Q4 2021 Two Harbors Investment Corp Earnings Call
Good morning, My name is Peter and I will be your conference facilitator.
Speaker 1: Good morning, my name is Peter and I will be your conference facilitator. At this time I would like to thank you for your support and for your support.
At this time I would like to welcome everyone to two.
Speaker 1: Two Harbors Fourth Quarter 2021 Financial Results Conference call. All participants will be in a listen-only mode.
Two harbors fourth quarter 2021 financial results conference call.
All participants will be in a listen only mode.
After the Speakers' remarks there.
There will be a question and answer period.
Speaker 1: If anyone should require assistance during the call, please press star 0 on your keypad.
If anyone should require assistance during the call. Please press star zero on your keypad.
Yeah.
As a reminder, this call is being recorded.
Speaker 1: I would now like to turn the call over to Paulina
I would now like to turn the.
Paul what to fall in a sense.
Yeah.
Speaker 2: Good morning, everyone, and welcome to our call to discuss Two Harbors fourth quarter 2021 financial results. With me on the call this morning are Bill Greenberg, our president, chief executive officer, and chief investment officer, and Mary Risky, our chief financial officer.
Good morning, everyone and welcome to our call to discuss two harbors fourth quarter 2021 financial results.
With me on the call. This morning are Bill Greenberg, our President Chief Executive Officer, and Chief Investment Officer.
Mary Ritchie, our Chief Financial Officer.
Speaker 2: The earnings press release and presentation associated with today's call have been filed with the SEC and are available on the SEC's website as well as the investor relations page of our website at 2harborsinvestment.com
The earnings press release and presentation associated with today's call have been filed with the SEC.
Are available on the SEC's website as well as the Investor Relations page of our website at two harbors investment dotcom.
Speaker 2: In our earnings release and presentation, we have provided a reconciliation of GAAP to non-GAAP financial measures, and we urge you to review this information in conjunction with today's call.
In our earnings release and presentation, we have provided a reconciliation of GAAP to non-GAAP financial measures.
And we urge you to review this information in conjunction with today's call.
Speaker 2: As a reminder, our comments today will include forward-looking statements which are subject to risks and uncertainties that may cause our results to differ materially from expectations.
As a reminder, our comments today will include forward looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectations.
Speaker 2: These are described on page 2 of the presentation.
These are described on page two of the presentation.
Speaker 2: and in our Form 10-K and subsequent reports filed with the SEC.
And in our Form 10-K , and subsequent reports filed with the SEC.
Speaker 2: except as may be required by law, Two Harbors does not update forward-looking statements and disclaims any obligation to do so. I will now turn the call over to Bill.
Except as may be required by law two harbors does not update forward looking statements and disclaims any obligation to do so.
I will now turn the call over to Bill.
Yeah.
Speaker 3: Thank you Paulina. Good morning everyone and welcome to our fourth quarter earnings call.
Thank you Paulino and good morning, everyone and welcome to our fourth quarter earnings call.
Speaker 3: We'll turn to slide three. At quarter end, the book value was $5.87 per share, representing a negative 5.6% total economic quarterly return.
Yeah.
Please turn to slide three.
Quarter end book value was $5 87 per share representing a negative five 6% total economic quarterly return.
Speaker 3: This underperformance can be attributed in approximately two equal parts.
This underperformance can be attributed in approximately two equal parts.
Speaker 3: Firstly, to spread widening and higher coupon RMBS and IOS securities due to slower than expected declines in prepayment speeds and higher volatility.
Firstly to spread widening and higher coupon RBS and Io securities due to slower than expected declines in prepayment speeds and higher volatility.
Speaker 3: And secondly, to a 20 basis point widening in the spread of the MSR asset, which we see as being within the typical period over period variability of MSR spreads, and which arise from using the simple average of three independent broker marks.
And secondly to a 20 basis point widening in the spread of the MSR asset, which we see as being within the typical period over period variability of MSR spreads and which arise from using the simple average of three independent broker marks.
Speaker 3: The overall environment in 2021 was challenging as the market wrestled with continued waves of coronavirus infections and uncertainty around the path of economic growth and monetary policy.
The overall environment in 2021 was challenging as the market wrestled with continued waves of Corona virus infections and uncertainty around the path of economic growth and monetary policy.
Speaker 3: For the year, we delivered total dividends of 68 cents per share, equivalent to an average dividend yield of 10.0%.
For the year, we delivered total dividends of 68 per share equivalent to an average dividend yield of 10.0%.
With the starting book value of $7 63 at the end of 2020.
Speaker 3: with a starting book value of $7.63 at the end of 2020, the total economic return on book value equates to minus 14.2%.
The total economic return on book value equates to minus 14, 2%.
Speaker 3: In many ways, the underperformance in 2021 was a continuation of the market stress of 2020.
In many ways. The underperformance in 2021 was a continuation of the market stress of 2020.
Speaker 3: While the Fed came to the rescue in 2020, buying unlimited amounts of RMBs and stabilizing the market,
While the fed came to the rescue in 2020 buying unlimited amounts of RMB S and stabilizing the market.
Speaker 3: The Fed's continuing monetary accommodation also had two other effects.
The fed's continuing monetary accommodation also had two other effects.
Speaker 3: First, with the Fed having bought almost $3 trillion of RMBS during QE4, spreads collapsed to all-time tight levels, which reduced the tailwind of carry meaningfully.
First with the fed having bought almost three trillion dollars of RMB, yes. During Q4 spreads collapsed all time tight levels, which reduced the tailwind of carry meaningfully.
Speaker 3: Second, the Fed's asset purchases also reduced mortgage rates to all-time lows, igniting a prepay wave that hasn't been seen since 2003, and creating a very strong headwind for portfolios such as ours with premium and interest-only cash flows.
Second the feds asset purchases also reduced mortgage rates to all time lows igniting a prepay wave that hasn't been seen since 2003, and creating a very strong headwind for portfolio, such as ours with premium and interest only cash flows.
Speaker 3: Nevertheless, we took proactive actions during the year which benefited the company.
Nevertheless, we took proactive actions during the year, which benefited the company.
We issued N repurchase convertible notes last February redeemed our series D and E preferred shares and we raised common stock through two public offerings.
Speaker 3: We issued and repurchased convertible notes last February , redeemed our series D and E of preferred shares and we raised common stock through two public offerings.
Speaker 3: On the asset side, we grew our MSR portfolio, acquiring over $88 billion of UPB at a very attractive level.
On the asset side, we grew our MSR portfolio acquiring over $88 billion of UBB at very attractive levels.
Speaker 3: and in expectation of spread widening, we reduce leverage, increasing the amount of dry powder to be deployed in a more attractive investing environment.
And an expectation of spread widening we reduced leverage increasing the amount of dry powder to be deployed in a more attractive investing environment.
Speaker 3: Indeed, over the past few weeks, it has become clear that the Fed has shifted to a much more hawkish stance, and mortgage spreads have reacted by widening about 20 basis points during the month of January .
Indeed over the past few weeks it has become clear that the fed has shifted to a much more hawkish stance and mortgage spreads have reacted by widening about 20 basis points during the month of January .
Despite the rapid and large spread movements. We think there is more to go and expect more volatility in the near term as the timing and pace of rate hikes balance sheet normalization and other supply demand dynamics are sorted out.
Speaker 3: Despite the rapid and large spread movement, we think there is more to go, and expect more volatility in the near term as the timing and pace of rate hikes, balance sheet normalization, and other supply demand dynamics are sorted out.
Speaker 3: It is in precisely these kind of environments that our agency plus MSR construction should benefit. And indeed, our best estimate of book value through the end of January is approximately positive 2%.
It is precisely these kind of environments that our agency plus MSR construction should benefit and indeed, our best estimate of book value through the end of January is approximately positive 2%.
Looking ahead, we see a path towards normalization in RBS spread levels.
Speaker 3: Looking ahead, we see a path towards normalization in RMBS spread level.
Speaker 3: The refi wave appears to be over and the prospect of higher rates and slower prepayments points to a more constructive environment for both RMBs and MSR.
The refi wave appears to be over and the prospect of higher rates and slower prepayments points to a more constructive environment for both RMS and MSR.
Speaker 3: We are well positioned to capitalize on the improved investment opportunities as they present themselves in the coming year.
We are well positioned to capitalize on the improved investment opportunities as they present themselves in the coming year.
Please turn to slide four.
Speaker 3: During the fourth quarter, economic data, Federal Reserve commentary, and market expectations converged on an accelerated timeline to higher rates and the removal of monetary accommodation.
During the fourth quarter economic data Federal reserve commentary and market expectations converged on an accelerated timeline to higher rates and the removal of monetary accommodation.
