Good morning. My name is John. And I will be your conference facilitator. At this time, I would like to welcome everyone to Two Harbors Third Quarter 2021 Financial Results Conference Call. All participants will be on a listen-only mode. After the speakers remarks, there will be a question-and-answer period. I would now like to turn the call over to Paulina Sims, Head of Investor Relations. You may begin.

Good morning, everyone. And welcome to our call to discuss Two Harbors, Third 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 may be accessed in the Investor Relation 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 may be materially different because of a variety of risks and other factors. We caution investors not to rely unduly on forward-looking statements 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 Bill.

Thank you, Paulina. Good morning, everyone, and welcome to our Third Quarter Earnings Call. Please turn to Slide 3. At quarter-end book value was $6.40 per share representing a 2.3% total economic quarterly return. The performance, which was largely in line with the dividend, reflected the partial retracement tighter of high-coupon spreads as recent data pointed to early signs of burnouts and slower prepayment speeds. Earnings available for distribution, formerly known as core earnings, were $0.24 per share. Elevated activity in the MSR market continued in the third quarter and into the fourth. We saw $120 billion UPB in bulk deals come to market in Q3, and another $100 billion in October bringing the year-to-date volumes to approximately $400 billion. This is more than double the volume that we might typically see for a full year and we expect this heightened activity to continue for the rest of the Fourth Quarter. In the Third Quarter, we acquired 15 billion UPB through bulk transactions and have committed to add another 21 billion over the next 2 quarters. Additionally, we settled on 14 billion through our flow program. Lastly, post-quarter end, we issued common equity for net proceeds of approximately $194 million in a transaction that was accretive to book value. We are seeing attractive opportunities in the MSR market and have already committed additional capital in that area. Furthermore, with the Fed taper upon us, we expect we will be able to increase leverage and deploy more capital in RMBS at attractive spreads in the near to intermediate term. Please turn to slide 4 and I will briefly discuss the overall market environment. The 10-year swap rate fell from 1.44% on June 30th to a low of 1.16% in the middle of July, and then subsequently rose 40 basis points to…

Thank you, Bill and good morning, everyone. Please turn to Slide 5 to review our financial results for the Third Quarter. Comprehensive income was $45.2 million, representing an annualized return on average common equity of 9.1%. Our book value was $6.40 per share compared to $6.42 at June 30th, including the $0.17 common dividend results in the quarterly economic return of 2.3%. As Bill mentioned earlier, the result reflects spread tightening and high-coupon specified pools, which offset spread widening and lower coupon RMBS. Moving on to slide 6, as we note at the top of the page, core earnings will now be referred to as earnings available for distribution or EAD in line with the evolving industry practice. Earnings available for distribution increased to $0.24 per share, compared to $0.19 in the second quarter. Beginning in the third quarter, EAD includes U.S. Treasury futures income, which is the economic equivalent to holding and financing irrelevant, cheapest to deliver US treasury note or bond using short-term repurchase rates. As a hedging instruments. We use futures interchangeably with swaps. And we think the treatment of hedging instruments in EAD should be consistent. Futures income in EAD was approximately $0.03 per share for Q3. Had futures income ban included for Q2, it would've increased EAD by $0.02 for a total of $0.21 per share. Interest income decreased from $43.4 million to $36 million as our RMBS position continued to decline through a combination of sales and paydowns. Interest expense declined by $2.5 million reflecting lower RMBS and MSR borrowings. Turning to MSR, net servicing income increased by $9 million to $56.7 million as a result of higher balances and collections and slower prepayment. Gain on other derivatives rose by almost $20 million as we benefited from a larger position and continued drill specialness…

Thank you, Mary. Let's turn to Slide 8 to discuss our quarterly portfolio activity and composition. During the quarter, our portfolio grew to $17.9 billion as we deployed some of the capital that was raised in July into MSR and RMBS. We adjusted our allocation in RMBS by selling some higher coupon pools that had tightened to unattractive spreads and reinvested into TBA, which continued to benefit for role's specialness. We also added to our hedging mix by increasing our options positions, utilizing both interest rates and mortgage options, which are expected to benefit from volatility in a sharp breakout to higher rates should that occur. Please turn to Slide 9 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. Although prepayment speeds have generally been very fast, the New York collateral has performed particularly well with speeds in the 4 % and 4.5% coupons, coming in around 30 CPR during the third quarter compared with generics, which came in higher than 50 CPR. 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. You can see that our coupon pools outperformed TBA s as the market reacted to data published during the quarter, plenty to nascent but clear evidence of burnouts. Finally, Figure 3 compares by coupon, observe prepayment speeds from pools delivered into TBA contracts to observe prepayment speeds on our specified portfolio. Overall, prepayment speeds in our specified pools declined 8 % to 30 CPR and remained significantly slower than pools delivered into TBA, showing the value of the prepayment characteristics of that collateral. Please turn to Slide 10, our MSR…

Thank you. At this time, we will be conducting a question-and-answer session. A confirmation tone will indicate that your line is in the question queue.

