency RMBS at the
settlement date.
It may be uneconomical to roll our TBA dollar roll transactions or
we may be unable to meet margin calls on our TBA contracts, which
could negatively affect our financial condition and results of
operations.
We utilize TBA dollar roll transactions as a means of investing in
and financing Agency RMBS. TBA contracts enable us to purchase or
sell, for future delivery, Agency RMBS with certain principal and
interest terms and certain types of collateral, but the specific
securities to be delivered are not identified until shortly before
the TBA settlement date. Prior to settlement of the TBA contract we
may choose to move the settlement of the securities to a later date
by entering into an offsetting position (referred to as a “pair
off”), net settling the paired off positions for cash, and
simultaneously purchasing a similar TBA contact for a later
settlement date, collectively referred to as a “dollar roll”. The
Agency RMBS purchased for a forward settlement date under the TBA
contracts are typically priced at a discount to Agency RMBS for
settlement in the current month. This difference (or discount) is
referred to as the “price drop.” The price drop is the economic
equivalent of net interest carry income on the underlying Agency
RMBS over the roll period (interest income less implied financing
cost) and is commonly referred to as a “dollar roll income.”
Consequently, dollar roll transactions and such forward purchase of
Agency RMBS represent a form of financing and increase our
“at-risk” leverage.
Under certain market conditions, TBA dollar roll transactions may
result in negative carry income whereby the Agency RMBS purchased
for a forward settlement date under TBA contract are priced at a
premium to Agency RMBS for settlement in the current month. Under
such conditions, it may be uneconomical to roll our TBA positions
prior to the settlement date, and we may have to take physical
delivery of the underlying securities and settle our obligations
for cash. We may not have sufficient funds or alternative financing
sources available to settle such obligations. In addition, pursuant
to the margin provisions established by the Mortgage-Backed
Securities Division (MBSD) of the FICC, we are subject to margin
calls on our TBA contracts. Further, our prime brokerage agreements
may require us to post additional margin above the levels
established by the MBSD. Any failure to procure adequate financing
to settle our obligations or meet margin calls under our TBA
contracts could result in defaults or force us to sell assets under
adverse market conditions or through foreclosure and adversely
affect our financial condition and results of
operations.
Increases in interest rates could adversely affect the value of our
assets and cause our interest expense to increase.
Our operating results depend in large part on the difference
between the income from our assets and financing costs. We
anticipate that, in many cases, the income from our assets will
respond more slowly to interest rate fluctuations than the cost of
our borrowings. Consequently, changes in interest rates,
particularly short-term interest rates, may significantly influence
our financial results.
Interest rates are highly sensitive to many factors, including
governmental monetary and tax policies, domestic and international
economic and political considerations and other factors beyond our
control. We cannot predict the impact that any future actions or
non-actions by the Federal Reserve with respect to the federal
funds rate or otherwise may have on the markets or the economy.
Interest rate fluctuations present a variety of risks, including
the risk of a narrowing of the difference between asset yields and
borrowing rates, flattening or inversion of the yield curve and
fluctuating prepayment rates.
We endeavor to hedge our exposure to changes in interest rates, but
there can be no assurances that our hedges will be successful, or
that we will be able to enter into or maintain such hedges. As a
result, interest rate fluctuations can cause significant losses,
reductions in income, and limitations on our cash available for
distribution to stockholders.
An increase in interest rates may cause a decrease in the
availability of certain of our target assets, which could adversely
affect our ability to acquire target assets that satisfy our
investment objectives and to generate income and pay
dividends.
Rising interest rates generally reduce the demand for mortgage
loans due to the higher cost of borrowing. A reduction in the
volume of mortgage loans originated may affect the volume of
certain target assets available to us, which could adversely affect
our ability to acquire assets that satisfy our investment and
business objectives. Rising interest rates may also cause certain
target assets that were issued prior to an interest rate increase
to provide yields that are below prevailing market interest rates.
If rising interest rates cause us to be unable to acquire a
sufficient volume of our target assets with a yield that is above
our borrowing cost, our ability to satisfy our investment
objectives and to generate income and pay dividends may be
materially and adversely affected.
The value of our Agency RMBS and MSR may be adversely affected by
deficiencies in servicing and foreclosure practices, as well as
related delays in the foreclosure process.
Deficiencies in servicing and foreclosure practices among servicers
of residential mortgage loans have raised and may in the future
raise concerns relating to such practices. The integrity of
servicing and foreclosure processes is critical to the value of our
Agency RMBS and MSR, and our financial results could be adversely
affected by deficiencies in the conduct of those processes. For
example, delays in the foreclosure process that may result from
improper servicing practices may adversely affect the values of,
and our losses on, our mortgage-related assets. Foreclosure delays
may also result in the curtailment of payments to the GSEs, thereby
resulting in additional expense and reducing the amount of funds
available for distribution to investors. We continue to monitor and
review the issues raised by improper servicing practices. While we
cannot predict exactly how servicing, loss mitigation and
foreclosure matters or any resulting litigation, regulatory actions
or settlement agreements will affect our business, there can be no
assurance that these matters will not have an adverse impact on our
results of operations and financial condition.
We are required to make servicing advances that can be subject to
delays in recovery or may not be recoverable.
During any period in which a borrower is not making payments on a
loan underlying our MSR, we may be required under our servicing
agreements with the GSEs to advance our own funds to meet some
combination of contractual principal and interest remittance
requirements, property taxes and insurance premiums, legal expenses
and other protective advances. We may also be required under these
agreements to advance funds to maintain, repair and market real
estate properties. In certain situations, our contractual
obligations may require us to make certain advances for which we
may not be reimbursed. In addition, in the event a loan underlying
our MSR defaults or becomes delinquent, or the mortgagor is allowed
to enter into a forbearance, the repayment of advances may be
delayed, which may adversely affect our liquidity. Any significant
increase in required servicing advances, material delays in our
receipt of advance reimbursements or the ineligibility of advances
for reimbursement could have an adverse impact on our financial
condition and cash flows.
Risks Related to Our Organization and Structure
Certain provisions of Maryland law could inhibit changes in
control.
Certain provisions of the Maryland General Corporation Law, or
MGCL, may have the effect of deterring a third party from making a
proposal to acquire us or of impeding a change in control under
circumstances that otherwise could provide the holders of shares of
our common stock with the opportunity to realize a premium over the
then-prevailing market price of such shares. We are subject to the
“business combination” provisions of the MGCL that, subject to
limitations, prohibit certain business combinations between our
company and an “interested stockholder” (as defined under the MGCL)
or an affiliate thereof for five years after the most recent date
on which the stockholder becomes an interested stockholder. In
addition, the “unsolicited takeover” provisions of the MGCL (Title
3, Subtitle 8 of the MGCL) permit our board of directors, without
stockholder approval and regardless of what is currently provided
in our charter or bylaws, to implement takeover defenses, some of
which we do not currently have. These provisions may have the
effect of inhibiting a third party from making an acquisition
proposal for our company or of delaying, deferring or preventing a
change in control of our company.
Our authorized but unissued shares of common and preferred stock
and the ownership limitations contained in our charter may prevent
a change in control.
Our charter authorizes Two Harbors to issue additional authorized
but unissued shares of common or preferred stock. In addition, our
board of directors may, without stockholder approval, amend our
charter to increase or decrease the aggregate number of shares of
our stock or the number of shares of stock of any class or series
that Two Harbors has the authority to issue and classify or
reclassify any unissued shares of common or preferred stock and set
the terms of the classified or reclassified shares. As a result,
our board may establish a series of shares of common or preferred
stock that could delay or prevent a transaction or a change in
control that might be in the best interests of
stockholders.
In addition, our charter contains restrictions limiting the
ownership and transfer of shares of our common stock and other
outstanding shares of capital stock. The relevant sections of our
charter provide that, subject to certain exceptions, ownership of
shares of our common stock by any person is limited to 9.8% by
value or by number of shares, whichever is more restrictive, of our
outstanding shares of common stock (the common share ownership
limit), and no more than 9.8% by value or number of shares,
whichever is more restrictive, of our outstanding capital stock
(the aggregate share ownership limit). The common share ownership
limit and the aggregate share ownership limit are collectively
referred to herein as the “ownership limits.” These charter
provisions will restrict the ability of persons to purchase shares
in excess of the relevant ownership limits.
Our charter contains provisions that make removal of our directors
difficult, which could make it difficult for stockholders to effect
changes in management.
Our charter provides that, subject to the rights of any series of
preferred stock, a director may be removed only by the affirmative
vote of at least two-thirds of all the votes entitled to be cast
generally in the election of directors. Our charter and bylaws
provide that vacancies generally may be filled only by a majority
of the remaining directors in office, even if less than a quorum.
These requirements make it more difficult to change management by
removing and replacing directors and may prevent a change in
control that is in the best interests of stockholders.
Our rights and stockholders’ rights to take action against
directors and officers are limited, which could limit recourse in
the event of actions not in the best interests of
stockholders.
As permitted by Maryland law, our charter eliminates the liability
of its directors and officers to Two Harbors and its stockholders
for money damages, except for liability resulting from: actual
receipt of an improper benefit or profit in money, property or
services; or a final judgment based upon a finding of active and
deliberate dishonesty by the director or officer that was material
to the cause of action adjudicated.
In addition, pursuant to our charter we have agreed contractually
to indemnify our present and former directors and officers for
actions taken by them in those capacities to the maximum extent
permitted by Maryland law. Further, our bylaws require us to
indemnify each present or former director or officer, to the
maximum extent permitted by Maryland law, who is made, or
threatened to be made, a party to any proceeding because of his or
her service to Two Harbors. As part of these indemnification
obligations, we may be obligated to fund the defense costs incurred
by our directors and officers.
Our amended and restated bylaws designate certain Maryland courts
as the sole and exclusive forum for certain types of actions and
proceedings that may be initiated by our stockholders.
Our amended and restated bylaws provide that, unless we consent in
writing to the selection of an alternative forum, the Circuit Court
for Baltimore City, Maryland, or, if that Court does not have
jurisdiction, the United States District Court for the District of
Maryland, Baltimore Division, shall be the sole and exclusive forum
for the following: any derivative action or proceeding brought on
behalf of the company; any action asserting a claim of breach of
any duty owed by any of our directors, officers or other employees
to the company or to our stockholders; any action asserting a claim
against the company or any of our directors, officers or other
employees arising pursuant to any provision of the MGCL or our
charter or bylaws; or any action asserting a claim against the
company or any of our directors, officers or other employees that
is governed by the internal affairs doctrine. This choice of forum
provision may limit a stockholder’s ability to bring a claim in a
judicial forum that the stockholder believes is favorable for
disputes with us or our directors, officers or other employees,
which may discourage lawsuits against us and our directors,
officers and employees.
Risks Related to Our Securities
Future issuances and sales of shares of our common stock may
depress the market price of our common stock or have adverse
consequences for our stockholders.
We may issue additional shares of our common stock in public
offerings, private placements as well as through equity awards to
our directors, officers and employees pursuant to our Second
Restated 2009 Equity Incentive Plan or our 2021 Equity Incentive
Plan. Additionally, shares of our common stock have also been
reserved for issuance in connection with the conversion of our
6.25% convertible senior notes due 2026 and our Series A, Series B
and Series C preferred stock. We cannot predict the effect, if any,
of future issuances or sales of our common stock on the market
price of our common stock. We also cannot predict the amounts and
timing of equity awards to be issued pursuant to our equity
incentive plans, nor can we predict the amount and timing of any
conversions of our convertible senior notes due January 2026 or our
Series A, Series B and Series C preferred stock into shares of our
common stock. Any stock offerings, awards or conversions resulting
in the issuance of substantial amounts of common stock, or the
perception that such awards or conversions could occur, may
adversely affect the market price for our common
stock.
Any future offerings of our securities could dilute our existing
stockholders and may rank senior for purposes of dividend and
liquidating distributions.
We may from time to time issue securities which may rank senior
and/or be dilutive to our stockholders. For example, our senior
unsecured notes due January 2026 are convertible into shares of our
common stock at the election of the noteholder, and our Series A,
Series B and Series C preferred shares may be converted into shares
of our common stock following the occurrence of certain events, as
set forth in the articles supplementary for each series. Any
election by noteholders or preferred stockholders to convert their
notes or preferred shares into shares of our common stock will
dilute the interests of other common stockholders.