Have you seen in figure one the 10 year rate fluctuated between one 4% and one 6% during the quarter before breaking out in January to the one 9% range, where it's at pre pandemic.
Speaker 3: As we see in Figure 1, the 10-year rate fluctuated between 1.4% and 1.6% during the quarter before breaking out in January to the 1.9% range where it sat pre-pandemic.
Speaker 3: prospect of more rate hikes pushed short-term rates higher, flattening the yield curve by 53 basis points during the quarter.
The prospect of more rate hikes put short term rates higher flattening the yield curve by 53 basis points during the quarter.
Speaker 3: The market has continued to reprice and expectations have become more front loaded with almost five and a half hikes now expected in 2022 with a total of seven by the end of 2023.
The market has continued to reprice and expectations have become more frontloaded with almost five and a half hikes now expected in 2022 with a total of seven by the end of 2023.
The Federal Reserve has announced it will complete its monthly purchases of Treasury and agency RBS by March as seen in figure two.
Speaker 3: The Federal Reserve has announced it will complete its monthly purchases of Treasury and Agency RBS by March, as seen in Figure 2.
Speaker 3: More recently, while the Fed has said that interest rates will be their primary tool in implementing monetary policy, they do recognize that the balance sheet is bigger than it needs to be and have expressed a desire for the balance sheet to return to a treasury-only portfolio.
More recently, while the fed has said that interest rates will be their primary tool and implementing monetary policy. They do recognize that the balance sheet is bigger than it needs to be and have expressed a desire for the balance sheet to return to a treasury only portfolio.
Chairman Powell has also said that the pace of balance sheet normalization could be faster than it had been in past episodes.
Speaker 3: Chairman Powell has also said that the pace of balance sheet normalization could be faster than it had been in past episodes.
Speaker 3: timing and pace of any runoff or outright sales should also affect mortgage spread.
Timing and pace of any runoff or outright sales should also affect mortgage spreads.
Speaker 3: We have consistently said that mortgages at historically tight spreads would need to widen eventually.
We have consistently said that mortgages at historically tight spreads would need to widen eventually.
Speaker 3: In our view, the question was not if they would widen, but how quickly and by how much.
In our view the question was that if they would widen but how quickly and by how much.
With the fed removing its accommodation and banks likely having less appetite for securities as a function of lower reserves and increased loan demand. Some mortgage analysts are projecting the private sector may need to absorb up to $700 billion of mortgages in 2022.
Speaker 3: With the Fed removing its accommodation and banks likely having less appetite for securities as a function of lower reserves and increased loan demand, some mortgage analysts are projecting the private sector may need to absorb up to $700 billion of mortgages in 2020.
Speaker 3: Current coupon spreads remain near historical tight throughout the fourth quarter, although as I mentioned have swiftly widened out by roughly 20 basis points into year end, as shown in Figure 3.
Current coupon spreads remained near historical types throughout the fourth quarter, although as I mentioned have swiftly widened out by roughly 20 basis points since year end as shown in figure three.
Speaker 3: However, spreads still remain approximately 15 basis points tighter than other periods where the Fed had not been buying mortgages, let alone periods where the Fed is net shrinking.
However, spreads still remain approximately 15 basis points tighter than other periods, where the fed had not been buying mortgages, let alone periods, where the fed is net shrinking.
Speaker 3: Indeed, relative to the last period of quantitative tightening in 2017 through 2019,
Indeed relative to the last period of quantitative tightening in 2017 through 2019 spreads were at current levels or tighter only 8% of the time.
Speaker 3: spreads were at current levels or tighter only 8% of the time. 92% of the time they were wider than they are now.
92% of the time they were wider than they are now.
Speaker 3: In the shaded area in Figure 3, we show how wide mortgage spreads might be able to go.
In the shaded area in figure three we show how wide mortgage spreads might be able to go.
Speaker 3: We don't expect spreads to widen and stay at levels much beyond historical averages, but it's instructive to note that during the last period of quantitative tightening, mortgage spreads overshot the long-term average by an additional 20 basis points.
We don't expect spreads to widen and stay at levels much beyond historical averages, but it's instructive to note that during the last period of quantitative tightening.
Spreads overshot the long term average by an additional 20 basis points.
Please turn to slide five.
Speaker 3: Since the beginning of the pandemic, the average coupon of the mortgage universe has declined by approximately 75 basis points from four and a quarter
Since the beginning of the pandemic the average coupon of the mortgage universe has declined by approximately 75 basis points from four to quarter percent to three 5%.
Speaker 3: As a result of this restriking of the mortgage universe and the upward trajectory in mortgage rates, the percentage of mortgages in the Fannie Freddie universe with at least 50 basis points of refinance incentive has fallen to around 30% at year end 2021, compared with roughly 80% at year end 2020.
As a result of this re striking of the mortgage universe and the upward trajectory in mortgage rates the percentage of mortgages in the Fannie Freddie universe with at least 50 basis points of refinancing incentive has fallen to around 30% at year end 2021, compared with roughly 80% at year end 2020.
Speaker 3: With the jump in mortgage rates in 2022 to north of 3.5%, that percentage is projected to fall further to roughly 11%.
With the jump in mortgage rates in 2022 to north of three 5% that percentage is projected to fall further to roughly 11%.
With such with such a small percentage of the market eligible to refinance we're looking at an environment of sharply lower prepayment speeds.
Speaker 3: With such a small percentage of the market eligible to refinance, we are looking at an environment of sharply lower prepayment speeds.
How much slower as shown in figure two.
Speaker 3: The dark grey bars indicate the realized prepayment speeds for our current specified pool coupons over the course of 2021.
The dark gray bars indicate the realized prepayment speeds for our current specified pool coupons over the course of 2021.
Speaker 3: Yes, these speeds were much faster than what was expected at the beginning of the year as a result of high HPA and GSE policies to make refinancing easier.
Yes. These speeds were much faster than what was expected at the beginning of the year as a result of high HPA and GSE policies to make refinancing easier.
Speaker 3: But higher rates will necessarily lead to slower speeds, and we show our projections for those TBA and specified coupons in the light gray bars, assuming current interest rates stay unchanged throughout the year.
But higher rates will necessarily lead to slower speeds and we show our projections for those TBA and specified coupons in the light gray bars, assuming current interest rates stay unchanged throughout the year.
Speaker 3: With prepayment rates projected to come down sharply and quickly, the economic, carry, and cash flows of our paired MSR strategy are expected to dramatically improve.
With prepayment rates projected to come down sharply and quickly the economic carry and cash flows of our paired MSR strategy are expected to dramatically improve.
Figure three we show the components of economic carry of our MSR portfolio for 2021, and the projected amounts for our current portfolio over the next year, assuming rates are unchanged and we do not replace or add any MSR.
Speaker 3: In Figure 3, we show the components of economic carry of our MSR portfolio for 2021 and the projected amounts for our current portfolio over the next year, assuming rates are unchanged and we do not replace or add any MSR.
In 2021, the value loss from prepayments labeled runoff in the charts overwhelmed the MSR cash flows despite contributions from our recapture agreements, resulting in total net economic carry of close to negative $200 million.
Speaker 3: 2021, the value loss from prepayments, labeled runoff in the chart, overwhelmed the MSR cash flows, despite contributions from our recapture.
Speaker 3: resulting in total net economic carry of close to negative $200 million.
Speaker 3: static projections for 2022 change this picture dramatically.
Our static projections for 2020 to change this picture dramatically.
Speaker 3: Runoff is forecast to drop by over 50% and we project the net economic carry of our MSR to be close to positive $200 million, nearly the inverse of last year's MSR.
Runoff is forecast to drop by over 50% and we project the net economic carry of our MSR to be close to a positive $200 million.
Nearly the inverse of last year.
Speaker 3: Of course, these projections are model-based and reflect a single point in time with a number of assumptions.
Of course, these projections are model based and reflect a single point in time with a number of assumptions.
Speaker 3: But the idea is that the fast prepay headwind that we experienced in 2021 has shifted, and our base case expectation is for a much more favorable environment in 2022.
The idea is that the fast prepay headwinds that we experienced in 2021 has shifted and our base case expectation is for a much more favorable environment in 2022.
Speaker 3: Now I will turn it over to Mary to discuss our financial results in more detail.
Now I will turn it over to Mary to discuss our financial results in more detail.
Speaker 4: Thank you, Bill, and good morning, everyone. Please turn to slide 6 to review our financial results for the fourth quarter.
Thank you Bill and good morning, everyone.
Please turn to slide six to review our financial results for the fourth quarter.
