Yahoo Finance

William Dellal

Thank you, Bill. Please turn to slide 6. Our book value was $14.47 per share at December 31 compared to $14.93 on September 30 including the 45% common stock dividend. This resulted in a flat quarterly economic return. As Bill has already mentioned for the year, we generated an economic return of 7.0%.
Please turn to slide 7. The company incurred a comprehensive loss of $1.6 million or $0.03 per weighted average common share in the fourth quarter. Net interest expense of $35 million was lower in the fourth quarter by $7.4 million due to lower RMBS borrowing balances as a result of sales of R and BS.
Additionally, we shifted a portion of our MSR financing from credit facilities to VFN repurchase agreements which on average carry lower floating rate spreads. This was slightly offset by higher overall average MSR borrowing balances net servicing income was $168 million minus $5 million of non operating MSR related servicing costs.
This is now slightly from the third quarter due to lower float income resulting from lower average outstanding balances and lower rates earned on the balances. Given the decline in short term rates, the lower float was offset partially by higher servicing fee collections and higher subservicing related income earned as expected due to higher yields, investment securities gains and changes in OCI swung from a gain of $270 million in the third quarter to a loss of $267 million in the fourth quarter.
Additionally, net swap and other derivative gains in our RMBS hedge portfolio were $145 million in the fourth quarter compared to losses of $205 million in the third quarter resulting from market movements in swaps and futures offset by market movement and TVS and slightly lower swap interest spread income.
The servicing assets showed a gain of $82.5 million in the fourth quarter. After a loss of $133.4 million in the third quarter, higher rates and lower projected prepayments resulted in a positive $139.4 million change in the valuation of MSR as opposed to a negative $93.8 million change in the third quarter, Rolph declined in the fourth quarter to $57 million from 62 million in the third quarter.
The decline and went off was a result of lower UPB due to the sale of MSR in the third quarter. As well as the decline in realized prepayment rates.
It is important to look at changes in values for the assets and the hedges together rather than in isolation, the net change in the sum of investment securities gain and changes in oci net swap in other derivative gains. And the servicing asset gain shows a loss of $47.5 million in the fourth quarter compared to a loss of $67.3 million in the.
Please turn to slide 8, our MBS funding markets remain stable and available throughout the quarter with spreads for repurchase agreements at sour plus 35 basis forms concerns about anticipated yearend. Funding pressures and uncertainty around fed actions have dissipated and rates have reverted back to more normal ranges around sulfur plus 15 to 20 basis points.
In retrospect, was uneventful in the funding markets and early indications in 2025 or that spreads are normalizing into a tighter historical context.
At quarter end, our weighted average days to maturity for our agency RMBS repo was 49 days compared to 78 days at the end of Q3, our days to maturity are typically lower at December 31st as we intentionally rule rebuilds in the third quarter past year round to avoid any disruption of funding that can sometimes occur.
We finance our MSR activities across five lenders with $1.8 billion of outstanding borrowings under the bilateral facilities. We ended the quarter with a total of $865 million in unused MSR asset financing capacity and $60 million in unused capacity for servicing and facets.
I will now turn the call over to Nick.

