Greetings and welcome to the Two Harbors Investment Corp. Third Quarter 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Maggie Karr, Head of Investor Relations. Thank you, Maggie. You may begin.

Good morning, everyone, and welcome to our call to discuss Two Harbors' third quarter 2023 financial results. With me on the call this morning are Bill Greenberg, our President and Chief Executive Officer; Nick Letica, our Chief Investment Officer; and Mary Riskey, our Chief Financial Officer. The 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 twoharborsinvestment.com. In our earnings release and presentation, we have provided reconciliations 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 2 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, Maggie. Good morning, everyone, and welcome to our third quarter earnings call. Today, I'll provide an overview of our quarterly performance and the markets. Mary will cover our financial results in detail and Nick will discuss our portfolio and return outlook. Let's begin with Slide 3. Our book value at September 30th was $15.36 per share, representing a negative 3.5% total economic return. Income excluding market-driven value changes or IXM was $0.51 per share, representing a 12.6% annualized return. This backward looking metric or realized return is analogous to the forward-looking metrics on Slide 14, but includes actual cash flows, actual prepayments and actual costs incurred in the quarter. Please turn to Slide 4. Undoubtedly, the highlight of our third quarter was the closing of the acquisition of RoundPoint Mortgage Servicing, which reinforces our commitment to MSR as a core and essential part of our strategy. When we first envisioned acquiring a servicer, our goal was to achieve economies of scale, improve MSR economics, and be able to leverage a more expansive set of opportunities in the mortgage finance space. Everything we have seen at Roundpoint in the last year from the announcement through the closing has given us confidence that our visions were not misplaced. Let me expand a little more on this topic. The sub-servicing model works well, when you have a small portfolio, because the cost to service is a fixed number of dollars per loan. However, when a portfolio gets to a certain size, it becomes more expensive since the marginal cost of service is lower than the average cost. For instance, the cost less to service the one millionth loan than it does the 100,000th loan or the very first loan. Conventional wisdom says that portfolios with the approximately 500,000 loans are about…

Thank you, Bill and good morning. Please turn to Slide 6. The company incurred a comprehensive loss of $56.8 million or $0.61 per weighted average share in the third quarter. Our book value was $15.36 per share at September 30th, compared to $16.39 at June 30th including the $0.45 common dividend results in a quarterly economic return of negative 3.5%. Let's take a moment to review the Roundpoint, acquisition purchase price and anticipated post-closing adjustments. As a reminder, we paid a preliminary purchase price of $23.6 million, which was equal to Roundpoint’s tangible net book value, plus a premium of $10.5 million, less certain purchase price adjustments. Additionally, we agreed to pay certain post-closing adjustments, which reflect the earnings of Roundpoint from October 1st 2022 through September 30th, 2023. While these adjustments will be finalized in the next 30 days or so, and are subject to change, we currently estimate that this adjustment will add approximately $21.1 million to the aggregate purchase price. The estimated final purchase price of $44.7 million is reflected in our financial statements at September 30th, 2023 and resulted in goodwill and other intangibles of $28.4 million. In addition, we expect to pay a total of $16 million dollars in deporting fees to move our loans from our sub-servicers to Roundpoint. It's worth noting that $10 million of these deporting fees has already been realized and paid and are reflected in our current book value. In combination with the expected incremental earnings of $25 million to $30 million, that Bill highlighted, we expect a return of approximately 60% on the invested capital. Please turn to Slide 7. IXM for the third quarter was $49.3 million or $0.51 per share, representing an annualized return of 12.6%. This was within the range of our estimated return potential of…

Thank you, Mary. Please turn to Slide 10. Over the third quarter, the correlation of higher rates, higher, volatility, and wider mortgage spreads remained in place. Nevertheless, the active management of our agency coupon positioning and our exposure to MSR, coupled with disciplined re-hedging of our interest rate risk as yields rose, protected the portfolio and resulted in less of an impact to our book value. Let's look at figure one, mortgage spreads performed well in July as rates and volatility remained stable. Only they weakened during the months of August and September, as the yield of the 10-year treasury notched its highest level in over a decade. For the current coupon the nominal spreads of treasuries widened by 11 basis points over the quarter to 151 basis points, while the OAS increased 48 basis points, only wider by four basis points, given the concurrent increase in volatility. At these levels, spreads remain very wide historically with a nominal current coupon spread, well, above the 90th percentile of long-term history. In a nearer term context, spreads finished the quarter much closer to their averages since the beginning of June, a period that is mostly passed the distortions of the banking crisis and raising the debt ceiling in the second quarter. Focusing solely on the current coupon does not reveal the underperformance of lower coupons for the quarter, most of which took place during the later half of September as longer end rates shot higher. What made us particularly interesting is that the FDIC successfully completed their sales of lower coupon MBS like two and a halves by early August, at which point the bonds had recovered almost all the widening that occurred since the banking crisis was touched off in March. Call it guilt by association, but given the rise…

[Operator Instructions] Thank you. Our first question is from Bose George with KBW. Please proceed with your question.

Hey, everyone. Good morning. Can I get an update on your book value quarter-to-date?