Speaker 4: Comprehensive income was negative $128.6 million, representing an annualized return on average common equity of negative 24.7%.
Comprehensive income was negative $128 $6 million, representing an annualized return on average common equity of negative 25, 7%.
Speaker 4: Our book value is $5.87 per share compared to $6.40 at September 30th.
Our book value was $5.87 per share compared to $6 40 at September 30.
Speaker 4: including the 17-cent common dividend, results in a quarterly economic return of negative 5.6 percent.
Including the 17 common dividend resulted in a quarterly economic return of negative five 6%.
Speaker 4: As Bill mentioned earlier, the result mostly reflects spread widening in high-coupon RMBs, IO securities, and MSR.
As Bill mentioned earlier the result, mostly reflects the spread widening in high coupon MBS securities.
Securities and MSR.
Speaker 4: Moving on to slide seven, earnings available for distribution with 22 cents per share, compared to 24 cents for the third quarter, and compared to our fourth quarter dividend of 17 cents.
Moving on to slide seven earnings available for distribution was <unk> 22 per share compared to 24 for the third quarter and compared to our fourth quarter dividend of <unk> 17.
Speaker 4: Overall, the benefit of our investment in MSR served to partially offset reduced RMBs balance.
Overall, the benefit of our investment in MSR served to partially offset reduced our MBS balances.
Net interest income declined by $1 $3 million with lower our MBS balances translating into lower interest income and repo funding cost.
Speaker 4: Net interest income declined by $1.3 million, with lower RMBS balances translating into lower interest income and repo funding costs.
Speaker 4: Interest expense was further reduced by a decline in MSR borrowing costs.
Interest expense was further reduced by a decline in MSR borrowing costs.
And then the derivatives of $39 $5 million compared to $46 $3 million in the prior quarter.
Speaker 4: in another derivative with $39.5 million compared to $46.3 million in the prior quarter.
Speaker 4: The result was driven by a reduction in TBA exposure, which was largely offset by role specialists.
As a result, Ms. Kevin by a reduction in TBA exposure, which was largely offset by Ralph Veselin.
Speaker 4: and a lower notional position in U.S. Treasury futures.
And a lower position in U S Treasury futures.
Turning to MSR.
Speaker 4: Turning to MSR, servicing income rose by more than $4 million to almost $61 million as average GPV balances continued to grow and prepayment speeds slowed.
Anything income rose by more than $4 million to almost $61 million.
Average CPB balances continued to grow and prepayment speeds slowed.
Speaker 4: As Bill noted earlier, we expect to settle on $39 billion UPD of MSR in the first quarter and expect to see the economics of that growth come through over the next couple quarters.
As Bill noted earlier.
Back to settle in 39 billion NPV of MSR in the first quarter and expect to see the economics of that growth come through over the next couple of quarters.
Speaker 4: Lastly, operating expenses fell by $3 million to $31.4 million due to compensation accrual adjustments offset by the rescission of the CARES Act employee retention credit that we benefited from in the first three quarters of the year.
Lastly, operating expenses fell by $3 million to $31 $4 million due to compensation accrual adjustments.
Offset by the rescission of the cares Act employee retention credit that we benefited from in the first three quarters of the year.
In the table on the lower right, Michelle our portfolio yield.
Speaker 4: our realized net spread in the quarter rose by 44 basis points to 2.99%.
I realized that spread in the quarter rose by 44 basis points to nine 9%.
Speaker 4: This net increase was attributable to the combination of higher yields on recently purchased MSR and a greater proportion of MSR in the portfolio.
This net increase was attributable to the combination of higher yields on recently purchased MSR and.
And a greater proportion of MSR in the portfolio.
Net spread as of December 31st which reflects our estimate for the near term.
Speaker 4: net spread as of December 31st, which reflects our estimate for the near term.
Speaker 4: increase further to 3.1%, but will depend on our portfolio mix and pace and impact of interest rate hikes.
Increased further to three 1%.
All dependent on our portfolio mix and patient impact of interest rate hikes.
Please turn to slide eight.
Speaker 4: Our liquidity position continues to be strong with unrestricted cash of $1.2 billion at quarter end.
Our liquidity position continues to be strong with unrestricted cash of $1 2 billion at quarter end.
Speaker 4: Funding in the repo market remains liquid and well supported, and we retain balances with 19 different repo counterparties.
Funding in the repo market remains liquid and well supported and we retained balances with 19 different repo counterparties.
Speaker 4: While funding costs for agency RMBF through the repo markets froze late in the quarter on an absolute basis as the market priced in rising short-term rates and Fed hikes.
While funding costs for agency MBS to the repo markets rose late in the quarter on an absolute basis as the market priced in rising short term rates and fed hikes.
Speaker 4: The spread to OIS and SOFR remains low, currently right around 10 basis points for both 3-month and 6-month maturities, as shown in the chart in the upper right.
It's spread to OIS and sulfur remains low.
Currently right around 10 basis points from Paul Fremont in six months maturity.
As shown in the chart in the upper right.
Speaker 4: We maintained access to diverse funding sources for MSR, and our unfunded and committed MSR asset financing capacity stands at $313 million.
We maintained access to diverse funding sources for MSR and.
And our unfunded and committed MSR asset financing capacity stands at $313 million.
Speaker 4: Turning to leverage, in conjunction with the reduction in our RMBs position, economic debt to equity declined to 4.7 times that quarter end, compared to 6.1 times at the end of September .
Turning to leverage in conjunction with the reduction in our MBS position economic debt to equity declined to four seven times at quarter end.
Compared to six one times at the end of September .
Speaker 4: Average economic debt to equity in the fourth quarter was 5.1 times compared to the third quarter average of 6.0 times.
Average economic debt to equity in the fourth quarter was five one times compared to the third quarter average of $6 <unk>.
As a final note. We have included information on REIT taxable income and the tax characterization of our dividend distributions on appendix slide 28.
Speaker 4: As a final note, we have included information on REIT taxable income and the tax characterization of our dividend distributions on Appendix slide 28.
Speaker 4: For additional information regarding the distributions and the tax treatment, please reference the dividend information found in the Investor Relations section of our website. I will now turn the call back to Bill for a portfolio update.
For additional information regarding the distributions and the tax treatment. Please.
Please reference the dividend information found in the Investor Relations section of our website.
I will now turn the call back to bill for a portfolio update.
Thank you Mary please turn to slide nine.
Speaker 3: As spreads fluctuated during the fourth quarter at tight levels, we became increasingly concerned about the potential for a more aggressive Fed, and in early December , we reduced our overall mortgage exposure to be more defensive, reducing our portfolio leverage to 4.7x.
As spreads fluctuated during the fourth quarter at tight levels, we became increasingly concerned about the potential for a more aggressive fed and in early December we reduced our overall mortgage exposure to be more defensive reducing our portfolio leverage to four seven times.
Speaker 3: As we did this, we also utilized option structures to replicate the convexity and volatility characteristics of RMBS, which preserved virtually all of the carry.
As we did this we also utilize the option structures to replicate the convexity and volatility characteristics of RMB, yes, which preserved virtually all of the carry but without the spread risk.
Within our specified pool position, we rotated out of our season, 3% pools into new production investor property loan balance and geography stories.
Speaker 3: Within our specified pool position, we rotated out of our season 3% pools into new production investor property, loan balance, and geography story.
Speaker 3: We also added some very low pay of 2.5% bank service collateral, which we think will outperform PBA as the deliverable works.
We also added some very low pay up two 5% bank service to collateral, which we think will outperform TBA as the deliverable worsens.
Speaker 3: In high coupons, we were not active, and we let that position continue to run off without replacement.
In high coupons, we were not active and we let that position continue to run off without replacements.
Please turn to slide 10.
Speaker 3: Figure 1 shows our story and coupon distribution of specified pools and includes the bank service and new production investor stories that I just mentioned.
Figure one shows our story and coupon distribution of specified pools and includes the bank serviced and new production Investor stories that I just mentioned.
Speaker 3: Figure 2 shows the quarterly total return performance by coupon on TBA contracts and then our specified pool holdings.
Figure two shows the quarterly total return performance by coupon on TBA contracts and then our specified pool holdings here.
Speaker 3: Here we can see that every coupon with the exception of TBA2s underperformed their interest rate hedges along the curve and higher coupons suffered more.
Here, we can see that every coupon with the exception of TBA twos underperformed their interest rate hedges, along the curve and higher coupons suffered more.
Speaker 3: Finally, Figure 3 compares by coupon TVA speeds to those of our specified portfolio.
Finally figure three compares by coupon TBA speeds to those of our specified portfolio.
