Notes to the
Condensed Consolidated
Financial Statements (unaudited)
Note 1
. Organization and Operations
Two Harbors Investment Corp., or the Company, is a Maryland corporation investing in, financing and managing Agency residential mortgage-backed securities, or Agency RMBS, non-Agency securities, mortgage servicing rights, or MSR, and other financial assets. The Company’s Chief Investment Officer manages the investment portfolio as a whole and resources are allocated and financial performance is assessed on a consolidated basis. The Company is externally managed and advised by PRCM Advisers LLC, or PRCM Advisers, which is a subsidiary of Pine River Capital Management L.P., or Pine River. The Company’s common stock is listed on the NYSE under the symbol “TWO”.
The Company was incorporated on May 21, 2009, and commenced operations as a publicly traded company on October 28, 2009, upon completion of a merger with Capitol Acquisition Corp., or Capitol, which became a wholly owned indirect subsidiary of the Company as a result of the merger.
The Company has elected to be treated as a real estate investment trust, or REIT, as defined under the Internal Revenue Code of 1986, as amended, or the Code, for U.S. federal income tax purposes. As long as the Company continues to comply with a number of requirements under federal tax law and maintains its qualification as a REIT, the Company generally will not be subject to U.S. federal income taxes to the extent that the Company distributes its taxable income to its stockholders on an annual basis and does not engage in prohibited transactions. However, certain activities that the Company may perform may cause it to earn income which will not be qualifying income for REIT purposes. The Company has designated certain of its subsidiaries as taxable REIT subsidiaries, or TRSs, as defined in the Code, to engage in such activities.
On June 28, 2017, the Company completed the contribution of its portfolio of commercial real estate assets to Granite Point Mortgage Trust Inc., or Granite Point, a newly formed Maryland corporation intended to qualify as a REIT, externally managed and advised by Pine River, and focused on directly originating, investing in and managing senior floating-rate commercial mortgage loans and other debt and debt-like commercial real estate investments. The Company contributed its equity interests in its wholly owned subsidiary, TH Commercial Holdings LLC, to Granite Point and, in exchange for its contribution, received approximately
33.1 million
shares of common stock of Granite Point, which represented approximately
76.5%
of the outstanding stock of Granite Point upon completion of the initial public offering, or IPO, of its common stock on June 28, 2017. On November 1, 2017, the Company distributed, on a pro rata basis, the
33.1 million
shares of Granite Point common stock that it acquired in connection with the contribution to stockholders holding shares of Two Harbors common stock outstanding as of the close of business on October 20, 2017.
On April 26, 2018, the Company announced that it had entered into a definitive merger agreement pursuant to which the Company would acquire CYS Investments, Inc., or CYS, a Maryland corporation investing in primarily Agency RMBS and treated as a REIT for U.S. federal income tax purposes. The transaction was approved by the stockholders of both the Company and CYS on July 27, 2018, and the merger was completed on July 31, 2018, at which time CYS became a wholly owned subsidiary of the Company. In exchange for all of the shares of CYS common stock outstanding immediately prior to the effective time of the merger, the Company issued approximately
72.6 million
new shares of common stock, as well as aggregate cash consideration of
$15.0 million
, to CYS common stockholders. In addition, the Company issued
3 million
shares of newly classified Series D cumulative redeemable preferred stock and
8 million
shares of newly classified Series E cumulative redeemable preferred stock in exchange for all shares of CYS’s Series A and Series B cumulative redeemable preferred stock outstanding prior to the effective time of the merger.
Note 2
. Basis of Presentation and Significant Accounting Policies
Consolidation and Basis of Presentation
The interim unaudited condensed consolidated financial statements of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission, or SEC. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, have been condensed or omitted according to such SEC rules and regulations. However, management believes that the disclosures included in these interim condensed consolidated financial statements are adequate to make the information presented not misleading.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The condensed consolidated financial statements of the Company include the accounts of all subsidiaries; inter-company accounts and transactions have been eliminated. Certain prior period amounts have been reclassified to conform to the current period presentation. All per share amounts, common shares outstanding and restricted shares for all prior periods presented have been adjusted on a retroactive basis to reflect the Company’s one-for-two reverse stock split effected on November 1, 2017 (refer to
Note 18
-
Stockholders’ Equity
for additional information). The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2017
. In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at
September 30, 2018
and results of operations for all periods presented have been made. The results of operations for the
three and nine months ended
September 30, 2018
should not be construed as indicative of the results to be expected for future periods or the full year.
Due to its controlling ownership interest in Granite Point through November 1, 2017, the Company consolidated Granite Point on its financial statements. Effective November 1, 2017 (the date the
33.1 million
shares of Granite Point common stock were distributed to the Company’s common stockholders), the Company no longer had a controlling interest in Granite Point and, therefore, deconsolidated Granite Point and its subsidiaries from its financial statements and reclassified all of Granite Point’s prior period assets, liabilities and results of operations to discontinued operations.
The Company retains debt securities and excess servicing rights purchased from securitization trusts sponsored by either third parties or the Company’s subsidiaries. The securitization trusts are considered variable interest entities, or VIEs, for financial reporting purposes and, thus, are reviewed for consolidation under the applicable consolidation guidance. Whenever the Company has both the power to direct the activities of a trust that most significantly impact the entities’ performance, and the obligation to absorb losses or the right to receive benefits of the entities that could be significant, the Company consolidates the trust. During the majority of 2017, the Company retained the most subordinate security in each of the securitization trusts, which gave the Company the power to direct the activities of the trusts that most significantly impact the trusts’ performance and the obligation to absorb losses or the right to receive benefits of the securitization trusts that could be significant. As a result, the Company consolidated all of the securitization trusts on its
condensed consolidated
balance sheet. During the fourth quarter of 2017, the Company sold all of the retained subordinated securities thereby removing the Company’s power to direct the activities of the trusts and the obligation to absorb losses or the right to receive benefits of the securitization trusts. As a result, the securitization trusts are no longer consolidated on the Company’s
condensed consolidated
balance sheet and the remaining retained securities are included within non-Agency available-for-sale, or AFS, securities.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make a number of significant estimates. These include estimates of fair value of certain assets and liabilities, amount and timing of credit losses, prepayment rates, the period of time during which the Company anticipates an increase in the fair values of real estate securities sufficient to recover unrealized losses in those securities, and other estimates that affect the reported amounts of certain assets and liabilities as of the date of the consolidated financial statements and the reported amounts of certain revenues and expenses during the reported period. It is likely that changes in these estimates (
e.g.
, valuation changes due to supply and demand, credit performance, prepayments, interest rates, or other reasons) will occur in the near term. The Company’s estimates are inherently subjective in nature and actual results could differ from its estimates and the differences may be material.
Significant Accounting Policies
Included in Note 2 to the Consolidated Financial Statements of the Company’s
2017
Annual Report on Form 10-K is a summary of the Company’s significant accounting policies. Provided below is a summary of additional accounting policies that are significant to the Company’s consolidated financial condition and results of operations for the
nine months ended
September 30, 2018
.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Asset Acquisition
In accordance with U.S. GAAP, the acquirer in a merger transaction is to evaluate whether substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If that threshold is met, the set of acquired assets and associated activities is not deemed a business and is required to be accounted for as an asset acquisition. Upon completion of the merger with CYS on July 31, 2018, approximately
89%
of the CYS assets acquired were Agency RMBS. The Company concluded that they were similar identifiable assets to be grouped to evaluate whether the “substantially all” threshold was met as the Agency RMBS are financial assets with similar risk characteristics associated with managing these assets. Given the concentration of the fair value of the Agency RMBS of the gross assets acquired, the Company concluded that the fair value of the gross assets acquired was concentrated in a group of similar identifiable assets and, therefore, the merger was accounted for as an asset acquisition. The financial results of CYS since the closing date of the acquisition have been included in the Company’s
condensed consolidated
financial statements.
Asset acquisitions are generally accounted for by allocating the cost of the acquisition plus direct transaction costs to the individual assets acquired, including identified intangible assets, and liabilities assumed on a relative fair value basis. This allocation may cause identified assets to be recognized at amounts that are greater than their fair values. However, “non-qualifying” assets, which include financial assets and other current assets, should not be assigned an amount greater than their fair value. The gross assets acquired in the merger consisted most significantly of financial assets and other current assets. The cost of the acquisition of CYS plus direct transaction costs exceeded gross assets acquired less liabilities assumed in the merger. As there were no meaningful nonfinancial assets and non-current assets in this transaction and no identified intangible assets to assign value, the excess consideration and transaction costs were recognized in the
condensed consolidated statements of comprehensive (loss) income
as an expense and an associated reduction in stockholders’ equity.
Reverse Repurchase Agreements
The Company may borrow U.S. Treasury securities through reverse repurchase transactions under its master repurchase agreements to cover short sales. The Company accounts for these reverse repurchase agreements as securities borrowing transactions and records them at amortized cost, which approximates fair value due to their short-term nature, on its
condensed consolidated
balance sheets.
Offsetting Assets and Liabilities
Certain of the Company’s repurchase agreements are governed by underlying agreements that provide for a right of setoff in the event of default by either party to the agreement. The Company also has netting arrangements in place with all derivative counterparties pursuant to standard documentation developed by the International Swap and Derivatives Association, or ISDA, or central clearing exchange agreements, in the case of centrally cleared interest rate swaps. The Company and the counterparty or clearing agency are required to post cash collateral based upon the net underlying market value of the Company’s open positions with the counterparty. Additionally, the Company’s centrally cleared interest rate swaps require that the Company posts an “initial margin” amount determined by the clearing exchange, which is generally intended to be set at a level sufficient to protect the exchange from the interest rate swap’s maximum estimated single-day price movement. The Company also exchanges “variation margin” based upon daily changes in fair value, as measured by the exchange.
Under U.S. GAAP, if the Company has a valid right of setoff, it may offset the related asset and liability and report the net amount. As a result of amendments to rules governing certain central clearing activities, the exchange of variation margin is considered a settlement of the interest rate swap, as opposed to pledged collateral. Accordingly, beginning in the first quarter of 2018 and in subsequent periods, the Company accounts for the receipt or payment of variation margin as a direct reduction to the carrying value of the interest rate swap asset or liability. The receipt or payment of initial margin will continue to be accounted for separate from the interest rate swap asset or liability. As of December 31, 2017, variation margin pledged or received was netted on a counterparty basis and classified within restricted cash, due from counterparties, or due to counterparties on the Company’s
condensed consolidated
balance sheets.
