Good morning, my name is Gerald and I will be your conference facilitator. At this time, I would like to welcome everyone to Two Harbors’ second quarter 2019 financial results conference call. All participants will be in a listen-only mode. After the speakers’ remarks, there will be a question and answer period. I would now like to turn the conference over to Maggie Field with Investor Relations for Two Harbors. Please go ahead.

Thank you and good morning everyone. Thank you for joining our call to discuss Two Harbors’ second quarter 2019 financial results. With me on the call this morning are Tom Siering, our President and CEO; Mary Riskey, our CFO; and Bill Roth, our CIO. After my introductory comments, Tom will provide an overview of our quarterly results and long term strategy, Mary will highlight key items from our financials, and Bill will review our portfolio and investment opportunity. The press release and financial tables associated with today’s call were filed yesterday with the SEC. If you do not have a copy, you may find them on our website at or on the SEC’s website at SEC.gov. In our earnings release and slides, which are posted in the Investor Relations section of our website, we’ve provided a reconciliation of GAAP to non-GAAP financial measures. We urge you to review this information in conjunction with today’s call. I would also like to mention that this call is being webcast and may be accessed on our website in the same location. Before I turn the call over to Tom, I would like to remind you that remarks made by management during this conference call and the 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 words such as anticipate, expect, estimate, and believe, or other such words. We caution investors not to rely unduly on forward-looking statements. Two Harbors describes these risks and uncertainties in its annual report on Form 10-K for the fiscal year ended December 31, 2018 and in other filings it makes or may make with the SEC from time to time which are available in the Investor Relations section of Two Harbors’ website and on the SEC’s website at SEC.gov. Except as may be required by law, Two Harbors does not update forward-looking statements and expressly disclaims any obligation to do so. I will now turn the call over to Tom.

Thank you Maggie, and good morning everyone. We hope that you had a chance to review our earnings press release and presentation that we issued last night. Please turn to Slide 3 to review our results. This quarter was highlighted by our strong book value growth. We delivered a 5.4% quarterly return on book value and a 14.7% return on book value for the first half of 2019. Our book value performance was a result of both portfolio positioning and active hedging. We are also pleased to have completed our first MSR securitization in the quarter, which has competitive terms compared to our bilateral facilities and gives us more financing flexibility for MSR. Please turn to Slide 4. In the second quarter, our sector traded under stock price pressure which we believe was driven by dividend cut concerns, lower interest rates, and a flatter yield curve, as well as an emergence of faster money buyers and sellers which created more inter-day volume and volatility. As you know, our goal is to deliver book value stability through a variety of market environments. We construct our portfolio with this long term focus in mind while endeavoring to minimize the impact of short term changes in rates. In particular, we believe our strategy of pairing MSR with agency RMBS generates a more stable risk-adjusted return throughout market cycles compared to hedging agencies with swaps only. Additionally, our unique portfolio of legacy non-agency securities is one that can’t be easily replicated, and we believe this strategy will continue to generate attractive returns give the strong tailwinds in housing. On this slide, you can see how these differentiating factors have resulted in total stockholder outperformance of 45% since our inception. Recently we have received some questions on possible GSE reform. We think it is unlikely that anything of substance happens prior to the 2020 election. Obviously that outcome could greatly influence any reform efforts. Finally, I would like to congratulate Bill on behalf of Two Harbors on his retirement at the end of the year. Under his leadership, we have built a strong team of investment professionals. I’d also like to congratulate Bill Greenberg and Matt Koeppen on their appointment as co-Chief Investment Officers beginning in 2020. We have a great team at Two Harbors and we are very excited about the opportunities ahead. I will now turn the call over to Mary to review our financial results.

Thank you Tom. Turning to Slide 5, let’s review our financial results for the second quarter. We generated comprehensive income of $201 million or $0.74 per share, and our book value was $14.17 per share compared to $13.83 at March 31. The increase in book value was primarily driven by the outperformance of higher coupon agencies in specified pools with MSR performing as expected and offsetting current coupon spread widening. Credit spreads also improved and contributed to positive book value. Finally, I’d note that through the end of July, our third quarter book value is up between 2% to 3% after accruing for dividends. Moving to Slide 6, let’s review our core earnings results. Core earnings, including dollar roll income, was $0.39 per share in the second quarter, representing a return on average common equity of 11.1%. Core earnings was impacted primarily by the higher prepayment environment, however, we also realized a minor impact from the compression of the LIBOR repo spread. We avoided much of the effects from spread widening that occurred in the first half of this year by maintaining longer repo maturities. We do expect to see a small impact from this in the third quarter, however we are actively managing our repo laddering to minimize both cost and exposures. I’d like to take a brief moment to discuss a change we made this quarter to core earnings. The change involves the modifications approach we use to calculate MSR amortization, specifically an adjustment for any gain or loss on the capital used to purchase the MSR. We recognize that core earnings is an important metric to the investment community. We believe that our new approach allows core earnings to better reflect how the carry earned in MSR varies as a function of prepayment rates. As such, we…