Speaker 3: Overall, prepayment speeds in our specified pools declined 8% to 27.7CPR and remained much slower than TBA.
Overall prepayment speeds as our specified pools declined to 8% to 27, seven CPR and remained much slower than TBA.
Speaker 3: To the extent that this quarter's underperformance in higher coupons was due to the market being disappointed by the pace of deceleration in prepayment speeds, we are optimistic that that may be short-lived as prepayment should begin to slow materially in the coming months.
To the extent that this quarter's underperformance in the higher coupons was due to the market being disappointed by the pace of deceleration in prepayment speeds. We are optimistic that that may be short lived as prepayments should begin to slow materially in the coming months.
Speaker 3: Indeed, the February prepayment report released last Friday showed speeds declining by 21% in aggregate, and the market is expecting an additional 15% decline next month too.
Deed. The February prepayment report released last Friday showed speeds declining by 21% in aggregate and the market is expecting an additional 15% decline next month too.
Please turn to slide 11, we will discuss our MSR portfolio.
Speaker 3: Our flow and bulk additions almost exactly offset our runoff, and market pricing was indifferent to the large curve flattening experience during the quarter, as the long end of the yield curve was essentially unchanged.
Our flow and bulk editions, almost exactly offset a runoff and market pricing was indifferent to the large curve flattening experienced during the quarter as the long end of the yield curve was essentially unchanged.
The percentage of our MSR portfolio, which is in forbearance has declined to below 1% by loan count.
Speaker 3: The percentage of our MSR portfolio which is in forbearance has declined to below 1% by loan.
Speaker 3: More than 80% of our borrowers are exiting forbearance in a contractually current state through payment deferral or loan modification.
More than 80% of our borrowers are exiting forbearance in a contractually current state through payment deferral or loan modification.
Speaker 3: About half of the remaining 20% have prepaid, while the other half continue to work through loss mitigation solutions, including modifications.
About half of the remaining 20% have prepaid while the other half continue to work through loss mitigation solutions, including modification.
Because forbearance as are now very small relative to our portfolio. We will not continue to report it going forward.
Speaker 3: Because forbearances are now very small relative to our portfolio, we will not continue to report it going forward.
Speaker 3: Our 60-plus-day delinquencies are still elevated from pre-pandemic levels by about 100 basis points, and sitting now at 1.4%, and we will continue to monitor this closely.
Our 60, plus day delinquencies are still elevated for pre pandemic levels by about 100 basis points and sitting now at one 4% and we will continue to monitor this closely.
Speaker 3: Figure 2, we showed the trend of our settled UPB for our flow and bulk channels over the last five quarters.
Figure two we show the trend of our settled UBB for our flow and bulk channels over the last five quarters.
Speaker 3: While flow channel settlements have continued to decline, we were able to capitalize on the elevated activity in the bulk market and committed to purchase another $22 billion of UPB.
While flow channel settlements have continued to decline we were able to capitalize on the elevated activity in the bulk market and committed to purchase another $22 billion of UBB.
In total we expect to settle on $39 billion of <unk> in the first quarter.
Speaker 3: In Figure 3, we compare our servicing prepayment fees versus TBA.
Figure three we compare our servicing prepayment speeds versus TBA.
Speaker 3: Overall, prepay speeds on our MSR portfolio declined considerably by 17% to 22.1 cpr.
Overall prepay speeds on our MSR portfolio declined considerably by 17% to $22 one CPR.
Speaker 3: This is a much greater slowdown than we experienced in our specified pool position, and is a result of having more exposure in the lower coupons, which are more reactive to changes in interest rates.
This is a much greater slowdown that we experienced in our specified pool position and as a result of having more exposure in the lower coupons, which are more reactive to changes in interest rates.
Please turn to slide 12.
Speaker 3: One of the main differentiating features of Two Harbors is the extensive and robust platform we have created to acquire MSR on a flow basis from multiple counterparties.
What are the main differentiating features of two harbors is the extensive and robust platform. We have created to acquire MSR on a flow basis for multiple counterparties.
Two harbors has been a consistent presence in the slow market through many different environments and this is shown in figure one.
Speaker 3: Two harbors has been a consistent presence in the flow market through many different environments, and this is shown in Figure 1.
The same 10 buyers have accounted for 83% of flow of market share in the last five years.
Speaker 3: The same 10 buyers have accounted for 83% of flow market share in the last five years.
Speaker 3: During those years, Two Harbors has had an average market share of 25%, and we have been the top buyer of flow servicing in four of those years, and number two in the fifth.
During those years two harbors has had an average market share of 25% and we have been the top buyer flow servicing and four of those years and number two in the fifth.
Speaker 3: During 2020 and 2021, our flow acquisition volumes essentially offset our portfolio runoff, as seen in Figure 2.
During 2020 in 2021, our flow of acquisition volumes, essentially offset our portfolio runoff as seen in figure two.
Speaker 3: While we are not an originator or a correspondent lender, our flow channel platform acts similarly in many of its effects.
While we are not an originator or a correspondent lender our flow channel platform Act. Similarly in many of its effects, one such effect being the ability to source more product low rates and high refi environment.
Speaker 3: One such effect being the ability to source more product in a low rate and high refi environment.
Lastly, and figure three we showed the volume of transactions in the bulk MSR market as well as our participation in that market.
Speaker 3: Lastly, in Figure 3, we show the volume of transactions in the bulk MSR market as well as our participation in that market.
Speaker 3: Since 2014, the amount of MSR coming to market in bulk transactions has been between 150 billion and 250 billion of UPB, and a typical success ratio for us during those years ranged from 5% to 10%.
Since 2014, the amount of MSR coming to market in bulk transactions has been between $150 billion and $250 billion of UCB and a typical success ratio for us during those years range from 5% to 10%.
For reasons, we have discussed previously.
Speaker 3: A record high amount of roughly $450 billion of UPB came to market in 2021.
A record high amount of roughly $450 billion of UBB came to market in 2021.
Speaker 3: 2022 is shaping up to be another record year, as we have seen roughly $125 billion of UPB come to market in January alone.
In 2022 is shaping up to be another record year as we have seen roughly $125 billion of UBB come to market in January alone.
Speaker 3: This slide is meant to give a better sense of the supply dynamics in the MSR market and in our ability to source the MSR that is a core part of our investment strategy.
This slide is meant to get give a better sense of the supply dynamics in the MSR market and in our ability to source. The MSR is a core part of our investment strategy.
Speaker 3: We are very proud of the platform we have built and the reliability to our portfolio balances that it provides.
We're very proud of the platform, we've built and the reliability to our portfolio of balances that it provides.
Please turn to slide 13.
As we've discussed previously the MSR asset acts in many ways like a short position in RBS as shown by the gray bars in the top left chart.
Speaker 3: As we've discussed previously, the MSR asset acts in many ways like a short position in RMBs, as shown by the gray bars in the top left chart.
Speaker 3: The blue bars represent RMVS hedges and the amount is chosen to be equal in offsetting by construction.
The blue bars represent the RMB as hedges and the amount is chosen to be equal and offsetting by construction.
Speaker 3: After allocating the RMBS positions necessary to hedge the MSR, we are left with additional RMBS that we hedge with rates as seen in the middle chart.
After allocating the RBS positions necessary to hedge the MSR. We are left with additional RBS there'll be hedged with rates as seen in the middle charts.
Speaker 3: As you can see, we were net short close to $2.5 billion in the 2.5 coupon and small positive positions in higher coupons.
As you can see we were net short close to $2 $5 billion in the two and a half coupon and small positive positions in higher coupons.
Speaker 3: The short two and a half position resulted mainly from de-levering the portfolio as we believe the two and a half coupon looks rich and had the most to lose given a reduction of Fed support.
The short two and a half position resulted mainly from Delevering the portfolio as we believe the two and a half coupon looks rich and had the most to lose given a reduction of fed support.
In the second row, we show book value exposure to changes in current coupon mortgage spread.
Speaker 3: In the second row, we show book value exposure to changes in current coupon mortgage spread.
The chart on the bottom right shows a total of 0.8% exposure for 25 basis point spread widening in the current coupon mortgage spread.
Speaker 3: The chart on the bottom right shows a total of 0.8% exposure for a 25 basis point spread widening in the current coupon mortgage spread.
Speaker 3: This estimate assumes a parallel shock across the coupon stack and is not relevant for the book value sensitivity to spread to the higher coupons moving in isolation or on MSR.
This estimate assumes a parallel shock across the coupon stack and is not relevant for the book value sensitivity to spreads and higher coupons moving in isolation or on MSR.
Speaker 3: Besides the presence of MSR in our portfolio, this number also reflects the fact that we have very low leverage.
