Greetings, and welcome to the Two Harbors Investment Corp. Reports Second Quarter 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this call is being recorded. I would now like to turn the call over to Paulina Sims, Head of Investor Relations. Thank you. You may begin.

Good morning, everyone, and welcome to our call to discuss Two Harbors Second Quarter 2022 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 earnings press release and presentation associated with today's call have been filed with the SEC and are available on the SEC's Web site as well as the Investor Relations page of our Web site at twoharborsinvestment.com. 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. 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. These are described on Page two of the presentation and in our Form 10-K and subsequent reports filed with the SEC. 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.

Thank you, Paulina. Good morning, everyone, and welcome to our second quarter earnings call. Please turn to slide tree, at quarter-end, book value was $5.10 per share, representing a negative 4.7% total economic quarterly return. Following the historic bond market re-pricing in the first quarter, elevated market volatility continued through the second quarter. Inflation continued to exceed expectations, leading the Federal Reserve to accelerate the pace of monetary tightening and, in turn, raising the possibility of a recession. The risk-off sentiment across many asset classes, including mortgages, gathered steam during the quarter, and as a result mortgage performance in the first-half of 2022 ranked among the worst in decades. Entering the year with mortgage spreads standing near record tight levels, we added significantly to our MSR portfolio, while reducing RMBS balances and overall leverage to help protect against spread widening. While those actions significantly reduced losses during the last two quarters, we now find ourselves in the exact opposite situation, with mortgages currently standing at historically wide levels. Despite plenty of uncertainty surrounding the economy, the future path of interest rates and monetary policy, we believe there are significant opportunities in both RMBS and MSR, and we have repositioned our portfolio again to take advantage of the market environment by increasing our RMBS exposure and leverage. We have also positioned ourselves to further capitalize on our MSR assets. We are very excited to announce that we have agreed to acquire RoundPoint Mortgage Servicing Corporation from Freedom Mortgage Corporation. This transaction will mark a strategic shift for us as we transition to an in-house servicing model. With the growth we have experienced in the MSR portfolio, bringing the servicing operations in-house will not only increase efficiencies and returns on our MSR asset, but enable us to better manage recapture and portfolio…

Thank you, Bill, and good morning, everyone. Please turn to slide seven. For the second quarter, the Company reported a comprehensive loss of $90.4 million, representing an annualized return on average common equity of -19.1%. Our book value was $5.10 per share compared to $5.53 at March 31. Including the $0.17 common dividend, results in a quarterly economic return of -4.7%. The results primarily reflect the mortgage spread widening Bill discussed earlier and to a lesser degree higher hedging costs as a result of the elevated volatility we saw during the quarter. Moving on to slide eight, earnings available for distribution was $0.22 per share compared to $0.18 for the first quarter. Interest income increased by $12.2 million as we grew the RMBS portfolio and rotated into higher coupon securities. Interest income also benefited from lower amortization as prepayment speeds declined. Interest expense rose by $14.8 million to $37.1 million due to the combination of growth in MSR borrowing balances as well as an overall rise in rates. TBA dollar roll income increased to $57.7 million on a higher average notional position in a shift to higher coupon TBA which benefited from roll specialness. As we noted earlier in the year, we expected roll specialness to fade in the second-half as supply catches up to demand in the production coupons. And currently, we aren’t seeing TBA persistently special in any coupon. Finally, our U.S. Treasury futures income was also lower reflecting a larger short position which was used to hedge lengthening mortgage duration. Turning to MSR, net servicing revenue grew by roughly $6.7 million to approximately $76.1 million in conjunction with a larger average MSR portfolio. Turning to page nine, the portfolio yield increased $94 basis points to 4.39% driven by our investment in higher coupon RMBS and higher yield…

Thank you, Mary. With large re-pricing and mortgage spread since the beginning of the year, we felt that the historically cheap valuations currently available in the mortgage market no longer justified the underweight be had been carrying even despite continued market uncertainties. Overall, our specified pool and TBA positions both grew by $1.7 billion respectively as we increased portfolio leverage. We aggressively moved our position up in coupon where we saw the best value with ZV spreads in the 125 to 150 basis point area. During the quarter, we increased our total spec pool and TBA position in 4.5 and 5s coupons by over $7 billion while decreasing our position in 3 through 4 coupons by over $4 billion. Furthermore, after the material widening of lower coupons within the quarter, we increased our position in 2.5s by nearly $0.5 billion. With roll specialness largely a thing of the past, we have added specified pools when we find ones that meet our criteria. Within specified pools, we have focused our purchases within higher loan balance 2k to 250k max pools investor properties in Florida geographies. We view Florida geography as a particularly compelling story as it trade to a sizeable discount to loan balance collateral with similar prepayment profile. Overall, we view these stories as providing cheap prepayments options with low absolute pay ups and trade at spreads that are wider than TBA. Please turn to slide 12. While all mortgages widened during the quarter, lower coupon suffered the most. As tenure rates rose towards 3.5% and mortgage rates approached 6%, a market wide rotation from lower coupons to current coupons caused that part of the stack to underperform 30 to 60 ticks. In contrast, the 3.5 through 5 coupons where our portfolio was positioned for the majority of the quarter…

Thank you. We will now be conducting a question-and-answer session. Our first question comes from the line of Doug Harter with Credit Suisse. Please proceed with your question.