You bet, Bose. Good morning. It's been pretty volatile in the markets with in terms of both rates and spreads. But given all that, we estimate that as of last Friday's close, that our book value or that our TR was down around 6%.

Okay. Great, Thanks. And then, with the acquisition of Roundpoint, do you have thoughts about how much capital invested in the MSR change, as you can benefit from synergies of being a larger servicer or just how does that kind of play into your capital allocation?

Sure. Well, one thing I want to clarify is, of course is that the acquisition of Roundpoint in itself doesn't really attract more capital to the business, right? It's a servicing operational entity. The amount of servicing that we own as owners is, we're pretty close to the ideal amount of what we want to own here. Yes, we can add a little bit if there's good opportunities in that space. But we're pretty close to the capital allocation that we prefer. We do intend to grow the amount of loans on the Roundpoint platform through sub-servicing relationships as we said, but that won't change the capital allocation mix per se. You will look at Slide 14 that will just change the returns in that Roundpoint line in the bottom half of the chart.

Okay. Great. And then, just one more on the sub-servicing. How meaningful do you think that opportunity could be?

Well, I think there's a lot of opportunity there. There's lots of servicing that is for sale. There's lots of services that is moving around from sub-servicers from one to another. And I think that that, our positioning in the market and what we are, which is a large owner of servicing and a sub-servicer is not that many of those guys in the market where people can put their loans next to someone who is - as I wrote, as I said in my prepared remarks is eating their own cooking, right? And I think we're able to provide sub-servicing clients a lot of what they're looking for that is underserved in the marketplace. So I think we're really excited about that.

Great. Thanks. And then good job protecting your book value with all this volatility.

Thanks, Bose.

Thank you. Our next question is from Trevor Cranston from JMP Securities. Please proceed with your question.

Hey, thanks. Another question on the Roundpoint acquisition. You made the points about potentially having the ability to explore participating in other segments of the structured finance market. I was curious if you could elaborate on a little - add a little bit and sort of what you would envision that to be in terms of investments for Two Harbors of that can include things like, taking credit risk on these types of loans or exactly how you see that evolving?

Sure. Well, with a large servicing portfolio, and with a large operating platform, some amounts of portfolio defense and recapture is certainly going to be an important part of what we do. But the main point is that, once we have such an entity and we're involved in those activities, it opens up the opportunities to be able to do other things as I said, in my prepared remarks, whether it's offering HELOCs or second liens or other products. That's something that we can certainly do with an operating platform rather than just being exposed to MBS spreads and MSR spreads. In terms of taking credit risk that's not something that we are particularly looking at, we like where we are in the conventional MSR and MBS space. And if we do participate in some of those other products, we would figure out ways to provide an outlook for those sort of things and so forth. It’s unclear what form that will take yet, because we haven't done it yet. These are still in the in the former stages. But I think the number of different things and opportunities that we have is certainly plentiful.

Okay. Got it. And this is a question that I think has come up on a number of calls before, but given how much mortgage rates have increased over the last couple of months. Can you talk about how much rate sensitivities these - the MSR asset having at this point?

Yeah, so, it's one of those things that I think is tempting sometimes and sometimes as a short hand we'll even say, oh! with the mortgage rates 400, or 450 basis points out of the money that the MSR has no duration or it's a very low duration, low conventional asset. And that's true, but it doesn't have no duration, right? It has low duration. And so, what I always like to think is that, is that an at the money pool servicing will have a duration of say, minus 30. That means, that for not the money pool of mortgages, if interest rates rise by a 100 basis points, servicing asset will change by 30% in value. Right? Our servicing 450 basis points out of the money probably has a duration of, I don't know, minus three, right? Minus three, minus four, somewhere in that zone. But we have a lot of servicing, right? And so all that adds up to a non-negligible amount of duration, right? And you might ask, why does a servicing portfolio that's 450 basis points out of the money even have any duration? Why isn't it zero, right? And this is something that we tried to talk about, I think in the first quarter, when we talked about what the duration, sensitivity of the float components of MSR is relative to the whole thing. Remember, as the owner of service, we not only receive the, the service fee, cash flows, but we also enjoy the benefit of the float earnings on the principal and interest and on the taxes of it and insurance. And I always like to call that the float components of servicing acts like what in the in the CMO market days of all, we used to call a superfloater IO,…

Okay. Yeah, it’s a very good answer. Thank you.

Thank you.

Thank you. Our final question will be from Arren Cyganovich with Citi. Please proceed with your question.

Thanks. I was wondering if you could talk a little bit about the outlook for rate volatility and maybe spread volatility. I know it's kind of crystal ball kind of question, but in this kind of higher for longer and the Fed, getting hopefully close to this tightening cycle. With the natural expectation be for that volatility to subside a bit?

