Greetings. Welcome to the Two Harbors Investment Corp. reports Second Quarter 2021 Financial Results. Please note this conference is being recorded. I will now turn the conference over to your host, Paulina Sims. You may begin.

Good morning, everyone and welcome to our call to discuss Two Harbors’ second 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 Riskey, our Chief Financial Officer. The press release and financial tables associated with today’s call were filed yesterday with the SEC and are available on both the Two Harbors and SEC website. In our earnings release and slides, we have 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 maybe accessed in the Investor Relations section of our website. As a reminder, remarks made by management during this conference call and the supporting slides may include forward-looking statements. These statements are based on the current beliefs and expectations of management and actual results maybe materially different, because of a variety of risks and other factors. We caution investors not to rely unduly on forward-looking statements. Except as maybe 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 Bill.

Thank you, Paulina. Good morning, everyone and welcome to our second quarter earnings call. Before we begin, I’d like to acknowledge Matt Koeppen’s departure from the company on June 30. Matt and I have worked very closely together over the last 9 years and we had a very productive partnership. On behalf of the Two Harbors team, I’d like to thank Matt for his years of service to the company and we wish him good luck in his future endeavors. As we announced a few weeks ago, I have taken on the role of Chief Investment Officer once again and I look forward to working with the investment team as well as the rest of the company to navigate through the complex market environment in front of us. Please turn to Slide 3. At quarter end, book value was $6.42 per share, representing a negative 9.6% total economic quarterly return. The second quarter performance is almost entirely the result of significantly wider spreads on high coupon RMBS. The stubborn absence of prepayment burnouts, along with the introduction of government programs, to help borrowers refinance both contributed to changing market expectations around prepayment speeds in these coupons. The MSR market was very active and we saw $125 billion UPB in both deals come to market in the second quarter alone, bringing the year-to-date volumes to approximately $180 billion, which is roughly the volume that we might typically see for a full year. We have been successful in deploying more capital in the MSR space. This quarter, as we purchased $6.5 billion UPB through both transactions and have commitments to add another $17 billion UPB subsequent to quarter end. Additionally, we settled on $16.4 billion UPB in our flow-sale program during the quarter. Core earnings were $0.19 per share. However, spread movements…

Thank you, Bill and good morning everyone. Please turn to Slide 6 to review our financial results for the second quarter. Comprehensive income was negative $194.6 million, representing an annualized return on average common equity of negative 40.7% and our book value was $6.42 per share compared to $7.29 at March 31, resulting in a total economic return of negative 9.6%. As Bill mentioned earlier, the quarter-over-quarter decline was the result of significantly wider spreads on high coupon RMBS, where we have significant exposure. Moving on to Slide 7, core earnings were $0.19 per share compared to $0.17 in Q1. Interest income decreased from $56.1 million to $43.4 million as our RMBS position continued to decline through a combination of sales and pay-downs. Interest expense rose by $1.7 million, reflecting the increase in financing related to the growth in our MSR portfolio as well as a full quarter of interest expense on our convertible debt issued in February. Gains and other derivatives rose by $7.7 million as we benefited from a larger position in TDA, as well as increased roll specialness. Turning to MSR, net servicing income increased by $3.6 million to $47.4 million, this was a result of higher balances, slower speeds and fewer delinquencies. There was also a notable decrease in expense, the majority of which is related to servicing expenses and driven by a number of opposing one-time items, with the first quarter incurring certain non-recurring costs and second quarter, including certain non-recurring credits. An average of the two quarter’s expense is a better indication of the run-rate for the first half of the year. In the table on the lower right, we show our portfolio yields. Our realized net spread in the quarter rose by 28 basis points to 1.93% driven by a 47 basis point…