In the future, we may again elect to raise capital through the
issuance of convertible or non-convertible debt or common or
preferred equity securities. Upon liquidation, holders of our debt
securities and preferred stock, if any, and lenders with respect to
other borrowings will be entitled to our available assets prior to
the holders of our common stock. Convertible debt and convertible
preferred stock may have anti-dilution provisions which are
unfavorable to our common stockholders. Because our decision to
issue debt or equity securities in any future offering will depend
on market conditions and other factors beyond our control, we
cannot predict or estimate the amount, timing or nature of our
future offerings. Thus, our stockholders bear the risk of our
future offerings reducing the market price of our common stock and
diluting the value of their holdings.
We have not established a minimum distribution payment level and we
cannot assure you of our ability to pay distributions in the
future.
We intend to continue to pay quarterly distributions and to make
distributions to our stockholders in an amount such that we
distribute all or substantially all of our REIT taxable income in
each year. We have not established a minimum distribution payment
level and our ability to pay distributions may be adversely
affected by a number of factors, including the risk factors
described herein. All distributions will be made, subject to
Maryland law, at the discretion of our board of directors and will
depend on our earnings, our financial condition, any debt
covenants, maintenance of our REIT qualification and other factors
as our board of directors may deem relevant. We cannot assure you
that we will achieve results that will allow us to make a specified
level of cash distributions and distributions in future periods may
be significantly lower than in prior quarterly
periods.
The market price of our common stock could fluctuate and could
cause you to lose a significant part of your
investment.
The market price of our common stock may be highly volatile. In
addition, the trading volume in our common stock may fluctuate and
cause significant price variations to occur. If the market price of
our common stock declines significantly, you may be unable to
resell your shares of our common stock at a gain. We cannot assure
you that the market price of our common stock will not fluctuate or
decline significantly in the future.
The market price of our common stock may be influenced by many
factors, including without limitation: changes in financial
estimates by analysts; fluctuations in our results of operations or
financial condition or the results of operations or financial
condition of companies perceived to be similar to us; general
economic and financial and real estate market conditions; changes
in market valuations of similar companies; monetary policy and
regulatory developments in the U.S.; and additions or departures of
key personnel.
Tax Risks
Our failure to qualify as a REIT would subject us to U.S. federal
income tax and potentially increased state and local taxes, which
would reduce the amount of our income available for distribution to
our stockholders.
We operate in a manner that will enable us to qualify as a REIT and
have elected to be taxed as a REIT for U.S. federal income tax
purposes commencing with our taxable year ended December 31, 2009.
We have not requested and do not intend to request a ruling from
the Internal Revenue Service, or IRS, that we qualify as a REIT.
The U.S. federal income tax laws governing REITs and the assets
they hold are complex, and judicial and administrative
interpretations of the U.S. federal income tax laws governing REIT
qualification are limited. To continue to qualify as a REIT, we
must meet, on an ongoing basis, various tests regarding the nature
of our assets and income, the ownership of our outstanding shares,
and the amount of our distributions. Moreover, new legislation,
court decisions, administrative guidance or actions by federal
agencies or others to modify or re-characterize our assets may make
it more difficult or impossible for us to qualify as a REIT. Thus,
while we intend to operate so that we qualify as a REIT, no
assurance can be given that we will so qualify for any particular
year.
If we fail to qualify as a REIT in any taxable year, and do not
qualify for certain statutory relief provisions, we would be
required to pay U.S. federal income tax on our taxable income, and
distributions to our stockholders would not be deductible by us in
determining our taxable income. Furthermore, if we fail to maintain
our qualification as a REIT, we no longer would be required to
distribute substantially all of our net taxable income to
stockholders.
Complying with REIT requirements may cause us to forego otherwise
attractive investment opportunities or financing or hedging
strategies.
In order to qualify as a REIT for U.S. federal income tax purposes,
we must continually satisfy various tests on an annual and
quarterly basis regarding the sources of our income, the nature and
diversification of our assets, the amounts we distribute to
stockholders and the ownership of our stock. To meet these tests,
we may be required to forego investments we might otherwise make.
We may be required to make distributions to stockholders at
disadvantageous times. Thus, compliance with the REIT requirements
may hinder our investment performance.
Complying with REIT requirements may force us to liquidate
otherwise profitable assets.
In order to continue to qualify as a REIT, we must ensure that at
the end of each calendar quarter, at least 75% of the value of our
assets consists of cash, cash items, government securities and
designated real estate assets, including certain mortgage loans and
shares in other REITs. Subject to certain exceptions, our ownership
of securities, other than government securities and securities that
constitute real estate assets, generally cannot include more than
10% of the outstanding voting securities of any one issuer or more
than 10% of the total value of the outstanding securities of any
one issuer. In addition, in general, no more than 5% of the value
of our total assets, other than government securities and
securities that constitute real estate assets, can consist of the
securities of any one issuer, no more than 20% of the value of our
total assets can be represented by securities of one or more
TRSs,
and no more than 25% of the value of our total assets can consist
of debt of “publicly offered” REITs that is not secured by real
property or interests in real property.
If we fail to comply with these requirements at the end of any
calendar quarter, we must generally correct such failure within 30
days after the end of such calendar quarter to avoid losing our
REIT qualification. As a result, we may be required to liquidate
otherwise profitable assets prematurely, which could reduce our
return on assets, which could adversely affect our results of
operations and financial condition.
Potential characterization of distributions or gain on sale may be
treated as unrelated business taxable income to tax exempt
investors.
If (i) all or a portion of our assets are subject to the rules
relating to taxable mortgage pools, (ii) we are a “pension held
REIT,” (iii) a tax exempt stockholder has incurred debt to purchase
or hold our common stock, or (iv) we purchase residual REMIC
interests that generate “excess inclusion income,” then a portion
of the distributions to and, in the case of a stockholder described
in clause (iii), gains realized on the sale of common stock by such
tax exempt stockholder may be subject to U.S. federal income tax as
unrelated business taxable income under the Code.
Complying with REIT requirements may limit our ability to hedge
effectively.
The REIT provisions of the Code may limit our ability to hedge our
assets and liabilities. Any income from a hedging transaction will
not constitute gross income for purposes of the 75% or 95% gross
income test if we properly identify the transaction as specified in
applicable Treasury Regulations and we enter into such transaction
(i) in the normal course of our business primarily to manage risk
of interest rate or price changes or currency fluctuations with
respect to borrowings made or to be made, or ordinary obligations
incurred or to be incurred, to acquire or carry real estate assets
or (ii) primarily to manage risk of currency fluctuations with
respect to any item of income or gain that would be qualifying
income under the 75% or 95% gross income tests. To the extent that
we enter into other types of hedging transactions, the income from
those transactions is likely to be treated as non-qualifying income
for purposes of both of these gross income tests. As a result of
these rules, we intend to limit our use of advantageous hedging
techniques or implement those hedges through a TRS. This could
increase the cost of our hedging activities.
The failure of our Agency RMBS that are subject to a repurchase
agreement to qualify as real estate assets would adversely affect
our ability to qualify as a REIT.
We may enter into repurchase agreements under which we will
nominally sell certain of our Agency RMBS to a counterparty and
simultaneously enter into an agreement to repurchase the sold
assets. We believe that we will be treated for U.S. federal income
tax purposes as the owner of the securities that are the subject of
any such agreement notwithstanding that such agreement may transfer
record ownership of the assets to the counterparty during the term
of the agreement. It is possible, however, that the IRS could
assert that we did not own the securities during the term of the
repurchase agreement, in which case we could fail to qualify as a
REIT.
REIT distribution requirements could adversely affect our ability
to execute our business plan and may require us to incur debt, sell
assets or take other actions to make such
distributions.
In order to continue to qualify as a REIT, we must distribute to
stockholders, each calendar year, at least 90% of our REIT taxable
income (including certain items of non-cash income), determined
without regard to the deduction for dividends paid and excluding
net capital gain. To the extent that we satisfy the 90%
distribution requirement, but distribute less than 100% of our
taxable income, we will be subject to U.S. federal corporate income
tax on our undistributed income. In addition, we will incur a 4%
nondeductible excise tax on the amount, if any, by which our
distributions in any calendar year are less than a minimum amount
specified under U.S. federal income tax law.
We intend to distribute our net income to stockholders in a manner
intended to satisfy the 90% distribution requirement and to avoid
both corporate income tax and the 4% nondeductible excise tax. Our
taxable income may substantially exceed our net income as
determined by U.S. GAAP or differences in timing between the
recognition of taxable income and the actual receipt of cash may
occur in which case we may have taxable income in excess of cash
flow from our operating activities. In such event, we may generate
less cash flow than taxable income in a particular year and find it
difficult or impossible to meet the REIT distribution
requirements.
Our qualification as a REIT may depend on the accuracy of legal
opinions or advice rendered or given or statements by the issuers
of assets we acquire, including with respect to the treatment of
our TBA securities and transactions for tax purposes.
When purchasing securities, we may rely on opinions or advice of
counsel for the issuer of such securities, or statements made in
related offering documents, for purposes of determining, among
other things, whether such securities represent debt or equity
securities for U.S. federal income tax purposes, the value of such
securities, and also to what extent those securities constitute
qualified real estate assets for purposes of the REIT asset tests
and produce qualified income for purposes of the 75% gross income
test. In addition, we may from time to time obtain and rely upon
opinions of counsel regarding the qualification of certain assets
and income as real estate assets. The inaccuracy of any such
opinions, advice or statements may adversely affect our ability to
qualify as a REIT and result in significant corporate-level
tax.
We may utilize TBAs as a means of investing and financing Agency
RMBS. There is no direct authority with respect to the
qualification of TBAs as real estate assets or U.S. government
securities for purposes of the 75% asset test or the qualification
of income or gains from dispositions of TBAs as gains from the sale
of real property (including interests in real property and
interests in mortgages on real property) or other qualifying income
for purposes of the 75% gross income test. We intend to treat our
TBAs as qualifying assets for purposes of the 75% asset test, to
the extent set forth in an opinion from Sidley Austin LLP
substantially to the effect that, for purposes of the 75% asset
test, our ownership of TBAs should be treated as ownership of the
underlying Agency RMBS, and to treat income and gains from our TBAs
as qualifying income for purposes of the 75% gross income test, to
the extent set forth in an opinion from Sidley Austin LLP
substantially to the effect that, for purposes of the 75% gross
income test, any gain recognized by us in connection with the
settlement of our TBAs should be treated as gain from the sale or
disposition of the underlying Agency RMBS. Such opinions of counsel
are not binding on the IRS, and there can be no assurance that the
IRS will not successfully challenge the conclusions set forth
therein.
Our ownership of, and relationship with, our TRSs will be
restricted and a failure to comply with the restrictions would
jeopardize our REIT status and may result in the application of a
100% excise tax.
A REIT may own up to 100% of the stock of one or more TRSs. A TRS
may earn income that would not be qualifying REIT income if earned
directly by the parent REIT. Both the TRS and the REIT must jointly
elect to treat the subsidiary as a TRS. A corporation of which a
TRS directly or indirectly owns more than 35% of the voting power
or value of the stock will automatically be treated as a TRS.
Overall, no more than 20% of the value of a REIT’s total assets may
consist of stock or securities of one or more TRSs. The value of
our interests in and thus the amount of assets held in a TRS may
also be restricted by our need to qualify for an exclusion from
regulation as an investment company under the Investment Company
Act.
Any domestic TRS we own will pay U.S. federal, state and local
income tax at regular corporate rates. In addition, the TRS rules
limit the deductibility of interest paid or accrued by a TRS to its
parent REIT to assure that the TRS is subject to an appropriate
level of corporate taxation. The rules also impose a 100% excise
tax on certain transactions between a TRS and its parent REIT that
are not conducted on an arm’s-length basis. Although we monitor our
investments in and transactions with TRSs, there can be no
assurance that we will be able to comply with the limitation on the
value of our TRSs discussed above or to avoid application of the
100% excise tax discussed above.
Dividends payable by REITs generally do not qualify for the reduced
tax rates on dividend income from regular corporations, which could
adversely affect the value of our shares.