Thank you Mary, and good morning everyone. Please turn to Slide 9. In the second quarter global growth concerns, especially trade issues with China and Mexico, fueled the rally in interest rates and impacted economic growth expectations. This resulted in a flatter yield curve and three-month LIBOR above most longer term rates. This curve shape reflects the market’s expectation that the Fed will lower rates, which ended up occurring in July, and the anticipation is that there will be further rate cuts in the latter half of 2019. In the mortgage market, the agency basis widened with current coupons widening by about a point while higher coupon mortgages outperformed, widening only by about three-eighths of a point. Specified pools performed quite well in the rally, offsetting much of the basis widening. MSR performed as expected, declining in value in line with its duration and current coupon spread. Residential credit assets continued to perform well. Discounted legacy non-agencies benefited from lower expected forward LIBOR, which would have the effect of increasing the excess spread available to cover future losses. As a result, prices were modestly higher by about one point. Let’s move to Slide 10 to review our portfolio, which at June 30 was comprised of $32 billion of assets and about $9 billion of net long TBA. From a capital allocation perspective, 76% of capital was allocated to our rate strategy and 24% to credit. In terms of portfolio activity, as the market rallied in the quarter, we added agency RMBS in part to manage our duration exposure but also to take advantage of the wider spreads available in the market. Specifically, we added approximately $5.7 billion of 3.5% and 4% coupon lower pay-up specified pools. We think that these bonds have excellent prepayment protection and convexity characteristics at reasonable…

[Operator instructions] We will take our first question from Doug Harter. Please go ahead, your line is open.

Thanks. Obviously the start to August has been quite volatile. If you could just talk about how your rate positioning is for this kind of magnitude of rate declines we’ve seen and how you see the prepay outlook changing with this move.

Sure, good morning, Doug. How are you?

I’m well, thank you.

First, I’d like to apologize for the technical glitch we had this morning. With that, I’ll turn your question to Bill.

Hey Doug, thanks for joining us. There are a couple questions in there. I think Slide 11 is a relatively good depiction of where we were at the end of June. We continue to maintain a slightly long bias in duration, but we have a substantial--you know, I talked on the call that one of things that benefited us in the second quarter is the extensive use of options. Certainly as markets become more volatile and whip around, protecting the mortgage--the portfolio by use of options is very important and effective. In terms of what we’ve seen in August, it’s a little hard to make sense of what’s going on but we continue to stay close to home. If the primary rate comes down, and it’s been pretty sticky so far but I guess it depends on what rate level we settle at, if the primary rate comes down, then I think you’ll see a reasonable pick-up in generic prepays, prepays on generic collateral. One of the reasons that we’ve been active, continue to be active in adding specified pools, especially off of lower coupons as I discussed on the call, is because that creates more stability in the portfolio, it’s easier to hedge, and there’s less prepay volatility there, so we continue to move in that direction.

Yes, the team has done a really good job managing this, Doug, and that continues into August as well.

Great. On that, where do you see relative attractiveness of specified pools today, obviously given the commentary that generic speed is going to likely continue to increase but obviously pay-ups have increased substantially.

Great question. I think the positioning that we talked about on the call is representative of where we think value is. We’ve been trying to buy lower pay-up off of, say, 3.5s. We haven’t seen as much off the 3s yet, but we sold pools that had performed very well and pay-ups went up quite a bit off the higher coupon, and so by recycling into lower pay-ups off of lower coupons, we’ve come up with better convexity with less premium at risk and we think those represent good value and we continue to pursue those.

Great, thank you, Bill and Tom.

Thank you. We will now take our next question from Mark DeVries.

Yes, thanks. Let me be the first to congratulate you, Bill, on your retirement. I know we may have for another quarter, but it’s been a pleasure working with you over the years. First question, as you noted in the prepared remarks, leverage went up more than a half turn in the quarter, although it sounds like part of that was efforts to manage both spread and duration risk. Are there any implications we should think about, though, from the higher leverage in terms of higher earnings power at the end of the quarter versus the average for the quarter?