Thanks. Bill, since the Fed meeting mortgage spreads have tightening quite nicely. I guess just one, can you talk about what that has done to book value quarter-to-date, and two, how that has impacted returns and whether that changes any of the attractiveness of assets today?

Yes, thanks for the question, Doug. Good morning, nice to have you. The interest rate volatility and the spread volatility of mortgages has continued through the Fed meeting, price performances throughout July has been moving up and down. Mortgage spreads, as you note, have been -- they can be a quarter-point, half-a-point wider one day, and the same tighter the next day. So, in terms of performance, our performance has also moved commensurately with that. I hesitate to give one number because it's been both higher than this and lower than this. But as of the end of July, we were up around 1.5% in book value.

Great. And then so I guess based on that, do you still see the return environment as relatively consistent with kind of what that outlook slide has?

Yes, generally, given -- within the bounds of the volatility that we see on a daily basis, I do. I still see -- well, in certain ways I think the higher coupons are certainly what we show, both on the ZV and the OAS graph earlier in the presentation, as well as the returns that are on page 16. The low coupons have tightened a lot, as you probably noticed. And they look closer to what they did at the end of March, I'd say.

Great, that makes sense. Thank you.

Thank you. Our next questions come from the line of Arren Cyganovich with Citi. Please proceed with your questions.

Thanks. I just wanted to dig into the acquisition a little bit more. Can you talk about the rationale; is it more of a cost savings or a revenue opportunity that you see there? And maybe dig into some of the benefits of having your own servicer versus using a subservicer?

Yes, sure. As I think there are -- there's many benefits here, which is one of the reasons why we're so excited about it actually. Over time, as our portfolio has grown, we've really just reached a scale where it makes sense for us to bring it in-house. The cost savings that we can achieve from bringing in-house and then not paying subservicers is significant, it gives us more control over the servicing of the portfolio. And it allows us to enter into the ancillary businesses, as I mentioned, such as subservicing and other ways to partner with our existing seller network and other counterparties in more meaningful ways as well. So, we think it has lots of benefits across our activities in the servicing and mortgage space. But really one of -- maybe the main issue is the extra revenue and cost savings that we're going to generate.

Okay, got it. And in -- you had mentioned that it was a $10.5 million premium to tangible book. Are you able to provide what the total sale price is and will you have to raise any equity capital associated with the acquisition?

Hi, Arren, this is Mary. So, we can't disclose their book value, they're not a public company. However, we are acquiring their servicing platform, which is a capitalized business, so we're not acquiring any MSR. And they're divesting as certain businesses that would have capital. So, we don't expect the book value to be a material number.

Okay, thank you.

Thank you. Our next questions come from the line of Trevor Cranston with JMP Securities. Please proceed with your questions.

Great, thanks. Good morning. You mentioned the benefit of MSR being less rate-sensitive and spread-sensitive in the prepared remarks in terms of increasing your portfolio's spread exposure. I guess where you stand today, does it make or would it make sense, potentially, to sell more of the MSR portfolio in order to reallocate capital to MBS or given the lower sensitivities, that's not going to be as meaningful of a benefit where we are today?

Yes, thanks for that question. That's an ongoing relative value decision that we make all the time. RMBS is attractive here, but MSR, having very little spread exposure and interest rate exposure and cash flowing as much as us, is also attractive in a different way with a different risk profile. So, I mentioned, prepayment speeds have fallen quite a bit already, as I said in my prepared remarks. We expect speeds in our servicing portfolio to be around 7 CPR for July. We expect them to go slower still in August. My own view, obviously everyone can have their own views, but my view is that there's probably more possibility of speeds rising to the slow side than to the fast side here. So, we like having a bunch of servicing with low coupons and deep discounts, and exposed to turnover speeds here. So, it's a combination of -- or the analysis is one of relative value and risk profiles. And we may sell more, and we may buy more, it depends on the prices in the market.

Okay, got it. And then on leverage, I think the current leverage level was characterized as a neutral position in the opening remarks. Can you talk about how high you'd be willing to take leverage if you were to get more aggressive, and can you be kind of more outright positive on the market?