One moment, please, while we poll for questions. Our first question comes from the line of Trevor Cranston with JMP Securities. You may proceed with your question.

All right, thanks and thanks for all the new turnkey and data you couldn't deck this quarter. It's very helpful. Just curious, you talked about the level of current coupon spreads today versus historical levels and why they are liquid wide and over the next few quarters. I was curious if you could share your thoughts on the role specialness, where -- where that is today versus maybe an average historical level and how you think that evolves as that taper starts to get implemented? Thanks.

Sure, thanks very much, Trevor. And thanks for joining us. I think that the role specialist in the reason for the role specialists at about 50 basis points special is -- we've certainly seen it slightly more special over in certain period than it is today. We've certainly seen it less special. And in a normal environment, it's typically the case that roles are not very special at all. And in fact, one of the main sources, probably the main source of role specialists today, is the activity of the Fed and large banks buying and creating this supply-demand imbalance between front with contracts. I do fully expect that role will follow mortgage spreads and that as the market returns to normalize, the Fed reduces its involvement spreads will, in all likelihood, normalized. And role specialists will probably also be normalized along with it in roughly the same kinds of time periods. So, I would think by the time that the Fed has done tapering, spreads will be somewhat more normalized, and role mostly be gone. That's my expectation.

Okay. That makes sense. Then you also commented that the floor MSR purchase volume was declining a bit as originations come down and the bulk activities picked up. Do you guys see any opportunities to add more flow partners that are more originators were looking for partners to provide that capital, just given the lower profitability of the origination business today?

Sure. We have a group of flow seller partners that have been among the larger participants in that market over time. The reason that people choose to be in the flow market is because they don't want to accumulate the interest rate risk and the prepayment risk and they don't want to bother hedging, either because they don't want to or it cost too much to implement the program. As the market -- as interest rates fell off, as refinancing volumes go down, there's less of that to do, right? And so that's why we expect flow volumes to continue to decline. It's possible, I guess that some people have kept servicing because they thought that rates were low and we are going to rise and that markets were low and they wanted to hold. That's been one of the sources of bulk supply over the last year as those participants have chosen to monetize their holdings. It's possible that maybe some of those guys with compressed margins could want to restart flow relationships. Some of those guys have been in and out of the flow market over time. So, we may see some of that. We're well-positioned and already in touch with those guys in order to be able to reengage with them, should they desire.

I appreciate the comment. Thank you.

Thank you.

Our next question comes from the line of Eric Hagen with BTIG. You may proceed with your question.

Hey, thanks. Good morning. Seems like you're -- you're active and growing the MSR portfolio and you've identified an opportunity with all the bulk paper coming to market. On the $21 billion in bulk that you've bought since quarter end, can you clarify when those are expected to settle? And then the $413 million in funding capacity for MSR that you noted, I assume that's before the bulk settles that you've bought since quarter end, but maybe you can clarify that too. Thank you.

Yes. Thanks for the question Eric. Mary, can you take that one? Do you do you have that information handy?

Sure. The bulk settlements are expected in the December and January time frame. Your other question was related to unused committed capacity and you're correct, that is -- that capacity is before the bulk transactions that have not yet closed.

Got it. Can you say how you expect to finance the $21 billion that you're closing on in December and January? Is it from the breakdown of capital and funding capacity that is going to be absorbed?

Yeah, we actually took down financing and MSR a bit in the third quarter, just due to our excess cash position. So, I think the answer is it's going to depend on opportunities to deploy capital. And we have plenty of options to finance that should we need to from a cash perspective.

Thank you.

Thanks, Eric.

Our next question comes from the line of Bose George with KBW. You may proceed with your question.

Hey, everyone. This is actually Mike Smith on for Bose. Just a few related to the equity rates, can you just talk about your pro - forma leverage? How much of the capital is deployed, and then whether or not there's any expectations for a drag on earnings in the fourth quarter?

Yeah. Thanks for the question. I'll start with that and then maybe Mary can add with the pro - forma numbers. We've already started to deploy some of that capital as we indicated previously, with some of the MSR purchases that we've settled on as well as committed to. We continue to see attractive opportunities in the MSR market. And when we do that, we often pair it with RMBS, so that capital is already in the process of being deployed. Of course, we're cognizant of the overall level of mortgage spreads, which are still very tight. So, to the extent that we are deploying capital, it's in the MSR assets right now or in the paired construction. We're not adding outright RMBS versus rate investments here yet, because spreads are still unattractive, as we said, 15 basis points reached to periods where the Fed is buying and 35 basis points reached to other periods. We expect that to occur in coming quarters. and we're prepared to deploy more capital there as well. But when you look at how much capital is being deployed here, looking at the overall leverage number is not necessarily a good indication of that rather than looking at the assets that we're buying and how we're funding it. Mary, do you want to speak to the proforma numbers.