Nicholas Letic

Thank you, William. Before I launch into the slides and provide more detail, let's talk a little bit about the fourth quarter. Performance at a high level was an interesting quarter, particularly for mortgage performance as mortgage spreads didn't exactly follow the usual playbook in total. We started the quarter with less mortgage spread risk than any recent quarter with most of our exposure in 5.5. And up as rates rose and spreads widened. We let our spread exposure increase which contributed positively to our performance.
Our MSR was aided by slower than expected prepayment speeds. Though the quick rise in rates in October which triggered a fair amount of rehedging impacted our MSR performance as we discussed in last quarter's earnings, call the risk of our MSR varies as rates move both in terms of duration and coupon exposure as rates increase, the duration of exposure declines and shifts into higher coupons. In practice. That means having to sell some of our RMBS at lower prices due to higher rates. And in a month like October at wider spreads, higher rates have typically spelled trouble for mortgage performance. And it did again October as interest rates increased and volatility spiked ahead of the Presidential election which negatively affected many mortgage re book values.
However, in November, following the decisive election results, investors aggressively returned to the market leading to a recovery and spreads that would not have been predicted based on the move in rates. Over that two month time period, the 10 year treasury yield increased by 39 basis points and the slope with a two year 10 year treasury curve flattened by 12 basis points. Yet the index turned in a net positive excess return of plus five basis points.
Though hawkish comments from the fed in December drove rates higher yet again and pushed the quarterly index excess return to minus 11 basis points. The muted reaction of mortgage spreads compared to prior periods was notable. Of course, the index is heavily weighted to lower coupons and performance across the stack varied widely higher coupons especially in pool form, outperformed, turning in a positive hedged return performance.
Jumping into the deck, please turn to slide 9. Our portfolio at December 31 was $14.8 billion including $10.4 billion in settled positions and $4.4 billion in TBAS. Our economic debt to equity decreased slightly to 6.5 times though, as you can see in figure three, our mortgage spread exposure increased into a more normal range as spreads became more attractive in the quarter. As we have said in the past leverage exposure is but one of many risks we manage and it can't be taken by itself to assess our overall risk. We continue to manage our exposure to rates across the curve closely. You can see more detail on our risk exposures on Appendix slide 17.
Please turn to slide 10. As you can see in figure one, our preferred implied volatility gauge to your options on 10 year rates increased from 94 to 101 basis points on an annualized basis. Right in the middle of its range for 2024 implied volatility and nominal spreads remain higher than longer term averages. While option adjusted spreads are close to longer term averages, the level of mortgage spread volatility has materially declined from earlier parts of this interest rate cycle, improving the risk adjusted return profile. The nominal spread on TBA current coupon finished 11 basis points wider at 117 basis points of the treasury curve. While the option adjusted spread finished six basis points wider at plus 23.
Note that some of the spread widening reflects the shift from about a 5% current coupon at the start of the quarter to something in between 5.5 and six by quarter end. As you can see in figure 2, the nominal spread curve steepened with peak spreads around the 6% coupon at quarter end, the oas curve flattened with higher coupons picking up spread as prepayment risk diminished.
Please turn to slide 11 to review our agency RMBs portfolio. Figure one shows the performance of TBAs compared to the specified pools we own throughout this quarter. As I mentioned earlier, given that the interest rate curve bare steepened and implied volatility ticked up lower coupons underperformed higher coupons, higher coupon specified pools are the best performer. As you can see in figure one, outperforming Tbas by at least a quarter point and rate hedges by about a half point in terms of activity. We shifted TBA exposure up in coupon and replaced some specified pools with TBAS.
We also bought some higher coupon pools to improve carry as dollar rolls weaken, incorporating the effect that our MSR has on our net notional mortgage exposure. Our position increased by about $1.5 billion over the quarter.
Though primary mortgage rates increased by about 75 basis points in the quarter. Overall prepayment rates for 30 year agency RMBs rose by 0.4% points to 6.9%. CPR as higher coupon speeds reflected the lagged effect of the mini refi wave triggered by the fall in rates in Q3 borrowers with a refinance incentive responded to the lower rates in September with a propensity similar to borrower behavior in 2019. Figure 2 on the bottom right shows our specified pool prepayment speeds by coupon aggregate speeds increased to 8.1% from 7.6% in the third quarter. Led by an increase in speeds from 5.5, 6, and 6.5.
Please turn to slide 12. As we discuss the market for investing in MSR, the MSR market remains stable and well supported with bulk deals. Consistently receiving double digit competitive bids. Some large scale bids and acquisitions in Q4 lifted 2024 transfers to $662 billion UPD approximately the same amount in 2023. So the number of bulk bid opportunities dropped by about 25% year over year. As you can see in figure 1, while demand for MSR continues to be strong from both bank and non bank portfolios, we expect there to be ample opportunities in 2025 to add MSR at attractive spread.
Please turn to slide 13 where we will discuss our MSR portfolio figure. One is an overview of our portfolio quarter M the details of which can be found on appendix slide 23 the portfolio was 202 billion UPD at December 31, reflecting the settlement of $2.5 billion UPD through bulk and flow channels and portfolio recapture with mortgage rates increasing in the quarter. The price multiple of our MSR increased slightly to 5.9 times from 5.6 times and 60-plus-day delinquencies remained low at under 1%.
Our MSR portfolio with a low gross mortgage rate of 3.46% experienced a 4.9%. CPR in Q4 down 0.4% points compared to Q3 as slower seasonal factors kicked in order to facilitate comparison of our MSR prepayment rates with a larger universe, we map our portfolio into cohorts by mortgage rates so that they resemble RMBs. Figure 2 compares CPRs across those implied security coupons in our portfolio of MSR versus TBA. You can see that prepaids remain low and steady for the majority of our portfolio with 5.5 and above slightly increasing.
Finally please turn to slide 14, our return potential outlook slide. The top half of this table is meant to show what returns we believe are available on the assets in our portfolio, we estimate that about 61% of our capital is allocated to servicing with a static return projection of 11% to 14%. The remaining capital is allocated its securities with a static return estimate of 14% to 15%. With our portfolio allocations shown in the top half of the table. And after expenses, the static return estimate for our portfolio is between 9.8% to 12.1% before applying any capital structural leverage to the portfolio.
After giving effect to our outstanding convertible notes and preferred stock, we believe that the potential static return on common equity falls in the range of 10.8% to 14.4% or a prospective quarterly static return per share of 39 to $0.52. We like that our current capital allocation is focused on MSR and believe it will result in strong returns for our stockholders.
Low prepayments are a positive tailwind for our servicing portfolio. But even if prepayments pick up, we believe that the significant progress we have made at Roundpoint on our direct to consumer originations platform will serve as a hedge to our MSR portfolio. Additionally, our focus on generating additional cost efficiencies and servicing especially through technology and process improvements at roundpoint will contribute positively to the value of MSR.
We continue to actively manage our RMBs positioning to complement our MSR portfolio and aim to extract additional returns from historically wide nominal current coupon spreads we believe that our unique hedged MSR centric strategy will continue to generate a tractor levered return in 2025 and beyond.
Thank you very much for joining us today. And now we will be happy to take any questions you might have.