The maximum U.S. federal income tax rate for dividends payable to
domestic stockholders that are individuals, trusts and estates is
20%. Dividends payable by REITs, however, are generally not
eligible for these reduced rates. Although the reduced U.S. federal
income tax rate applicable to dividend income from regular
corporate dividends does not adversely affect the taxation of REITs
or dividends paid by REITs, the more favorable rates applicable to
regular corporate dividends could cause investors who are
individuals, trusts and estates to perceive investments in REITs to
be relatively less attractive than investments in the stocks of
non-REIT corporations that pay dividends, which could adversely
affect the value of the shares of REITs, including our shares of
common stock.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We lease administrative office space in New York and Minnesota. We
do not own, lease or utilize any physical properties that would be
considered material to our business and operations.
Item 3. Legal Proceedings
From time to time, we may be involved in various legal and
regulatory matters that arise in the ordinary course of business.
As previously disclosed, on July 15, 2020, we provided PRCM
Advisers with a notice of termination of the Management Agreement
for “cause” in accordance with Section 15(a) of the Management
Agreement. We terminated the Management Agreement for “cause” on
the basis of certain material breaches and certain events of gross
negligence on the part of PRCM Advisers in the performance of its
duties under the Management Agreement. On July 21, 2020, PRCM
Advisers filed a complaint against us in the United States District
Court for the Southern District of New York, or the Court.
Subsequently, Pine River Domestic Management L.P. and Pine River
Capital Management L.P. were added as plaintiffs to the matter. As
amended, the complaint, or the Federal Complaint, alleges, among
other things, the misappropriation of trade secrets in violation of
both the Defend Trade Secrets Act and New York common law, breach
of contract, breach of the implied covenant of good faith and fair
dealing, unfair competition and business practices, unjust
enrichment, conversion, and tortious interference with contract.
The Federal Complaint seeks, among other things, an order enjoining
us from making any use of or disclosing PRCM Advisers’ trade
secret, proprietary, or confidential information; damages in an
amount to be determined at a hearing and/or trial; disgorgement of
our wrongfully obtained profits; and fees and costs incurred by the
plaintiffs in pursuing the action. We have filed our answer to the
Federal Complaint and made counterclaims against PRCM Advisers and
Pine River Capital Management L.P. On May 5, 2022, the plaintiffs
filed a motion for judgment on the pleadings, seeking judgment in
their favor on all but one of our counterclaims and on one of our
affirmative defenses. We have opposed the motion for judgment on
the pleadings, which is pending with the Court. Discovery has
commenced and is ongoing. Our board of directors believes the
Federal Complaint is without merit and that we have fully complied
with the terms of the Management Agreement.
Item 4. Mine Safety Disclosures
None.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder
Matters, and Issuer Purchases of Equity Securities
Market Information
Our common stock is listed on the NYSE under the symbol “TWO”. As
of February 21, 2023, 96,616,279 shares of common stock were
issued and outstanding.
On September 21, 2022, our board of directors approved a
one-for-four reverse stock split of our outstanding shares of
common stock. The reverse stock split was effected on November 1,
2022 at 5:01 p.m. Eastern Time. At the effective time, every four
issued and outstanding shares of our common stock were converted
into one share of common stock. No fractional shares were issued in
connection with the reverse stock split; instead, each stockholder
holding fractional shares was entitled to receive, in lieu of such
fractional shares, cash in an amount determined on the basis of the
volume weighted average price of our common stock on the NYSE on
November 1, 2022. In connection with the reverse stock split, the
number of authorized shares of our common stock was also reduced on
a one-for-four basis, from 700,000,000 to 175,000,000. The par
value of each share of common stock remained unchanged. All per
share amounts, common shares outstanding and common equity-based
awards for all periods presented have been adjusted on a
retroactive basis to reflect the reverse stock split.
Holders
As of February 17, 2023, there were 517 registered holders and
approximately 112,512 beneficial owners of our common
stock.
Dividends
We have historically paid dividends on our common stock. All
dividend distributions are authorized by our board of directors, in
its discretion, and will depend on such items as our REIT taxable
income, financial condition, maintenance of REIT status, and other
factors that the board of directors may deem relevant from time to
time. The holders of our common stock share proportionally on a per
share basis in all declared dividends on our common stock.
Dividends cannot be paid on our common stock unless we have paid
full cumulative dividends on all classes of our preferred stock. We
have paid full cumulative dividends on all classes of our preferred
stock from the respective dates of issuance through
December 31, 2022. We intend to continue to pay quarterly
dividends on our common stock and to distribute to our common
stockholders as dividends 100% of our REIT taxable income, on an
annual basis.
We have not established a minimum dividend distribution level for
our common stock. See Item 1A, “Risk
Factors”
and Item 7, “Management’s
Discussion and Analysis of Financial Conditions and Results of
Operations”
of this Annual Report on Form 10-K for information regarding the
sources of funds used for dividends and for a discussion of
factors, if any, which may adversely affect our ability to pay
dividends in 2023 and thereafter.
Our stock transfer agent and registrar is Equiniti Trust Company.
Requests for information from Equiniti Trust Company can be sent to
Equiniti Trust Company, P.O. Box 64856, St. Paul, MN 55164-0856 and
their telephone number is 1-800-468-9716.
Securities Authorized for Issuance under Equity Compensation
Plans
Our Second Restated 2009 Equity Incentive Plan and our 2021 Equity
Incentive Plan, or the Equity Incentive Plans, were adopted by our
board of directors and approved by our stockholders for the purpose
of enabling us to provide equity compensation to attract and retain
qualified directors, officers, advisers, consultants and other
personnel. The Equity Incentive Plans are administered by the
compensation committee of our board of directors and permit the
grants of restricted common stock, restricted stock units, or RSUs,
performance-based awards (including performance share units, or
PSUs), phantom shares, dividend equivalent rights and other
equity-based awards. For a detailed description of the Equity
Incentive Plans, see Note 17 - Equity
Incentive Plans
of the consolidated financial statements included under Item 8 of
this Annual Report on Form 10-K.
The following table presents certain information about the Equity
Incentive Plans as of December 31, 2022:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2022 |
Plan Category |
|
Number of securities to be issued upon exercise of outstanding
options, warrants and rights |
|
Weighted-average exercise price of outstanding options, warrants
and rights |
|
Number of securities remaining available for future issuance under
equity compensation plans (excluding securities reflected in the
first column of this table) |
Equity compensation plans approved by stockholders
(1)
|
|
— |
|
|
$ |
— |
|
|
4,223,261 |
|
Equity compensation plans not approved by stockholders
|
|
— |
|
|
— |
|
|
— |
|
Total |
|
— |
|
|
$ |
— |
|
|
4,223,261 |
|
___________________
(1)For
a detailed description of the Equity Incentive Plans, see Note
17 - Equity
Incentive Plans
of the consolidated financial statements included under Item 8 of
this Annual Report on Form 10-K.
Performance Graph
The following graph compares a stockholder’s cumulative total
return, assuming $100 invested at December 31, 2017, with all
reinvestment of dividends, as if such amounts had been invested in:
(i) our common stock; (ii) the stocks included in the Standard and
Poor’s 500 Stock Index, or S&P 500; and (iii) the stocks
included in the Bloomberg REIT Mortgage Index.
COMPARISON OF CUMULATIVE TOTAL RETURN
Among Two Harbors Investment Corp.,
S&P 500 and Bloomberg REIT Mortgage Index
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|
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|
|
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|
|
|
|
December 31, |
Index |
|
2022 |
|
2021 |
|
2020 |
|
2019 |
|
2018 |
Two Harbors Investment Corp. |
|
$ |
42.25 |
|
|
$ |
55.09 |
|
|
$ |
55.05 |
|
|
$ |
115.18 |
|
|
$ |
89.52 |
|
S&P 500 |
|
$ |
156.77 |
|
|
$ |
191.48 |
|
|
$ |
148.81 |
|
|
$ |
125.70 |
|
|
$ |
95.61 |
|
Bloomberg REIT Mortgage Index |
|
$ |
83.05 |
|
|
$ |
109.82 |
|
|
$ |
93.38 |
|
|
$ |
120.03 |
|
|
$ |
97.09 |
|
Purchases of Equity Securities by the Issuer and Affiliated
Purchasers
Our preferred share repurchase program allows for the repurchase of
up to an aggregate of 5,000,000 shares of the company’s preferred
stock, which includes the 8.125% Series A Fixed-to-Floating Rate
Cumulative Redeemable Preferred Stock, 7.625% Series B
Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock and
7.25% Series C Fixed-to-Floating Rate Cumulative Redeemable
Preferred Stock. Preferred shares may be repurchased from time to
time through privately negotiated transactions or open market
transactions, pursuant to trading plans in accordance with Rule
10b5-1 under the Securities Exchange Act of 1934, as amended, or
the Exchange Act, or by any combination of such methods. The
manner, price, number and timing of preferred share repurchases are
subject to a variety of factors, including market conditions and
applicable SEC rules. The preferred share repurchase program does
not require the purchase of any minimum number of shares, and,
subject to SEC rules, purchases may be commenced or suspended at
any time without prior notice. The preferred share repurchase
program does not have an expiration date.
The following table reflects purchases of our 8.125% Series A
Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock,
7.625% Series B Fixed-to-Floating Rate Cumulative Redeemable
Preferred Stock and 7.25% Series C Fixed-to-Floating Rate
Cumulative Redeemable Preferred Stock under the preferred share
repurchase program during the three months ended December 31,
2022:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period |
|
Total Number of Shares Purchased |
|
Average Price Paid per Share |
|
Total Number of Shares Purchased as Part of Publicly Announced
Plans of Programs |
|
Maximum Number of Shares that May Yet Be Purchased Under the Plans
or Programs
(1)
|
Series A Preferred Stock: |
|
|
|
|
|
|
|
|
October 1, 2022 through October 31, 2022 |
|
413,549 |
|
|
$ |
18.14 |
|
|
413,549 |
|
|
N/A |
November 1, 2022 through November 30, 2022 |
|
— |
|
|
— |
|
|
— |
|
|
N/A |
December 1, 2022 through December 31, 2022 |
|
15,000 |
|
|
19.51 |
|
|
15,000 |
|
|
N/A |
Total |
|
428,549 |
|
|
$ |
18.18 |
|
|
428,549 |
|
|
N/A |
Series B Preferred Stock: |
|
|
|
|
|
|
|
|
October 1, 2022 through October 31, 2022 |
|
756,846 |
|
|
$ |
17.48 |
|
|
756,846 |
|
|
N/A |
November 1, 2022 through November 30, 2022 |
|
— |
|
|
— |
|
|
— |
|
|
N/A |
December 1, 2022 through December 31, 2022 |
|
30,000 |
|
|
18.42 |
|
|
30,000 |
|
|
N/A |
Total |
|
786,846 |
|
|
$ |
17.52 |
|
|
786,846 |
|
|
N/A |
Series C Preferred Stock: |
|
|
|
|
|
|
|
|
October 1, 2022 through October 31, 2022 |
|
1,712,555 |
|
|
$ |
17.09 |
|
|
1,712,555 |
|
|
N/A |
November 1, 2022 through November 30, 2022 |
|
— |
|
|
— |
|
|
— |
|
|
N/A |
December 1, 2022 through December 31, 2022 |
|
30,000 |
|
|
18.55 |
|
|
30,000 |
|
|
N/A |
Total |
|
1,742,555 |
|
|
$ |
17.12 |
|
|
1,742,555 |
|
|
N/A |
____________________
(1)Our
preferred share repurchase program allows for the repurchase of up
to an aggregate of 5,000,000 shares of the company’s preferred
stock, which includes the 8.125% Series A Fixed-to-Floating Rate
Cumulative Redeemable Preferred Stock, 7.625% Series B
Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock and
7.25% Series C Fixed-to-Floating Rate Cumulative Redeemable
Preferred Stock. As of December 31, 2022, we had repurchased
an aggregate of 2,957,950 preferred shares under the program and
had remaining authorization to repurchase up to 2,042,050 of such
securities.
Our common share repurchase program allows for the repurchase of up
to an aggregate of 9,375,000 shares of the company’s common stock.
Common shares may be repurchased from time to time through
privately negotiated transactions or open market transactions,
pursuant to a trading plan in accordance with Rules 10b5-1 and
10b-18 under the Exchange Act or by any combination of such
methods. The manner, price, number and timing of common share
repurchases are subject to a variety of factors, including market
conditions and applicable SEC rules. The common share repurchase
program does not require the purchase of any minimum number of
shares, and, subject to SEC rules, purchases may be commenced or
suspended at any time without prior notice. The common share
repurchase program does not have an expiration date. As of
December 31, 2022, we had repurchased 3,043,575 common shares
under the program for a total cost of $201.5 million. We did not
repurchase common shares during the three months ended
December 31, 2022.