The Company presents repurchase agreements subject to master netting arrangements or similar agreements on a gross basis and derivative assets and liabilities (other than centrally cleared interest rate swaps) subject to such arrangements on a net basis, based on derivative type and counterparty, in its
condensed consolidated
balance sheets. Separately, the Company presents cash collateral subject to such arrangements (other than variation margin on centrally cleared interest rate swaps) on a net basis, based on counterparty, in its
condensed consolidated
balance sheets. However, the Company does not offset repurchase agreements or derivative assets and liabilities (other than centrally cleared interest rate swaps) with the associated cash collateral on its
condensed consolidated
balance sheets.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following tables present information about the Company’s assets and liabilities that are subject to master netting arrangements or similar agreements and can potentially be offset on the Company’s
condensed consolidated
balance sheets as of
September 30, 2018
and
December 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
|
|
|
|
|
|
Gross Amounts Not Offset with Financial Assets (Liabilities) in the Consolidated Balance Sheets
(1)
|
|
|
(in thousands)
|
Gross Amounts of Recognized Assets (Liabilities)
|
|
Gross Amounts Offset in the Consolidated Balance Sheets
|
|
Net Amounts of Assets (Liabilities) Presented in the Consolidated Balance Sheets
|
|
Financial Instruments
|
|
Cash Collateral (Received) Pledged
|
|
Net Amount
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
Derivative assets
|
$
|
864,680
|
|
|
$
|
(461,449
|
)
|
|
$
|
403,231
|
|
|
$
|
(44,643
|
)
|
|
$
|
—
|
|
|
$
|
358,588
|
|
Reverse repurchase agreements
|
759,375
|
|
|
—
|
|
|
759,375
|
|
|
(752,861
|
)
|
|
—
|
|
|
6,514
|
|
Total Assets
|
$
|
1,624,055
|
|
|
$
|
(461,449
|
)
|
|
$
|
1,162,606
|
|
|
$
|
(797,504
|
)
|
|
$
|
—
|
|
|
$
|
365,102
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
Repurchase agreements
|
$
|
(23,806,631
|
)
|
|
$
|
—
|
|
|
$
|
(23,806,631
|
)
|
|
$
|
23,806,631
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Derivative liabilities
|
(1,258,953
|
)
|
|
461,449
|
|
|
(797,504
|
)
|
|
797,504
|
|
|
—
|
|
|
—
|
|
Total Liabilities
|
$
|
(25,065,584
|
)
|
|
$
|
461,449
|
|
|
$
|
(24,604,135
|
)
|
|
$
|
24,604,135
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
|
|
|
|
|
|
Gross Amounts Not Offset with Financial Assets (Liabilities) in the Consolidated Balance Sheets
(1)
|
|
|
(in thousands)
|
Gross Amounts of Recognized Assets (Liabilities)
|
|
Gross Amounts Offset in the Consolidated Balance Sheets
|
|
Net Amounts of Assets (Liabilities) Presented in the Consolidated Balance Sheets
|
|
Financial Instruments
|
|
Cash Collateral (Received) Pledged
|
|
Net Amount
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
Derivative assets
|
$
|
340,576
|
|
|
$
|
(30,658
|
)
|
|
$
|
309,918
|
|
|
$
|
(31,903
|
)
|
|
$
|
—
|
|
|
$
|
278,015
|
|
Total Assets
|
$
|
340,576
|
|
|
$
|
(30,658
|
)
|
|
$
|
309,918
|
|
|
$
|
(31,903
|
)
|
|
$
|
—
|
|
|
$
|
278,015
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
Repurchase agreements
|
$
|
(19,451,207
|
)
|
|
$
|
—
|
|
|
$
|
(19,451,207
|
)
|
|
$
|
19,451,207
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Derivative liabilities
|
(62,561
|
)
|
|
30,658
|
|
|
(31,903
|
)
|
|
31,903
|
|
|
—
|
|
|
—
|
|
Total Liabilities
|
$
|
(19,513,768
|
)
|
|
$
|
30,658
|
|
|
$
|
(19,483,110
|
)
|
|
$
|
19,483,110
|
|
|
$
|
—
|
|
|
$
|
—
|
|
____________________
|
|
(1)
|
Amounts presented are limited in total to the net amount of assets or liabilities presented in the
condensed consolidated
balance sheets by instrument. Excess cash collateral or financial assets that are pledged to counterparties may exceed the financial liabilities subject to a master netting arrangement or similar agreement, or counterparties may have pledged excess cash collateral to the Company that exceed the corresponding financial assets. These excess amounts are excluded from the table above, although separately reported within restricted cash, due from counterparties, or due to counterparties in the Company’s
condensed consolidated
balance sheets.
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Recently Issued and/or Adopted Accounting Standards
Revenue from Contracts with Customers
In May 2014, the Financial Accounting Standards Board, or FASB, issued ASU No. 2014-09, which is a comprehensive revenue recognition standard that supersedes virtually all existing revenue guidance under U.S. GAAP. The standard’s core principle is that an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. As a result of the issuance of ASU No. 2015-14 in August 2015 deferring the effective date of ASU No. 2014-09 by one year, the ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2017, with early adoption prohibited. The Company has evaluated the new guidance and determined that interest income, gains and losses on financial instruments and income from servicing residential mortgage loans are outside the scope of ASC 606,
Revenues from Contracts with Customers
, or ASC 606. For income from servicing residential mortgage loans, the Company considered that the FASB Transition Resource Group members generally agreed that an entity should look to ASC 860,
Transfers and Servicing
, to determine the appropriate accounting for these fees and ASC 606 contains a scope exception for contracts that fall under ASC 860. As a result, the adoption of this ASU did not have a material impact on the Company’s financial condition, results of operations or financial statement disclosures.
Lease Classification and Accounting
In February 2016, the FASB issued ASU No. 2016-02, which requires lessees to recognize on their balance sheets both a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term. The ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2018, with early adoption permitted. The Company has determined this ASU will not have a material impact on the Company’s financial condition, results of operations or financial statement disclosures.
Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued ASU No. 2016-13, which changes the impairment model for most financial assets and certain other instruments. Valuation allowances for credit losses on AFS debt securities will be recognized, rather than direct reductions in the amortized cost of the investments, regardless of whether the impairment is considered to be other-than-temporary. The new model also requires the estimation of lifetime expected credit losses and corresponding recognition of allowance for losses on trade and other receivables, held-to-maturity debt securities, loans, and other instruments held at amortized cost. The ASU requires certain recurring disclosures and is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2019, with early adoption permitted for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2018. The Company is evaluating the adoption of this ASU to determine the impact it may have on its
condensed consolidated
financial statements, which at the date of adoption, will establish an allowance for credit losses on AFS securities which will be derived from the current designated credit reserve with a resulting increase to amortized cost on the securities. The Company also expects adoption of this ASU to impact the recording for the purchase of certain non-Agency securities with purchased credit deterioration by recording an allowance for credit losses with an increase in amortized cost above the purchase price of the same amount. Subsequent changes in expected credit losses will be recognized immediately in earnings as a provision for credit losses until the allowance is reduced to zero. Further favorable changes will result in prospective yield adjustments.
Clarifying the Definition of a Business
In January 2017, the FASB issued ASU No. 2017-01, which changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. The ASU requires an entity to evaluate if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set of transferred assets and activities is not a business. The guida
nce also requires a business to include at least one substantive process and narrows the definition of outputs by more closely aligning it with how outputs are described in ASC 606.
The ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2017, with early adoption permitted. The Company’s adoption of this ASU impacted how the Company accounted for the acquisition of CYS (see discussion above).
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income
In February 2018, the FASB issued ASU No. 2018-02, which permits entities to reclassify tax effects stranded in accumulated other comprehensive income as a result of the Tax Cuts and Jobs Act, or TCJA, to retained earnings and requires entities to disclose whether or not they elected to reclassify the tax effects related to the TCJA as well as their policy for releasing income tax effects from accumulated other comprehensive income. The ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2018, with early adoption permitted. Early adoption of this ASU was elected and applied by recording a cumulative-effect adjustment of
$9.9 million
to retained earnings, with the offsetting impact to accumulated other comprehensive income as of January 1, 2018.
Accounting for Share-Based Payments to Nonemployees
In June 2018, the FASB issued ASU No. 2018-07 to simplify the accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees, with certain exceptions. Under the guidance, equity-classified nonemployee awards will be measured on and fixed at the grant date, rather than measured at fair value at each reporting date until the date at which the nonemployee’s performance is complete. The ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2018, with early adoption permitted. Early adoption of this ASU was elected on July 1, 2018 and applied by recording a cumulative-effect adjustment to retained earnings as of January 1, 2018, which did not have a material impact on the Company’s financial condition, results of operations or financial statement disclosures.
Fair Value Measurement Disclosure Requirements
In August 2018, the FASB issued ASU No. 2018-13, which eliminates, adds and modifies certain disclosure requirements for fair value measurements. Under the guidance, entities are no longer required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but public companies are required to disclose (1) the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements of instruments held at the end of the reporting period and (2) the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. The ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2019, with early adoption permitted. Early adoption of this ASU did not have an impact on the Company’s financial condition or results of operations but resulted in some modified financial statement disclosures.
SEC Disclosure Update and Simplification
In August 2018, the SEC adopted a final rule that amends certain disclosure requirements that have become duplicative, overlapping, or outdated in light of other SEC disclosure requirements, U.S. GAAP, or changes in the information environment. However, the guidance also added requirements for entities to include in their interim financial statements a reconciliation of changes in stockholders’ equity for each period for which an income statement is required (both year-to-date and quarterly periods). The final rule is effective for all filings made on or after November 5, 2018. However, the SEC staff said it would not object to a registrant waiting to comply with the new interim disclosure requirement until the filing of its Form 10-Q for the quarter that begins after the effective date. As a result, the Company plans to adopt the new interim disclosure requirement in its Form 10-Q for the three months ended March 31, 2019. The Company has determined this final rule will not have a material impact on the Company’s financial condition, results of operations or financial statement disclosures.
Note 3
. Acquisition of CYS Investments, Inc.
On July 31, 2018, the Company completed the acquisition of CYS through a merger of CYS with and into a wholly owned subsidiary of Two Harbors, in exchange for approximately
72.6 million
shares of Two Harbors common stock, as well as aggregate cash consideration of
$15.0 million
. In accordance with the merger agreement, the number of shares of Two Harbors common stock issued was based on an exchange ratio of
0.4680
and the cash consideration received by CYS common stockholders was
$0.0965
per share. In addition, the Company issued
3 million
shares of newly classified Series D cumulative redeemable preferred stock and
8 million
shares of newly classified Series E cumulative redeemable preferred stock in exchange for all shares of CYS’s Series A and Series B cumulative redeemable preferred stock outstanding prior to the effective time of the merger.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The total purchase price for the merger of
$1.4 billion
consists primarily of Two Harbors common stock issued in exchange for shares of CYS common stock and was calculated based on the closing price of Two Harbors common stock on July 31, 2018 of
$15.50
.
|
|
|
|
|
|
|
|
|
(dollars in thousands, except per share prices)
|
July 31,
2018
|
Common Stock Exchange:
|
|
|
|
CYS common stock outstanding
|
155,102,543
|
|
|
|
Common exchange ratio
|
0.4680
|
|
|
|
Two Harbors common stock to be issued
|
72,587,990
|
|
|
|
Less: fractional shares
|
218
|
|
|
|
Two Harbors common stock issued
|
72,587,772
|
|
|
|
Two Harbors share price
|
$
|
15.50
|
|
|
|
|
|
|
$
|
1,125,114
|
|
Cash in Lieu of Common Stock:
|
|
|
|
Fractional shares
|
218
|
|
|
|
Cash in lieu rate
|
$
|
15.59
|
|
|
|
|
|
|
$
|
3
|
|
Per Share Cash Consideration:
|
|
|
|
CYS common stock outstanding
|
155,102,543
|
|
|
|
Per share cash consideration
|
0.0965
|
|
|
|
|
|
|
|
$
|
14,967
|
|
|
|
|
|
Preferred Stock Exchange:
|
Shares
|
|
|
Series D preferred stock
|
3,000,000
|
|
|
$
|
75,000
|
|
Series E preferred stock
|
8,000,000
|
|
|
$
|
200,000
|
|
|
|
|
|
Total Purchase Price
|
|
|
$
|
1,415,084
|
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
As discussed in
Note 2
-
Basis of Presentation and Significant Accounting Policies
, the merger was accounted for as an asset acquisition. The total purchase price for the merger including direct transaction costs, which exceeded gross assets acquired less liabilities assumed in the merger, was allocated to the individual assets acquired and liabilities assumed on a relative fair value basis, as shown below:
|
|
|
|
|
(in thousands)
|
July 31,
2018
|
Assets:
|
|
Available-for-sale securities, at fair value
|
$
|
10,034,557
|
|
Cash and cash equivalents
|
386
|
|
Restricted cash
|
1,062
|
|
Accrued interest receivable
|
30,646
|
|
Due from counterparties
|
21,572
|
|
Derivative assets, at fair value
|
314,811
|
|
Reverse repurchase agreements
|
761,460
|
|
Other assets
|
11,947
|
|
Total Assets
|
$
|
11,176,441
|
|
Liabilities:
|
|
Repurchase agreements
|
$
|
8,743,527
|
|
Derivative liabilities, at fair value
|
765,837
|
|
Due to counterparties
|
301,287
|
|
Accrued interest payable
|
27,487
|
|
Other liabilities
|
821
|
|
Total Liabilities
|
9,838,959
|
|
Stockholders’ Equity
|
|
Cumulative deficit (acquisition transaction costs)
|
(77,602
|
)
|
Total Stockholders’ Equity
|
$
|
(77,602
|
)
|
|
|
Total Purchase Price
|
$
|
1,415,084
|
|
As there were no meaningful nonfinancial assets and non-current assets in this transaction and no identified intangible assets to assign value, the excess consideration and transaction costs were recognized in the
condensed consolidated statements of comprehensive (loss) income
as an expense and an associated reduction in stockholders’ equity.