Question and Answer Session

Operator

(Operator Instructions) We will pause for just a moment to allow everyone an opportunity to signal for questions.
Doug Harter, UBS.

Thanks and good morning. It's Marissa, on for Doug. I was hoping you could give us an update on how book has performed so far in the quarter.

William Greenberg

Yeah, good morning, Marissa. Thanks for the question. It's been a reasonably quiet quarter, although I'll stress that it's early in the quarter. It's only been one month, of course. But our total return is estimated to be up between about 1.5% and 2% as of last night.

Got it. Thank you. And second, how does the lower leverage level impact your view on earnings power? And what was the normalized range for, for earnings be?

Nicholas Letic

Thank you for the question. This is Nick. You know, the, as I mentioned in my prepared remarks, the our overall debt to economic ratio is really but one measure that we look at in terms of our return potential and our earnings power. And as you can see, our our from our return potential slide, that overall, we, our the central, tendency of our, of our, of our returns and and the range of our returns is still, supportive of our dividend and very much in the range of what it was in prior quarters. So, the leverage itself is, is it, determines, you know, some of the components of our, of the debt to equity. But if you look at other components of our risks such as our, our the amount of mortgage spread risk, we have, as a as again, as I said, in my prepared remarks, quarter over quarter that increased into a more normal range. And that was really, that's really reflective of where, how we feel about spreads and you know, how they, how they look right now. And, beyond that, our, the overall mix of our assets of, of having, over 60% of our, of our capital in MSR is very supportive of stable and you know, in our opinion, predictable returns for future.
Periods.

William Greenberg

One thing I might add, Marissa also is is that you know, the way that we hedge your MS R and we're hedging the current coupon risk. But as rates rise, we need less M BS to hedge the current coupon risk of the portfolio, right? And as rates go down and we need more. And so that has a direct impact in when we're keeping everything unchanged, our risk unchanged as rights move, that has an impact on the overall leverage, which is why Nick stresses that the leverage is just one component of the risk that we manage and measure.

Thanks for that. And finally, does this your earning power outlook? Does that reflect the cost of volatility?

William Greenberg

No, as it says that those are static spreads.

Got it. Thank you. That's it for me.
Thank you.

Operator

Mikhail Goberman, Citizens JMP.