Item 6. [Reserved]
Item 7. Management’s Discussion and Analysis of Financial Condition
and Results of Operations
The following discussion and analysis should be read in conjunction
with the consolidated financial statements and accompanying notes
included elsewhere in this Annual Report on Form 10-K.
This section of this Form 10-K generally
discusses 2022 and 2021 items and year-to-year
comparisons between 2022 and 2021. Discussions
of 2020 items and year-to-year comparisons
between 2021 and 2020 that are not included in
this Form 10-K can be found in “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations”
in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal
year ended December 31, 2021.
General
We are a Maryland corporation focused on investing in and managing
Agency residential mortgage-backed securities, or Agency RMBS,
mortgage servicing rights, or MSR, and other financial assets,
which we collectively refer to as our target assets. We operate as
a real estate investment trust, or REIT, as defined under the
Internal Revenue Code of 1986, as amended, or the
Code.
Our objective is to provide attractive risk-adjusted total return
to our stockholders over the long term, primarily through dividends
and secondarily through capital appreciation. We acquire and manage
an investment portfolio of our target assets, which include the
following:
•Agency
RMBS (which includes inverse interest-only Agency securities
classified as “Agency Derivatives” for purposes of U.S. generally
accepted accounting principles, or U.S. GAAP), meaning RMBS
whose principal and interest payments are guaranteed by a U.S.
government agency, such as the Government National Mortgage
Association (or Ginnie Mae), or 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);
•MSR;
and
•Other
financial assets comprising approximately 5% to 10% of the
portfolio.
Our Agency RMBS portfolio is comprised primarily of fixed rate
mortgage-backed securities backed by single-family and multi-family
mortgage loans. All of our principal and interest Agency RMBS are
Fannie Mae or Freddie Mac mortgage pass-through certificates or
collateralized mortgage obligations, or Ginnie Mae mortgage
pass-through certificates, which are backed by the guarantee of the
U.S. government. The majority of these securities consist of whole
pools in which we own all of the investment interests in the
securities.
Within our MSR business, we acquire MSR assets, which represent the
right to control the servicing of residential mortgage loans and
the obligation to service the loans in accordance with relevant
standards, from high-quality originators. We do not directly
service the mortgage loans underlying the MSR we acquire; rather,
we contract with appropriately licensed third-party subservicers to
handle substantially all servicing functions in the name of the
subservicer. As the servicer of record, however, we remain
accountable to the GSEs for all servicing matters and, accordingly,
provide substantial oversight of each of our subservicers. We
believe MSR are a natural fit for our portfolio over the long term.
Our MSR business leverages our core competencies in prepayment and
credit risk analytics and the MSR assets provide offsetting risks
to our Agency RMBS, hedging both interest rate and mortgage spread
risk.
On August 2, 2022, Matrix Financial Services Corporation, or
Matrix, one of our wholly owned subsidiaries, entered into a
definitive stock purchase agreement to acquire RoundPoint Mortgage
Servicing Corporation, or RoundPoint, from Freedom Mortgage
Corporation. In connection with the acquisition, Matrix has 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 will
divest 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. Upon closing, all
servicing licenses and operational capabilities will remain with
RoundPoint, and RoundPoint will become a wholly owned subsidiary of
Matrix. The parties expect to close the transaction in 2023,
subject to the satisfaction of customary closing conditions and the
receipt of required regulatory and GSE approvals.
For the three months ended December 31, 2022, our net spread
realized on the portfolio was lower than recent quarters due
primarily to higher cost of financing due to rising interest rates,
offset by higher coupon and lower amortization on Agency RMBS due
to slower prepayment speeds and the higher yielding MSR making up a
larger proportion of the portfolio. The following table provides
the average portfolio yield and cost of financing on our assets for
the three months ended December 31, 2022, and the four
immediately preceding quarters:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
December 31,
2022 |
|
September 30,
2022 |
|
June 30,
2022 |
|
March 31,
2022 |
|
December 31,
2021 |
Average portfolio yield
(1)
|
4.92% |
|
4.61% |
|
4.39% |
|
3.90% |
|
3.72% |
Average cost of financing
(2)
|
3.95% |
|
2.84% |
|
1.13% |
|
1.01% |
|
0.73% |
Net spread |
0.97% |
|
1.77% |
|
3.26% |
|
2.89% |
|
2.99% |
____________________
(1)Average
portfolio yield includes interest income on Agency RMBS and
non-Agency securities and MSR servicing income, net of estimated
amortization, and servicing expenses. Beginning with the three
months ended June 30, 2022, average portfolio yield also includes
the implied asset yield portion of dollar roll income on TBAs. MSR
estimated amortization refers to the portion of change in fair
value of MSR primarily attributed to the realization of expected
cash flows (runoff) of the portfolio, which is deemed a non-GAAP
measure due to the company’s decision to account for MSR at fair
value. TBA dollar roll income is the non-GAAP economic equivalent
to holding and financing Agency RMBS using short-term repurchase
agreements.
(2)Average
cost of financing includes interest expense and amortization of
deferred debt issuance costs on borrowings under repurchase
agreements (excluding those collateralized by U.S. Treasuries),
revolving credit facilities, term notes payable and convertible
senior notes and interest spread income/expense and amortization of
upfront payments made or received upon entering into interest rate
swap agreements. Beginning with the three months ended June 30,
2022, average cost of financing also includes the implied financing
benefit/cost portion of dollar roll income on TBAs. TBA dollar roll
income is the non-GAAP economic equivalent to holding and financing
Agency RMBS using short-term repurchase agreements. Beginning with
the three months ended September 30, 2022, average cost of
financing also includes U.S. Treasury futures income, which
represents the economic equivalent to holding and financing a
relevant cheapest-to-deliver U.S. Treasury note or bond using
short-term repurchase agreements.
We seek to deploy moderate leverage as part of our investment
strategy. We generally finance our Agency RMBS through short- and
long-term borrowings structured as repurchase agreements. We also
finance our MSR through revolving credit facilities, repurchase
agreements, term notes payable and convertible senior
notes.
Our Agency RMBS, given their liquidity and high credit quality, are
eligible for higher levels of leverage, while MSR, with less
liquidity and/or more exposure to prepayment, utilize lower levels
of leverage. As a result, our debt-to-equity ratio is determined by
our portfolio mix as well as many additional factors, including the
liquidity of our portfolio, the availability and price of our
financing, the diversification of our counterparties and their
available capacity to finance our assets, and anticipated
regulatory developments. Our debt-to-equity ratio is also directly
correlated to the composition of our portfolio; specifically, the
higher percentage of Agency RMBS we hold, the higher our
debt-to-equity ratio is. We may alter the percentage allocation of
our portfolio among our target assets depending on the relative
value of the assets that are available to purchase from time to
time, including at times when we are deploying proceeds from
offerings we conduct. See Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Financing”
for further discussion.
We recognize that investing in our target assets is competitive and
we compete with other entities for attractive investment
opportunities. We believe that our significant focus in the
residential market, the extensive mortgage market expertise of our
investment team, our operational capabilities to invest in MSR, our
strong analytics and our disciplined relative value investment
approach give us a competitive advantage versus our
peers.
We have elected to be treated as a REIT for U.S. federal income tax
purposes. To qualify as a REIT we are required to meet certain
investment and operating tests and annual distribution
requirements. We generally will not be subject to U.S. federal
income taxes on our taxable income to the extent that we annually
distribute all of our net taxable income to stockholders, do not
participate in prohibited transactions and maintain our intended
qualification as a REIT. However, certain activities that we may
perform may cause us to earn income which will not be qualifying
income for REIT purposes. We have designated certain of our
subsidiaries as taxable REIT subsidiaries, or TRSs, as defined in
the Code, to engage in such activities. We also operate our
business in a manner that will permit us to maintain our exemption
from registration under the Investment Company Act of 1940, as
amended, or the 1940 Act. While we do not currently originate or
directly service residential mortgage loans, certain of our
subsidiaries have obtained the requisite licenses and approvals to
own and manage MSR.
Factors Affecting our Operating Results
Our net interest income includes income from our securities
portfolio, including the amortization of purchase premiums and
accretion of purchase discounts. Net interest income, as well as
our servicing income, net of subservicing expenses, will fluctuate
primarily as a result of changes in market interest rates, our
financing costs and prepayment speeds on our assets. Interest
rates, financing costs and prepayment rates vary according to the
type of investment, conditions in the financial markets,
competition and other factors, none of which can be predicted with
any certainty.
Fair Value Measurement
A significant portion of our assets and liabilities are reported at
fair value and, therefore, our consolidated balance sheets and
statements of comprehensive loss are significantly affected by
fluctuations in market prices. At December 31, 2022,
approximately 80.1% of our total assets, or $10.8 billion,
consisted of financial instruments recorded at fair value. See Note
10 -
Fair Value
to the consolidated financial statements, included in this Annual
Report on Form 10-K, for descriptions of valuation methodologies
used to measure material assets and liabilities at fair value and
details of the valuation models, key inputs to those models and
significant assumptions utilized. Although we execute various
hedging strategies to mitigate our exposure to changes in fair
value, we cannot fully eliminate our exposure to volatility caused
by fluctuations in market prices.
Any temporary change in the fair value of our AFS securities,
excluding certain AFS securities for which we have elected the fair
value option, is recorded as a component of accumulated other
comprehensive (loss) income and does not impact our reported income
(loss) for U.S. GAAP purposes, or GAAP net income (loss). However,
changes in the provision for credit losses on AFS securities are
recognized immediately in GAAP net income (loss). Our GAAP net
income (loss) is also affected by fluctuations in market prices on
the remainder of our financial assets and liabilities recorded at
fair value, including interest rate swap, cap and swaption
agreements and certain other derivative instruments
(i.e.,
Agency to-be-announced securities, or TBAs, options on TBAs,
futures, options on futures, and inverse interest-only securities),
which are accounted for as derivative trading instruments under
U.S. GAAP, fair value option elected AFS securities and
MSR.
We have numerous internal controls in place to help ensure the
appropriateness of fair value measurements. Significant fair value
measures are subject to detailed analytics and management review
and approval. Our entire investment portfolio reported at fair
value is priced by third-party brokers and/or by independent
pricing vendors. We generally receive three or more broker and
vendor quotes on pass-through Agency P&I RMBS, and generally
receive multiple broker or vendor quotes on all other securities,
including interest-only Agency RMBS and inverse interest-only
Agency RMBS. We also receive multiple vendor quotes for the MSR in
our investment portfolio. For Agency RMBS, the third-party pricing
vendors and brokers use pricing models that commonly incorporate
such factors as coupons, primary and secondary mortgage rates, rate
reset periods, issuer, prepayment speeds, credit enhancements and
expected life of the security. For MSR, vendors use pricing models
that generally incorporate observable inputs such as principal
balance, note rate, geographical location, loan-to-value (LTV)
ratios, FICO, appraised value and other loan characteristics, along
with observed market yields and trading levels. Pricing vendors
will customarily incorporate loan servicing cost, servicing fee,
ancillary income, and earnings rate on escrow as observable inputs.
Unobservable or model-driven inputs include forecast cumulative
defaults, default curve, forecast loss severity and forecast
voluntary prepayment.
We evaluate the prices we receive from both third-party brokers and
pricing vendors by comparing those prices to actual purchase and
sale transactions, our internally modeled prices calculated based
on market observable rates and credit spreads, and to each other
both in current and prior periods. We review and may challenge
valuations from third-party brokers and pricing vendors to ensure
that such quotes and valuations are indicative of fair value as a
result of this analysis. We then estimate the fair value of each
security based upon the median of the final broker quotes received,
and we estimate the fair value of MSR based upon the average of
prices received from third-party vendors, subject to
internally-established hierarchy and override
procedures.
We utilize “bid side” pricing for our Agency RMBS and, as a result,
certain assets, especially the most recent purchases, may realize a
markdown due to the “bid-offer” spread. To the extent that this
occurs, any economic effect of this would be reflected in
accumulated other comprehensive (loss) income.