The Company also incurred the following charges in connection with the acquisition of CYS, which are included within restructuring charges on the Company’s
condensed consolidated statements of comprehensive (loss) income
, for the
three and nine months ended
September 30, 2018
:
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
(in thousands)
|
2018
|
|
2018
|
Termination benefits
|
$
|
6,216
|
|
|
$
|
6,216
|
|
Contract terminations
|
979
|
|
|
979
|
|
Other associated costs
|
1,043
|
|
|
1,043
|
|
Total
|
$
|
8,238
|
|
|
$
|
8,238
|
|
The Company does not expect to incur additional restructuring costs related to the acquisition of CYS in
2018
or beyond.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 4
. Discontinued Operations
On June 28, 2017, the Company contributed its equity interests in its wholly owned subsidiary, TH Commercial Holdings LLC, to Granite Point and, in exchange for its contribution, received approximately
33.1 million
shares of common stock of Granite Point, representing approximately
76.5%
of the outstanding stock of Granite Point upon completion of the IPO of its common stock on June 28, 2017. On November 1, 2017, the Company distributed, on a pro rata basis, the
33.1 million
shares of Granite Point common stock that it acquired in connection with the contribution to stockholders holding shares of Two Harbors common stock outstanding as of the close of business on October 20, 2017. Due to the Company’s controlling ownership interest in Granite Point through November 1, 2017, its results of operations and financial condition through such date reflect Granite Point’s commercial strategy, which is focused on directly originating, investing in and managing senior floating-rate commercial mortgage loans and other debt and debt-like commercial real estate investments. As of November 1, 2017, the Company no longer had a controlling interest in Granite Point and, therefore, deconsolidated Granite Point and its subsidiaries from its financial statements and reclassified all of Granite Point’s prior period assets, liabilities and results of operations to discontinued operations. In accordance with ASC 845,
Nonmonetary Transactions
, the pro rata distribution of a consolidated subsidiary is recognized at carrying amount within stockholders’ equity. As a result, no gain or loss was recognized on the distribution.
Summarized financial information for the discontinued operations are presented below.
|
|
|
|
|
(in thousands)
|
November 1,
2017
|
Assets:
|
|
Commercial real estate assets
|
$
|
2,233,080
|
|
Available-for-sale securities, at fair value
|
12,814
|
|
Cash and cash equivalents
|
84,183
|
|
Restricted cash
|
2,838
|
|
Accrued interest receivable
|
6,588
|
|
Other assets
|
22,774
|
|
Total Assets
|
$
|
2,362,277
|
|
Liabilities:
|
|
Repurchase agreements
|
$
|
1,516,294
|
|
Dividends payable
|
48
|
|
Other liabilities
|
10,337
|
|
Total Liabilities
|
$
|
1,526,679
|
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
(in thousands)
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Interest income:
|
|
|
|
|
|
Commercial real estate assets
|
$
|
—
|
|
|
$
|
30,595
|
|
|
$
|
—
|
|
|
$
|
80,005
|
|
Available-for-sale securities
|
—
|
|
|
265
|
|
|
—
|
|
|
767
|
|
Other
|
—
|
|
|
4
|
|
|
—
|
|
|
10
|
|
Total interest income
|
—
|
|
|
30,864
|
|
|
—
|
|
|
80,782
|
|
Interest expense
|
—
|
|
|
12,497
|
|
|
—
|
|
|
26,376
|
|
Net interest income
|
—
|
|
|
18,367
|
|
|
—
|
|
|
54,406
|
|
Expenses:
|
|
|
|
|
|
|
|
Management fees
|
—
|
|
|
3,130
|
|
|
—
|
|
|
6,717
|
|
Servicing expenses
|
—
|
|
|
333
|
|
|
—
|
|
|
962
|
|
Other operating expenses
|
—
|
|
|
3,388
|
|
|
—
|
|
|
7,561
|
|
Total expenses
|
—
|
|
|
6,851
|
|
|
—
|
|
|
15,240
|
|
Income from discontinued operations before income taxes
|
—
|
|
|
11,516
|
|
|
—
|
|
|
39,166
|
|
Benefit from income taxes
|
—
|
|
|
(2
|
)
|
|
—
|
|
|
(3
|
)
|
Income from discontinued operations
|
—
|
|
|
11,518
|
|
|
—
|
|
|
39,169
|
|
Income from discontinued operations attributable to noncontrolling interest
|
—
|
|
|
2,674
|
|
|
—
|
|
|
2,714
|
|
Income from discontinued operations attributable to common stockholders
|
$
|
—
|
|
|
$
|
8,844
|
|
|
$
|
—
|
|
|
$
|
36,455
|
|
Note 5
. Available-for-Sale Securities, at Fair Value
The Company holds AFS investment securities which are carried at fair value on the
condensed consolidated
balance sheets. The following table presents the Company’s AFS investment securities by collateral type as of
September 30, 2018
and
December 31, 2017
:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Agency
|
|
|
|
Federal National Mortgage Association
|
$
|
16,905,970
|
|
|
$
|
13,920,721
|
|
Federal Home Loan Mortgage Corporation
|
4,138,060
|
|
|
3,616,967
|
|
Government National Mortgage Association
|
1,074,916
|
|
|
701,037
|
|
Non-Agency
|
3,819,970
|
|
|
2,982,094
|
|
Total available-for-sale securities
|
$
|
25,938,916
|
|
|
$
|
21,220,819
|
|
At
September 30, 2018
and
December 31, 2017
, the Company pledged AFS securities with a carrying value of
$24.6 billion
and
$21.0 billion
, respectively, as collateral for repurchase agreements and advances from the Federal Home Loan Bank of Des Moines, or the FHLB. See
Note 14
-
Repurchase Agreements
and
Note 15
-
Federal Home Loan Bank of Des Moines Advances
.
At
September 30, 2018
and
December 31, 2017
, the Company did not have any securities purchased from and financed with the same counterparty that did not meet the conditions of ASC 860, to be considered linked transactions and, therefore, classified as derivatives.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The Company is not required to consolidate VIEs for which it has concluded it does not have both the power to direct the activities of the VIEs that most significantly impact the entities’ performance, and the obligation to absorb losses or the right to receive benefits of the entities that could be significant. The Company’s investments in these unconsolidated VIEs include all non-Agency securities, which are classified within available-for-sale securities, at fair value on the
condensed consolidated
balance sheets. As of
September 30, 2018
and
December 31, 2017
, the carrying value, which also represents the maximum exposure to loss, of all non-Agency securities in unconsolidated VIEs was
$3.8 billion
and
$3.0 billion
, respectively.
The following tables present the amortized cost and carrying value of AFS securities by collateral type as of
September 30, 2018
and
December 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
(in thousands)
|
Principal/ Current Face
|
|
Un-amortized Premium
|
|
Accretable Purchase Discount
|
|
Credit Reserve Purchase Discount
|
|
Amortized Cost
|
|
Unrealized Gain
|
|
Unrealized Loss
|
|
Carrying Value
|
Agency
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal and interest
|
$
|
21,566,476
|
|
|
$
|
1,065,985
|
|
|
$
|
(38,957
|
)
|
|
$
|
—
|
|
|
$
|
22,593,504
|
|
|
$
|
7,285
|
|
|
$
|
(665,408
|
)
|
|
$
|
21,935,381
|
|
Interest-only
|
3,228,729
|
|
|
218,997
|
|
|
—
|
|
|
—
|
|
|
218,997
|
|
|
14,812
|
|
|
(50,244
|
)
|
|
183,565
|
|
Total Agency
|
24,795,205
|
|
|
1,284,982
|
|
|
(38,957
|
)
|
|
—
|
|
|
22,812,501
|
|
|
22,097
|
|
|
(715,652
|
)
|
|
22,118,946
|
|
Non-Agency
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal and interest
|
5,076,875
|
|
|
6,566
|
|
|
(684,614
|
)
|
|
(1,194,749
|
)
|
|
3,204,078
|
|
|
552,816
|
|
|
(9,093
|
)
|
|
3,747,801
|
|
Interest-only
|
5,196,493
|
|
|
70,511
|
|
|
—
|
|
|
—
|
|
|
70,511
|
|
|
4,264
|
|
|
(2,606
|
)
|
|
72,169
|
|
Total Non-Agency
|
10,273,368
|
|
|
77,077
|
|
|
(684,614
|
)
|
|
(1,194,749
|
)
|
|
3,274,589
|
|
|
557,080
|
|
|
(11,699
|
)
|
|
3,819,970
|
|
Total
|
$
|
35,068,573
|
|
|
$
|
1,362,059
|
|
|
$
|
(723,571
|
)
|
|
$
|
(1,194,749
|
)
|
|
$
|
26,087,090
|
|
|
$
|
579,177
|
|
|
$
|
(727,351
|
)
|
|
$
|
25,938,916
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
(in thousands)
|
Principal/ Current Face
|
|
Un-amortized Premium
|
|
Accretable Purchase Discount
|
|
Credit Reserve Purchase Discount
|
|
Amortized Cost
|
|
Unrealized Gain
|
|
Unrealized Loss
|
|
Carrying Value
|
Agency
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal and interest
|
$
|
17,081,849
|
|
|
$
|
1,079,246
|
|
|
$
|
(24,638
|
)
|
|
$
|
—
|
|
|
$
|
18,136,457
|
|
|
$
|
42,149
|
|
|
$
|
(134,969
|
)
|
|
$
|
18,043,637
|
|
Interest-only
|
2,941,772
|
|
|
223,289
|
|
|
—
|
|
|
—
|
|
|
223,289
|
|
|
10,955
|
|
|
(39,156
|
)
|
|
195,088
|
|
Total Agency
|
20,023,621
|
|
|
1,302,535
|
|
|
(24,638
|
)
|
|
—
|
|
|
18,359,746
|
|
|
53,104
|
|
|
(174,125
|
)
|
|
18,238,725
|
|
Non-Agency
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal and interest
|
3,758,134
|
|
|
2,757
|
|
|
(676,033
|
)
|
|
(653,613
|
)
|
|
2,431,245
|
|
|
488,931
|
|
|
(3,166
|
)
|
|
2,917,010
|
|
Interest-only
|
5,614,925
|
|
|
65,667
|
|
|
—
|
|
|
—
|
|
|
65,667
|
|
|
2,163
|
|
|
(2,746
|
)
|
|
65,084
|
|
Total Non-Agency
|
9,373,059
|
|
|
68,424
|
|
|
(676,033
|
)
|
|
(653,613
|
)
|
|
2,496,912
|
|
|
491,094
|
|
|
(5,912
|
)
|
|
2,982,094
|
|
Total
|
$
|
29,396,680
|
|
|
$
|
1,370,959
|
|
|
$
|
(700,671
|
)
|
|
$
|
(653,613
|
)
|
|
$
|
20,856,658
|
|
|
$
|
544,198
|
|
|
$
|
(180,037
|
)
|
|
$
|
21,220,819
|
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following tables present the carrying value of the Company’s AFS securities by rate type as of
September 30, 2018
and
December 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
(in thousands)
|
Agency
|
|
Non-Agency
|
|
Total
|
Adjustable Rate
|
$
|
19,594
|
|
|
$
|
3,446,632
|
|
|
$
|
3,466,226
|
|
Fixed Rate
|
22,099,352
|
|
|
373,338
|
|
|
22,472,690
|
|
Total
|
$
|
22,118,946
|
|
|
$
|
3,819,970
|
|
|
$
|
25,938,916
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
(in thousands)
|
Agency
|
|
Non-Agency
|
|
Total
|
Adjustable Rate
|
$
|
23,220
|
|
|
$
|
2,622,710
|
|
|
$
|
2,645,930
|
|
Fixed Rate
|
18,215,505
|
|
|
359,384
|
|
|
18,574,889
|
|
Total
|
$
|
18,238,725
|
|
|
$
|
2,982,094
|
|
|
$
|
21,220,819
|
|
The following table presents the Company’s AFS securities according to their estimated weighted average life classifications as of
September 30, 2018
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
(in thousands)
|
Agency
|
|
Non-Agency
|
|
Total
|
≤ 1 year
|
$
|
11,626
|
|
|
$
|
89,957
|
|
|
$
|
101,583
|
|
> 1 and ≤ 3 years
|
110,610
|
|
|
192,192
|
|
|
302,802
|
|
> 3 and ≤ 5 years
|
273,557
|
|
|
399,152
|
|
|
672,709
|
|
> 5 and ≤ 10 years
|
18,130,930
|
|
|
2,501,914
|
|
|
20,632,844
|
|
> 10 years
|
3,592,223
|
|
|
636,755
|
|
|
4,228,978
|
|
Total
|
$
|
22,118,946
|
|
|
$
|
3,819,970
|
|
|
$
|
25,938,916
|
|