Besides the presence of MSR in our portfolio. This number also reflects the fact that we have very low leverage.
Please turn to slide 14, where we show our interest rate and curve exposures.
Speaker 3: Please turn to slide 14, where we show our interest rate and curve exposure.
Speaker 3: We are carefully monitoring and hedging the shape of the entire yield curve in general and we are focused, of course, on the very front end of the curve in particular
We are carefully monitoring and hedging the shape of the entire yield curve in general and we are focused of course on the very front end of the curve in particular.
Speaker 3: With inflation fears in the foreground, the obvious concern is a shock upward in the front end in a continued bear flattening move.
With inflation fears in the foreground the obvious concern is a shock upward in the front end and a continued bare flattening move.
Speaker 3: In Figure 3, we show that in this scenario, our portfolio has low sensitivity with only a minus 0.3% impact to book value.
Figure three we show that in this scenario our portfolio has low sensitivity with only a minus 0.3% impact to value.
Speaker 3: Taken together, these three charts demonstrate our commitment to hedging the full yield curve exposure and our desire to have little book value volatility no matter the rate environment.
Taken together these three charts demonstrates our commitment to hedging the full yield curve exposure and our desire to have a little book value volatility no matter the rate environment.
Speaker 3: Finally, I'd like to discuss our outlook for two harbors and our return expectations for new investments on slide 15.
Finally, I'd like to discuss our outlook for two harbors and our return expectations for new investments on slide 15.
Speaker 3: The most notable change from the third quarter is the sharp move in current coupon pools hedged with interest rates.
The most notable change from the third quarter is the sharp move in current coupon pools hedged with interest rates.
Speaker 3: The rapid widening of spreads earlier this year has pushed returns from the low to mid single digits to the very high single digits.
The rapid widening of spreads earlier. This year has pushed returns from the low to mid single digits to the very high single digits.
Speaker 3: These assets are getting close to our target returns, and we believe that they will be an attractive use of capital early this year.
These assets are getting close to our target returns and we believe that they will be an attractive use of capital early this year.
Speaker 3: In high coupon pools, although we saw some widening in the fourth quarter, they have outperformed somewhat in January and so combined with a much flatter yield curve, we see static spreads roughly unchanged in the high single business.
In high coupon pools, although we saw some widening in the fourth quarter to have outperformed somewhat in January and so combined with a much flatter yield curve, we see static spreads roughly unchanged in the high single digits.
TBA roll Specialness remains elevated and thus the duration hedges carry which is not particularly impacted by the recent spread widening continues to look attractive on the surface.
Speaker 3: TBA role specialist remains elevated and thus the duration hedged carry, which is not particularly impacted by the recent spread widening, continues to look attractive on the surface.
Speaker 3: However, despite the specialness, we believe the supply-demand imbalances will weigh on actual realized returns in the near term and so we are taking a wait-and-see approach to TBA –
However, despite the Specialness, we believe the supply demand imbalances will weigh on actual realized returns in the near term and so we are taking a wait and see approach to TBA investments.
The pair construction of MSR and agency RBS continues to be the most attractive way to deploy new capital with returns in the low to mid teens.
Speaker 3: The prepared construction of MSR and agency RBS continues to be the most attractive way to deploy new capital with returns in the low to mid-term.
Speaker 3: Although the MSR market is competitive, we continue to find pockets of opportunity through our market leading position in flow and our disciplined pricing of bulk packages.
Although the MSR market is competitive we continue to find pockets of opportunity through our market leading position in flow and our disciplined pricing of bulk packages.
Speaker 3: This environment, with prepayment speeds beginning to slow and current coupon mortgage spreads widening, is one for which our portfolio strategy was designed.
This environment with prepayment speeds is beginning to slow and current coupon mortgage spreads widening is one for which our portfolio strategy was designed.
Speaker 3: As a result, we are very constructive and optimistic about the forward outlook for two harbors and our paired agency plus MSR portfolio construction.
As a result, we are very constructive and optimistic about the forward outlook for two harbors and our parent agency <unk> MSR portfolio construction.
Thank you very much for joining us today, and we'll now be happy to take any questions you might have.
Thank you.
Speaker 1: Thank you. At this time, we will be conducting a question and answer session.
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One moment, please while we poll for questions.
Our first question is from Jeff.
Speaker 1: Our first question is from Trevor Cranston with JMP Securities. Please go ahead.
Gladstone.
<unk> Securities. Please go ahead.
Hey, Thanks, good morning.
Speaker 5: You talked a lot about the widening of current coupons in January and performance somewhat of higher coupons, which kind of reversed what happened in the fourth quarter, I guess.
You talked a lot about the.
The widening of current coupons of January performance somewhat of a higher coupons.
So it's kind of reverse what happened in the fourth quarter I guess.
Speaker 5: Can you talk about going forward as TAPOR progresses and the Fed embarks on...
Can you talk about going forward as taper progresses.
The fed embarks on.
Speaker 5: monetary tightening, how you expect the
Monetary tightening.
How you expect the.
Speaker 5: kind of performance of the coupon stack to evolve over the course of the year. And if you could also provide any commentary on sort of what risk scenarios you guys think about that would potentially cause high coupon underperformance going forward. Thanks. Yeah, sure. Thank you.
Kind of performance of the coupon start to evolve over the course of the year.
If you could also provide any commentary on sort of what.
Risk scenarios do you guys think about that would potentially cause.
Groupon underperformance going forward. Thanks.
Yes, sure Thanks, Trevor and good morning.
Sure.
Speaker 3: you know, as we've sort of been saying for, you know, a while and shown by the chart on slide four of the presentation.
Okay.
As we've sort of been saying for.
A while and just shown by the chart on slide four of the presentation.
Speaker 3: We've been saying for a long time, we think spreads on current coupons.
We've been saying for a long time, we think spreads on current coupons.
Speaker 3: are going to, should continue to widen towards long-term averages, and given the environment that we're in, with the Fed still removing accommodation, talking about balance sheet tightening, and all those factors, I think the possibility of an overshoot of long-term averages in spreads is possible.
<unk> two should continue to widen towards long term averages and given the environment that we're in with the fed still removing accommodation talking about balance sheet tightening and all of those factors I think the possibility of an overshoot of long term averages and spreads as possible.
Speaker 3: And so we are positioned accordingly for that. As rates continue to rise, what is known as current coupon migrates up also. So looking at a current coupon chart like the one that we show here is talking about not a single coupon in the coupon stack, it changes over time a little bit.
And so we.
We are positioned accordingly for that.
As rates continue to rise what is known as current coupon migrates up also so looking at at current coupon chart like the one that we show here.
Is talking about.
Not a single.
The coupon in the coupon stack it changes over time, a little bit.
Speaker 3: Currently right now, the high coupons called three and a half and above, they haven't made any of those for a long time. As rates rise and the current coupon shifts up there, the current coupon now is probably in the 3% area.
Currently right now there.
High coupons.
Called three five.
And above they havent made any of those for a long time right.
Alright, and so.
As rates rise and the current coupon shifts up there. The current coupon now is probably in the 3% area right.
Speaker 3: You should start to see more supply come in those coupons as well. But refinancing speeds across the entire stack, not just the current coupons, will start to fall as the entire machinery of the refinance universe starts to power down.
Alright, you should start to see more supply.
In those coupons as well, but refinance refinancing speeds.
Across the entire stack not just the current coupons will start to fall as the entire machinery.
The refinance.
Universe starts too so.
So a powered out.
I'm not sure if that answered your question.
Yes, yes. It does that's helpful.
Speaker 5: When you were talking about the attribution to the book value performance in 4Q, I think you mentioned about half was underperformance of high coupons and then the other component was the
And then when.
When you were talking about the.
The attribution to the book value performance in <unk> I think you mentioned about half was.
Underperformance of high coupons and then the other component was.
Speaker 5: widening of MSR. And I think there was.
Widening of MSR.
And I think there was.
Speaker 5: a comment that it was partially related to the pricing variance based on how MSR marks are provided.
A comment that it was.
Partially related to the.
The pricing variance.
Based on how MSR marks are provided could you clarify that a little bit or just elaborate on.
If the MSR widening was.
Speaker 5: just sort of that pricing variance or if there was anything sort of fundamental related to expected prepaid speeds or anything else going on.
Just sort of the pricing variance or if there was anything sort of fundamental related to expected prepay speed is there anything else going on.
Speaker 3: Well, I'll start with that, right? And maybe Mary can jump in also. Our fair value marking process is to take the average of three independent broker marks.
Well I'll start with that and maybe Mary can jump in also our fair value marketing processes to take the average of three independent broker marks.