Thank you, Mary. Let’s turn to Slide 9 to discuss our quarterly portfolio activity and composition. We have remained disciplined in our positioning ahead of anticipated RMBS tapering and reduction in bank buying. The portfolio balance decreased from $18.6 billion to $17.1 billion through a combination of sales and runoff. In particular, we sold some 2.5% and 3% coupon pools and bought 2.5% coupon TBAs as we felt the pools were unattractive from a spread perspective, while the roll specialness of the TBA still allowed for positive return potential. Our MSR value was down slightly even though we added more UPB than prepaid, which simply reflects lower prices into a lower interest rate environment. Please turn to Slide 10 as we discuss our specified pool positioning, prepayments and performance. As you can see in Figure 1, we remain positioned in loan balance and geography stories. Within the geography stories, which are focused on New York collateral, our investments are predominantly in the 4% and 4.5% coupons, while our loan balance exposures are more evenly distributed in the 3% through 4.5% coupons. Figure 2 shows the quarterly total return performance by coupon on TBA contracts, shown by the gray bars and on our specified pool holdings shown by the blue bars. The most notable properties of this chart are first, the higher the coupon, the worse the quarterly performance and second, only the 2.5% coupon assets were spared from material underperformance, which was clearly the result of Fed and bank support to the coupon. Finally, Figure 3 shows a comparison by coupon of observed prepayment speeds from pools delivered into TBA contracts, again shown by gray bars to observe prepayment speeds on our specified portfolio, again shown by blue bars. Overall, prepayment speeds in our specified pools remain significantly slower than…

Our first question is from Doug Harter with Credit Suisse. Please proceed with your question.

Thanks. Bill, just I was wondering if you could just talk about your thoughts around longer term portfolio construction and kind of whether a quarter – two quarters like you just saw where you had significant divergence in coupon performance kind of makes you rethink about kind of how you would want to structure that coupon distribution with MSRs and pools and whether you would want more of a balance there?

Sure. Good morning, Doug. Thanks very much for the question. So, as we show on Slide 12, the amount of MSR that we currently hold hedges a certain amount of mortgages of current coupon mortgages, right. And so, as you see from the chart and as we said in the prepared remarks, we are generally net flat, the current coupons, if you look at 2s and 2.5s and we have some relative value thoughts around like in 2.5s more than 2s there, which is why you see that positioning. And then we have more capital. And so we have to deploy that somewhere, right. And we have chosen to deploy that in the higher coupon specified pools. For reasons we discussed, as I said in my prepared remarks, the high coupon specifieds have a long history of generally having wider spreads and be having stable prepayment profiles, which makes it easier to extract spreads from those investments. Now, if I am saying your question, you are wondering, well, maybe we should have that amount of capital deployed instead to lower coupons. And of course, we thought about that during the quarter, or before and we chose not to do that, mostly because, we felt that there was significant widening risk from the Fed tapering in the low coupons. Now, it’s true, right. All spreads were tight in the quarter. And I guess you would say, what were we surprised by, we were surprised that high coupons widens without low coupons widening, right. If everything had widened in parallel, the performance would have been different. And so going forward, we think that it is much more likely for the low coupons to widen without necessarily the high coupons, sharing in that going forward, that certainly more likely than it is then the high coupons continue to widen and the low coupons do nothing. So, we like our positioning here. And we think the high coupons offer a fair amount of value.

Great. Thank you for that color, Bill.

And our next question is from Bose George with B. Riley FBR. Please proceed with your question.

Hey, this is Bose actually from KBW. Actually, first, in terms of the capital that you guys raised? Can you talk about just the deployment? Is that sort of the timeline for that, or is that going to be based on spread widening and what you see out there?

Yes. Good morning, Bose. Thanks for the question. It’s going to be a combination. We have been deploying some of that capital into our target assets already in terms of MSR and low coupon TBAs. We have not deployed it all, as we have discussed previously, and in the prepared remarks. We expect better opportunities to invest in RMBS in the near-term. And in the paired construction, that’s still attractive. So, we are deploying our capital there where we can.

Okay, great. Thanks. And then, actually, in terms of the MSR as a percentage of the portfolio. Can you just remind us is there just kind of a level where it could go to as you keep deploying capital there?