When the Company purchases a credit-sensitive AFS security at a significant discount to its face value, the Company often does not amortize into income a significant portion of this discount that the Company is entitled to earn because the Company does not expect to collect the entire discount due to the inherent credit risk of the security. The Company may also record an other-than-temporary impairment, or OTTI, for a portion of its investment in the security to the extent the Company believes that the amortized cost will exceed the present value of expected future cash flows. The amount of principal that the Company does not amortize into income is designated as a credit reserve on the security, with unamortized net discounts or premiums amortized into income over time to the extent realizable.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following table presents the changes for the
three and nine months ended
September 30, 2018
and
2017
of the net unamortized discount/premium and designated credit reserves on non-Agency AFS securities.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
(in thousands)
|
Designated Credit Reserve
|
|
Net Unamortized Discount/Premium
|
|
Total
|
|
Designated Credit Reserve
|
|
Net Unamortized Discount/Premium
|
|
Total
|
Beginning balance at January 1
|
$
|
(653,613
|
)
|
|
$
|
(607,609
|
)
|
|
$
|
(1,261,222
|
)
|
|
$
|
(367,437
|
)
|
|
$
|
(623,440
|
)
|
|
$
|
(990,877
|
)
|
Acquisitions
|
(606,728
|
)
|
|
(37,924
|
)
|
|
(644,652
|
)
|
|
(217,206
|
)
|
|
(111,938
|
)
|
|
(329,144
|
)
|
Accretion of net discount
|
—
|
|
|
64,538
|
|
|
64,538
|
|
|
—
|
|
|
67,219
|
|
|
67,219
|
|
Realized credit losses
|
20,983
|
|
|
—
|
|
|
20,983
|
|
|
11,385
|
|
|
—
|
|
|
11,385
|
|
Reclassification adjustment for other-than-temporary impairments
|
(363
|
)
|
|
—
|
|
|
(363
|
)
|
|
(429
|
)
|
|
—
|
|
|
(429
|
)
|
Transfers from (to)
|
44,972
|
|
|
(44,972
|
)
|
|
—
|
|
|
44,412
|
|
|
(44,412
|
)
|
|
—
|
|
Sales, calls, other
|
—
|
|
|
18,430
|
|
|
18,430
|
|
|
3,588
|
|
|
81,846
|
|
|
85,434
|
|
Ending balance at September 30
|
$
|
(1,194,749
|
)
|
|
$
|
(607,537
|
)
|
|
$
|
(1,802,286
|
)
|
|
$
|
(525,687
|
)
|
|
$
|
(630,725
|
)
|
|
$
|
(1,156,412
|
)
|
The following table presents the components comprising the carrying value of AFS securities not deemed to be other than temporarily impaired by length of time that the securities had an unrealized loss position as of
September 30, 2018
and
December 31, 2017
. At
September 30, 2018
, the Company held
1,605
AFS securities, of which
522
were in an unrealized loss position for less than twelve consecutive months and
361
were in an unrealized loss position for more than twelve consecutive months. At
December 31, 2017
, the Company held
1,435
AFS securities, of which
253
were in an unrealized loss position for less than twelve consecutive months and
234
were in an unrealized loss position for more than twelve consecutive months. Of the
$15.4 billion
and
$12.2 billion
of AFS securities in an unrealized loss position for less than twelve consecutive months as of
September 30, 2018
and
December 31, 2017
,
$14.8 billion
, or
96.6%
, and
$12.0 billion
, or
98.5%
, respectively, were Agency AFS securities, whose principal and interest are guaranteed by the GSEs.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized Loss Position for
|
|
Less than 12 Months
|
|
12 Months or More
|
|
Total
|
(in thousands)
|
Estimated Fair Value
|
|
Gross Unrealized Losses
|
|
Estimated Fair Value
|
|
Gross Unrealized Losses
|
|
Estimated Fair Value
|
|
Gross Unrealized Losses
|
September 30, 2018
|
$
|
15,358,443
|
|
|
$
|
(309,999
|
)
|
|
$
|
6,941,115
|
|
|
$
|
(417,352
|
)
|
|
$
|
22,299,558
|
|
|
$
|
(727,351
|
)
|
December 31, 2017
|
$
|
12,198,870
|
|
|
$
|
(65,313
|
)
|
|
$
|
2,464,544
|
|
|
$
|
(114,724
|
)
|
|
$
|
14,663,414
|
|
|
$
|
(180,037
|
)
|
Evaluating AFS Securities for Other-Than-Temporary Impairments
In evaluating AFS securities for OTTI, the Company determines whether there has been a significant adverse quarterly change in the cash flow expectations for a security. The Company compares the amortized cost of each security in an unrealized loss position against the present value of expected future cash flows of the security. The Company also considers whether there has been a significant adverse change in the regulatory and/or economic environment as part of this analysis. If the amortized cost of the security is greater than the present value of expected future cash flows using the original yield as the discount rate, an other-than-temporary credit impairment has occurred. If the Company does not intend to sell and will not be more likely than not required to sell the security, the credit loss is recognized in earnings and the balance of the unrealized loss is recognized in either
other comprehensive (loss) income
, net of tax, or
(loss) gain on investment securities
, depending on the accounting treatment. If the Company intends to sell the security or will be more likely than not required to sell the security, the full unrealized loss is recognized in earnings.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
During the
three and nine months ended
September 30, 2018
, the Company recorded
$0.1 million
and
$0.4 million
in other-than-temporary credit impairments on a total of
three
non-Agency securities where the future expected cash flows for each security were less than its amortized cost. During the nine months ended
September 30, 2017
, the Company recorded
$0.4 million
in other-than-temporary credit impairments on
one
non-Agency security where its future expected cash flows were less than its amortized cost. The Company did not record any other-than-temporary credit impairments during the three months ended
September 30, 2017
. As of
September 30, 2018
, impaired securities with a carrying value of
$140.3 million
had actual weighted average cumulative losses of
8.3%
, weighted average three-month prepayment speed of
7.0%
, weighted average 60+ day delinquency of
19.0%
of the pool balance, and weighted average FICO score of
668
. At
September 30, 2018
, the Company did not intend to sell the securities and determined that it was not more likely than not that the Company will be required to sell the securities; therefore, only the projected credit loss was recognized in earnings.
The following table presents the changes in OTTI included in earnings for the
three and nine months ended
September 30, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
(in thousands)
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Cumulative credit loss at beginning of period
|
$
|
(6,663
|
)
|
|
$
|
(6,035
|
)
|
|
$
|
(6,395
|
)
|
|
$
|
(5,606
|
)
|
Additions:
|
|
|
|
|
|
|
|
Other-than-temporary impairments not previously recognized
|
(72
|
)
|
|
—
|
|
|
(157
|
)
|
|
(429
|
)
|
Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments
|
(23
|
)
|
|
—
|
|
|
(206
|
)
|
|
—
|
|
Reductions:
|
|
|
|
|
|
|
|
Decreases related to other-than-temporary impairments on securities paid down
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Decreases related to other-than-temporary impairments on securities sold
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Cumulative credit loss at end of period
|
$
|
(6,758
|
)
|
|
$
|
(6,035
|
)
|
|
$
|
(6,758
|
)
|
|
$
|
(6,035
|
)
|
Cumulative credit losses related to OTTI may be reduced for securities sold as well as for securities that mature, are paid down, or are prepaid such that the outstanding principal balance is reduced to zero. Additionally, increases in cash flows expected to be collected over the remaining life of the security cause a reduction in the cumulative credit loss.
Gross Realized Gains and Losses
Gains and losses from the sale of AFS securities are recorded as realized gains (losses) within
(loss) gain on investment securities
in the Company’s
condensed consolidated statements of comprehensive (loss) income
. For the
three and nine months ended
September 30, 2018
, the Company sold AFS securities for
$5.4 billion
and
$9.2 billion
with an amortized cost of
$5.5 billion
and
$9.3 billion
for net realized losses of
$42.2 million
and
$100.7 million
, respectively. For the
three and nine months ended
September 30, 2017
, the Company sold AFS securities for
$0.6 billion
and
$5.7 billion
with an amortized cost of
$0.6 billion
and
$5.7 billion
for net realized losses of
$3.9 million
and
$21.0 million
, respectively.
The following table presents the gross realized gains and losses on sales of AFS securities for the
three and nine months ended
September 30, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
(in thousands)
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Gross realized gains
|
$
|
6,603
|
|
|
$
|
408
|
|
|
$
|
16,357
|
|
|
$
|
57,133
|
|
Gross realized losses
|
(48,758
|
)
|
|
(4,342
|
)
|
|
(117,075
|
)
|
|
(78,125
|
)
|
Total realized losses on sales, net
|
$
|
(42,155
|
)
|
|
$
|
(3,934
|
)
|
|
$
|
(100,718
|
)
|
|
$
|
(20,992
|
)
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 6
. Servicing Activities
Mortgage Servicing Rights, at Fair Value
One of the Company’s wholly owned subsidiaries has approvals from Fannie Mae and Freddie Mac to own and manage MSR, which represent the right to control the servicing of mortgage loans. The Company and its subsidiaries do not originate or directly service mortgage loans, and instead contract with appropriately licensed subservicers to handle substantially all servicing functions in the name of the subservicer for the loans underlying the Company’s MSR.
The following table summarizes activity related to MSR for the
three and nine months ended
September 30, 2018
and
2017
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
(in thousands)
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Balance at beginning of period
|
$
|
1,450,261
|
|
|
$
|
898,025
|
|
|
$
|
1,086,717
|
|
|
$
|
693,815
|
|
Additions from purchases of mortgage servicing rights
|
201,197
|
|
|
66,280
|
|
|
480,462
|
|
|
340,156
|
|
Additions from sales of residential mortgage loans
|
—
|
|
|
—
|
|
|
—
|
|
|
20
|
|
Subtractions from sales of mortgage servicing rights
|
—
|
|
|
—
|
|
|
—
|
|
|
(946
|
)
|
Changes in fair value due to:
|
|
|
|
|
|
|
|
Changes in valuation inputs or assumptions used in the valuation model
|
62,680
|
|
|
(154
|
)
|
|
209,610
|
|
|
(23,083
|
)
|
Other changes in fair value
(1)
|
(42,085
|
)
|
|
(28,595
|
)
|
|
(107,754
|
)
|
|
(66,543
|
)
|
Other changes
(2)
|
(8,029
|
)
|
|
(4,943
|
)
|
|
(5,011
|
)
|
|
(12,806
|
)
|
Balance at end of period
|
$
|
1,664,024
|
|
|
$
|
930,613
|
|
|
$
|
1,664,024
|
|
|
$
|
930,613
|
|
____________________
|
|
(1)
|
Other changes in fair value primarily represents changes due to the realization of expected cash flows.
|
|
|
(2)
|
Other changes includes purchase price adjustments, contractual prepayment protection, and changes due to the Company’s purchase of the underlying collateral.
|
At
September 30, 2018
and
December 31, 2017
, the Company pledged MSR with a carrying value of
$1.2 billion
and
$0.6 billion
, respectively, as collateral for repurchase agreements and revolving credit facilities. See
Note 14
-
Repurchase Agreements
and
Note 16
-
Revolving Credit Facilities
.