Considerable judgment is used in forming conclusions and estimating
inputs to our Level 3 fair value measurements. Level 3 inputs such
as interest rate movements, prepayments speeds, credit losses and
discount rates are inherently difficult to estimate. Changes to
these inputs can have a significant effect on fair value
measurements. Accordingly, there is no assurance that our estimates
of fair value are indicative of the amounts that would be realized
on the ultimate sale or exchange of these assets. At
December 31, 2022, 23.1% of our total assets were classified
as Level 3 fair value assets.
Critical Accounting Estimates
The preparation of financial statements in accordance with U.S.
GAAP requires us to make certain judgments and assumptions, based
on information available at the time of our preparation of the
financial statements, in determining accounting estimates used in
preparation of the statements. Accounting estimates are considered
critical if the estimate requires us to make assumptions about
matters that were highly uncertain at the time the accounting
estimate was made and if different estimates reasonably could have
been used in the reporting period or changes in the accounting
estimate are reasonably likely to occur from period to period that
would have a material impact on our financial condition, results of
operations or cash flows. Our significant accounting policies are
described in Note 2 to the consolidated financial statements,
included under Item 8 of this Annual Report on Form 10-K. Our most
critical accounting policies involve our fair valuation of AFS
securities, MSR and derivative instruments.
The methods used by us to estimate fair value for AFS securities,
MSR and derivative instruments may produce a fair value calculation
that may not be indicative of net realizable value or reflective of
future fair values. Furthermore, while we believe that our
valuation methods are appropriate and consistent with other market
participants, the use of different methodologies, or assumptions,
to determine the fair value of certain financial instruments could
result in a different estimate of fair value at the reporting date.
We use prices obtained from third-party pricing vendors or broker
quotes deemed indicative of market activity and current as of the
measurement date, which in periods of market dislocation, may have
reduced transparency. For more information on our fair value
measurements, see Note 10 to the consolidated financial statements,
included under Item 8 of this Annual Report on Form 10-K.
Additionally, the key economic assumptions and sensitivity of the
fair value of MSR to immediate adverse changes in these assumptions
are presented in Note 5 to the consolidated financial statements,
included under Item 8 of this Annual Report on Form
10-K.
Market Conditions and Outlook
Fixed-income volatility remained high throughout the fourth quarter
of 2022, and the Federal Reserve, or Fed, continued to raise
short-term rates to combat inflation, despite lower than expected
inflation readings that provided some evidence that inflation was
easing in response to prior rate hikes. During the quarter, the Fed
raised the Federal Funds target rate by 150 basis points (75 basis
points in each of November and December), in excess of the 116
basis points priced into the market at the beginning of the
quarter. By December 31, 2022, the market’s expectation for where
short-term rates will be once the Fed finishes hiking rose by 43
basis points, to 4.97% in June 2023. Though the Fed raised rates
more than expected and the market’s expectations for forward rates
continued to move higher, the deviations were smaller than in the
prior quarter, indicating that market expectations were more
closely aligned with the Fed. Interest rates on U.S. Treasuries
rose slightly in the fourth quarter and the yield curve flattened,
with the 2-year U.S. Treasury rate increasing by 15 basis points to
4.43% and the 10-year U.S. Treasury rate increasing by 5 basis
points to 3.88%. The Standard and Poor’s 500 Index, or the S&P
500, gained about 7% after losing close to 25% through the first
three quarters of the year.
Interest rate volatility and mortgage spreads peaked in October,
then declined into quarter end. The better than expected CPI data
(first reported on November 10th and then on December 13th)
encouraged market participants that the Fed’s actions were working
and provided greater confidence that further rate hikes, while
expected, were nearing an end. Spreads for mortgages ratcheted
tighter in November, displacing July as the best month on record
for the excess return of the Bloomberg U.S. MBS Index, and
contributing to the seventh best quarterly performance in history.
Nominal and option-adjusted spreads for current coupon RMBS had
tightened by 30 and 37 basis points, respectively, to 128 and 30
basis points. Thirty-year mortgage rates declined by 28 basis
points to finish at 6.42%, though still 330 basis points higher for
the year, driving the MBS Refinance Index to its lowest level in
two decades.
Funding markets for RMBS and MSR continued to function well.
Spreads on repurchase agreement financing for RMBS increased
marginally to SOFR plus 11 to 17 basis points with no signs of
balance sheet stress.
We continue to believe that inflation will subside and expect
volatility to decline in the first quarter of 2023, given the
historically aggressive rate hikes by the Fed. Though mortgage
spreads tightened over the quarter, they are still near the 90th
percentile of long-term averages, and on a levered basis generate
attractive long-term returns. Furthermore, should volatility fall,
we expect mortgage spreads to tighten, adding to our portfolio’s
returns. With regard to MSR, continued slow prepayment rates on our
existing portfolio should generate attractive long-term returns.
Owing to a supply/demand imbalance driven by lower origination
volumes and the decision of several market participants to step
back from the MSR market, we intend to opportunistically allocate
capital to acquire MSR at attractive prices in the first half of
2023. Taking all this into account, we are optimistic that our
paired Agency RMBS and MSR portfolio strategy will deliver strong
results.
The following table provides the carrying value of our investment
portfolio by product type:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands) |
December 31,
2022 |
|
December 31,
2021 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency RMBS |
$ |
7,653,576 |
|
|
71.0 |
% |
|
$ |
7,149,399 |
|
|
76.1 |
% |
Mortgage servicing rights |
2,984,937 |
|
|
27.7 |
% |
|
2,191,578 |
|
|
23.3 |
% |
Agency Derivatives |
15,176 |
|
|
0.1 |
% |
|
40,911 |
|
|
0.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Agency securities |
125,158 |
|
|
1.2 |
% |
|
12,304 |
|
|
0.1 |
% |
Total |
$ |
10,778,847 |
|
|
|
|
$ |
9,394,192 |
|
|
|
Prepayment speeds and volatility due to interest rates
Our portfolio is subject to market risks, primarily interest rate
risk and prepayment risk. We seek to offset a portion of our Agency
pool market value exposure through our MSR and interest-only Agency
RMBS portfolios. During periods of decreasing interest rates with
rising prepayment speeds, the market value of our Agency pools
generally increases and the market value of our interest-only
securities and MSR generally decreases. The inverse relationship
occurs when interest rates rise and prepayments fall. Although
30-year mortgage rates fell modestly during the fourth quarter of
2022, most mortgages continue to have large refinancing
disincentive. Reported prepayment speeds continued to decline
during the quarter reflecting the drop in activity in the housing
market owing to seasonality and a slowing economy. Looking forward,
prepayment speeds are expected to slow further in the first quarter
of 2023 as seasonal factors plunge to their lowest annual levels.
In addition to changes in interest rates, changes in home price
performance, key employment metrics and government programs, among
other macroeconomic factors, can affect prepayment speeds. We
believe our portfolio management approach, including our asset
selection process, positions us to respond to a variety of market
scenarios. Although we are unable to predict future interest rate
movements, our strategy of pairing Agency RMBS with MSR, with a
focus on managing various associated risks, including interest
rate, prepayment, credit, mortgage spread and financing risk, is
intended to generate attractive yields with a low level of
sensitivity to changes in the yield curve, prepayments and interest
rate cycles.
The following table provides the three-month average constant
prepayment rate, or CPR, experienced by our Agency RMBS and MSR
during the three months ended December 31, 2022, and the four
immediately preceding quarters:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
December 31,
2022 |
|
September 30,
2022 |
|
June 30,
2022 |
|
March 31,
2022 |
|
December 31,
2021 |
Agency RMBS |
|
5.9 |
% |
|
9.1 |
% |
|
14.2 |
% |
|
17.3 |
% |
|
27.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
Mortgage servicing rights |
|
4.6 |
% |
|
6.9 |
% |
|
10.0 |
% |
|
14.2 |
% |
|
22.1 |
% |
Our Agency RMBS are primarily collateralized by pools of fixed-rate
mortgage loans. Our Agency portfolio also includes securities with
implicit prepayment protection, including lower loan balances
(securities collateralized by loans of less than $200,000 in
initial principal balance), higher LTVs (securities collateralized
by loans with LTVs greater than or equal to 80%), certain
geographic concentrations, loans secured by investor-owned
properties and lower FICO scores. Our overall allocation of Agency
RMBS and holdings of pools with specific characteristics are viewed
in the context of our aggregate portfolio strategy, including MSR
and related derivative hedging instruments. Additionally, the
selection of securities with certain attributes is driven by the
perceived relative value of the securities, which factors in the
opportunities in the marketplace, the cost of financing and the
cost of hedging interest rate, prepayment, credit and other
portfolio risks. As a result, Agency RMBS capital allocation
reflects management’s flexible approach to investing in the
marketplace.
The following tables provide the carrying value of our Agency RMBS
portfolio by underlying mortgage loan rate type:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2022 |
(dollars in thousands) |
Principal/ Current Face |
|
Carrying Value |
|
|
|
Weighted Average CPR
(1)
|
|
% Prepayment Protected |
|
Gross Weighted Average Coupon Rate |
|
Amortized Cost |
|
Allowance for Credit Losses |
|
Weighted Average Loan Age (months) |
Agency RMBS AFS: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
30-Year Fixed |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
≤ 2.5% |
$ |
— |
|
|
$ |
— |
|
|
|
|
— |
% |
|
— |
% |
|
— |
% |
|
$ |
— |
|
|
$ |
— |
|
|
— |
|
3.0% |
— |
|
|
— |
|
|
|
|
— |
% |
|
— |
% |
|
— |
% |
|
— |
|
|
— |
|
|
— |
|
3.5% |
— |
|
|
— |
|
|
|
|
— |
% |
|
— |
% |
|
— |
% |
|
— |
|
|
— |
|
|
— |
|
4.0% |
1,459,733 |
|
|
1,382,120 |
|
|
|
|
3.9 |
% |
|
100.0 |
% |
|
4.6 |
% |
|
1,474,169 |
|
|
— |
|
|
20 |
|
4.5% |
3,087,310 |
|
|
3,006,356 |
|
|
|
|
5.9 |
% |
|
100.0 |
% |
|
5.2 |
% |
|
3,152,567 |
|
|
— |
|
|
25 |
|
5.0% |
2,439,709 |
|
|
2,430,470 |
|
|
|
|
6.5 |
% |
|
100.0 |
% |
|
5.7 |
% |
|
2,506,339 |
|
|
— |
|
|
10 |
|
≥ 5.5% |
411,899 |
|
|
419,956 |
|
|
|
|
3.9 |
% |
|
98.8 |
% |
|
6.5 |
% |
|
424,199 |
|
|
— |
|
|
36 |
|
|
7,398,651 |
|
|
7,238,902 |
|
|
|
|
5.6 |
% |
|
99.9 |
% |
|
5.3 |
% |
|
7,557,274 |
|
|
— |
|
|
19 |
|
Other P&I |
382,626 |
|
|
378,558 |
|
|
|
|
1.3 |
% |
|
88.5 |
% |
|
5.4 |
% |
|
379,837 |
|
|
— |
|
|
30 |
|
Interest-only |
963,865 |
|
|
36,116 |
|
|
|
|
8.1 |
% |
|
— |
% |
|
4.9 |
% |
|
45,882 |
|
|
(6,785) |
|
|
143 |
|
Agency Derivatives |
196,457 |
|
|
15,176 |
|
|
|
|
8.4 |
% |
|
— |
% |
|
6.7 |
% |
|
20,696 |
|
|
— |
|
|
216 |
|
Total Agency RMBS |
$ |
8,941,599 |
|
|
$ |
7,668,752 |
|
|
|
|
|
|
98.7 |
% |
|
|
|
$ |
8,003,689 |
|
|
$ |
(6,785) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2021 |
(dollars in thousands) |
Principal/ Current Face |
|
Carrying Value |
|
|
|
Weighted Average CPR
(1)
|
|
% Prepayment Protected |
|
Gross Weighted Average Coupon Rate |
|
Amortized Cost |
|
Allowance for Credit Losses |
|
Weighted Average Loan Age (months) |
Agency RMBS AFS: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
30-Year Fixed |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
≤ 2.5% |
$ |
1,243,928 |
|
|
$ |
1,271,382 |
|
|
|
|
5.9 |
% |
|
— |
% |
|
3.3 |
% |
|
$ |
1,272,323 |
|
|
$ |
— |
|
|
3 |
|
3.0% |
1,316,662 |
|
|
1,384,176 |
|
|
|
|
9.6 |
% |
|
100.0 |
% |
|
3.7 |
% |
|
1,381,936 |
|
|
— |
|
|
8 |
|
3.5% |
739,922 |
|
|
789,499 |
|
|
|
|
27.3 |
% |
|
100.0 |
% |
|
4.2 |
% |
|
769,989 |
|
|
— |
|
|
29 |
|
4.0% |
1,421,793 |
|
|
1,543,595 |
|
|
|
|
26.5 |
% |
|
100.0 |
% |
|
4.6 |
% |
|
1,478,444 |
|
|
— |
|
|
49 |
|
4.5% |
1,307,504 |
|
|
1,435,877 |
|
|
|
|
27.7 |
% |
|
100.0 |
% |
|
5.0 |
% |
|
1,373,076 |
|
|
— |
|
|
47 |
|
5.0% |
231,941 |
|
|
255,059 |
|
|
|
|
44.9 |
% |
|
100.0 |
% |
|
5.7 |
% |
|
244,888 |
|
|
— |
|
|
47 |
|
≥ 5.5% |
93,544 |
|
|
106,687 |
|
|
|
|
15.7 |
% |
|
93.1 |
% |
|
6.4 |
% |
|
99,655 |
|
|
— |
|
|
172 |
|
|
6,355,294 |
|
|
6,786,275 |
|
|
|
|
20.5 |
% |
|
81.2 |
% |
|
4.3 |
% |
|
6,620,311 |
|
|
— |
|
|
31 |
|
Other P&I |
56,069 |
|
|
62,228 |
|
|
|
|
53.9 |
% |
|
— |
% |
|
6.5 |
% |
|
61,739 |
|
|
— |
|
|
224 |
|
Interest-only |
3,198,447 |
|
|
300,896 |
|
|
|
|
20.2 |
% |
|
— |
% |
|
3.6 |
% |
|
305,577 |
|
|
(12,851) |
|
|
47 |
|
Agency Derivatives |
247,101 |
|
|
40,911 |
|
|
|
|
18.6 |
% |
|
— |
% |
|
6.7 |
% |
|
33,237 |
|
|
— |
|
|
206 |
|
Total Agency RMBS |
$ |
9,856,911 |
|
|
$ |
7,190,310 |
|
|
|
|
|
|
76.6 |
% |
|
|
|
$ |
7,020,864 |
|
|
$ |
(12,851) |
|
|
|
____________________
(1)Weighted
average actual one-month CPR released at the beginning of the
following month based on RMBS held as of the preceding
month-end.