Speaker 3: right and they have their own information and look as to what their estimates of our portfolio are and we think the best way to manage that is to take the simple average of those and within that process we saw a 20 basis point widening of that average level.
And they have their own information in and.
And.
Look as to what the what their estimates of our portfolio are and we think the best way to manage that is to take the simple average of those and within that process. We saw a 20 basis point widening of that average level.
Got it okay.
Speaker 5: Got it. Okay. And then the last question for me, I think we were talking about the refinanceability of the market. I think you gave a number of something like 11 percent after the move in rates in January . Do you have the number offhand for how much of your MSR portfolios remains in the money for refinancing or if that's generally kind of close to what the market level is overall?
And then last question for me I think.
When you were talking about the refinance ability of the market.
I think you gave a number something like 11% after the move in rates in January .
Do you have the number offhand for how much of it.
Your MSR portfolios remains in the money for refinancing here.
Generally kind of close to what the market levels overall.
Speaker 3: Yeah, I think that's one of the charts actually. You see it attracts pretty closely on page 5 of the presentation.
Yes, I think I think that's one of the charts actually.
You see the tracks pretty closely I'm on page five of the presentation.
Speaker 3: We showed this percentage in light blue is the Fannie Freddie universe and the dark blue line in the chart on the upper right is our servicing portfolio. So it's tracking pretty closely with the universe. There was a little bit of divergence in 2020, but it's largely converged now to the universe. Gotcha. Okay.
We showed this percentage in light blue.
Is the Fannie Freddie universe in the dark Blue line in the chart on the upper right is our servicing portfolio. So it is tracking pretty closely with the universe, there was a little bit of divergence.
In 2020, but it's largely converged now to the universe.
Gotcha Okay.
I appreciate the color. Thank you guys.
Thank you.
Speaker 1: Thank you. Our next question is from Doug Harter with Credit Suisse Securities. Please go ahead.
Thank you.
Next question is from Doug Harter with Credit Suisse Securities. Please go ahead.
Speaker 5: Thanks. Bill, you talked about, you know, and you've talked about for a while that the kind of the construct of the portfolio with agency MBS and MSR is meant to dampen volatility in book value. You know, I would say, you know, for 2021 that didn't work. Can you just talk about lessons learned and how you might, whether there's any changes to portfolio construction or hedging that you might do to accomplish that lower book value volatility?
Thanks, Phil you talked about and you've talked about for a while.
The construct of the portfolio with agency MBS and MSR is meant to dampen volatility.
And book value I would say for 2021.
Didn't work can you just talk about lessons learned and how do you mind.
Whether there is any changes to portfolio construction or hedging that you might do too.
To accomplish that at lower book value volatility.
Yes sure. Thanks for the question, Doug and thanks for joining us.
Speaker 3: Yeah, sure, thanks for the question, Doug. Thanks for joining us. 2021, our performance, you can phrase it in two different ways, really. One way is the portfolio construction and the sensitive that we show as we say on page...
2021 .
Our performance you can.
Fraser in two different ways really one way is.
Is the portfolio of construction and the sensitivities that we show as we say on on page.
Uh huh.
13, right really reflect.
Speaker 3: right, really reflect parallel changes and spreads across the stack.
Parallel changes in spreads across the stack.
Speaker 3: And what we saw in 2021 with the Fed continuing to buy lots of mortgages, that current coupon mortgage is
<unk>.
What we saw in 2021 with the fed continuing to buy lots of mortgages that current coupon mortgages.
Speaker 3: didn't really widen at all during 2021. They stayed at very, very tight levels, even through the end of the fourth quarter.
Didn't really widened at all.
During 2021, they stayed at very very tight levels, even through the end of the fourth quarter.
Speaker 3: At the end of the fourth quarter, they were within eight basis points or thereabouts eight or nine basis points of the tight levels experienced throughout the year. So we didn't see any current coupon widening during 2021. What we did see was high coupon spread widening.
At the end of fourth quarter they were within.
Eight basis points or thereabouts 89 basis points of the tight levels.
Experienced throughout the year. So we didn't see any current coupons widening during 2021, when we did see was high coupon spread widening during the year.
Speaker 3: during the year, which as rates fell and the Fed started buying more low coupons, they weren't making any more high coupons. It was sort of a static pool portfolio where you couldn't trade in it particularly, couldn't add to it. You could sell, we did sell a fair amount of that asset. But what happened was prepaid speed.
Which.
As rates fell and the fed started buying buying more low coupons, they werent, making any more high coupons.
It was it was sort of.
A static pool portfolio, where we couldnt, we couldnt trading at particularly can add to it.
You could sell we did sell.
Fair amount of that asset.
But what happened was prepay speeds were generally faster than the world expected right.
Speaker 3: generally faster than the world expected, right? And as a result of that...
And as a result of that.
Those coupons suffered in an actual realized cash flow performance as well as forward looking spread performance on the high coupons alone and the portfolio was not able to benefit from the offset of the MSR, which benefits from low coupon spread widening.
Speaker 3: those coupons suffered in actual realized cash flow performance as well as forward-looking spread performance on the high coupons alone. And the portfolio was not able to benefit from the offset of the MSR, which benefits from low coupon spread wide.
Speaker 3: That's what we're seeing today in the early part of the first quarter, a very rapid 20 basis point move in January . Mortgies are under stress again in February , and I'm sure you're aware. So in that environment...
That's what we're seeing today in the in the in the early part of the first quarter of.
Very rapid 20 basis point move in January .
Mortgage they're under stress again in February .
Im sure Youre aware.
And so in that environment. The MSR does provide an offset and here we're switching to a.
Speaker 3: the MSR does provide an offset. And here we're switching to a turnover environment out of a refi environment, and so I'm much more confident in the ability of the MSR to provide the offset that it's designed to do in this environment.
A turnover environment out of a refi environment and so.
And so much more.
I'm confident in the ability of the MSR to provide the offset that is designed to do in this environment.
Okay makes sense, thanks for the answer Bill.
Thank you.
Okay.
Speaker 1: Thank you. Our next question is from Eric Hagen with BTIG. Please go ahead.
Thank you.
Question is from.
Eric Hagen with <unk>. Please go ahead.
Speaker 6: Hey, thanks. Good morning. So, maybe two questions on my end. Before any offsets from MBS and hedges just by itself, can you say what the total return has been year to date for the MSR portfolio? And then separately, what was the end levered yield for the $39 billion that you bought so far this quarter?
Hey, Thanks, good morning.
Maybe two questions on my end before any offsets from MBS and hedges just by itself can you say what the total return has been year to date for the MSR portfolio and then separately what were the Unlevered yield what was unlevered yield for the 39 billion that you bought so far this quarter.
Speaker 3: Good morning, thanks for joining us. I don't think I have the returns broken out on just now.
Good morning every thanks for joining us.
I don't think I have the returns broken out.
On just the MSR.
Speaker 3: of the portfolio. Without hedges, if I understood your question correctly, that's not something we regularly compute.
Of the portfolio without.
Without hedges if I understood your question correctly.
That's not something we regularly.
Computer or monitor.
Speaker 3: We look at the portfolio on a heady basis and it's not particularly interesting.
When you look at the portfolio on a hedge basis, and and it's not particularly interesting to me.
What.
The.
Speaker 3: return of the individual sides of that construction are.
Return of the individual size of that construction.
So that doesn't have that my figure tips for sure not sure. It seems though that we calculate or monitor.
Speaker 3: So that's what I have at my fingertips for sure. I'm not sure if it's something we calculate or monitor.
Speaker 3: In terms of the static yields of the portfolios that we've been buying, we see in general static spreads in the very high single digits on a single digit.
In terms of the static yields of of of the portfolios that we've been buying.
We see in general.
Static spreads in the.
In the very high single digits.
On an unlevered unhedged basis.
Speaker 6: Okay, gotcha. Thanks. And then maybe you can shed some more light on the decision to rotate back into specified pools and really just how you expect the premium there to hold up if the expectation is for wider spreads like you guys did note in your prepared remarks.
Okay got you. Thanks, and then maybe you can shed some more light on the decision to rotate back into specified pools and really just how you expect the premium there to hold up if the expectation is for wider spreads look like you guys did note in your.
Prepared remarks.
Speaker 3: Yeah, so we talked about this in the past and there have been many questions about this in past quarters. With the Fed tapering and removing their purchases, we expect the role specialness to decline. And that should cause TBA, that's one effect which should cause TBA's to underperform specified pools. In addition, when you talk about TBA investments, that's also a
Yes so.
We talked about this in the past and there have been many questions about this in past quarters with the fed.
Tapering in removing their purchases, we expect the roll specialness.