As of
September 30, 2018
and
December 31, 2017
, the key economic assumptions and sensitivity of the fair value of MSR to immediate 10% and 20% adverse changes in these assumptions were as follows:
|
|
|
|
|
|
|
|
|
(dollars in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Weighted average prepayment speed:
|
7.3
|
%
|
|
9.8
|
%
|
Impact on fair value of 10% adverse change
|
$
|
(45,151
|
)
|
|
$
|
(40,100
|
)
|
Impact on fair value of 20% adverse change
|
$
|
(87,971
|
)
|
|
$
|
(77,483
|
)
|
Weighted average delinquency:
|
1.2
|
%
|
|
1.7
|
%
|
Impact on fair value of 10% adverse change
|
$
|
(5,824
|
)
|
|
$
|
(4,274
|
)
|
Impact on fair value of 20% adverse change
|
$
|
(11,593
|
)
|
|
$
|
(8,875
|
)
|
Weighted average discount rate:
|
9.7
|
%
|
|
9.9
|
%
|
Impact on fair value of 10% adverse change
|
$
|
(55,024
|
)
|
|
$
|
(35,137
|
)
|
Impact on fair value of 20% adverse change
|
$
|
(106,220
|
)
|
|
$
|
(68,246
|
)
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
These assumptions and sensitivities are hypothetical and should be considered with caution. Changes in fair value based on 10% and 20% variations in assumptions generally cannot be extrapolated because the relationship of the change in assumptions to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of MSR is calculated without changing any other assumptions. In reality, changes in one factor may result in changes in another (
e.g.
, increased market interest rates may result in lower prepayments and increased credit losses) that could magnify or counteract the sensitivities. Further, these sensitivities show only the change in the asset balances and do not show any expected change in the fair value of the instruments used to manage the interest rates and prepayment risks associated with these assets.
Risk Mitigation Activities
The primary risk associated with the Company’s MSR is interest rate risk and the resulting impact on prepayments. A significant decline in interest rates could lead to higher-than-expected prepayments that could reduce the value of the MSR. The Company economically hedges the impact of these risks with its Agency RMBS portfolio.
Mortgage Servicing Income
The following table presents the components of servicing income recorded on the Company’s
condensed consolidated statements of comprehensive (loss) income
for the
three and nine months ended
September 30, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
(in thousands)
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Servicing fee income
|
$
|
80,690
|
|
|
$
|
53,989
|
|
|
$
|
218,022
|
|
|
$
|
141,923
|
|
Ancillary and other fee income
|
358
|
|
|
310
|
|
|
1,004
|
|
|
615
|
|
Float income
|
8,570
|
|
|
3,088
|
|
|
19,447
|
|
|
5,930
|
|
Total
|
$
|
89,618
|
|
|
$
|
57,387
|
|
|
$
|
238,473
|
|
|
$
|
148,468
|
|
Mortgage Servicing Advances
In connection with the servicing of loans, the Company’s subservicers make certain payments for property taxes and insurance premiums, default and property maintenance payments, as well as advances of principal and interest payments before collecting them from individual borrowers. Servicing advances, including contractual interest, are priority cash flows in the event of a loan principal reduction or foreclosure and ultimate liquidation of the real estate-owned property, thus making their collection reasonably assured. These servicing advances, which are funded by the Company, totaled
$26.1 million
and
$31.1 million
and were included in other assets on the
condensed consolidated
balance sheets as of
September 30, 2018
and
December 31, 2017
, respectively.
Serviced Mortgage Assets
The Company’s total serviced mortgage assets consist of residential mortgage loans underlying MSR, residential mortgage loans held in previous on-balance sheet securitization trusts for which the Company is the named servicing administrator and loans owned and classified as residential mortgage loans held-for-sale. The following table presents the number of loans and unpaid principal balance of the mortgage assets for which the Company manages the servicing as of
September 30, 2018
and
December 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
(dollars in thousands)
|
Number of Loans
|
|
Unpaid Principal Balance
|
|
Number of Loans
|
|
Unpaid Principal Balance
|
Mortgage servicing rights
|
581,677
|
|
|
$
|
131,114,538
|
|
|
454,028
|
|
|
$
|
101,344,054
|
|
Residential mortgage loans in securitization trusts
|
3,663
|
|
|
2,443,368
|
|
|
3,845
|
|
|
2,618,016
|
|
Residential mortgage loans held-for-sale
|
206
|
|
|
33,448
|
|
|
236
|
|
|
37,632
|
|
Other assets
|
17
|
|
|
1,339
|
|
|
24
|
|
|
2,590
|
|
Total serviced mortgage assets
|
585,563
|
|
|
$
|
133,592,693
|
|
|
458,133
|
|
|
$
|
104,002,292
|
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 7
. Residential Mortgage Loans Held-for-Sale, at Fair Value
Residential mortgage loans held-for-sale consists of residential mortgage loans carried at fair value as a result of a fair value option election. The following table presents the carrying value of the Company’s residential mortgage loans held-for-sale as of
September 30, 2018
and
December 31, 2017
:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Unpaid principal balance
|
$
|
33,448
|
|
|
$
|
37,632
|
|
Fair value adjustment
|
(5,911
|
)
|
|
(7,218
|
)
|
Carrying value
|
$
|
27,537
|
|
|
$
|
30,414
|
|
Note 8
. Cash, Cash Equivalents and Restricted Cash
Cash and cash equivalents include cash held in bank accounts and cash held in money market funds on an overnight basis.
The Company is required to maintain certain cash balances with counterparties for securities and derivatives trading activity and collateral for the Company’s repurchase agreements and FHLB advances in restricted accounts. The Company has also placed cash in a restricted account pursuant to a letter of credit on an office space lease.
The following table presents the Company’s restricted cash balances as of
September 30, 2018
and
December 31, 2017
:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Restricted cash balances held by trading counterparties:
|
|
|
|
For securities and loan trading activity
|
$
|
47,450
|
|
|
$
|
27,050
|
|
For derivatives trading activity
|
283,034
|
|
|
191,421
|
|
As restricted collateral for repurchase agreements and Federal Home Loan Bank advances
|
558,088
|
|
|
417,018
|
|
Total restricted cash balances held by trading counterparties
|
888,572
|
|
|
635,489
|
|
Restricted cash balance pursuant to letter of credit on office lease
|
60
|
|
|
347
|
|
Total
|
$
|
888,632
|
|
|
$
|
635,836
|
|
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported on the Company’s
condensed consolidated
balance sheets as of
September 30, 2018
and
December 31, 2017
that sum to the total of the same such amounts shown in the statements of cash flows:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Cash and cash equivalents
|
$
|
422,851
|
|
|
$
|
419,159
|
|
Restricted cash
|
888,632
|
|
|
635,836
|
|
Total cash, cash equivalents and restricted cash
|
$
|
1,311,483
|
|
|
$
|
1,054,995
|
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 9
. Accrued Interest Receivable
The following table presents the Company’s accrued interest receivable by collateral type as of
September 30, 2018
and
December 31, 2017
:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Available-for-sale securities:
|
|
|
|
Agency
|
|
|
|
Federal National Mortgage Association
|
$
|
56,484
|
|
|
$
|
46,517
|
|
Federal Home Loan Mortgage Corporation
|
16,258
|
|
|
12,255
|
|
Government National Mortgage Association
|
5,987
|
|
|
4,635
|
|
Non-Agency
|
5,492
|
|
|
4,740
|
|
Total available-for-sale securities
|
84,221
|
|
|
68,147
|
|
Residential mortgage loans held-for-sale
|
155
|
|
|
162
|
|
Reverse repurchase agreements
|
881
|
|
|
—
|
|
Total
|
$
|
85,257
|
|
|
$
|
68,309
|
|
Note 10
. Derivative Instruments and Hedging Activities
The Company enters into a variety of derivative and non-derivative instruments in connection with its risk management activities. The primary objective for executing these derivative and non-derivative instruments is to mitigate the Company’s economic exposure to future events that are outside its control, principally market risk and cash flow volatility associated with interest rate risk (including associated prepayment risk). Specifically, the Company enters into derivative and non-derivative instruments to economically hedge interest rate risk or “duration mismatch (or gap)” by adjusting the duration of its floating-rate borrowings into fixed-rate borrowings to more closely match the duration of its assets. This particularly applies to floating-rate borrowing agreements with maturities or interest rate resets of less than six months. Typically, the interest receivable terms (
i.e.
, LIBOR) of certain derivatives match the terms of the underlying debt, resulting in an effective conversion of the rate of the related borrowing agreement from floating to fixed. The objective is to manage the cash flows associated with current and anticipated interest payments on borrowings, as well as the ability to roll or refinance borrowings at the desired amount by adjusting the duration.
To help manage the adverse impact of interest rate changes on the value of the Company’s portfolio as well as its cash flows, the Company may, at times, enter into various forward contracts, including short securities, Agency to-be-announced securities, or TBAs, options, futures, swaps, caps and total return swaps. In executing on the Company’s current risk management strategy, the Company has entered into interest rate swap, cap and swaption agreements, TBAs, put and call options for TBAs and total return swaps (based on the Markit IOS Index). The Company has also entered into a number of non-derivative instruments to manage interest rate risk, principally MSR and Agency interest-only securities (see discussion below).
The following summarizes the Company’s significant asset and liability classes, the risk exposure for these classes, and the Company’s risk management activities used to mitigate these risks. The discussion includes both derivative and non-derivative instruments used as part of these risk management activities. Any of the Company’s derivative and non-derivative instruments may be entered into in conjunction with one another in order to mitigate risks. As a result, the following discussions of each type of instrument should be read as a collective representation of the Company’s risk mitigation efforts and should not be considered independent of one another. While the Company uses derivative and non-derivative instruments to achieve the Company’s risk management activities, it is possible that these instruments will not effectively mitigate all or a substantial portion of the Company’s market rate risk. In addition, the Company might elect, at times, not to enter into certain hedging arrangements in order to maintain compliance with REIT requirements.
