Two Harbors Investment Corp. (NYSE: TWO) was founded in 2009, with the aim of extracting value from the distressed residential finance markets that existed in the wake of the great financial crisis. The company took a hybrid approach to investing in Agency and non-Agency residential mortgage-backed securities (RMBS).
In 2020, it re-focused its business solely on MSR paired with Agency RMBS. “We are sticking to our knitting, and staying with the things we know, which will allow us to succeed in the future,” says Greenberg.
The acquisition of RoundPoint Mortgage Servicing in 2023 reinforced the company’s commitment to MSR as a core and essential part of their business. Two Harbors is now a top 10 conventional servicer.
Complementary assets underpin success
Two Harbors’ strategy of pairing of MSR with Agency RMBS has evolved over time.
In a lower rate environment, when most of the company’s MSR was produced, the MSR acted as a spread and interest rate hedge to most of its Agency mortgage-backed securities portfolio. If the risk premium happened to widen or tighten, the servicing offset most of that.
Now, as interest rates have risen so substantially, the company’s MSR has become less sensitive to rates and spreads. While it’s servicing still hedges a portion of its rate and spread risk, the Agency mortgage-backed securities portfolio has largely decoupled from it.
MSR in the current market environment has low prepayment and convexity risks, while producing a highly positive cash flow and attractive yield. Meanwhile, Agency spreads are attractive, especially in a historical context, but the market is in the midst of transitioning from a period of Fed tightening to one with a more neutral posture and one where the company thinks spreads on RMBS are roughly fair.
“They’re two very good complementary portfolios, although not in the same way as they were complementary before,” Greenberg says.
Operational platform drives growth
The RoundPoint acquisition brings Two Harbors’ MSR portfolio in-house, allowing them to benefit from all of the cashflows associated with its servicing asset. Additionally, the operational platform provides the opportunity for the company to participate more fully in the mortgage finance space.
For example, Two Harbors recently announced that they are building a direct-to-consumer origination business to provide portfolio protection should interest rates fall. It is also working on expanding its third-party sub-servicing business.
Greenberg sums it up: “Owning an operating company really allows us to impact our results and returns through our own actions,” which is in contrast to simply owning a portfolio of securities.
Reduced exposure protects against uncertainty
The reset of interest rates after years of historically low levels has caused dislocation and realignment in the market, sparking discussion about the natural resting level of rates and spreads.
In its recent earnings call, Two Harbors declared it believes spreads on RMBS are fairly valued. It is taking a neutral position on risk: it believes spreads are equally likely to widen or tighten at present.
With two-thirds of its capital allocated to MSR, the company’s portfolio is less exposed to fluctuations in mortgage spreads. Greenberg believes that is an attractive position amid uncertainty over future mortgage spread performance.
Companies with disciplined approach will succeed
Since taking over as CEO in 2020, Greenberg has worked with his team to define the company’s direction and, most recently, vertically integrate the RoundPoint business.
He believes future success in the sector will be earned by companies with the discipline to stick to their areas of expertise. “I like to think that we’re experts in managing interest rate risk and prepayment risk,” he concludes. “We’ve been able to succeed by really focusing on the things that we know how to do well.”
Featured Guest:
Bill Greenberg
CEO, Two Harbors