Business Context and Reporting Period
Company: Two Harbors Investment Corp. (TWO)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2010
Business Overview: The Company is a Maryland corporation and a Real Estate Investment Trust (REIT) focused on investing in residential mortgage-backed securities (RMBS), including Agency and non-Agency tranches. It is externally managed by PRCM Advisers LLC, a subsidiary of Pine River Capital Management L.P.
Key Financial Metrics
| Metric | Q1 2010 | Q1 2009 |
|---|---|---|
| Net Income (Loss) Attributable to Common Stockholders | $5,326,956 | $(211,005) |
| Earnings Per Share (Diluted) | $0.40 | $(0.01) |
| Total Assets | $599,016,802 | N/A (Development Stage) |
| Available-for-Sale Securities (Fair Value) | $520,169,039 | N/A |
| Repurchase Agreements (Debt) | $449,960,805 | N/A |
| Stockholders' Equity | $125,756,110 | $183,950,886 (Pre-merger) |
| Cash and Cash Equivalents | $25,443,339 | $2,572,203 |
| Net Interest Income | $5,640,579 | $48,247 |
| Dividends Declared Per Share | $0.36 | $0.00 |
Liquidity & Leverage: The debt-to-equity ratio was 3.6:1.0 as of March 31, 2010. The weighted average cost of funds on repurchase agreements was 0.54%. The Company held approximately $9.8 million in estimated unused borrowing capacity.
Material Changes vs. Prior Period
- Operational Status: The Q1 2009 results reflect the Company's predecessor (Capitol Acquisition Corp.) as a development-stage entity with no operations. Q1 2010 represents the first full quarter of active operations following the merger completed in late October 2009.
- Profitability: The Company reported a net income of $5.3 million in Q1 2010, a significant turnaround from the $0.2 million net loss in Q1 2009.
- Portfolio Growth: Available-for-sale securities increased from $0 in Q1 2009 to $520.2 million in Q1 2010. The portfolio consists of 79.3% Agency RMBS and 20.7% non-Agency RMBS.
- Derivative Activity: The Company recognized a $1.5 million loss on interest rate swap agreements and a $0.9 million gain on other derivative instruments (TBAs and inverse interest-only securities) in Q1 2010, compared to no such activity in Q1 2009.
- Dividends: The Company declared its first dividend of $0.36 per share in Q1 2010.
Outlook, Risks, and Management Commentary
- Market Conditions: Management notes that the first quarter of 2010 continued to experience regulatory developments aimed at stabilizing economic conditions. The Company believes its blended Agency and non-Agency strategy allows it to navigate the dynamic RMBS environment.
- Interest Rate Risk: The Company utilizes interest-only securities and derivatives (swaps, TBAs) to hedge interest rate risk. A sensitivity analysis indicates that a 100 basis point increase in interest rates could decrease the value of the financial position by approximately 1.4% of equity, while a 100 basis point decrease could decrease it by 0.4% of equity.
- Prepayment Risk: The portfolio is exposed to prepayment risk, particularly in Agency securities. Management mitigates this through a mix of fixed-rate, hybrid, and adjustable-rate securities, as well as prepayment protection features.
- Credit Risk: While Agency securities are guaranteed by GSEs or the U.S. Government, non-Agency securities carry credit risk. The Company maintains a designated credit reserve of $52.8 million on non-Agency securities.
- Subsequent Event: On April 26, 2010, the Company completed a public offering of 11.5 million shares at $8.90 per share, raising approximately $102.4 million in gross proceeds. Including over-allotments, total shares outstanding reached 26,067,590.
Investor Verification Checklist
- REIT Compliance: Verify the Company's ability to maintain REIT status, which requires distributing at least 90% of taxable income to avoid federal income tax.
- Liquidity & Margin Calls: Monitor the $450 million in repurchase agreements and the potential for margin calls if collateral values decline, given the 3.6x leverage ratio.
- Non-Agency Credit Quality: Review the performance of the $107.6 million non-Agency portfolio, specifically the 31% delinquency rate on senior bonds and the adequacy of the $52.8 million credit reserve.
- Derivative Valuation: Assess the impact of interest rate swap losses ($1.5 million) and the effectiveness of hedging strategies in volatile rate environments.
- Capital Deployment: Track the deployment of the $107.3 million in net proceeds from the April 2010 offering and its impact on future leverage and yield.