Balance Sheet Presentation
In accordance with ASC 815,
Derivatives and Hedging
, or ASC 815, the Company records derivative financial instruments on its
condensed consolidated
balance sheets as assets or liabilities at fair value. Changes in fair value are accounted for depending on the use of the derivative instruments and whether they are designated or qualifying as hedge instruments. Due to the volatility of the credit markets and difficulty in effectively matching pricing or cash flows, the Company has not designated any current derivatives as hedging instruments.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following tables present the gross fair value and notional amounts of the Company’s derivative financial instruments treated as trading derivatives as of
September 30, 2018
and
December 31, 2017
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
|
Derivative Assets
|
|
Derivative Liabilities
|
(in thousands)
|
|
Fair Value
|
|
Notional
|
|
Fair Value
|
|
Notional
|
Inverse interest-only securities
|
|
$
|
67,665
|
|
|
$
|
498,826
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Interest rate swap agreements
|
|
238,116
|
|
|
28,128,766
|
|
|
—
|
|
|
2,375,000
|
|
Interest rate cap contracts
|
|
52,370
|
|
|
2,500,000
|
|
|
—
|
|
|
—
|
|
Swaptions, net
|
|
24,912
|
|
|
164,000
|
|
|
—
|
|
|
—
|
|
TBAs
|
|
15,212
|
|
|
1,108,000
|
|
|
(43,314
|
)
|
|
8,216,000
|
|
Put and call options for TBAs, net
|
|
4,954
|
|
|
780,000
|
|
|
(1,329
|
)
|
|
130,000
|
|
Markit IOS total return swaps
|
|
2
|
|
|
49,691
|
|
|
—
|
|
|
—
|
|
Short U.S. Treasuries
|
|
—
|
|
|
—
|
|
|
(752,861
|
)
|
|
800,000
|
|
Total
|
|
$
|
403,231
|
|
|
$
|
33,229,283
|
|
|
$
|
(797,504
|
)
|
|
$
|
11,521,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
|
Derivative Assets
|
|
Derivative Liabilities
|
(in thousands)
|
|
Fair Value
|
|
Notional
|
|
Fair Value
|
|
Notional
|
Inverse interest-only securities
|
|
$
|
91,827
|
|
|
$
|
588,246
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Interest rate swap agreements
|
|
206,773
|
|
|
21,516,125
|
|
|
(29,867
|
)
|
|
6,966,000
|
|
Swaptions, net
|
|
10,405
|
|
|
2,666,000
|
|
|
—
|
|
|
—
|
|
TBAs
|
|
913
|
|
|
733,000
|
|
|
(1,930
|
)
|
|
1,306,000
|
|
Markit IOS total return swaps
|
|
—
|
|
|
—
|
|
|
(106
|
)
|
|
63,507
|
|
Total
|
|
$
|
309,918
|
|
|
$
|
25,503,371
|
|
|
$
|
(31,903
|
)
|
|
$
|
8,335,507
|
|
Comprehensive (Loss) Income
Statement Presentation
The Company has not applied hedge accounting to its current derivative portfolio held to mitigate interest rate risk and credit risk. As a result, the Company is subject to volatility in its earnings due to movement in the unrealized gains and losses associated with its derivative instruments.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following table summarizes the location and amount of gains and losses on derivative instruments reported in the
condensed consolidated statements of comprehensive (loss) income
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative Instruments
|
|
Location of Gain (Loss) Recognized in Income on Derivatives
|
|
Amount of Gain (Loss) Recognized in Income on Derivatives
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
(in thousands)
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Interest rate risk management
|
|
|
|
|
|
|
|
|
TBAs
|
|
Loss on other derivative instruments
|
|
$
|
(45,231
|
)
|
|
$
|
(16,891
|
)
|
|
$
|
(55,766
|
)
|
|
$
|
(45,671
|
)
|
Short U.S. Treasuries
|
|
Loss on other derivative instruments
|
|
1,606
|
|
|
—
|
|
|
1,606
|
|
|
—
|
|
Put and call options for TBAs
|
|
Loss on other derivative instruments
|
|
13,489
|
|
|
(3,405
|
)
|
|
43,328
|
|
|
(22,467
|
)
|
Interest rate swaps - Payers
|
|
Gain (loss) on interest rate swap, cap and swaption agreements
|
|
105,195
|
|
|
17,422
|
|
|
412,291
|
|
|
(27,723
|
)
|
Interest rate swaps - Receivers
|
|
Gain (loss) on interest rate swap, cap and swaption agreements
|
|
(54,653
|
)
|
|
(5,280
|
)
|
|
(252,375
|
)
|
|
22,813
|
|
Swaptions
|
|
Gain (loss) on interest rate swap, cap and swaption agreements
|
|
24,629
|
|
|
(12,349
|
)
|
|
94,933
|
|
|
(62,080
|
)
|
Interest rate caps
|
|
Gain (loss) on interest rate swap, cap and swaption agreements
|
|
686
|
|
|
—
|
|
|
686
|
|
|
—
|
|
Markit IOS total return swaps
|
|
Loss on other derivative instruments
|
|
(302
|
)
|
|
(134
|
)
|
|
371
|
|
|
(821
|
)
|
Non-risk management
|
|
|
|
|
|
|
|
|
|
|
Inverse interest-only securities
|
|
Loss on other derivative instruments
|
|
(1,025
|
)
|
|
1,506
|
|
|
(5,274
|
)
|
|
2,631
|
|
Total
|
|
|
|
$
|
44,394
|
|
|
$
|
(19,131
|
)
|
|
$
|
239,800
|
|
|
$
|
(133,318
|
)
|
For the
three and nine months ended
September 30, 2018
, the Company recognized
$16.2 million
and
$33.9 million
, respectively, of income for the accrual and/or settlement of the net interest expense associated with its interest rate swaps and caps. The income results from receiving either LIBOR interest or a fixed interest rate and paying either a fixed interest rate or LIBOR interest on an average
$31.8 billion
and
$26.2 billion
notional, respectively. For the
three and nine months ended
September 30, 2017
, the Company recognized
$0.4 million
and
$10.9 million
, respectively, of expenses for the accrual and/or settlement of the net interest expense associated with its interest rate swaps and caps. The expenses result from paying either a fixed interest rate or LIBOR interest and receiving either LIBOR interest or a fixed interest rate on an average
$16.7 billion
and
$17.6 billion
notional, respectively.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following tables present information with respect to the volume of activity in the Company’s derivative instruments during the
three and nine months ended
September 30, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2018
|
(in thousands)
|
Beginning of Period Notional Amount
|
|
Additions
|
|
Settlement, Termination, Expiration or Exercise
|
|
End of Period Notional Amount
|
|
Average Notional Amount
|
|
Realized Gain (Loss), net
(1)
|
Inverse interest-only securities
|
$
|
529,056
|
|
|
$
|
—
|
|
|
$
|
(30,230
|
)
|
|
$
|
498,826
|
|
|
$
|
514,879
|
|
|
$
|
—
|
|
Interest rate swap agreements
|
26,047,264
|
|
|
12,544,820
|
|
|
(8,088,318
|
)
|
|
30,503,766
|
|
|
30,144,641
|
|
|
(50,240
|
)
|
Interest rate cap contracts
|
—
|
|
|
2,500,000
|
|
|
—
|
|
|
2,500,000
|
|
|
1,684,783
|
|
|
—
|
|
Swaptions, net
|
(738,000
|
)
|
|
1,164,000
|
|
|
(262,000
|
)
|
|
164,000
|
|
|
(157,663
|
)
|
|
10,374
|
|
TBAs, net
|
3,049,000
|
|
|
21,060,000
|
|
|
(14,785,000
|
)
|
|
9,324,000
|
|
|
6,430,924
|
|
|
(23,067
|
)
|
Short U.S. Treasuries
|
—
|
|
|
(800,000
|
)
|
|
—
|
|
|
(800,000
|
)
|
|
(539,130
|
)
|
|
—
|
|
Put and call options for TBAs, net
|
(320,000
|
)
|
|
(1,710,000
|
)
|
|
1,120,000
|
|
|
(910,000
|
)
|
|
(1,106,120
|
)
|
|
910
|
|
Markit IOS total return swaps
|
51,541
|
|
|
—
|
|
|
(1,850
|
)
|
|
49,691
|
|
|
50,296
|
|
|
(516
|
)
|
Total
|
$
|
28,618,861
|
|
|
$
|
34,758,820
|
|
|
$
|
(22,047,398
|
)
|
|
$
|
41,330,283
|
|
|
$
|
37,022,610
|
|
|
$
|
(62,539
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2017
|
(in thousands)
|
Beginning of Period Notional Amount
|
|
Additions
|
|
Settlement, Termination, Expiration or Exercise
|
|
End of Period Notional Amount
|
|
Average Notional Amount
|
|
Realized Gain (Loss), net
(1)
|
Inverse interest-only securities
|
$
|
659,768
|
|
|
$
|
—
|
|
|
$
|
(38,219
|
)
|
|
$
|
621,549
|
|
|
$
|
642,143
|
|
|
$
|
(40
|
)
|
Interest rate swap agreements
|
14,764,719
|
|
|
9,878,549
|
|
|
(4,626,391
|
)
|
|
20,016,877
|
|
|
16,710,894
|
|
|
36,171
|
|
Swaptions, net
|
1,350,000
|
|
|
5,364,000
|
|
|
(3,900,000
|
)
|
|
2,814,000
|
|
|
2,213,533
|
|
|
(3,264
|
)
|
TBAs, net
|
(1,140,000
|
)
|
|
(1,585,000
|
)
|
|
1,320,000
|
|
|
(1,405,000
|
)
|
|
(1,370,043
|
)
|
|
(14,997
|
)
|
Put and call options for TBAs, net
|
1,285,000
|
|
|
1,905,000
|
|
|
(1,190,000
|
)
|
|
2,000,000
|
|
|
54,402
|
|
|
(3,980
|
)
|
Markit IOS total return swaps
|
68,629
|
|
|
—
|
|
|
(2,734
|
)
|
|
65,895
|
|
|
66,802
|
|
|
—
|
|
Total
|
$
|
16,988,116
|
|
|
$
|
15,562,549
|
|
|
$
|
(8,437,344
|
)
|
|
$
|
24,113,321
|
|
|
$
|
18,317,731
|
|
|
$
|
13,890
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2018
|
(in thousands)
|
Beginning of Period Notional Amount
|
|
Additions
|
|
Settlement, Termination, Expiration or Exercise
|
|
End of Period Notional Amount
|
|
Average Notional Amount
|
|
Realized Gain (Loss), net
(1)
|
Inverse interest-only securities
|
$
|
588,246
|
|
|
$
|
—
|
|
|
$
|
(89,420
|
)
|
|
$
|
498,826
|
|
|
$
|
544,691
|
|
|
$
|
—
|
|
Interest rate swap agreements
|
28,482,125
|
|
|
37,894,452
|
|
|
(35,872,811
|
)
|
|
30,503,766
|
|
|
25,588,646
|
|
|
(46,101
|
)
|
Interest rate cap contracts
|
—
|
|
|
2,500,000
|
|
|
—
|
|
|
2,500,000
|
|
|
567,766
|
|
|
—
|
|
Swaptions, net
|
2,666,000
|
|
|
(74,000
|
)
|
|
(2,428,000
|
)
|
|
164,000
|
|
|
(2,015,260
|
)
|
|
78,266
|
|
TBAs, net
|
(573,000
|
)
|
|
38,773,000
|
|
|
(28,876,000
|
)
|
|
9,324,000
|
|
|
3,210,355
|
|
|
(28,681
|
)
|
Short U.S. Treasuries
|
—
|
|
|
(800,000
|
)
|
|
—
|
|
|
(800,000
|
)
|
|
(181,685
|
)
|
|
—
|
|
Put and call options for TBAs, net
|
—
|
|
|
2,892,000
|
|
|
(3,802,000
|
)
|
|
(910,000
|
)
|
|
(590,168
|
)
|
|
39,452
|
|
Markit IOS total return swaps
|
63,507
|
|
|
—
|
|
|
(13,816
|
)
|
|
49,691
|
|
|
57,303
|
|
|
(765
|
)
|
Total
|
$
|
31,226,878
|
|
|
$
|
81,185,452
|
|
|
$
|
(71,082,047
|
)
|
|
$
|
41,330,283
|
|
|
$
|
27,181,648
|
|
|
$
|
42,171
|
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2017
|
(in thousands)
|
Beginning of Period Notional Amount
|
|
Additions
|
|
Settlement, Termination, Expiration or Exercise
|
|
End of Period Notional Amount
|
|
Average Notional Amount
|
|
Realized Gain (Loss), net
(1)
|
Inverse interest-only securities
|
$
|
740,844
|
|
|
$
|
—
|
|
|
$
|
(119,295
|
)
|
|
$
|
621,549
|
|
|
$
|
681,126
|
|
|
$
|
(40
|
)
|
Interest rate swap agreements
|
20,371,063
|
|
|
23,408,358
|
|
|
(23,762,544
|
)
|
|
20,016,877
|
|
|
17,617,836
|
|
|
47,691
|
|
Swaptions, net
|
225,000
|
|
|
1,109,000
|
|
|
1,480,000
|
|
|
2,814,000
|
|
|
669,377
|
|
|
21,164
|
|
TBAs, net
|
(1,489,000
|
)
|
|
(5,710,400
|
)
|
|
5,794,400
|
|
|
(1,405,000
|
)
|
|
(1,231,793
|
)
|
|
(57,424
|
)
|
Put and call options for TBAs, net
|
(1,136,000
|
)
|
|
4,460,000
|
|
|
(1,324,000
|
)
|
|
2,000,000
|
|
|
(13,289
|
)
|
|
20,166
|
|
Markit IOS total return swaps
|
90,593
|
|
|
—
|
|
|
(24,698
|
)
|
|
65,895
|
|
|
76,670
|
|
|
(181
|
)
|
Total
|
$
|
18,802,500
|
|
|
$
|
23,266,958
|
|
|
$
|
(17,956,137
|
)
|
|
$
|
24,113,321
|
|
|
$
|
17,799,927
|
|
|
$
|
31,376
|
|
____________________
|
|
(1)
|
Excludes net interest paid or received in full settlement of the net interest spread liability.
|
Cash flow activity related to derivative instruments is reflected within the operating activities and investing activities sections of the
condensed consolidated
statements of cash flows. Realized gains and losses and derivative fair value adjustments are reflected within the
realized and unrealized (gain) loss on interest rate swaps, caps and swaptions
and
unrealized loss on other derivative instruments
line items within the operating activities section of the
condensed consolidated
statements of cash flows. The remaining cash flow activity related to derivative instruments is reflected within the (purchases) short sales of other derivative instruments, proceeds from sales (payments for termination) of other derivative instruments, net and
decrease in due to counterparties, net
line items within the investing activities section of the
condensed consolidated
statements of cash flows.