Mikhail Goberman

Hey. Good morning, guys. Could you maybe expand a bit on your outlook for agency MBS spreads for this year? And also how do you guys see the allocation to MSRs versus MBS evolving throughout the year? Thank you.

William Greenberg

Mikhail, thank you for the question. You know what I would say is the, we have seen and we've made note of it and about that there has been a much more controlled response of mortgage spreads. I would say really notably since November, when you know, when you know when we got through the Presidential election and slightly before that, when we, when the fed first cut. And I think that the, that's really a reflection of the fact that there is a more predictable fed path than there than there was in the earlier parts of the cycle. I still think, this is still a very data dependent fed. It's still quarter to quarter, there's a lot of other things that are being factored into the risk equation out there in the world, but the overall amount of spread risk has declined.
And you know, there are, there are good, there are reasons to be positive about mortgages, mortgage spread this year. I mean, net supply and you know, supply demand seems to be pretty much imbalanced. We have something like a net net amount of supply in the low 200 billion, which has been reasonably absorbed by the market. There's been better uptake by banks and, and I think the general consensus is, there's the uptake by banks has been, more than what the it was generally assuming kind of a consistent amount of demand from money managers and you know, flows into funds that buy mortgages. You know, the RV of mortgages looks quite good relative to other spread assets in the world. Funding rates. You know, they were, they spiked a little bit towards the end of last year, but now they've come right back into the zone they've been in which is good of course, if the yield, if the fed does cut more this year, the, steeper yield curve is usually usually constructive for mortgage spreads because it encourages, it encourages institutions, mostly banks to go further out on the curve and buy mortgages.
So all of those things are good points. So, the, our overall feeling is and we're kind of keeping it down the fairway here is that, mortgages should be, should continue to be constructive for us from a return perspective. And you know, where spreads are right now, we don't really need spreads and we say this in our quarter, but it's true, we really don't really do not need spreads to tighten, to get performance. I think what the part of it that can be, you know, that that is, is difficult is when you have a tremendous amount of volatility and that really has kind of come down. So overall, I'd say we are, we're positive on mortgage spreads. But, as we know from the volatility that this market, has given us that there is, that there's always something that can, that can change that. However, one of the key parts of our strategy which, we can't really overemphasize is the core of our MSR, that really does provide a lot of stability to our, our return profile. And you know, if you look at, look at our returns over the last, many quarters, you can see we've had a lot of stability of book value and good economic returns and we think that will bode us well for the foreseeable future.

Mikhail Goberman

Great. So given that I'm guessing that the MSR allocation versus MBS is kind of going to be steady as she goes similar to what it's been in the recent quarter or two. Correct?

William Greenberg

Sorry, I didn't mean to not answer that question. Yes, we do. We don't expect to see a material change in our, in our MSR allocation. You know, we're always looking at the, at the very at the asset allocation that we can, that we can that, to move asset allocation as we get, cash flows to invest or new capital. But you know, we don't see a material change in our, in the allocation to ours.

Mikhail Goberman

Great. Thank you. And if I can squeeze in one more any, any thoughts on potential GSE reform and the nomination of this new FH person to lead it.

William Dellal

Hi, this is William. I don't think we have more information than what the market has regarding GSE reform, but I think we can break the GSC reform question into two questions actually, what is the status of privatization and what is the status of the guarantee and the guarantee itself breaks into two subquestion. What is going to happen to existing securities that have a guarantee and what is going to happen to, perspective securities, that will, whether they will carry the guarantee or not. Once we have more detail about the, about potential plans, we can look at the implications through the length of those two questions, but we really don't have any more information at current about and we don't want to speculate about what's going on.

Mikhail Goberman

Got you. Well, thank you very much and best of luck going forward.

William Greenberg

Thanks very much, Michael.

Nicholas Letic

Thank you.

Operator

Bose George, KBW.

Francesco Labetti

Hi. Good morning. This is actually Frankie Labetti, on for Bose. Just to start, can you discuss the main differences between the E AD and the static return range you provide on slide 14.