Yes, thanks. So, when we talk about overall portfolio leverage, it's important to incorporate the amount of MSR that we have in our portfolio at any given time, right. So, more MSR because the leverage in that asset is lower than the leverage in the MBS asset will generally generate a lower overall portfolio leverage, right. And we have more MSR today than we've had in the past, if you compare our portfolio to what it was pre-COVID. What I would say, as I said, neutral is right around here, mid-high sixes. I would say full overweight is probably in the high sevens, low eights kind of area. But that would be like max overweight kind of thing, which, that's why I say, if you say that's one-and-a-half to two turns higher, go back one-and-a-half to two turns lower, that's what we were when we thought we were maximum underweight, right. So, that's why we say we're sort of in the midpoint here.

Okay, that makes sense. Thank you.

With today's portfolio, of course, right.

Thank you. Our next questions come from the line of Bose George with KBW. Please proceed with your questions.

Hey, everyone, good morning. Actually going back to RoundPoint, now that you'll have a service there you'll be, I guess, recapture will be a growing part of the mix, et cetera, or at least part of the mix. Does it -- will you potentially look at origination capacity as well as another way to sort of obtain MSR?

Yes, so it's not particularly our intention to compete in the origination space with retail participants or wholesale participants. As you point out, we are interested in recapturing other portfolio defense strategies, right, and other ways in which to partner in a complimentary way with our existing servicing seller network and other counterparties. And so, we will be doing some things along that line, but we don't intend, at this time, to really compete any meaningful way in the retail or wholesale origination space.

Okay, great, thanks. And than actually just in terms of servicing technology, is there a decision to be made in terms of that? Is RoundPoint, on MSB, is there any sort of cost saves that could be from a servicing technology standpoint?

That's something we are all is going to be looking at over time as these things unfolds and as it develops.

Okay, great. Thanks.

Thank you.

Thank you. Our next question is coming from the line of Rick Shane with J.P. Morgan. Please proceed with your questions.

Thanks guys for taking my questions. So, a couple of things on the acquisition, there was question trying to denationalize the size of the acquisition, and it sounds like de minimis book value plus the 10.5 million. Are we -- should we assume that consideration here is going to be 100% cash, and then when we think about things on an EPS basis, you talked about $20 million of net income accretion, I'm assuming that you see this is EPS accretive as well?

Good morning, Rick. Thanks for joining. So, on an EPS basis we did disclose we expect incremental pre-tax income to be approximately 20 million once our portfolio has fully transferred, which on per share after-tax basis will be $0.45 accretive. And I'm sorry, what was the first part of your question?

Consideration, and again, the EPS accretion makes a lot of sense, and it sounds like the book value de minimis, so it's relatively small acquisition price for $20 million of pre-tax?

Yes, you can expect that will be cash.

Got it. And then, when we think about the P&L on a go-forward basis, a servicing platform certainly brings on some additional operating expenses. So, is there anything we need to consider there in terms of how much of an impact it will have on your OpEx side?

So, I actually think we will have -- let's see, we will see some integration savings over time. So, we will expect our operating expense ratio to improve as we integrate common functions.

Got it, okay.

And obviously these expense will -- you know, is what it is, but on the OpEx side we would expect some integration savings.

Got it. And then, look, historically the plus and minus of being a servicer is that it is a business that doesn’t scale particularly well, but it is a business that at the same time has a very predictable stream of revenues. And as a business that has historically relied upon outside servicing, you have been able to bulk up very quickly opportunistically. Do you lose that by taking on the scalability issues of owing your own servicing platform?

Well, I mean, yes and no. And I would phrase it this way, servicing is an integral core part of our strategy. It's going to continue to be so. And having made that decision, then the best way to extract the most value from the assets and the platform is -- we decide is to have our own servicer, right? And so, you are not going to see us -- and our experience has been, our history has been not that we have moved our capital or moved our MSR balances up and down 50% over any periods of time, it's been steady or growing, we expect that to continue, and as long as that's going to be continuing, then owning your own servicer is going to be more efficient, and more able for us to extract the value of the platform of the borrower on all the ancillary opportunities that we see.

Got it. And then, last question, and this is for Mary, is there any reason, so you used their value counting for your MSR, many of the servicers use lower cost per market, is there any reason if you internalize your servicing that you need to change that accounting? I just don’t remember all the rules associated with us.

No, we will not change our accounting methodology for MSR. It will be continue to be valued at -- accounted for value.

Okay. Thank you, guys.

Thanks, Rick.

Thank you. There are no further questions at this time. I will now like to turn the call back over to Bill Greenberg for any closing comments.

I just want to thank you everyone for joining us again today, and as always, thanks for your interest in Two Harbors.

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.