Hey Mark, thanks for the good wishes. I appreciate it and enjoyed working with you as well. The average economic leverage for the quarter went from 7 to 7.2, and keep in mind that we think of leverage in terms of including net TBAs because that is economic leverage. I think as we discussed on the call, we frankly think about really more our risk metrics which we talked about on Slide 11, which is because we have MSR, MSR helps dramatically hedge mortgage spread risk, so even though we have more agencies, we actually have less risk to spread moves. That being said, we do not expect to see leverage change materially from the levels that we’ve been running recently.

Yes, leverage in isolation is sort of a hollow metric, Mark. Really, we think in terms of risk over kind of headline leverage metrics. Obviously that’s an important number, but in isolation it doesn’t mean all that much.

Okay, fair enough. Thank you. You also noted that through some of the levering or--I’m sorry, laddering of your maturities on repo, you’ve at least mitigated some of the impact of the bit of dislocation we’ve seen in that repo LIBOR spread. How much of a drag is that on earnings, and if that normalizes, how much of a lift might we see from core earnings?

That’s a great question. Mary’s going to answer that one.

Good morning, Mark. So yes, we realized just a small impact in Q2, about one cent per share due to our maintaining the longer repo maturities. I think repo costs obviously haven’t come down like the rest of short term rates, and it’s not really the availability but really the pricing. We are keeping our eyes on it and expect it to normalize as time passes.

Okay, got it. Thank you.

Thank you. We’ll now take our next question from Bose George. Please go ahead, your line is open.

Hey, good morning. In terms of incremental returns, you gave us some numbers on that, but I’m just curious how the incremental spreads that you’re getting compare to the level you were in the quarter.

Could you rephrase that, Bose? I wasn’t sure--

Sure, just the spreads on new investments and how that compares to the 138 basis point spread you guys had at quarter end.

Well, I’d say a couple things. The first thing, as we talked on the call, about our expected total return that we think we can realize generally being in the low double digits, and then on the non-agency clearly the--you know, we’ve talked about this in the past, sort of the baseline is lower than what we think the total return will be. If you think about it, we talked about the NIM, the prepays, the repo spreads, and then obviously some purchases at lower yields of assets, but as you know, we don’t really manage our portfolio based on a NIM. We really are thinking about it in terms of where we can generate the best total return while keeping book value stable. I think it’s kind of hard to talk about the spread vis-à-vis today versus historical accounting spread, rather we think about the returns that we discussed on the call - low double digits, and then potentially strong total returns on non-agencies being better than that.

So then maybe just in terms of the low double digit returns from an ROE standpoint, there’s a bit of a range there. Is that similar to what you have in the portfolio, is it a little lower, or just how would you characterize it versus the ROE you generated this quarter?

Well, I think it’s probably pretty similar to what you saw this quarter. I mean, obviously one of the things we’ve been positioned in has been the higher coupons in the specifieds, which did well last quarter. They’ve continued to do well this quarter, as Mary talked about our performance through July and so far this quarter, so I think that’s relatively consistent with what we saw.

Yes, you know Bose, we’re the kind of people that when we think we have our hat firmly in our hand, for instance in the fourth quarter, we’re very honest about our disappointment in our performance. But this was a great quarter for us. We generated a lot of alpha and the opportunities for us going forward are abundant, so we’re excited.

Okay, great. Thanks. Actually just on the MSR securitization that you guys did, should we think of that more as just a better structure because of the term funding, or is there any funding benefit as well from that?

Good morning Bose. We think there’s a number of benefits from it. The term is definitely beneficial, the scalability, the ability to add additional term notes in the future, and it’s non-recourse.

Okay, great. Thanks. Actually one just on the regulatory side. You noted that GSE reform is unlikely, but just curious what your take is on how the QM patch issue gets resolved.

Oh yeah, that’s a good one. I think what we saw was sort of an initial shot across the bow, if you will. I think--it sounds like FHFA, they would like to get a number of things accomplished and yet at the same time, it seems like Mr. Calabria is also aware that there’s a lot of this that might need legislation. So I think by putting something out there on the QM patch expiring, the idea is not necessarily to have it expire but maybe have a discussion and a dialog as to what should it look like and how can the GSEs continue to support housing but with a modified footprint. I think this is just the beginning of the discussion of how that patch and how the QM--how that is going to play out, and I think it will probably take a decent amount of time.

