Business Context and Reporting Period
Company: Two Harbors Investment Corp. (TWO)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Three months ended March 31, 2011
Business Overview: Two Harbors is a Maryland corporation operating as a Real Estate Investment Trust (REIT) focused on investing in residential mortgage-backed securities (RMBS), including Agency and non-Agency securities. The company is externally managed by PRCM Advisers LLC, a subsidiary of Pine River Capital Management L.P.
Key Financial Metrics
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Net Income (GAAP) | $22.4 million | $5.3 million |
| Earnings Per Share (Diluted) | $0.49 | $0.40 |
| Adjusted GAAP Earnings | $17.9 million | $6.1 million |
| Net Interest Income | $17.4 million | $5.6 million |
| Total Assets | $3.66 billion | $1.80 billion (Dec 31, 2010) |
| Stockholders' Equity | $685.6 million | $382.4 million (Dec 31, 2010) |
| Repurchase Agreements (Debt) | $2.62 billion | $1.17 billion (Dec 31, 2010) |
| Cash and Cash Equivalents | $302.3 million | $163.9 million (Dec 31, 2010) |
| Debt-to-Equity Ratio | 3.8x | 3.1x (Dec 31, 2010) |
| Dividends Declared Per Share | $0.40 | $0.36 |
Material Changes vs. Prior Period
- Portfolio Expansion: Total assets more than doubled from $1.80 billion to $3.66 billion, driven by a follow-on public offering in March 2011 that raised approximately $287.8 million in net proceeds.
- Investment Composition: Available-for-sale securities increased from $1.35 billion to $2.88 billion. The portfolio shifted to include $299.3 million in trading securities (U.S. Treasuries), a new asset class not held in the prior year.
- Leverage Increase: Repurchase agreements increased from $1.17 billion to $2.62 billion to fund the expanded portfolio, raising the debt-to-equity ratio to 3.8x.
- Derivative Gains: Significant unrealized gains on interest rate swaps and other derivative instruments contributed $8.8 million to "Other Income," compared to $0.6 million in Q1 2010.
- Yield Dynamics: The net asset yield on the consolidated RMBS portfolio was 4.7% in Q1 2011, down slightly from 4.9% in Q1 2010, primarily due to the deployment of new capital into non-Agency RMBS with lower stated coupons.
Outlook, Risks, and Management Commentary
- Market Outlook: Management expects regulatory reforms regarding Government Sponsored Enterprises (GSEs) to create opportunities in 2011. They anticipate no significant increase in prepayment speeds due to high unemployment and housing inventory.
- Interest Rate Risk: The company utilizes interest rate swaps, swaptions, and inverse interest-only securities to hedge against interest rate fluctuations. A 100 basis point increase in rates is projected to decrease net assets by approximately 2.0% of equity, while a 100 basis point decrease is projected to increase net assets by 0.1%.
- Liquidity: The company maintains an estimated unused borrowing capacity of $15.1 million. It holds $302.3 million in cash and cash equivalents. Management monitors daily liquidity to manage margin calls.
- Credit Risk: While Agency securities are guaranteed, the non-Agency portfolio carries credit risk. The company maintains a designated credit reserve of $233.5 million against non-Agency securities.
- Unusual Items: GAAP net income includes $4.5 million in unrealized fair value gains on interest rate swaps. Adjusted GAAP earnings exclude these to provide a core earnings view.
Investor Verification Checklist
- Capital Deployment: Verify the yield performance of the $287.8 million in new capital deployed into Agency and non-Agency RMBS.
- Derivative Exposure: Assess the sustainability of earnings given the significant reliance on unrealized gains from interest rate swaps and other derivatives ($8.8 million in Q1).
- Leverage Covenants: Confirm continued compliance with the Wells Fargo repurchase facility covenants (Debt-to-Tangible Net Worth < 6.0x; Liquidity > $15.0 million).
- Non-Agency Credit Quality: Monitor the 39.0% 60+ day delinquency rate in the non-Agency portfolio and the adequacy of the $233.5 million credit reserve.
- Prepayment Sensitivity: Evaluate the impact of potential changes in prepayment speeds on the amortization of premiums in the Agency portfolio versus accretion of discounts in the non-Agency portfolio.