Our MSR business offers attractive spreads and has many risk
reducing characteristics when paired with our Agency RMBS
portfolio. The following table summarizes activity related to the
unpaid principal balance, or UPB, of loans underlying our MSR
portfolio for the three months ended December 31, 2022, and
the four immediately preceding quarters:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
(in thousands) |
|
December 31,
2022 |
|
September 30,
2022 |
|
June 30,
2022 |
|
March 31,
2022 |
|
December 31,
2021 |
UPB at beginning of period |
|
$ |
206,613,560 |
|
|
$ |
227,074,413 |
|
|
$ |
229,415,913 |
|
|
$ |
193,770,566 |
|
|
$ |
194,393,942 |
|
Purchases of mortgage servicing rights
|
|
2,677,674 |
|
|
4,448,870 |
|
|
5,720,323 |
|
|
45,136,996 |
|
|
13,562,240 |
|
Sales of mortgage servicing rights
|
|
— |
|
|
(19,807,427) |
|
|
— |
|
|
— |
|
|
9,065 |
|
Scheduled payments |
|
(1,538,046) |
|
|
(1,564,465) |
|
|
(1,697,237) |
|
|
(1,572,871) |
|
|
(1,441,835) |
|
Prepaid |
|
(2,439,936) |
|
|
(3,709,416) |
|
|
(6,026,461) |
|
|
(8,249,432) |
|
|
(11,966,741) |
|
Other changes |
|
(436,559) |
|
|
171,585 |
|
|
(338,125) |
|
|
330,654 |
|
|
(786,105) |
|
UPB at end of period |
|
$ |
204,876,693 |
|
|
$ |
206,613,560 |
|
|
$ |
227,074,413 |
|
|
$ |
229,415,913 |
|
|
$ |
193,770,566 |
|
Counterparty exposure and leverage ratio
We monitor counterparty exposure amongst our broker, banking and
lending counterparties on a daily basis. We believe our broker and
banking counterparties are well-capitalized organizations, and we
attempt to manage our cash balances across these organizations to
reduce our exposure to any single counterparty.
As of December 31, 2022, we had entered into repurchase
agreements with 39 counterparties, 20 of which had outstanding
balances. In addition, we held short- and long-term borrowings
under revolving credit facilities, long-term term notes payable and
long-term unsecured convertible senior notes. As of
December 31, 2022, the debt-to-equity ratio funding our AFS
securities, MSR and Agency Derivatives, which includes unsecured
borrowings under convertible senior notes, was
4.4:1.0.
As of December 31, 2022, we held $683.5 million in cash and
cash equivalents, approximately $344.6 million of unpledged AFS
securities and Agency derivatives, which includes $343.0 million of
unsettled Agency RMBS purchases, and $7.6 million of unpledged
non-Agency securities. As a result, we had an overall estimated
unused borrowing capacity on our unpledged securities of
approximately $6.1 million. As of December 31, 2022, we held
approximately $26.9 million of unpledged MSR and $51.2 million of
unpledged servicing advances. Overall, on December 31, 2022,
we had $293.8 million unused committed and $402.3 million unused
uncommitted borrowing capacity on MSR financing facilities, and
$176.2 million in unused committed borrowing capacity on servicing
advance financing facilities. Generally, unused borrowing capacity
may be the result of our election not to utilize certain financing,
as well as delays in the timing in which funding is provided,
insufficient collateral or the inability to meet lenders’
eligibility requirements for specific types of asset
classes.
We also monitor exposure to our MSR counterparties. We may be
required to make representations and warranties to investors in the
loans underlying the MSR we own; however, some of our MSR were
purchased on a bifurcated basis, meaning the representation and
warranty obligations remain with the seller. If the
representations and warranties we make prove to be inaccurate, we
may be obligated to repurchase certain mortgage loans, which may
impact the profitability of our portfolio. Although we obtain
similar representations and warranties from the counterparty from
which we acquired the relevant asset, if those representations and
warranties do not directly mirror those we make to the investor, or
if we are unable to enforce the representations and warranties
against the counterparty for a variety of reasons, including the
financial condition or insolvency of the counterparty, we may not
be able to seek indemnification from our counterparties for any
losses attributable to the breach.
LIBOR transition
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, intends 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, as its preferred
alternative rate 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 are in process, if not complete.
The majority of our material contracts that are or were indexed to
USD-LIBOR have been amended to transition to an alternative
benchmark, where necessary. As of December 31, 2022, only the
Company’s term notes incorporate LIBOR as the referenced rate and
mature after the phase-out of LIBOR. However, the related
agreements have provisions in place that provide for an alternative
to LIBOR upon its phase-out. The Company has no other financing
arrangements or derivative instruments that incorporate LIBOR as
the referenced rate as of December 31, 2022. Additionally,
each series of our fixed-to-floating preferred stock that becomes
redeemable at the time the stock begins to pay a LIBOR-based rate
has existing LIBOR cessation fallback language.
Summary of Results of Operations and Financial
Condition
All per share amounts, common shares outstanding and common
equity-based awards for all periods presented have been adjusted on
a retroactive basis to reflect the reverse stock
split.
Our book value per common share for U.S. GAAP purposes was $17.72
at December 31, 2022, an increase from $16.42 per common share
at September 30, 2022, and a decrease from $23.47 per common
share at December 31, 2021. The rise in book value for the
three months ended December 31, 2022 was primarily the result
of mortgage spread tightening, as well as the repurchase of
2,957,950 shares of preferred stock, which contributed
approximately $0.26 to book value per common share. The decline in
book value for the year ended December 31, 2022 was primarily
the result of significant widening in mortgage spreads during the
first nine months of the year, as the market reacted unfavorably to
higher than expected inflation and aggressively hawkish words and
actions from the Fed as it removed accommodation, offset by the
positive fourth quarter developments noted above.
Our GAAP net loss attributable to common stockholders was $262.4
million and GAAP net income attributable to common stockholders was
$186.8 million ($(3.04) and $2.13 per diluted weighted average
share) for the three and twelve months ended December 31,
2022, respectively, as compared to GAAP net loss attributable to
common stockholders of $15.0 million and GAAP net income
attributable to common stockholders of $128.8 million ($(0.18) and
$1.72 per diluted weighted average share) for the three and twelve
months ended December 31, 2021, respectively.
With our accounting treatment for AFS securities, unrealized
fluctuations in the market values of AFS securities, excluding
certain AFS securities for which we have elected the fair value
option and securities with an allowance for credit losses, do not
impact our GAAP net income (loss) or taxable income but are
recognized on our consolidated balance sheets as a change in
stockholders’ equity under “accumulated other comprehensive (loss)
income.” For the three months ended December 31, 2022, net
unrealized gains on AFS securities recognized as other
comprehensive income were $106.7 million, which was the result of
mortgage spread tightening. For the year ended December 31,
2022, net unrealized losses on AFS securities recognized as other
comprehensive loss were $893.6 million, which was driven by
significant underperformance of fixed income markets in general and
widening mortgage spreads, particularly in the third quarter.
Additionally, we reclassify unrealized gains and losses on AFS
securities in accumulated other comprehensive (loss) income to net
income (loss) upon the recognition of any realized gains and losses
on sales as individual securities are sold. For the three and
twelve months ended December 31, 2022 we reclassified
$316.0 million and $428.5 million in unrealized losses,
respectively, on sold AFS securities from accumulated other
comprehensive (loss) income to (loss) gain on investment securities
on the consolidated statements of comprehensive loss.
In total, we recognized other comprehensive income of $422.7
million for the three months ended December 31, 2022 and other
comprehensive loss of $465.1 million for the year ended
December 31, 2022. Combined with GAAP net loss attributable to
common stockholders of $262.4 million and GAAP net income
attributable to common stockholders of $186.8 million for the three
and twelve months ended December 31, 2022, respectively, this
resulted in comprehensive income attributable to common
stockholders of $160.2 million and comprehensive loss attributable
to common stockholders of $278.3 million for the three and twelve
months ended December 31, 2022, respectively.
