Q3 2019 Earnings Call

HM.

Remarks, there will be a question and answer period I would now like to turn over the call to Maggie field with Investor Relations for two harbors.

Thank you and good morning, everyone. Thank you for joining our call to discuss two harbors third quarter 2019 financial result.

With me on the call. This morning, our Tom Siering, our president and CEO .

You know married risky, our CFO and as Phil.

The press release and financial tables associated with today's call where.

Information in conjunction with today's call I would also mentioned that this call is being webcast and maybe I first on our website in the same location arc made by management. During this conference call and they're supporting slides may include forward looking statements.

Forward looking statements are based on the current beliefs and expectations of management and actual results may be materially different because of a variety of risks and other factors.

Such statements are typically associated with the words, such as anticipate expect estimate and believe or other such words, we caution investors not to rely unduly on forward looking statement.

Two harbors describes these risks and uncertainties and its annual report on Form 10-K for the fiscal year ended December 31st 2018, and another filings it makes or may make with the FCC from time to time.

Which are available on the Investor Relations section of two harbors web site and on the Fccs website I see be dot Gov.

Except as may be required by law two harbors does not update forward looking statements and expressly disclaims any obligations to do so.

I'll now turn the call over to Tom.

Thank you Maggie and good morning, everyone. We hope that you had a chance to do own inch press release and play some trees that we issued last smart.

Please turn to slide three to review our results.

We had a very strong quarter, but generated significant book value growth delivering a total quarterly return on book value of 6.7%.

For the first nine months for the year, we have achieved a 22% return on book value.

This was an interesting quarter in respect of market conditions, including the disruption of the repo market interest rate volatility and prepayment behavior.

Serving book value has always been our primary goal and we're quite proud about economic return in this environment.

This quarter demonstrates how our portfolio can deliver strong returns even one interest rate are volatile and mortgage spreads widen.

This is largely driven by our strategy apparent MSR with agency RMBS.

Core earnings were 24 cents per share.

Which is materially lower than our dividend.

We acknowledge this divergence, though we have consistently communicated that core earnings is not a proxy for our dividend.

Other total economic return is a much more important metric.

As such there are times, when we will emphasize generating economic returns over core earnings.

Which was the case this quarter.

With a large amount of capital allocated to MSR.

Certain interest rate environments like it is not possible simultaneously generate both high core earnings and optimize economic return.

Since stable book value is necessary for generating stable dividends, we will unhesitatingly choose the preservation of book value over the marquee number corn or soybeans and making investment decisions.

This quarter highlights that the economic return of our portfolio was more than sufficient to support the dividend.

Today, we are confident that are 40, some dividends as supported by both the expected ongoing earnings power of our portfolio as well as by taxable income generation.

When we set our current dividend in the second quarter, we were thoughtful and considering sustainability.

Expected economic return.

Act on book value and taxable income.

All of these factors continue to support that level.

As always all future dividends remain subject to the discretion and approval of our board of directors.

Please turn to slide four.

Through thoughtful portfolio construction security selection and active hedging we aim to protect and grow our book value over time.

We position our portfolio and assets that we believe will deliver the best long term risk adjusted returns.

This approach has resulted in strong performance this quarter and since our inception.

You can see on this slide that over the past 10 years, we have returned over 200% tourist stockholders as measured by the change in stock price with dividends reinvested.

During the same period of time, we have grown our book value by nearly 12%.

We're quite proud of these results both this quarter and overtime as they represent quite an hotwire over our pure cohort.

I will now turn the call over get married to review our financial results.

Thank you Tom <unk>.

Turning to slide five let's review our financial results for the third quarter.

We generated comprehensive income of 257.6, $9 or 94 cents per share and our book value was $14.72 per share compared to $14 in 17 cents at June Thirtyth.

The increase in book value was driven primarily by our portfolio allocation within agency RMBS.

The outperformance as specified pool.

MSR performed as expected given the current coupon spread widening experienced in the quarter.

Moving to Fivesix, let's spend a moment on our core earnings results.

Our earnings including dollar roll income were 24 cents per share in the third quarter.

The decrease in core earnings this quarter was primarily driven by elevated funding costs higher RMBS amortization due to faster prepayment speeds and portfolio rotation.

You can see on this slide a high level attribution of the quarter over quarter core earnings decreased.

Approximately four cents of the decline was driven by increased premium amortization on agency RMBS due to higher prepayments speeds.

He sensors due to the sale of higher yielding non agency RMBS.

And six cents was the result of lower TV, a dollar roll income from higher implied financing costs in prepayments speeds.

Additionally, in the aggregate the elevated repo LIBOR spread on agency RMBS.

And TV, a as compared to this spread at the end of 2018 resulted in a five cents drag on core earnings in Q3 compared to a two cents drag in Q2.

Well, we expect the elevated spread environment to continue into 2020 I.

I would note than the last two quarters current coupon mortgages have cheap and relative to live or even more than the repo funding costs have increased.

Well portfolio rotation resulted in a drag on our quarterly core earnings it strengthened the economic earnings power of our portfolio.

Specifically, we filled some legacy non agencies and recycle that capital in the current coupon agency RMBS, which had cheapened.

In particular, the non agencies that we sold at realize their upside potential and had only mid single digit levered market yields.

But had very high Belfield <unk>.

In contrast, the current coupon agency RMBS that we purchased at low to mid double digit labick market yields.

Turning to slide seven our portfolio yield declined in the quarter to 3.67%.

Lower yield was driven primarily by our portfolio rotation and increased premium amortization.

And see the yield on non agency securities declined from 6%, the 5.26%, reflecting the sales of higher dollar price legacy non agencies.

The lower interest the yield was the result of the aforementioned purchases of lower coupon RMBS in a lower interest rate environment as loves increased amortization due to higher prepayment speeds.

Let's review our financing profile as shown on slide eight.

Our average economic debt to equity, which includes the implied that on our TV positions.

That's consistent quarter over quarter at 7.2 times.

We're comfortable with their leverage and did not expected to change materially from here.

Our diverse financing profile includes a mix of traditional repo convertible that there's often credit facilities in MSR secured term now.

At September Thirtyth, we had 24 active agency repo counterparties with a weighted average maturity of 77 days.

Hi longer dated maturities benefited us during the spike in overnight repo rates late in the quarter and we did not observed significant disruptions to our financing.

We continue to monitor the repo markets closely and are focused on managing the laddering of our repo maturities minimize exposure changes in spreads in rates.

Respect to non agencies haircuts and spreads have continued to be favorable.

As we have discussed in the past we've been modest in our use of our federal home loan bank facility due to the fact that we continued to be able to access more attractive terms and the repo market even in this current conditions.

However, given the stress in the repo market that we saw this quarter, we may make greater use of that facility in the future as a reminder of federal home loan bank facility expires in 2021.

Across all of our MSR bilateral facilities, we had 563 million outstanding with a total capacity of 790 million as of September Thirtyth.

This is in addition to the 400 million of outstanding MSR time now.

These facilities and now are multiyear in term and therefore have been unaffected by the volatility in the overnight and short term repo market.

For more information.

And on our financing profile, please see appendix slide 25.

With that I will now turn the call over to Matt and Bill <unk>.

[noise], where rates fell current coupon RMBS widened in it.

Hey, protected collateral increased further.

Although MSR.

Bottom left shows that the current coupon mortgage spread has widened by 20.

And your lives.

The chart on the bottom right shows.

I'd like to spend a moment on the topic of the repo markets in the third quarter.

Resolve themselves over time.

Turning to slide 10.