To decline.
And that should cause TBA.
Thats, one effect, which should cause TBA as to underperform specified pools.
In addition.
When you talk about TBA investments.
That's also a.
Speaker 3: refers to what is, it's a cheapest to deliver concept, right, and so investing in a pool which is static, which doesn't change over time, unlike the TBA, what's implied in the TBA prices should also benefit the specified pools relative to the TBA. And so, what's implied in the TBA is that the pool is not a TBA, it's a TBA, it's a TBA, and so it's not a TBA, it's a TBA, it's a TBA, it's a TBA, it's a TBA,
Refers to what is what is it the cheapest to deliver concepts right and so investing in a pool, which is static which doesn't change.
Over time, unlike the TBA whats the whats implied in the TBA prices.
Should also benefit the specified pools relative to TBA and so over time as.
Speaker 3: As we've discussed, as role specialness declines in that market, we expect to rotate more into specified pools and this was really the beginning of that shift and we started by buying very low pay-up securities and which shouldn't, that pay-up should not be particularly at the inquired turns.
As we've discussed as roll Specialness declines in that market, we expect to rotate more into specified pools and this was really.
At the beginning of that shift and we started by buying very low pay up.
Securities.
And which which shouldnt.
That pay up should not be particularly at risk as spreads widen.
Got you. Thanks, and then one point of clarity.
Speaker 6: Gotcha, thanks. And then one point of clarity, the book value color quarter to date, does that include an accrued dividend or is it negative an accrued dividend? Well as you know the definition is bucks, which is profits. Those haircut silver not
Book value color quarter to date does that include an accrued dividend or is it negative and accrued dividend.
Well as you know the dividend is im sorry go <unk>.
Speaker 4: I was just going to say that it would not include a dividend as those aren't set until the board declared.
I was just going to say that.
It would not include a dividend.
Until the board declared in March.
Sure Okay. Thank you.
Okay.
Okay.
Speaker 1: Thank you. Our next question is from Bose George with KBW. Please go ahead.
Thank you.
Next question is from Bose George with key VW. Please go ahead.
Hey, everyone. This is actually Mike Smith on for Bose.
Speaker 7: Hey everyone, this is actually Mike Smith on for Bose. Just a couple questions on the Fed balance sheet. I'm just wondering if you can, you know, talk through your expectations for runoff and how that may compare to what we saw last time. And then, you know, maybe if you can just talk through where do you think the incremental demand comes from as the Fed moves away?
Just a couple of questions on the fed balance sheet I'm. Just wondering if you can talk through your expectations for runoff and how that may compare to what we saw last time and then maybe if you can just talk through where do you think the incremental demand comes from as the fed moves away.
Thanks very much for the question.
Speaker 3: Look, I have no particularly better insight into what the Fed is going to do than anybody else. They've said
Look I have no, particularly better insights into what the fed is going to do than anybody else they've said.
Speaker 3: that after rate hike liftoff, they will start to consider the normalization. They said it could be faster than other periods. They've said that they want to get to a treasury only portfolio. I take them at their word. I think the inflation fears have been internalized by the Fed. I think they will act accordingly.
That after after lift off after a rate hike lift off they will start to consider the normalization right. They said it could be faster than the other periods, they've said that they want to get to a treasury only portfolio.
Take them at their word I think.
The inflation fears.
Have been.
Internalized by the fed I think they will act accordingly, and I think.
If anything in this episode compared to the last one there's probably.
Speaker 3: If anything, in this episode compared to the last one, there's probably
Speaker 3: a higher risk that the Fed acts more quickly and more aggressively to take their mortgage balances down than they did in the past. I think as a result, that obviously puts higher risk on mortgage spread.
A higher risk that.
Is that the fed to act more quickly and more.
Aggressively to take their mortgage balances down that you did in the past and I think it results. That's obviously puts higher risk on mortgage spreads.
Great. That's helpful color and then just one more leverage quite a bit again I'm. Just wondering if you can kind of discuss what you are looking forward to go on offense and take that up and then maybe the timeline for doing so given that your targeted returns on assets.
Speaker 7: That's helpful, Koller. And then just one more. Leveraged your client quite a bit again. I'm just wondering if you can kind of discuss what you're looking for to go on offense and take that up. And then maybe the timeline for doing so, given that you're targeted at returns on assets has improved?
Improved modestly quarter over quarter.
Speaker 3: Sure. You know, I mean, the overarching environment here is one where the Fed is stepping away and where
Sure.
I mean, the overarching environment here is one where the fed is stepping away and where there's still lots of supply of mortgages and.
Speaker 3: still lots of supply of mortgages and spreads are tighter than they've been in other periods where the Fed has been removing accommodation and so we're watching spread levels carefully. It's a day-by-day decision about the environment and the relative value.
And spreads are tighter than they've been in other periods, where whereas the fed has been removing accommodation and so we're watching spread levels carefully. It's a it's a day by day decision about the environment and the relative value.
Speaker 3: I think that in the past we've said that our leverage could go up to eight or nine times. And of course, I'll remind you, leverage for us means something different than it does for a portfolio without MSR because we have this MSR offset. And so we really look at the spread exposures that we show on page 13.
<unk> did that in the past, we've said that our leverage could go up to eight or nine times and of course, I'll remind you leverage for us means something different than it does for portfolio without MSR because we have this.
MSR offset and so we really look at the at the spread exposures that we show on page 13.
Speaker 3: more carefully than we do at the nominal leverage, although we're respectful of the number. But given the amount of MSR in our portfolio today, we think that our leverage can go up into the sevens. If spreads overshoot towards the higher end of the range on slide five, then it could probably touch in the low eights or something like that. But we're watching the overall macro environment, the spread environment of the MBS market carefully and we'll make decisions when we think about it.
More carefully than we do at the nominal leverage although we're respectful of the number but given the amount of MSR in our portfolio today, we think that our leverage can go up into the sevens, if if spreads overshoot.
Towards the higher end of that range on on slide five then that it could probably touch in the low eights or something like that.
But we're watching the overall Max.
Macro environment, the spread environment of the MBS market carefully and we will make decisions when we think.
Speaker 3: when we think it's attractive to start increasing that over time.
When we think it's attractive to start.
Our increasing that over time.
Great. That's really helpful. Thanks, a lot for taking the questions.
Thank you.
Speaker 1: Thank you. Our next question is from Kenneth Lee with RBC Capital Markets.
Thank you our.
Our next question is from Kenneth Lee with RBC capital markets. Please go ahead.
Speaker 6: Hi, good morning and thanks for taking my question. Just one on the risk positioning and hedging profile.
Hi, good morning, and thanks for taking my question.
Just one on the risk positioning and hedging profile.
Speaker 6: Just based on the slide 14, it sounds as if Two Harbors is biased towards protection around a bear flattening scenario. I just wanted to gauge if that would be a correct reading or if there are a couple other scenarios that you guys are particularly focused on. Thanks. Thanks again. Good morning. Please note that the list of choose which cameras, the Fireman Selector, is the smallest
Just based on the <unk>.
Slide 14, it looks it sounds as if two harbors is biased towards protection around our bare flattening scenario just wanted to gauge if thats that would be a correct reading.
Or are there other couple other scenarios.
Is that you guys are particularly focused on thanks.
Thanks, Ken Good morning, Thanks for joining us.
Well, yes.
We're.
Speaker 3: most focused on that because that's where all the action has been in the last several weeks for sure. But you know as as we all knew where this market was heading which was towards fed liftoff in rate hikes and typically when that happens the yield curve flattens substantially and
Most focused on that because that's where all the action has been in the last.
Several weeks for sure but.
As we all knew where this where this market was heading which was towards fed lift off in rate hikes and typically when that happens the yield curve flattens substantially.
And so on and and the market is moving very quickly.
Speaker 3: and the market's moving very quickly. It shows how quickly the market moves. We actually prepared our remarks last night, and I said there were almost five and a half hikes priced in in the front end, and after today's CPI number, there's more than six hikes priced in.
It shows how quickly the market moves we actually prepared remarks last night and I said there were there were almost five five hikes priced in in the front and then after todays CPI number right. There is more than six months Preston.
Speaker 3: in 2022. It just shows how fast the market is moving here.
In 2022, so it just shows how fast the market is moving here.
Speaker 3: We try to hedge all along the yield curve, right, and to protect against bear flattening as well as bear steepening or bull flattening or bull steepening. We try to not run large interest rate risk.
We try to hedge all along the yield curve right and to protect against bare flattening as well as better steepening or bull flattening or both Steepening, we tried to not run large interest rate risks.