Okay, that helps, thanks. Let me add my congratulations to you, Bill, on your retirement, and to Bill Greenberg and Matt on their promotions as well.

Thanks Bose.

Thank you. We will now take our next question from Trevor Cranston.

Thanks, good morning. I’ll add my congratulations on your retirement, Bill. A question on the updated methodology you’re using for your core earnings calculation on the MSR amortization. I guess I want to make sure I understand the change better. Is the new method that you’re using similar to what we would think of in the agency MBS market, as using like a lifetime assumed yield on the MSR that you’re multiplying by the amortized cost, or maybe you can just expand a little bit on exactly what the change was there and how we should think about modeling that going forward.

Hi Trevor, this is Mary. As I discussed in my remarks, we did modify amortization to include an adjustment for the gain or loss on the capital used to purchase the MSR, so this is consistent with the rest of our portfolio where the hedging or the gains and losses on our RMBS portfolio are not included in core earnings. Appendix Slide 19 provides more details, but I think you can think about MSR core income as the amortized cost at the beginning of the period times the original pricing yield, and we really believe this is a more accurate reflection of economic return and the carry on MSR.

Okay, so I guess--so when we think about, for example, this third quarter to date where rates have dropped significantly, does the new methodology imply that there wouldn’t be a significant uptick in amortization because the original pricing yield hasn’t changed, or am I not thinking about that correctly?

Yes, that’s correct.

Okay, great. Thank you. A second question, more on the macro side, with the volatility we’ve seen this quarter and expectations for the Fed to likely continue dropping rates pretty significantly, I was curious if you guys had any thoughts on the likelihood if we do continue to see things move lower in the rates market, if you think the Fed would be likely to potentially reinstitute balance sheet growth or the QE programs, and whether or not you think that might be focused on the MBS market.

Great question. Matt Koeppen is here, he’s going to answer that one for you.

Hello. That’s an interesting question. Maybe some other people in the room want to weigh in. We’re definitely in the midst of a transitioning market here, back to the world where we were in a low rate environment and the Fed is cutting. We definitely--you know, I think you would expect to see in a higher volatility environment mortgages continuing to be under pressure. I think in terms of looking forward to QE again, I don’t think anybody is really talking about that or discussing that. That’s probably a ways down the road, but we are continuing to--like we said earlier, we are continuing to manage the portfolio consistent with how we have in the past. We’re certainly in an environment like this to be maintaining low risk exposures, low duration and low spread risk. This is the environment that we talk about and prepare for lots of times, so we feel like we’re holding in fairly well.

Okay, great. Appreciate the comments. Thank you.

Thank you. We will now take our next question from Rick Shane. Please go ahead, your line is open.

Hey guys, thanks for taking my question. Bill, those looks that everybody is giving you at the table are jealousy. Congratulations.

Thank you, Rick. Appreciate it.

That’s a good one, Rick.

I have my moments. Tom, you talked about the alpha that you guys created in the quarter, and given the challenging quarter it really stands out. I think we understand a lot of it. I think the call protected or prepayment protected agency MBS did very well, obviously some challenges on the MSR side, but when we look through the details, there are some significant gains and these are realized gains on swaps. That really makes sense to us. There’s $97 million of realized gains on other derivatives. What is that? Just help us understand when you think about the alpha and the outperformance this quarter what the puts and takes were.

Thanks for that question, Rick. Bill Greenberg is going to take that one.

Yes, hi Rick. Good to talk to you. You mentioned some causes for our outperformance this quarter, and obviously they’re really threefold. One--if I pulled one, it’s the asset selection that we have, our focus on being exposed to higher coupons is one. The existence of MSR in our portfolio which reduces our overall mortgage spread risk is another, and then lastly, as was alluded to on the call, our active hedging strategy and experience. I think all three of those things really contributed a lot. I think without going too much into detail to exactly what you’re talking about, I would expect that those realized gains on those derivatives result from realizing gains on options that we had. Typically when we buy, say, out of the money options in order to hedge for tail risk and the market rallies, those options become in the money or at the money, and rather than keeping them there with reduced convexity benefit, we will roll those options into ones that are further out of the money. I expect that those gains result from that.

Got it. Is that why the notionals on the swaps and the swaptions didn’t seem to change much, it was that you took the swaptions and rolled them?

Yes, that’s right.

Great, thank you guys.