William Greenberg

Sure. Thank you, Frankie, for the question. I'll get started. Yeah, the return potential that we show on slide 14 is our, is our actual portfolio at quarter end. It is projected out, it uses, it is it is a mark to market. It's a mark to market basis where everything in the portfolio is, is marked contemporaneously, at that date and valued at that date. So, in our in our opinion. I mean, it's, it's a, it's a, it's a good, it's a good assessment of where the return potential of the static yields are to the forward curve. When you take our, our entire portfolio marked on the same day and, and, and, and, and generate a yield or return potential ead is, is, the word that we use, you know about it is that it's asynchronous so that the ead is something where, if you have assets that are, like many of our mortgage pools, we bought long ago and the E A reflects the purchase price or you know, the return at that time. Whereas other components of our, of our overall business structure such as our, our, our, funding our repo are more contemporaneous so that, you can have a real difference in timing between those things and it can create distortions to what you know, to what, how we see the portfolio on a day to day basis and manage it on a day to day basis. If that makes sense to you.

Nicholas Letic

The way I like to think about it is that is that if you were to buy and sell the portfolio every day, you would look something more like what we have on slide 14.

Francesco Labetti

Great. That's very helpful. Thank you. And then just to stay on that slide, the return of your MSR fell to 11% to 14% from 12% to 16% last quarter. Given the higher rate environment is the driver of the lower return, the increase in the mark to market on the MS R this quarter.

William Greenberg

It's a very good question and it's a, it's a combination of things. The biggest thing that it is is that, and this is again, this is a slice in time. It is one, one day and you know, we manage our portfolio through time, but a component of the return of our MSR portfolio is its hedge and that hedge is our R and BS security is, current coupon securities typically, which add, which also add to the return of the strategy, right? It's, it's, it's, it's, it's a paired strategy of MSR plus MBS and the MBS A return when rates go up, as I mentioned in my comments, the amount of, of MBS that we need to hedge that MSR declines. So overall, if you, if you think about it that way, the leverage of that part of the portfolio goes down, right? There's less, there are less securities that are attached to the MSR. Consequently, the return potential will all else being equal, will tend to go down, as that hedge, as that hedge becomes, a smaller part of the overall.

Francesco Labetti

Great. Thank you very much. Appreciate it.

William Greenberg

Thank you.

Operator

Eric Hagen, BTIG.

Eric Hagen

Good morning. This is this is Jake Katsikas on for Eric. Thanks for taking my questions. Are you guys seeing any new financing counterparties or sources of leverage to support the MSR portfolio?

William Dellal

Yeah --

William Greenberg

Go ahead.

William Dellal

We've been working for the traditional lenders. We there are some new entrants that are trying to gain traction in the market. We've seen a few requests of in inbound calls for people who want to expand into MSR financing.

William Greenberg

Yeah, in general, I would just add to what William just said there. I think that that the depth of the market from our financing continues to grow and expand. As William said, there's, there's more counterparties entering the market all the time. And so it's a very healthy, healthy market for that product right now.

Eric Hagen

Great. Thank you. And then can you also just share how much the costs have changed in response to the first 100 bits of rate cuts that we've seen?

William Greenberg

Which costs are you thinking of specifically?

Eric Hagen

The in the MSR portfolio?

William Greenberg

I'm not sure I understand your question about that.
Are you talking about our financing costs?

Eric Hagen

And yeah, I can just back it up to maybe just kind of cost in general how they've shaped in response to the 100 bits of cuts that we saw, right? So things like that.

William Greenberg

So our financing costs on the MSR asset, our floating rates and our, and our index to short term funding rates and so forth. Right? So as the fed has cut rates, our funding costs have gone down, right? Just like they have on the RBS side of the portfolio, right? Lower sour rates also impact the float income that we have in our port that we have generated by the MSR asset as well, which offsets some of that.
In general, I would say that we hedge the entire yield curve, right? And so, you know, changes in rates in one part of the curve or another, generally have a very small effect on our portfolio. Not, I'm not fully understanding what you're getting at, so maybe we can follow up more fully later. But I hope that I hope that answers some of your questions.

Eric Hagen

Yeah, it does. Definitely. Thank you guys very much.

William Greenberg

Okay. Yeah.

Operator

We do not have any further questions. I would like to turn the call back to Bill Greenberg for closing remarks.

William Greenberg

I'd just like to thank everyone for joining us today and thank you all for your interest in Two Harbors.

Operator

This concludes today's call. Thank you for your participation. You may now disconnect.