Speaker 3: with large interest rate risk positions. You know, we view our job, our mandate, is to provide mortgage exposure and mortgage exposure with MSR and not to make guesses on the direction.
With large interest rate risk positions, we view our R. R. Our job our mandate is to provide mortgage exposure and.
And mortgage exposure with MSR and not to make guesses on the direction of interest rates.
Speaker 6: Gotcha, very helpful. And just one follow-up, if I may, in terms of the MSRs. You mentioned there could be a pickup in terms of potential available acquisitions on the bulk side. Just wondering if you could talk a little bit more about what could be driving the increased availability this year.
Got you very helpful.
One follow up.
If I may in terms of the Msr's.
You mentioned it could be a pickup in terms of potential available acquisitions on the bulk side. Just wondering if you can just talk a little bit more about what could be driving that.
Increased availability this year.
Yes.
The supply side in 2021.
Speaker 3: the supply side in 2021.
Speaker 3: is really the same thing that's driving what we're seeing in 2022, which is that
It's really the same thing that's driving what we're seeing in 2022, which is that.
Speaker 3: During the extraordinary refi wave that we saw in 2020, many participants chose not to sell their MSR into the market because they felt that rates were low or that moles were low. In fact, back in those times primary secondary spread was very wide.
During the the extraordinary refi wave that we saw in 2020.
Manny.
Participants chose not to sell their MSR into the market because they felt that.
That rates were low or that multiyear low remember back back in those times primary secondary spread was very wide and so.
Speaker 3: Price multiples on what I would call at the money servicing during those days was probably in the three area as opposed to where it more normally is in the four to four and a half area and market participants saw that and they said, I don't need to.
Price multiples on on what I would call at the money servicing during those days was probably in the three area.
As opposed to where it normally is in the four to four and a half area and market, but has been saw that and they said I don't need to.
Speaker 3: I'm going to hold on and wait because I think the price is low. And the primary secondary spread was so wide so they were making enough money that they didn't need to sell their servicing to monetize it in order to run their operating businesses. And so they just held on to it. And rates rose, the market healed, price multiples improved, and so now those prices have gone
I'm going to hold on and wait because I think the price is low and the primary secondary spread was so wide. So they were making enough money.
That they didn't need to sell their servicing to monetize it in order to run the operating businesses.
So they just held ambulate and rates rose the market healed.
Price multiples improved and so now those participants are looking to sell those.
Speaker 3: are looking to sell those balances into the market. And what we saw in 2021 was not all of that. And of course, 2021 also saw large refinances. So while they still had the 2020 backlog, they were still making just as much in 2021 as they made in 2020. And so not all of that pipeline has cleared. And so 2022 should probably see a continuation of that as.
Those balances into the market and what.
What we saw in 2021.
Not all of that and of course <unk> 'twenty 'twenty. One also saw large refinances so well.
While they still had the 2020 backlog they are still making just as much in 2021 does that mean 2020, and so not all of that pipeline has cleared and so 2020, we should probably see a continuation of that as <unk>.
Speaker 3: servicing participants work to monetize their servicing holdings off their balance sheets.
Servicing participants work too.
Monetize their servicing holdings off their balance sheets.
Got you very helpful. Thanks again.
Thank you.
Yes.
Thank you.
Speaker 1: Thank you. Our next question is from Rick Shane with JP Morgan. Please go ahead.
Our next question is from Rick Shane with JP Morgan. Please go ahead.
Hey, Bill Thanks for taking my questions and I want to follow up a little bit on the last question.
Speaker 8: Hey Bill, thanks for taking my questions. And I want to follow up a little bit on the last question.
Yes.
Speaker 8: You know, you guys point out sort of the differential in the market in terms of bank service versus non-bank originated.
You guys point out sort of the differential in the market in terms of bank service versus not.
Non bank originated.
Speaker 8: I am curious if you are starting to see any consolidation in the non-bank channels. And I'm also wondering, one of the things the non-bank originators talk about in terms of their volume opportunity going forward, even as the rate term refi wave ends, is the cash-out refi opportunity.
Lenders.
Im curious if you are starting to see any consolidation in the non bank channels.
And I'm also wondering one of the things the non bank originators talk about in terms of their volume opportunity going forward, even as the rate term refi wave and is the cash out refi opportunity.
Speaker 8: How are you sort of mitigating that risk within the portfolio, and are you seeing curing in pricing between bank and non-bank originators related to that adverse select?
How are you sort of mitigating that risk within the portfolio and are you seeing peering in pricing between bank and non bank originators related to that adverse selection.
Speaker 3: Thanks, Rick. I'm not sure I understand your question exactly, so let me just talk for a little bit and see if that helps and answer your question. If not, you can steer me back on course.
Thanks, Rick I'm not sure I understood. Your question exactly so let me just talk for a little bit and see if that helps and answers. Your question. If not you can steer me back on course.
The addition of some bank service.
Speaker 3: The addition of some bank service specified pool collateral was really just a relative value trade between TBA, which as I said, I believe will worsen as spreads widen as the deliverable worsens. Bank service collateral prepays a little bit slower than the generic cohort and so forth. But these are low payer pools and it's not a big risk position that we have in general.
Specified pool collateral was really just a.
A relative value trade between.
TBA, which as I said I believe will worsen.
As as spreads widened as the deliverable worsens, thanks surface collateral prepays little bit slower than than the generic cohort and so forth, but these are low pay up pools.
And it's not a big risk positions that we have in general.
Speaker 3: The cash out refinances is certainly a thing. You know, we've seen more of that in 2021. That's already known in the market. That's what's keeping turnover speeds higher than...
The cash out refinances, certainly a thing.
We've seen more of that in 2021.
That's already known in the market Thats whats keeping turnover speeds higher then.
Speaker 3: than it has been in the past over another turnover episodes. I think that's already priced into the market at reasonably fast levels of cash out refis. And so, I happen to think that if anything, the risk of cash out refi speed is probably to the downside more than to the upside. I think it's true of cash out refi, I think it's true of prepayment models in general as a result of this.
Then it has been in the past over another turnover episodes.
I think that is already priced into the market.
Reasonably fast levels of cash out refis and so.
I happen to think that that if anything.
The risk of cash out refi speeds is probably to the downside more than to the upside.
You have cash out refis. It is true of a prepayment models in general as a result of this episode.
Speaker 3: that these were fast and expected speeds across the board and models have been, and expectations, not just models, market expectations have been calibrated to these very fast speeds and I think it's just as likely that speeds can be slower than those expectations.
That these were faster than expected speeds across the board and models have been an expectation that just miles miles and <unk>.
Market expectations have been calibrated to these very fast speeds and.
It's just as likely that speeds can be slower than those expectations.
Speaker 3: then I think it's just like if I'm more likely that they'd be slower than expectations rather than a higher going forward. Additionally, I'd say in our servicing portfolio, you know, we do have recapture agreements in place with our sub-servicers and we're able to monetize some of that value as cash out refunds happen.
Then.
It's just like it's more likely that it would be slower than extensions rather than rather than higher going forward. Additionally, I'd say in our servicing portfolio.
We do have recapture agreements in place with our sub servicers.
And we're able to two <unk>.
Monetize some of that value as cash out refis happen as well.
Speaker 8: Okay, yeah, that's helpful. I mean, I think one of the assumptions that we all often mistakenly make is that normalization is back to normal, but oftentimes normalization episodically overshoots before it returns to normal.
Got it okay. That's helpful.
One of the.
Assumptions that we all often mistakenly make is that normalization is back to normal but oftentimes normalization.
Historically overshoots before it returns to normal.
Yes, I agree with that.
Speaker 8: Okay, well, thank you. I will say we enjoyed the slide deck. I think every one of them, it could be a syllabus for a course on mortgage-backed securities with each slide being one daily lecture, and we're going to have to delve into all of them a little bit deeper. Well, happy to help in that.
Okay, well. Thank you I will say, we enjoyed the slide deck I think every one of them it could be a syllabus for.
Of course on mortgage backed securities with each slide being one daily lecture when we're going to have to delve into all of them deeper.
Well happy to help in that if you need me too thanks very much.
Thanks, guys.
Speaker 1: Ladies and gentlemen, we have reached the end of the question and answer session.
Ladies and gentlemen, we have reached the end of the question and answer session.
Speaker 1: and I would like to turn the call back to Bill Greenberg for closing remarks.
And I would like to turn the call back to Bill Greenberg for closing remarks.
Speaker 3: I just want to thank everyone for joining us today, and thank you as always for your interest in 2Harper.
Just want to thank you everyone for joining us today and thank you as always for your interest in two harbors.
Speaker 1: This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.
Yeah.
Speaker 9: The the.
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Yes.
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