Yes. We don’t have a set limit in mind. We manage the portfolio to a set of risks, both drawdown risk, and spread movement risk as well as liquidity risks and so forth. So, we don’t have a firm number in mind, but we feel that we can grow that portfolio substantially in the near-term, if opportunity presents itself.

Okay, great. Thanks. Okay. Just one more quick one, can you give us an update on book value quarter-to-date?

Yes, sure. Book value is up slightly this quarter so far through the end of July. We were up around a 0.5%.

Okay, great. Thanks.

And our next question is from Rick Shane with JPMorgan. Please proceed with your question.

Hey, guys. Thanks for taking my questions this morning. Most have been asked and answered. But I do want to talk about what we are seeing in the primary markets and how you think the competitive dynamics there are impacting prepayments. You have talked about some expectation of burnout on the higher coupon pools. But given the intense competition for volume and the fights over spread by the originators why won’t that persist as long as rates remain low and the refi activity opportunity remains attractive?

Yes. Good morning, Rick. Thanks for the question. Well, it’s a set of long question and there is lots of moving pieces there as you know. Certainly, I think in the in the lower coupons and the active money coupons, speeds are expected to be fast. And, obviously, depending on interest rates, and if rates were to push lower still, I think we would expect to see speeds there pick up. One thing that’s interesting though is, what people call the re-striking of the mortgage universe, right, which is that you have mortgage rates here to the borrowers I say, 2.75s, 2.78s, something like that. I read one thing this week that said that the percentage of mortgage borrowers who have a 25 basis point incentive fee is right now around 61% of agency borrowers. The last time rates were here in January, with that same mortgage rate 74% of borrowers were had 25 basis points or more of incentive in the money. And so that’s just reflective of the fact that lots of people have refinanced already, right. And there is fewer people that have incentive at this rate level. And so in order to get the same refinancing response, rates actually have to push a little bit lower. In terms of higher coupons, and so forth, look, the concept of burnout has been true for generations of mortgage borrowers and investors. And simply reflects the fact that after investors – after borrowers have had many opportunities to refinance at lower rates, the people who remain, who haven’t, are less likely to do so when they see it for the third time or the fourth time or the fifth time, right. And despite the competition, and despite, government programs, just people are less reactive there. And we expect that to remain sure, at some point. And let’s say we are starting to see that in the July release of prepayments. We are seeing it in our own servicing portfolio, where we are able to track daily prepayments. There is obviously a prepayment report released tonight. And Black Knight data has – is projecting that that those prepayment speeds on high coupons will decline more than they count again. And so I think that’s just the behavior of the way mortgage borrowers are.

Got it. Okay and very helpful. Thank you, Bill.

You’re welcome.

And our next question is from Kenneth Lee with RBC Capital Markets. Please proceed with your question.

Hi. Thanks for taking my question. I am wondering if you could just share with us your current expectations for how long dollar roll specialness could be expected to last? Thanks.

Thanks Kenneth. Good morning and thanks for being with us. I think that dollar roll specialness is intimately tied to the Fed and the bank buying. So, I think that that once you see those things moderate or start to retreat, I think you will see roll specialness start to come off as well.

Got it. Very helpful. And then just one follow-up if I may, just broadly speaking in terms of your hedging profile or positioning, is there anything special that’s been done ahead of the potential Fed tapering, income scenarios being hedged specifically banks?

Yes. Well, we think that tapering or reduced buying does not have to be coincident with the change in interest rates. And so there is not much rate hedging or portfolio hedging to do, but are very positioning of being shorts 2s. And generally flat, the current coupon complex is by its construction, a hedge, a portfolio hedge to that tapering process. And so, when I think about what the risks in the portfolio are, one of the things that’s not a risk for our portfolio is Fed tapering.

Got it. Very helpful. Thanks again.

Thank you.

And our next question is from Trevor Cranston with JMP Securities. Please proceed with your question.