Interest Rate Sensitive Assets/Liabilities
The Company’s Agency RMBS portfolio is generally subject to change in value when mortgage rates decline or increase, depending on the type of investment. Rising mortgage rates generally result in a slowing of refinancing activity, which slows prepayments and results in a decline in the value of the Company’s fixed-rate Agency pools. To mitigate the impact of this risk on the Company’s fixed-rate Agency pool portfolio, the Company maintains a portfolio of fixed-rate interest-only securities and MSR, which increase in value when interest rates increase. As of
September 30, 2018
and
December 31, 2017
, the Company had
$139.5 million
and
$117.8 million
, respectively, of interest-only securities, and
$1.7 billion
and
$1.1 billion
, respectively, of MSR in place to economically hedge its Agency RMBS. Interest-only securities are included in AFS securities, at fair value, in the
condensed consolidated
balance sheets.
The Company monitors its borrowings under repurchase agreements, FHLB advances and revolving credit facilities, which are generally floating-rate debt, in relation to the rate profile of its portfolio. In connection with its risk management activities, the Company enters into a variety of derivative and non-derivative instruments to economically hedge interest rate risk or “duration mismatch (or gap)” by adjusting the duration of its floating-rate borrowings into fixed-rate borrowings to more closely match the duration of its assets. This particularly applies to borrowing agreements with maturities or interest rate resets of less than six months. Typically, the interest receivable terms (
i.e.
, LIBOR) of certain derivatives match the terms of the underlying debt, resulting in an effective conversion of the rate of the related borrowing agreement from floating to fixed. The objective is to manage the cash flows associated with current and anticipated interest payments on borrowings, as well as the ability to roll or refinance borrowings at the desired amount by adjusting the duration. To help manage the adverse impact of interest rate changes on the value of the Company’s portfolio as well as its cash flows, the Company may, at times, enter into various forward contracts, including short securities, TBAs, options, futures, swaps, caps, credit default swaps and total return swaps. In executing on the Company’s current interest rate risk management strategy, the Company has entered into TBAs, put and call options for TBAs, interest rate swap, cap and swaption agreements and Markit IOS total return swaps.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
TBAs.
At times, the Company may use TBAs as a means of deploying capital until targeted investments are available or to take advantage of temporary displacements, funding advantages or valuation differentials in the marketplace. Additionally, the Company may use TBAs independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. TBAs are forward contracts for the purchase (long notional positions) or sale (short notional positions) of Agency RMBS. The issuer, coupon and stated maturity of the Agency RMBS are predetermined as well as the trade price, face amount and future settle date (published each month by the Securities Industry and Financial Markets Association). However, the specific Agency RMBS to be delivered upon settlement is not known at the time of the TBA transaction. As a result, and because physical delivery of the Agency RMBS upon settlement cannot be assured, the Company accounts for TBAs as derivative instruments.
The Company may hold both long and short notional TBA positions, which are disclosed on a gross basis according to the unrealized gain or loss position of each TBA contract regardless of long or short notional position. The following tables present the notional amount, cost basis, market value and carrying value (which approximates fair value) of the Company’s TBA positions as of
September 30, 2018
and
December 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
|
|
|
|
|
|
Net Carrying Value
(4)
|
(in thousands)
|
Notional Amount
(1)
|
|
Cost Basis
(2)
|
|
Market Value
(3)
|
|
Derivative Assets
|
|
Derivative Liabilities
|
Purchase contracts
|
$
|
11,916,000
|
|
|
$
|
12,393,443
|
|
|
$
|
12,351,423
|
|
|
$
|
1,159
|
|
|
$
|
(43,179
|
)
|
Sale contracts
|
(2,592,000
|
)
|
|
(2,564,838
|
)
|
|
(2,550,920
|
)
|
|
14,053
|
|
|
(135
|
)
|
TBAs, net
|
$
|
9,324,000
|
|
|
$
|
9,828,605
|
|
|
$
|
9,800,503
|
|
|
$
|
15,212
|
|
|
$
|
(43,314
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
|
|
|
|
|
|
Net Carrying Value
(4)
|
(in thousands)
|
Notional Amount
(1)
|
|
Cost Basis
(2)
|
|
Market Value
(3)
|
|
Derivative Assets
|
|
Derivative Liabilities
|
Purchase contracts
|
$
|
733,000
|
|
|
$
|
769,446
|
|
|
$
|
770,359
|
|
|
$
|
913
|
|
|
$
|
—
|
|
Sale contracts
|
(1,306,000
|
)
|
|
(1,316,367
|
)
|
|
(1,318,297
|
)
|
|
—
|
|
|
(1,930
|
)
|
TBAs, net
|
$
|
(573,000
|
)
|
|
$
|
(546,921
|
)
|
|
$
|
(547,938
|
)
|
|
$
|
913
|
|
|
$
|
(1,930
|
)
|
___________________
|
|
(1)
|
Notional amount represents the face amount of the underlying Agency RMBS.
|
|
|
(2)
|
Cost basis represents the forward price to be paid (received) for the underlying Agency RMBS.
|
|
|
(3)
|
Market value represents the current market value of the TBA (or of the underlying Agency RMBS) as of period-end.
|
|
|
(4)
|
Net carrying value represents the difference between the market value of the TBA as of period-end and its cost basis, and is reported in derivative assets / (liabilities), at fair value, in the
condensed consolidated
balance sheets.
|
Short U.S. Treasuries.
The Company may use short U.S. Treasury securities independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. As of
September 30, 2018
, the Company had short sold U.S. Treasuries with a notional amount of
$800.0 million
with a fair market value of
$752.9 million
included in derivative liabilities, at fair value, on the
condensed consolidated
balance sheet as of
September 30, 2018
. The Company did not hold any short U.S. Treasuries as of
December 31, 2017
.
Put and Call Options for TBAs
. The Company may use put and call options for TBAs independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. As of
September 30, 2018
, the Company had purchased put and call options for TBAs with a notional amount of
$3.7 billion
and short sold put and call options for TBAs with a notional amount of
$4.6 billion
. The put and call options had a fair market value of
$5.0 million
included in derivative assets, at fair value, and
$1.3 million
included in derivative liabilities, at fair value, on the
condensed consolidated
balance sheet as of
September 30, 2018
. The Company did not hold any put and call options for TBAs as of
December 31, 2017
.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Interest Rate Swap Agreements
. The Company may use interest rate swaps independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. As of
September 30, 2018
and
December 31, 2017
, the Company held the following interest rate swaps that were utilized as economic hedges of interest rate exposure (or duration) whereby the Company receives interest at a three-month LIBOR rate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(notional in thousands)
|
|
|
|
|
|
|
September 30, 2018
|
Swaps Maturities
|
|
Notional Amount
(1)
|
|
Weighted Average Fixed Pay Rate
(2)
|
|
Weighted Average Receive Rate
(2)
|
|
Weighted Average Maturity (Years)
(2)
|
2018
|
|
$
|
1,000,000
|
|
|
1.008
|
%
|
|
2.336
|
%
|
|
0.01
|
2019
|
|
4,336,897
|
|
|
1.769
|
%
|
|
2.336
|
%
|
|
1.04
|
2020
|
|
5,140,000
|
|
|
1.705
|
%
|
|
2.334
|
%
|
|
2.07
|
2021
|
|
4,117,000
|
|
|
1.550
|
%
|
|
2.362
|
%
|
|
2.94
|
2022 and Thereafter
|
|
8,807,431
|
|
|
2.309
|
%
|
|
2.343
|
%
|
|
7.14
|
Total
|
|
$
|
23,401,328
|
|
|
1.876
|
%
|
|
2.343
|
%
|
|
3.77
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(notional in thousands)
|
|
|
|
|
|
|
December 31, 2017
|
Swaps Maturities
|
|
Notional Amount
(1)
|
|
Weighted Average Fixed Pay Rate
(2)
|
|
Weighted Average Receive Rate
(2)
|
|
Weighted Average Maturity (Years)
(2)
|
2018
|
|
$
|
4,320,000
|
|
|
1.155
|
%
|
|
1.508
|
%
|
|
0.50
|
2019
|
|
5,448,135
|
|
|
1.767
|
%
|
|
1.386
|
%
|
|
1.79
|
2020
|
|
5,490,000
|
|
|
1.945
|
%
|
|
1.509
|
%
|
|
2.87
|
2021
|
|
2,417,000
|
|
|
1.788
|
%
|
|
1.628
|
%
|
|
3.92
|
2022 and Thereafter
|
|
5,245,000
|
|
|
1.764
|
%
|
|
1.516
|
%
|
|
6.44
|
Total
|
|
$
|
22,920,135
|
|
|
1.694
|
%
|
|
1.493
|
%
|
|
3.01
|
____________________
|
|
(1)
|
Notional amount includes
$567.8 million
and
$570.0 million
in forward starting interest rate swaps as of
September 30, 2018
and
December 31, 2017
, respectively.
|
|
|
(2)
|
Weighted averages exclude forward starting interest rate swaps. As of
September 30, 2018
and
December 31, 2017
, the weighted average fixed pay rate on forward starting interest rate swaps was
2.8%
and
2.1%
, respectively.