Okay. Can you repeat the proforma part the question, please?

Yeah. I was just wondering if you could talk about how leverage has trended since quarter end and then if there's any expectations for a drag on earnings in the fourth quarter?

I don't -- there has not been a material change in leverage since quarter end, more about where we were.

Is there any expectation for --

-- go ahead.

I was going to say, on the earnings part of the question, is there any expectations for a drag in the fourth quarter with capital deployment?

And I would say no, not directly. We're expecting the taper to start and to be able to see more opportunities. And we've got MSR in the pipeline. So, no expectations for that.

Great. And then just one more. Could you just provide any updates on how book value has trended since quarter-end and what are the drivers of this?

Yes, since quarter-end, as of last Friday, we're down around 2 %. And that's been driven by some slight widening in both MSR to around 20 basis points in spreads and some slides widening in high-coupon specs as well.

Great, thanks a lot for taking the questions.

Thank you.

As a reminder, we are in the question-and-answer session. Our next question comes from the line of Rick Shane with JPMorgan. You may proceed with your question.

Hey, guys. Thanks for taking my questions this morning. And thank you for the additional disclosure. It's certainly very helpful. Bill, when we look at Slide 13, it's obviously really interesting in terms of how it differentiates both assets and hedging from a performance perspective. What is interesting to me is that the -- at this point that this positive factor driving your performance is the hedging strategy more than the asset gathering strategy. When we look at hedging swaps and MSR, you're certainly growing MSR much faster than , but you've grown swaps a bit as well. But when we compare TBA versus pools, you're growing TBA a lot faster than pools. I'm just trying to think about what that means. Are you creating in the short term less durable assets with the idea that that way when spreads widen as we move through taper, that you'll move back in the pools?

Thanks, Rick. Thanks for joining us today. Those are good questions. I'm not sure I totally understand the model. Let me talk for a little bit and see if I answer them, and if not, you can ask more explicitly. Recently, as we point out on the presentation, we've let our high coupons pools pay down and we've sold some and replace them with low coupon TBAs because the role specialness is adding incremental attorney. If you look at the charts on page 13, TBAs hedged with swaps, the higher end of that range in the low teens is assuming that real specialness last for a long time and the lower end of that range, is assuming that real specialness disappears tomorrow, right? And so, given the Fed's posture and the statements they've made, we think that real specialist will continue for a little bit. It should follow spreads so that as spreads begin to widen from reduced asset purchases and continued mortgage supply, we expect the role specialist to also decline in that way. When role specialist declines, that will also come with it in all likelihood a more attractive spread not just in the TBA but also in the specified pools that are associated with those coupons. Because as role specialist goes down, those specified pools become more attractive and I think it is fair to expect that during a period like that that we would be rotating out of TBA into specified pools in the lower coupons as that happens.

Got it. Okay, that's exactly what I was looking for. Yes. And then so when we think about it, clearly the strategy you are going to lean different directions, but you're also clearly not putting all of your eggs in any one basket either from an asset or a hedging perspective. As you look forward and see the scenario that would create an opportunity to migrate back into pools, I'm curious what -- and I really just don't know the answer here, looking forward, what would be the implication for the swap market, would that become a more compelling element of the strategy as well in that same environment?

So, first thing I would say is that one of the great things about our MSR plus MBS strategy is that we don't care very much about what's the -- what this current coupon spread does. And so, the fact that we're able to add investments in that paired construction is independent of our view as to whether spreads widened or not. And the fact that that can still be in the low teens is a very good fact and we're continuing to add capital in that strategy. To the extent that we have additional capital to invest in an RMBS plus rates strip part of the portfolio. Then, as we said, we're going to be looking for some widening there. The hedge -- or that exposure, whether it exists in current coupon TBAs or in specified pools, will depend on the relative attractiveness of those asset classes, which in turn will depend on Fed involvement, role specialists, and those dynamics. Not sure if I got your question there.

You did. That's exactly it. Perfect. Thank you so much.

Thank you.

At this time, we have reached the end of the question-and-answer session. And I would like to turn the call back over to Bill for any closing remarks.

I'd like to thank you everyone for joining us today. And as always, thank you for your interest in Two Harbors.

This concludes today's conference. You may disconnect your line at this time. Thank you for your participation and have a great day.