Hey, Arren. This is Nick. Thank you for the question. It's really the question - I'd say of the day and it's really been a question frankly for the last year. I think we've talked about this almost every call that we've been on, and, the, the markets are giving us signals that things are - that we're close to an end of this hiking cycle. And that, that maybe the Fed really is going to hold now. And we see that if you look at the shape of the yield curve, for example, we've seen the two tens curve for example, go from something like wider than minus 100 basis points. Not long ago to only minus 20 now, it's that curve has become less inverted or has become steeper by about 80 basis points. That's a signal the market is giving you that we are getting closer to the end of this cycle. But the reality is, these things are, famously difficult to predict and to tell. And, that's the reason why in our comments as we’ve said, we are being very respectful of the risk in the market. And we are - we believe that our position is balanced and is as we described our leverage position is being neutral. It gives us enough return potential, enough upside to as to a spread tightening event that we feel, that we will capture that. But yet at the same time, don't have an excessive amount of downside exposure should things continue to happen as with spreads widening. We have talked about spreads being wide historically, which they are. The problem is they keep getting a little bit wider every quarter. And we are we are respectful. And so, we've kind of built into the portfolio, the level of leverage and risk and composition between our MSR and our securities holdings that we know - that generates we think a very, very attractive return potential, and should spreads tighten and we get a cycle change. We will definitely participate in that upside, as well.

Thanks. And then, second question I had was, you had mentioned, shifting a little bit higher in coupon, I guess, I think you said in the TBA side. How do you – or how are you hedging that? And what's the risk to the extent that, I don't know the economy falters and there's a flight to quality and you start to see the 10-year fall again?

Oh! there has been, I mean, good question. And there certainly has been a correlation between the performance of lower and higher coupons with the rate directionality. Now we hedge it the same way we hedge everything else. We use our models and we have - we think as accurate representations of the risk of those securities versus the lower coupons. And we hedge it with a combination of futures and swaps. And of course, with our again, with our MSR, we have as Bose talked about it in the prior question about the sensitivity of our MSR to mortgage rates. There is still some sensitivity that impacts where - how our hedging ultimately resides where exposure is ultimately reside on the coupon stack. And one of the reasons that we did go up in coupon was the fact that the current coupon went higher. I mean, that was part of it. And part of it was also, as I said, the rotation out of – as coupons we thought did really well. And also just the fact that if you aren't a higher for longer environment, the higher the current coupon should provide a lot of good return.

Got it. All right. Thank you.

Yeah, I might just add that that, we do actively manage the portfolio not just in the interest rate rebalancing and so forth, above but also in coupon selection and where we are on the coupon stack. And some of that relates also to how we think that does relate also into how we hedge the portfolio and what risk we want to take in different environments. And so, as rates move sometimes in addition to, to hedging, block the theoretical interest rate exposures, we will often sometimes modify our coupon positioning which has an impact as well. And so, as we see the lower coupons underperforming, we may choose to increase exposure there from time to time or as rates fall, we might be moving that down a coupon or up a coupon, as well. And so it's a dynamic portfolio. But the hedging strategy is the same in any environment.

Got it. Thank you.

Thank you. Our next question is from Eric Hagen with BTIG. Please proceed with your question.

Hey, thanks. Good morning, guys. Hope all are well. How do you see the bulk market for MSR developing its interest rates maybe even higher from here? Like, how much overall capital do you feel like you can maybe devote to the MSR in that scenario where there's bulk MSRs to buy and rates are higher at the same time?

Sure, thanks for the question, Eric. Look, there's ample supply of MSR in the bulk markets, right? And as we've said in the quarters passing and it continues to be true that the market is trading rationally, and professionally and orderly. And the sellers, especially of large portfolios seem to be, strong hands that understand how the market works and isn't going to flood the market. Then in no way shape or form, is the MSR market trading as a distressed market. It's happening in a very, very orderly way. As I said a little bit earlier, we like our capital allocation right here. We're trying to balance the relative attractiveness of MSR with the relative attractiveness of MBS, along with making sure that we have ample liquidity in the portfolio and so forth of which the MBS portfolio provides more so than the MSR. So, if there's our average – if there are opportunities to acquire more MSR, we can certainly participate in that to some degree. We obviously can't double the amount of MSR portfolio that we have currently. But we can grow it a little bit, but we're happy with our capital allocation and the relative mix, given the opportunities in the market right now.

Okay. A follow-up on the hedging, I mean, is there a way to hedge the float income component of the MSR? Is that not really a cash flow that's really worth hedging with repo also being present in the portfolio? Just how to think about that? Thank you guys.

Yeah, thanks for the question. Not only is there a way to hedge the float components, but we do hedge the float components, right? That is to say that that when rates rose, we did not achieve a windfall from rates rising, and the increased earnings benefit that we have, because we hedged it. And should rates fall from here, we will not realize a degradation in our book value due to that because we will be hedging that, as well. So, when we talk about hedging our portfolio as we've discussed many times and actually I think one of our conversations series that we just posted is about partial durations and hedging along the yield curve, right? And so the floating rate components have their own exposure along the yield curve that's different than the pure interesting rate strip, but we put it all together when we manage the portfolio and we hedge the individual interest rate buckets, interest rate maturity buckets separately, so that we're able to hedge the floating components, as well.

Okay. Thanks for the information. Appreciate you guys. Thanks.

Thank you. There are no further questions at this time. I would like to hand the floor back over to Bill Greenberg for any closing comments.

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

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