The following tables present the components of our comprehensive
loss for the three and twelve months ended December 31, 2022
and 2021:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands, except share data) |
|
Three Months Ended |
|
Year Ended |
Income Statement Data: |
|
December 31, |
|
December 31, |
|
|
2022 |
|
2021 |
|
2022 |
|
2021 |
|
|
|
|
(unaudited) |
|
|
Interest income: |
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities |
|
$ |
83,712 |
|
|
$ |
32,729 |
|
|
$ |
272,230 |
|
|
$ |
167,310 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
15,591 |
|
|
276 |
|
|
23,310 |
|
|
1,287 |
|
|
|
Total interest income |
|
99,303 |
|
|
33,005 |
|
|
295,540 |
|
|
168,597 |
|
|
|
Interest expense: |
|
|
|
|
|
|
|
|
|
|
Repurchase agreements |
|
81,975 |
|
|
4,562 |
|
|
167,455 |
|
|
25,774 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revolving credit facilities |
|
21,854 |
|
|
5,050 |
|
|
51,814 |
|
|
22,425 |
|
|
|
Term notes payable |
|
6,906 |
|
|
3,251 |
|
|
19,514 |
|
|
12,936 |
|
|
|
Convertible senior notes |
|
4,892 |
|
|
7,295 |
|
|
19,612 |
|
|
28,038 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense |
|
115,627 |
|
|
20,158 |
|
|
258,395 |
|
|
89,173 |
|
|
|
Net interest (expense) income
|
|
(16,324) |
|
|
12,847 |
|
|
37,145 |
|
|
79,424 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other (loss) income:
|
|
|
|
|
|
|
|
|
|
|
(Loss) gain on investment securities
|
|
(347,450) |
|
|
1,626 |
|
|
(603,937) |
|
|
121,617 |
|
|
|
Servicing income
|
|
160,926 |
|
|
125,511 |
|
|
603,911 |
|
|
468,406 |
|
|
|
(Loss) gain on servicing asset
|
|
(64,085) |
|
|
(131,828) |
|
|
425,376 |
|
|
(114,941) |
|
|
|
Gain on interest rate swap and swaption agreements
|
|
— |
|
|
36,989 |
|
|
29,499 |
|
|
42,091 |
|
|
|
Gain (loss) on other derivative instruments
|
|
53,301 |
|
|
(11,565) |
|
|
9,310 |
|
|
(251,283) |
|
|
|
Other income (loss) |
|
112 |
|
|
1,856 |
|
|
(5) |
|
|
(3,845) |
|
|
|
Total other (loss) income |
|
(197,196) |
|
|
22,589 |
|
|
464,154 |
|
|
262,045 |
|
|
|
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Servicing expenses |
|
25,272 |
|
|
21,582 |
|
|
94,119 |
|
|
86,250 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and benefits |
|
7,411 |
|
|
6,396 |
|
|
40,723 |
|
|
35,041 |
|
|
|
Other operating expenses |
|
15,540 |
|
|
6,648 |
|
|
42,005 |
|
|
28,759 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses |
|
48,223 |
|
|
34,626 |
|
|
176,847 |
|
|
150,050 |
|
|
|
(Loss) income before income taxes
|
|
(261,743) |
|
|
810 |
|
|
324,452 |
|
|
191,419 |
|
|
|
Provision for income taxes |
|
8,480 |
|
|
2,104 |
|
|
104,213 |
|
|
4,192 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
(270,223) |
|
|
(1,294) |
|
|
220,239 |
|
|
187,227 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends on preferred stock |
|
(12,365) |
|
|
(13,747) |
|
|
(53,607) |
|
|
(58,458) |
|
|
|
Gain on repurchase and retirement of preferred stock |
|
20,149 |
|
|
— |
|
|
20,149 |
|
|
— |
|
|
|
Net (loss) income attributable to common stockholders
|
|
$ |
(262,439) |
|
|
$ |
(15,041) |
|
|
$ |
186,781 |
|
|
$ |
128,769 |
|
|
|
Basic (loss) earnings per weighted average common
share
|
|
$ |
(3.04) |
|
|
$ |
(0.18) |
|
|
$ |
2.15 |
|
|
$ |
1.72 |
|
|
|
Diluted (loss) earnings per weighted average common
share
|
|
$ |
(3.04) |
|
|
$ |
(0.18) |
|
|
$ |
2.13 |
|
|
$ |
1.72 |
|
|
|
Dividends declared per common share |
|
$ |
0.60 |
|
|
$ |
0.68 |
|
|
$ |
2.64 |
|
|
$ |
2.72 |
|
|
|
Weighted average number of shares of common stock:
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
86,391,405 |
|
|
83,775,184 |
|
|
86,179,418 |
|
|
74,443,000 |
|
|
|
Diluted
|
|
86,391,405 |
|
|
83,775,184 |
|
|
96,076,175 |
|
|
74,510,884 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
Three Months Ended |
|
Year Ended |
Income Statement Data: |
|
December 31, |
|
December 31, |
|
|
2022 |
|
2021 |
|
2022 |
|
2021 |
|
|
|
|
(unaudited) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income |
|
$ |
(270,223) |
|
|
$ |
(1,294) |
|
|
$ |
220,239 |
|
|
$ |
187,227 |
|
|
|
Other comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
Unrealized gain (loss) on available-for-sale
securities
|
|
422,672 |
|
|
(113,553) |
|
|
(465,057) |
|
|
(455,255) |
|
|
|
Other comprehensive income (loss)
|
|
422,672 |
|
|
(113,553) |
|
|
(465,057) |
|
|
(455,255) |
|
|
|
Comprehensive income (loss)
|
|
152,449 |
|
|
(114,847) |
|
|
(244,818) |
|
|
(268,028) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends on preferred stock |
|
(12,365) |
|
|
(13,747) |
|
|
(53,607) |
|
|
(58,458) |
|
|
|
Gain on repurchase and retirement of preferred stock |
|
20,149 |
|
|
— |
|
|
20,149 |
|
|
— |
|
|
|
Comprehensive income (loss) attributable to common
stockholders
|
|
$ |
160,233 |
|
|
$ |
(128,594) |
|
|
$ |
(278,276) |
|
|
$ |
(326,486) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
December 31,
2022 |
|
December 31,
2021 |
Balance Sheet Data: |
|
|
|
|
|
|
|
Available-for-sale securities |
|
$ |
7,778,734 |
|
|
$ |
7,161,703 |
|
Mortgage servicing rights |
|
$ |
2,984,937 |
|
|
$ |
2,191,578 |
|
Total assets |
|
$ |
13,466,160 |
|
|
$ |
12,114,305 |
|
Repurchase agreements |
|
$ |
8,603,011 |
|
|
$ |
7,656,445 |
|
|
|
|
|
|
Revolving credit facilities |
|
$ |
1,118,831 |
|
|
$ |
420,761 |
|
Term notes payable |
|
$ |
398,011 |
|
|
$ |
396,776 |
|
Convertible senior notes |
|
$ |
282,496 |
|
|
$ |
424,827 |
|
Total stockholders’ equity |
|
$ |
2,183,525 |
|
|
$ |
2,743,953 |
|
|
|
|
|
|
Results of Operations
The following analysis focuses on financial results during the
three and twelve months ended December 31, 2022 and 2021. The
analysis of our financial results during the three and twelve
months ended December 31, 2021 and 2020 is omitted from this
Form 10-K and included in Part II Item 7 of our Annual Report on
Form 10-K for the year ended December 31, 2021, which analysis
is incorporated by reference.
Interest Income
Interest income increased from $33.0 million and $168.6 million for
the three and twelve months ended December 31, 2021,
respectively, to $99.3 million and $295.5 million for the same
periods in 2022 due to lower amortization recognized on Agency RMBS
due to slower prepayments, higher interest on cash balances as a
result of the higher interest rate environment and increased use of
reverse repurchase agreements. Also contributing to the increase
for the three months ended December 31, 2022, as compared to
the same period in 2021, was an increase in average AFS securities
average amortized cost held due to net purchases. However, for the
year ended December 31, 2022, as compared to the same period
in 2021, the increase was offset by a decrease in average AFS
securities average amortized cost held due to net
sales.
Interest Expense
Interest expense increased from $20.2 million and $89.2 million for
the three and twelve months ended December 31, 2021,
respectively, to $115.6 million and $258.4 million for the same
periods in 2022 due primarily to the higher interest rate
environment as well as an increase in financing on MSR and Agency
RMBS.
Net Interest Income
The following tables present the components of interest income and
average net asset yield earned by asset type, the components of
interest expense and average cost of funds on borrowings incurred
by collateral type, and net interest income and average net
interest spread for the three and twelve months ended
December 31, 2022 and 2021:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended December 31, 2022 |
|
Year Ended December 31, 2022 |
|
|
(dollars in thousands) |
Average Balance
(1)
|
|
Interest Income/Expense |
|
Net Yield/Cost of Funds |
|
Average Balance
(1)
|
|
Interest Income/Expense |
|
Net Yield/Cost of Funds |
|
|
|
|
|
|
Interest-earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities |
$ |
8,118,269 |
|
|
$ |
83,712 |
|
|
4.1 |
% |
|
$ |
7,997,618 |
|
|
$ |
272,230 |
|
|
3.4 |
% |
|
|
|
|
|
|
Reverse repurchase agreements |
743,925 |
|
|
7,109 |
|
|
3.8 |
% |
|
311,844 |
|
|
8,469 |
|
|
2.7 |
% |
|
|
|
|
|
|
Other
|
— |
|
|
8,482 |
|
|
— |
% |
|
— |
|
|
14,841 |
|
|
— |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income/net asset yield
|
$ |
8,862,194 |
|
|
$ |
99,303 |
|
|
4.5 |
% |
|
$ |
8,309,462 |
|
|
$ |
295,540 |
|
|
3.6 |
% |
|
|
|
|
|
|
Interest-bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Borrowings collateralized by:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities |
$ |
7,664,204 |
|
|
$ |
68,627 |
|
|
3.6 |
% |
|
$ |
7,804,563 |
|
|
$ |
138,138 |
|
|
1.8 |
% |
|
|
|
|
|
|
Agency Derivatives
(2)
|
14,618 |
|
|
155 |
|
|
4.2 |
% |
|
24,553 |
|
|
438 |
|
|
1.8 |
% |
|
|
|
|
|
|
Mortgage servicing rights and advances
(3)
|
1,917,069 |
|
|
36,938 |
|
|
7.7 |
% |
|
1,620,847 |
|
|
95,192 |
|
|
5.9 |
% |
|
|
|
|
|
|
U.S. Treasuries
(4)
|
493,872 |
|
|
5,015 |
|
|
4.1 |
% |
|
123,468 |
|
|
5,015 |
|
|
4.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unsecured borrowings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Convertible senior notes
|
282,363 |
|
|
4,892 |
|
|
6.9 |
% |
|
287,399 |
|
|
19,612 |
|
|
6.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense/cost of funds
|
$ |
10,372,126 |
|
|
$ |
115,627 |
|
|
4.5 |
% |
|
$ |
9,860,830 |
|
|
$ |
258,395 |
|
|
2.6 |
% |
|
|
|
|
|
|
Net interest (expense) income/spread
|
|
|
$ |
(16,324) |
|
|
— |
% |
|
|
|
$ |
37,145 |
|
|
1.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended December 31, 2021 |
|
Year Ended December 31, 2021 |
(dollars in thousands) |
Average Balance
(1)
|
|
Interest Income/Expense |
|
Net Yield/Cost of Funds |
|
Average Balance
(1)
|
|
Interest Income/Expense |
|
Net Yield/Cost of Funds |
Interest-earning assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities |
$ |
6,067,568 |
|
|
$ |
32,729 |
|
|
2.2 |
% |
|
$ |
8,450,440 |
|
|
$ |
167,310 |
|
|
2.0 |
% |
Reverse repurchase agreements |
111,209 |
|
|
1 |
|
|
— |
% |
|
89,011 |
|
|
7 |
|
|
— |
% |
Other
|
— |
|
|
275 |
|
|
— |
% |
|
— |
|
|
1,280 |
|
|
— |
% |
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income/net asset yield
|
$ |
6,178,777 |
|
|
$ |
33,005 |
|
|
2.1 |
% |
|
$ |
8,539,451 |
|
|
$ |
168,597 |
|
|
2.0 |
% |
Interest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
|
Borrowings collateralized by:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities |
$ |
6,503,608 |
|
|
$ |
2,911 |
|
|
0.2 |
% |
|
$ |
9,098,301 |
|
|
$ |
20,794 |
|
|
0.2 |
% |
Agency Derivatives
(2)
|
38,045 |
|
|
69 |
|
|
0.7 |
% |
|
43,910 |
|
|
349 |
|
|
0.8 |
% |
Mortgage servicing rights and advances
(3)
|
942,357 |
|
|
9,883 |
|
|
4.2 |
% |
|
931,565 |
|
|
39,992 |
|
|
4.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unsecured borrowings:
|
|
|
|
|
|
|
|
|
|
|
|
Convertible senior notes
|
424,641 |
|
|
7,295 |
|
|
6.9 |
% |
|
412,107 |
|
|
28,038 |
|
|
6.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense/cost of funds
|
$ |
7,908,651 |
|
|
$ |
20,158 |
|
|
1.0 |
% |
|
$ |
10,485,883 |
|
|
$ |
89,173 |
|
|
0.9 |
% |
Net interest income/spread
|
|
|
$ |
12,847 |
|
|
1.1 |
% |
|
|
|
$ |
79,424 |
|
|
1.1 |
% |
____________________
(1)Average
asset balance represents average amortized cost on AFS securities
and average unpaid principal balance on other assets.
(2)Yields
on Agency Derivatives not shown as interest income is included in
gain (loss) on other derivative instruments in the consolidated
statements of comprehensive loss.
(3)Yields
on mortgage servicing rights and advances not shown as these assets
do not earn interest.
(4)U.S.
Treasury securities effectively borrowed under reverse repurchase
agreements.