So you’ve got swaptions at some--again, forget about the portfolio effect, at some price, the market rallies, they go up in value, their convexity increases for a little while and then it starts to decrease, and then in order to maintain the convexity benefit, the protection that we want for continued rate rallies, we basically will sell those and buy other ones, oftentimes at equal notionals and will reset the value of the convexity and the portfolio protection characteristics.

Got it, okay. Perfect, thank you very much.

Thank you. We will now take our next question from Matthew Howlett. Please go ahead, Matthew, your line is open.

Hey guys, thanks a lot, and Bill, congrats. Just two questions. First on the MSR, Bill, did I hear you correctly that you said the UPB would start to pick up, the portfolio on a UPB basis would start to grow again third quarter with the flow arrangements, and then what would it take--you said you’re out of the bulk market, what would it take to get more active? Is that more just where prices come down to, or is it just more of an outlook of where you think speeds are going to ultimately end up?

Hey Matt, thank you. Appreciate the good wishes. Yes, so a couple things. First, we have seen flow volumes pick up, which is not surprising given that we started seeing higher refinancing come in. Just to be clear, we are not out of the bulk market. We bought a number of packages first quarter, as you know, and we did not buy any--close any in the second quarter, but that was more a function of what was available and the prices and the collateral. It was more like saying, we didn’t see any bonds we liked at the prices that they were trading at. We do expect to see an increase in our bulk volumes through the remainder of the year. Obviously there’s a lot of volatility lately, so there might be a little bit of a pause from potential sellers until the market settles down a bit, but given that refi volumes are clearly picking up, we would expect the second half of the year eventually to see a pick-up in bulk volumes, and we anticipate participating if the prices make sense to us.

Got it, okay. What explains the lack of packages coming out in the second quarter? Was it just sellers didn’t like the prices or gain on sale margins have improved that they don’t need to sell MSRs?

Well, we don’t originate loans and look at whether we should keep servicing or not, but I can tell you first, volumes earlier in the year were quit substantial. One thing that we did see as the market rallied was we did see people who wanted to get a certain price hold off because they thought, well, they wanted yesterday’s price effectively, so there were a lot of packages that didn’t trade that might have traded. But if somebody makes them and maybe they don’t hedge and keep the duration in line with what the market’s doing, they might just say, well, I’ll wait. I think it was a combination of factors. As you know, once rates get to a certain point and stabilize and there’s more visibility and clarity, what I’ll call the bid offer, if you will, will tighten up and you’ll see a lot more transaction volume.

Got it, okay. Bill, just one quick question. The official [indiscernible], I know you took that down. Just curious on why you decided to take that down.

Sure. We had advances that were rolling off. We still maintained a $50 million position with a much longer term. We value that relationship, but with the agency book, the advances in rates are not better than what we can get in the repo market.

[Indiscernible] most economically, is the short answer.

Right, the wholesale market did better financing a little bit better - okay. Then the last thing, just on the--you know, I know you guys said low double digit on the agency, just the agency. This is putting aside the MSRs for a second. Is there sort of--if we look at the spread, it was sort of the realized spread was 1.1%. When you look at 3Q, you have this dynamic where in the Fed cut and swap rates are going down, yet prepays looked like they were up about 30% in July and the yields were lower, can we expect that spread to be stable, everything taken together? Any sort of color on where that spread could head in 3Q?

Sure. Some of the things you say about obviously prepays were up, etc., and there’s a question of what are the yields on the cheapest to deliver, if you will. When we look at deploying capital, whether it’s in the credit side or in the agency side, we’re basically surveying across all coupons, all collateral types, all specified pool types, etc. and accessing what we think is the most attractive. That’s sort of what we view our jobs as, to drive long term returns, so as a result when we cite those kind of returns, we’re really looking at what we think is the best of what we can purchase, which is definitely not necessarily the cheapest to deliver or the TBA, which is arguably not going to be nearly as attractive as certain specified pools.

Right, got it, so it’s very just really asset selection, literally, what it all really comes down to as you look at the portfolio.

That’s exactly correct. That’s the name of the game.

Great. Well, congrats on a really solid quarter. Thanks again, and congrats, Bill.

Thanks Matt.

Thank you very much.

Thank you. As there are no further questions, I will turn the call back to Ms. Field for concluding comments.

Thank you, and thank you for joining us on our conference call today. We plan to participate in the Barclays Global Financial Services Conference on September 10 and our presentation will be webcast live on our website under the Events and Presentations link. We look forward to speaking with you then. Have a wonderful day.

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.