Alright, thanks. Good morning. A follow-up on the question about your positioning within the coupon stack and being sort of neutral 2s and 2.5s and continuing to be along the high coupons, I was curious when you think about the risks to the portfolio and that positioning, what kind of scenarios could you foresee that would actually cause high coupons to continue underperforming after what we have already seen in the second quarter? Would that be sort of related to policy risks around making refis easier or are there other changes that you can foresee causing high coupons to continue to underperform? Thanks.

Yes. Thanks for that question. Yes, it would be something like that. I mean, many people have talked this quarter about whether the underperformance in high coupons has been a constant spread event and only changing prepayment expectations or not a change in expectations and only a spread widening events. We sort of come down in the middle of that. And we think that that even with increased prepayment expectations in those high coupons that these expected returns on those assets are attractive and consistent with our goals, as we show on page 14, right. And so we think that, that you would have to see prepayment expectations increase even from here, which I think has been done quite a lot. And so I view that as unlikely. And all of these government programs and increased policy risk has generally been incorporated into the prices already. So, it’s hard for me to see how that would happen more and again. I think there is a bigger risk to prices and spreads in the lower coupons. And so as I said, as you said that we were surprised by something, it was that the high coupons widened and lower coupons didn’t. But that happened differentially. And now I think the risk is inverted to the other way. And I think high coupons look more attractive than low coupons for the opposite reason.

Okay, that makes sense. And I was curious, when we listen to some of the earnings calls from the originators, it sounds like a lot of them are focusing much more intently on trying to increase cash out refi. So, I was curious, do you think increased focus there could be significant enough to prevent burnout and slowdown or is there something that’s likely to be a much more marginal and not that significant?

Yes. It could be, it’s hard to know. I think mortgage originators always like cash on refis, because the balances are bigger, and thus they make a point or whatever or two points on every loan. They like the bigger balances. And so we do live in a period where there has been a significant HPA and it’s not surprising that the originators want to do that. So, I think that fits part of the overall refinancing machine and is in people’s prepayment expectations already. I mean, it could be significant, but I think it’s – I think it’s in people’s expectations.

Okay, got it. And then last thing, apologies if you already addressed this, I got on to the call a little bit late. But the increase in the portfolio yield during the second quarter could you just talk through what drove the jump there? Thanks.

Yes. I will let Mary take that one please.

Sure. Good morning Trevor. So, the increase in yield came primarily from an increase in MSR yields.

Okay, got it.

The bulk of it.

Yes. Okay, that makes sense. Thank you.

And our next question is from Eric Hagen with BTIG. Please proceed with your question.

Hey. Thanks. Good morning. One follow-up on the $17.5 billion in bulk since quarter end, was that a single package or was it multiple packages? And can you talk about how you expect to finance it, like how much of the excess capacity from your financing lines are being used to acquire those that package or packages?

Yes. I will let Mary take that one too.

Yes, it’s multiple packages. And then I am sorry. The second part of your question was relating to financing.

Yes. How much of the excess capacity from your financing lines is being used to acquire those packages?

Well, I would just say that we will continue to increase the usage of MSF financing going forward. As the portfolio grows, we have plenty of capacity on our facilities. And we will use that to optimize the financing on that asset.

Okay. I guess what I am getting at is like, what is the pro forma leverage? I mean that’s a big package of both. What is the pro forma leverage for taking that onto your balance sheet considering the equity raise in July as well?

Well, typically the advance rates on MSR is around 70%. And we will optimize usage of the facilities given the use requirements and that compared with our excess cash on hand to determine the right amount of drawdown on those facilities.

Okay. Thank you.

And we have reached the end of the question-and-answer session. And I will now turn the call over to William Greenberg for closing remarks.

Thank you very much for everyone for joining us today. And thank you as always for your interest in Two Harbors. Have a good day.

This concludes today’s conference. And you may disconnect your lines at this time. Thank you for your participation.