The increase in yields on AFS securities for the three and twelve
months ended December 31, 2022, as compared to the same
periods in 2021 was primarily driven by lower amortization as a
result of slower prepayment speeds. The increase in cost of funds
associated with the financing of AFS securities for the three and
twelve months ended December 31, 2022, as compared to the same
periods in 2021, was due to rising interest
rates.
The increase in yields on reverse repurchase agreements for the
three and twelve months ended December 31, 2022, as compared
to the same periods in 2021, was the result of rising interest
rates. However, these yields were offset by the cost of financing
the associated repurchase agreements collateralized by U.S.
Treasury securities during the three and twelve months ended
December 31, 2022. We did not hold any repurchase agreements
collateralized by U.S. Treasury securities during the three and
twelve months ended December 31, 2021.
The increase in cost of funds associated with the financing of
Agency Derivatives for the three and twelve months ended
December 31, 2022, as compared to the same periods
in 2021, was the result of rising interest rates.
The increase in cost of funds associated with the financing of MSR
assets and related servicing advance obligations for the three and
twelve months ended December 31, 2022, as compared to the same
periods in 2021, was due to rising interest rates and an
increase in the use of revolving credit facility and repurchase
agreement financing which on average carry higher floating rate
spreads than term notes. We have one revolving credit facility in
place to finance our servicing advance obligations, which are
included in other assets on our consolidated balance
sheets.
The cost of funds associated with our convertible senior notes for
the three and twelve months ended December 31, 2022, as
compared to the same periods in 2021, was
consistent.
The following tables present the components of the yield earned on
our AFS securities portfolio as a percentage of our average
amortized cost of securities for the three and twelve months ended
December 31, 2022 and 2021:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Year Ended |
|
December 31, |
|
December 31, |
(in thousands) |
2022 |
|
2021 |
|
2022 |
|
2021 |
Gross yield/stated coupon |
4.6 |
% |
|
4.9 |
% |
|
4.4 |
% |
|
4.7 |
% |
Net (premium amortization) discount accretion
|
(0.5) |
% |
|
(2.7) |
% |
|
(1.0) |
% |
|
(2.7) |
% |
Net yield |
4.1 |
% |
|
2.2 |
% |
|
3.4 |
% |
|
2.0 |
% |
(Loss) Gain On Investment Securities
The following table presents the components of (loss) gain on
investment securities for the three and twelve months ended
December 31, 2022 and 2021:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Year Ended |
|
December 31, |
|
December 31, |
(in thousands) |
2022 |
|
2021 |
|
2022 |
|
2021 |
|
|
Proceeds from sales |
$ |
2,770,811 |
|
|
$ |
1,171,299 |
|
|
$ |
7,793,705 |
|
|
$ |
6,274,193 |
|
|
|
Amortized cost of securities sold |
(3,113,102) |
|
|
(1,139,241) |
|
|
(8,359,967) |
|
|
(6,137,824) |
|
|
|
Total realized (losses) gains on sales |
(342,291) |
|
|
32,058 |
|
|
(566,262) |
|
|
136,369 |
|
|
|
Reversal of (provision for) credit losses |
318 |
|
|
(3,347) |
|
|
(2,730) |
|
|
(9,763) |
|
|
|
Other |
(5,477) |
|
|
(27,085) |
|
|
(34,945) |
|
|
(4,989) |
|
|
|
(Loss) gain on investment securities
|
$ |
(347,450) |
|
|
$ |
1,626 |
|
|
$ |
(603,937) |
|
|
$ |
121,617 |
|
|
|
In the ordinary course of our business, we make investment
decisions and allocate capital in accordance with our views on the
changing risk/reward dynamics in the market and in our portfolio.
We do not expect to sell assets on a frequent basis, but may sell
assets to reallocate capital into new assets that we believe have
higher risk-adjusted returns.
We use a discounted cash flow method to estimate and recognize an
allowance for credit losses on AFS securities. Subsequent adverse
or favorable changes in expected cash flows are recognized
immediately in earnings as a provision for or reversal of provision
for credit losses (within (loss) gain on investment
securities).
The majority of the “other” component of (loss) gain on investment
securities is related to changes in unrealized gains (losses) on
certain AFS securities for which we have elected the fair value
option. Fluctuations in this line item are primarily driven by the
reclassification of unrealized gains and losses to realized gains
and losses upon sale, as well as changes in fair value
assumptions.
Servicing Income
The following table presents the components of servicing income for
the three and twelve months ended December 31, 2022 and
2021:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Year Ended |
|
December 31, |
|
December 31, |
(in thousands) |
2022 |
|
2021 |
|
2022 |
|
2021 |
|
|
Servicing fee income |
$ |
137,949 |
|
|
$ |
123,912 |
|
|
$ |
564,923 |
|
|
$ |
461,381 |
|
|
|
Ancillary and other fee income |
418 |
|
|
548 |
|
|
1,932 |
|
|
2,436 |
|
|
|
Float income |
22,559 |
|
|
1,051 |
|
|
37,056 |
|
|
4,589 |
|
|
|
Total |
$ |
160,926 |
|
|
$ |
125,511 |
|
|
$ |
603,911 |
|
|
$ |
468,406 |
|
|
|
The increase in servicing income for the three and twelve months
ended December 31, 2022, as compared to the same periods in
2021, was due to a higher portfolio balance, lower compensating
interest as a result of lower prepayment rates and higher float
income as a result of the higher interest rate
environment.
(Loss) Gain On Servicing Asset
The following table presents the components of gain (loss) on
servicing asset for the three and twelve months ended
December 31, 2022 and 2021:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Year Ended |
|
December 31, |
|
December 31, |
(in thousands) |
2022 |
|
2021 |
|
2022 |
|
2021 |
Changes in fair value due to changes in valuation inputs or
assumptions used in the valuation model
|
$ |
(6,441) |
|
|
$ |
21,189 |
|
|
$ |
793,631 |
|
|
$ |
562,843 |
|
Changes in fair value due to realization of cash flows
(runoff)
|
(60,908) |
|
|
(152,450) |
|
|
(371,023) |
|
|
(666,160) |
|
Gains (losses) on sales
|
3,264 |
|
|
(567) |
|
|
2,768 |
|
|
(11,624) |
|
(Loss) gain on servicing asset
|
$ |
(64,085) |
|
|
$ |
(131,828) |
|
|
$ |
425,376 |
|
|
$ |
(114,941) |
|
The decrease in loss on servicing asset for the three months ended
December 31, 2022, as compared to the same period in 2021, was
driven by lower portfolio runoff and gains on sales of MSR, offset
by unfavorable change in valuation assumptions used in the fair
valuation of MSR. The increase in gain (decrease in loss) on
servicing asset for the year ended December 31, 2022, as
compared to the same period in 2021, was driven by higher favorable
change in valuation assumptions used in the fair valuation of MSR,
lower portfolio runoff and gains on sales of MSR.
Gain On Interest Rate Swap And Swaption Agreements
The following table summarizes the net interest spread and gains
and losses associated with our interest rate swap and swaption
positions recognized during the three and twelve months ended
December 31, 2022 and 2021:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Year Ended |
|
December 31, |
|
December 31, |
(in thousands) |
2022 |
|
2021 |
|
2022 |
|
2021 |
Net interest spread |
$ |
— |
|
|
$ |
5,772 |
|
|
$ |
(4,830) |
|
|
$ |
14,262 |
|
Early termination, agreement maturation and option expiration
(losses) gains
|
— |
|
|
(5,143) |
|
|
43,197 |
|
|
2,369 |
|
Change in unrealized gain (loss) on interest rate swap and swaption
agreements, at fair value
|
— |
|
|
36,360 |
|
|
(8,868) |
|
|
25,460 |
|
Gain on interest rate swap and swaption agreements
|
$ |
— |
|
|
$ |
36,989 |
|
|
$ |
29,499 |
|
|
$ |
42,091 |
|
Net interest spread recognized for the accrual and/or settlement of
the net interest expense associated with our interest rate swaps
results from receiving either a floating interest rate (OIS or
SOFR) or a fixed interest rate and paying either a fixed interest
rate or a floating interest rate (OIS or SOFR) on positions held to
economically hedge/mitigate portfolio interest rate exposure (or
duration) risk. We may elect to terminate certain swaps and
swaptions to align with our investment portfolio, agreements may
mature or options may expire resulting in full settlement of our
net interest spread asset/liability and the recognition of realized
gains and losses, including early termination penalties. The change
in fair value of interest rate swaps and swaptions during the three
and twelve months ended December 31, 2022 and 2021 was a
result of changes to floating interest rates (OIS or SOFR), the
swap curve and corresponding counterparty borrowing rates. Since
swaps and swaptions are used for purposes of hedging our interest
rate exposure, their unrealized valuation gains and losses
(excluding the reversal of unrealized gains and losses to realized
gains and losses upon termination, maturation or option expiration)
are generally offset by unrealized losses and gains in our Agency
RMBS AFS portfolio, which are recorded either directly to
stockholders’ equity through other comprehensive loss or to (loss)
gain on investment securities, in the case of certain AFS
securities for which we have elected the fair value
option.
Gain (Loss) On Other Derivative Instruments
The following table provides a summary of the total net gains
(losses) recognized on other derivative instruments we hold for
purposes of both hedging and non-hedging activities, principally
TBAs, futures, options on futures, and inverse interest-only
securities during the three and twelve months ended
December 31, 2022 and 2021:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Year Ended |
(in thousands) |
December 31, |
|
December 31, |
|
2022 |
|
2021 |
|
2022 |
|
2021 |
|
|
TBAs
|
$ |
48,233 |
|
|
$ |
(20,225) |
|
|
$ |
(487,713) |
|
|
$ |
(193,479) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Futures
|
5,016 |
|
|
14,638 |
|
|
514,467 |
|
|
(49,213) |
|
|
|
Options on TBAs
|
— |
|
|
(5,683) |
|
|
— |
|
|
(5,683) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Options on futures
|
— |
|
|
— |
|
|
(2,224) |
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inverse interest-only securities
|
52 |
|
|
(295) |
|
|
(15,220) |
|
|
(2,908) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain (loss) on other derivative instruments
|
$ |
53,301 |
|
|
$ |
(11,565) |
|
|
$ |
9,310 |
|
|
$ |
(251,283) |
|
|
|
All derivative instruments shown above are considered trading
instruments. As a result, our financial results include both
realized and unrealized gains (losses) associated with these
instruments. The increase in gain (decrease in loss) on other
derivative instruments for the three months ended December 31,
2022, as compared to the same period in 2021, was driven by net
realized and unrealized gains recognized on TBAs. The increase in
gain (decrease in loss) on other derivative instruments for the
year ended December 31, 2022, as compared to the same period
in 2021, was driven by net realized and unrealized gains recognized
on futures, offset by net realized and unrealized losses recognized
on TBAs. For further details regarding our use of derivative
instruments and related activity, refer to Note 7 -
Derivative Instruments and Hedging Activities
to the consolidated financial statements, included in this Annual
Report on Form 10-K.
Expenses
The following table presents the components of expenses for the
three and twelve months ended December 31, 2022 and
2021:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Year Ended |
|
December 31, |
|
December 31, |
(dollars in thousands) |
2022 |
|
2021 |
|
2022 |
|
2021 |
|
|
|
|
|
|
|
|
Servicing expenses
|
$ |
25,272 |
|
|
$ |
21,582 |
|
|
$ |
94,119 |
|
|
$ |
86,250 |
|
Operating expenses: |
|
|
|
|
|
|
|
Compensation and benefits: |
|
|
|
|
|
|
|
Non-cash equity compensation expenses
|
$ |
1,653 |
|
|
$ |
2,525 |
|
|
$ |
11,630 |
|
|
$ |
11,485 |
|
All other compensation and benefits
|
5,758 |
|
|
3,871 |
|
|
29,093 |
|
|
23,556 |
|
Total compensation and benefits
|
$ |
7,411 |
|
|
$ |
6,396 |
|
|
$ |
40,723 |
|
|
$ |
35,041 |
|
Other operating expenses: |
|
|
|
|
|
|
|
Nonrecurring expenses |
$ |
10,836 |
|
|
$ |
665 |
|
|
$ |
18,982 |
|
|
$ |
5,220 |
|
All other operating expenses
|
4,704 |
|
|
5,983 |
|
|
23,023 |
|
|
|