|
Additionally, as of
September 30, 2018
and
December 31, 2017
, the Company held the following interest rate swaps in order to mitigate mortgage interest rate exposure (or duration) risk whereby the Company pays interest at a three-month LIBOR rate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(notional in thousands)
|
|
|
|
|
|
|
September 30, 2018
|
Swaps Maturities
|
|
Notional Amounts
|
|
Weighted Average Pay Rate
|
|
Weighted Average Fixed Receive Rate
|
|
Weighted Average Maturity (Years)
|
2020
|
|
$
|
250,000
|
|
|
2.347
|
%
|
|
2.258
|
%
|
|
1.31
|
2021
|
|
2,477,438
|
|
|
2.338
|
%
|
|
2.736
|
%
|
|
2.49
|
2022 and Thereafter
|
|
4,375,000
|
|
|
2.333
|
%
|
|
2.696
|
%
|
|
7.32
|
Total
|
|
$
|
7,102,438
|
|
|
2.335
|
%
|
|
2.694
|
%
|
|
5.42
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(notional in thousands)
|
|
|
|
|
|
|
December 31, 2017
|
Swaps Maturities
|
|
Notional Amounts
|
|
Weighted Average Pay Rate
|
|
Weighted Average Fixed Receive Rate
|
|
Weighted Average Maturity (Years)
|
2020
|
|
$
|
200,000
|
|
|
1.391
|
%
|
|
1.642
|
%
|
|
2.60
|
2021
|
|
500,000
|
|
|
1.357
|
%
|
|
1.327
|
%
|
|
3.05
|
2022 and Thereafter
|
|
4,861,990
|
|
|
1.475
|
%
|
|
2.325
|
%
|
|
8.34
|
Total
|
|
$
|
5,561,990
|
|
|
1.462
|
%
|
|
2.211
|
%
|
|
7.66
|
Interest Rate Swaptions
. The Company may use interest rate swaptions (agreements to enter into interest rate swaps in the future for which the Company would either pay or receive a fixed rate) independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. As of
September 30, 2018
and
December 31, 2017
, the Company had the following outstanding interest rate swaptions that were utilized as macro-economic hedges:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
(notional and dollars in thousands)
|
|
Option
|
|
Underlying Swap
|
Swaption
|
|
Expiration
|
|
Cost Basis
|
|
Fair Value
|
|
Average Months to Expiration
|
|
Notional Amount
|
|
Average Pay Rate
|
|
Average Receive Rate
|
|
Average Term (Years)
|
Purchase contracts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payer
|
|
< 6 Months
|
|
$
|
9,400
|
|
|
$
|
30,608
|
|
|
3.64
|
|
|
$
|
5,225,000
|
|
|
3.20
|
%
|
|
3M Libor
|
|
7.6
|
Sale contracts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Receiver
|
|
< 6 Months
|
|
$
|
(9,730
|
)
|
|
$
|
(5,696
|
)
|
|
3.87
|
|
|
$
|
(5,061,000
|
)
|
|
3M Libor
|
|
2.70
|
%
|
|
7.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
(notional and dollars in thousands)
|
|
Option
|
|
Underlying Swap
|
Swaption
|
|
Expiration
|
|
Cost
|
|
Fair Value
|
|
Average Months to Expiration
|
|
Notional Amount
|
|
Average Fixed Pay Rate
|
|
Average Receive Rate
|
|
Average Term (Years)
|
Purchase contracts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payer
|
|
< 6 Months
|
|
$
|
21,380
|
|
|
$
|
17,736
|
|
|
4.03
|
|
|
$
|
7,200,000
|
|
|
2.27
|
%
|
|
3M Libor
|
|
3.8
|
Receiver
|
|
< 6 Months
|
|
$
|
4,660
|
|
|
$
|
2,982
|
|
|
3.72
|
|
|
$
|
2,300,000
|
|
|
3M Libor
|
|
2.10
|
%
|
|
10.0
|
Sale contracts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payer
|
|
< 6 Months
|
|
$
|
(7,950
|
)
|
|
$
|
(5,619
|
)
|
|
4.66
|
|
|
$
|
(1,693,000
|
)
|
|
2.70
|
%
|
|
3M Libor
|
|
10.0
|
Receiver
|
|
< 6 Months
|
|
$
|
(16,260
|
)
|
|
$
|
(4,694
|
)
|
|
5.17
|
|
|
$
|
(5,141,000
|
)
|
|
3M Libor
|
|
1.89
|
%
|
|
5.6
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Interest Rate Cap Contracts
. The Company may use interest rate caps independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. As of
September 30, 2018
, the Company held the following interest rate caps that were utilized as economic hedges of interest rate exposure (or duration) whereby the Company receives interest at a three-month LIBOR rate, net of a fixed cap rate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(notional in thousands)
|
|
|
|
|
|
|
September 30, 2018
|
Caps Maturities
|
|
Notional Amount
|
|
Weighted Average Cap Rate
|
|
Weighted Average Receive Rate
|
|
Weighted Average Maturity (Years)
|
2019
|
|
$
|
800,000
|
|
|
1.344
|
%
|
|
2.339
|
%
|
|
0.78
|
2020
|
|
1,700,000
|
|
|
1.250
|
%
|
|
2.364
|
%
|
|
1.54
|
Total
|
|
$
|
2,500,000
|
|
|
1.280
|
%
|
|
2.356
|
%
|
|
1.29
|
The Company did not hold any interest rate caps as of
December 31, 2017
.
Markit IOS Total Return Swaps
. The Company may use total return swaps (agreements whereby the Company receives or makes payments based on the total return of an underlying instrument or index, such as the Markit IOS Index, in exchange for fixed or floating rate interest payments) independently, or in conjunction with other derivative and non-derivative instruments, in order to mitigate risks. The Company enters into total return swaps to help mitigate the potential impact of larger increases or decreases in interest rates on the performance of our portfolio (referred to as “convexity risk”). Total return swaps based on the Markit IOS Index are intended to synthetically replicate the performance of interest-only securities. The Company had the following total return swap agreements in place at
September 30, 2018
and
December 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(notional and dollars in thousands)
|
|
|
|
|
|
September 30, 2018
|
Maturity Date
|
|
Current Notional Amount
|
|
Fair Value
|
|
Cost Basis
|
|
Unrealized Gain (Loss)
|
January 12, 2043
|
|
$
|
(22,010
|
)
|
|
$
|
(1
|
)
|
|
$
|
(30
|
)
|
|
$
|
29
|
|
January 12, 2044
|
|
(27,681
|
)
|
|
3
|
|
|
(29
|
)
|
|
32
|
|
Total
|
|
$
|
(49,691
|
)
|
|
$
|
2
|
|
|
$
|
(59
|
)
|
|
$
|
61
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(notional and dollars in thousands)
|
|
|
|
|
|
December 31, 2017
|
Maturity Date
|
|
Current Notional Amount
|
|
Fair Value
|
|
Cost Basis
|
|
Unrealized Gain (Loss)
|
January 12, 2043
|
|
$
|
(24,362
|
)
|
|
$
|
(24
|
)
|
|
$
|
201
|
|
|
$
|
(225
|
)
|
January 12, 2044
|
|
(39,145
|
)
|
|
(82
|
)
|
|
366
|
|
|
(448
|
)
|
Total
|
|
$
|
(63,507
|
)
|
|
$
|
(106
|
)
|
|
$
|
567
|
|
|
$
|
(673
|
)
|
Credit Risk
The Company’s exposure to credit losses on its Agency RMBS portfolio is limited due to implicit or explicit backing from the GSEs. The payment of principal and interest on the Freddie Mac and Fannie Mae mortgage-backed securities are guaranteed by those respective agencies, and the payment of principal and interest on the Ginnie Mae mortgage-backed securities are backed by the full faith and credit of the U.S. government.
For non-Agency investment securities and residential mortgage loans, the Company may enter into credit default swaps to hedge credit risk. In future periods, the Company could enhance its credit risk protection, enter into further paired derivative positions, including both long and short credit default swaps, and/or seek opportunistic trades in the event of a market disruption (see discussion under
“Non-Risk Management Activities”
below). The Company also has processes and controls in place to monitor, analyze, manage and mitigate its credit risk with respect to non-Agency securities and residential mortgage loans.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Derivative financial instruments contain an element of credit risk if counterparties are unable to meet the terms of the agreements. Credit risk associated with derivative financial instruments is measured as the net replacement cost should the counterparties that owe the Company under such contracts completely fail to perform under the terms of these contracts, assuming there are no recoveries of underlying collateral, as measured by the market value of the derivative financial instruments. As of
September 30, 2018
, the fair value of derivative financial instruments as an asset and liability position was
$403.2 million
and
$797.5 million
, respectively.
The Company attempts to mitigate its credit risk exposure on derivative financial instruments by limiting its counterparties to banks and financial institutions that meet established credit guidelines. The Company also seeks to spread its credit risk exposure across multiple counterparties in order to reduce its exposure to any single counterparty. Additionally, the Company reduces credit risk on the majority of its derivative instruments by entering into agreements that permit the closeout and netting of transactions with the same counterparty or clearing agency, in the case of centrally cleared interest rate swaps, upon the occurrence of certain events. To further mitigate the risk of counterparty default, the Company maintains collateral agreements with certain of its counterparties and clearing agencies, which require both parties to maintain cash deposits in the event the fair values of the derivative financial instruments exceed established thresholds. The Company’s centrally cleared interest rate swaps require that the Company posts an “initial margin” amount determined by the clearing exchange, which is generally intended to be set at a level sufficient to protect the exchange from the interest rate swap’s maximum estimated single-day price movement. The Company also exchanges “variation margin” based upon daily changes in fair value, as measured by the exchange. As a result of amendments to rules governing certain central clearing activities, the exchange of variation margin is considered a settlement of the interest rate swap, as opposed to pledged collateral. Accordingly, beginning in the first quarter of 2018 and in subsequent periods, the Company accounts for the receipt or payment of variation margin as a direct reduction to the carrying value of the interest rate swap asset or liability. As of December 31, 2017, variation margin pledged or received was netted on a counterparty basis and classified within restricted cash, due from counterparties, or due to counterparties on the Company’s
condensed consolidated
balance sheets.
Non-Risk Management Activities
The Company has entered into certain financial instruments that are considered derivative contracts under ASC 815 that are not for purposes of hedging. These contracts are currently limited to inverse interest-only Agency RMBS.
Inverse Interest-Only Securities
. As of
September 30, 2018
and
December 31, 2017
, inverse interest-only securities with a carrying value of
$67.7 million
and
$91.8 million
, including accrued interest receivable of
$0.6 million
and
$0.9 million
, respectively, are accounted for as derivative financial instruments in the
condensed consolidated
financial statements. The following table presents the amortized cost and carrying value (which approximates fair value) of inverse interest-only securities as of
September 30, 2018
and
December 31, 2017
:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Face Value
|
$
|
498,826
|
|
|
$
|
588,246
|
|
|
|
|
|
Amortized Cost
|
$
|
73,098
|
|
|
$
|
86,734
|
|
Gross unrealized gains
|
2,668
|
|
|
6,843
|
|
Gross unrealized losses
|
(8,726
|
)
|
|
(2,602
|
)
|
Market Value
|
$
|
67,040
|
|
|
$
|
90,975
|
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 11
. Other Assets
Other assets as of
September 30, 2018
and
December 31, 2017
are summarized in the following table:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Property and equipment at cost
|
$
|
6,970
|
|
|
$
|
6,776
|
|
Accumulated depreciation
(1)
|
(6,107
|
)
|
|
(5,550
|
)
|
Net property and equipment
|
863
|
|
|
1,226
|
|
Equity securities, at fair value
|
—
|
|
|
29,413
|
|
Prepaid expenses
|
2,592
|
|
|
1,755
|
|
Income taxes receivable
|
590
|
|
|
130
|
|
Deferred tax assets, net
(2)
|
5,751
|
|
|
25,956
|
|
Servicing advances
|
26,134
|
|
|
31,050
|
|
Federal Home Loan Bank stock
|
40,848
|
|
|
53,826
|
|
Equity investments
|
6,529
|
|
|
3,000
|
|
Other receivables
|
39,121
|
|
|
29,482
|
|
Total other assets
|
$
|
122,428
|
|
|
$
|
175,838
|
|
____________________
|
|
(1)
|
Depreciation expense for the
three and nine months ended
September 30, 2018
was
$0.2 million
and
$0.5 million
, respectively.
|
|
|
(2)
|
Net of valuation allowance of
$2.4 million
and
$2.7 million
, respectively.
|
Note 12
. Other Liabilities
Other liabilities as of
September 30, 2018
and
December 31, 2017
are summarized in the following table:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Accrued expenses
|
$
|
14,979
|
|
|
$
|
24,737
|
|
Income taxes payable
|
4
|
|
|
—
|
|
Other
|
6,141
|
|
|
3,043
|
|
Total other liabilities
|
$
|
21,124
|
|
|
$
|
27,780
|
|
Note 13
. Fair Value
Fair Value Measurements
ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices available in active markets (
i.e.
, observable inputs) and the lowest priority to data lacking transparency (
i.e.
, unobservable inputs). Additionally, ASC 820 requires an entity to consider all aspects of nonperformance risk, including the entity’s own credit standing, when measuring fair value of a liability.
ASC 820 establishes a three-level hierarchy to be used when measuring and disclosing fair value. An instrument’s categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation. Following is a description of the three levels:
|
|
Level 1
|
Inputs are quoted prices in active markets for identical assets or liabilities as of the measurement date under current market conditions. Additionally, the entity must have the ability to access the active market and the quoted prices cannot be adjusted by the entity.
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
|
|
Level 2
|
Inputs include quoted prices in active markets for similar assets or liabilities; quoted prices in inactive markets for identical or similar assets or liabilities; or inputs that are observable or can be corroborated by observable market data by correlation or other means for substantially the full-term of the assets or liabilities.
|
|
|
Level 3
|
Unobservable inputs are supported by little or no market activity. The unobservable inputs represent the assumptions that market participants would use to price the assets and liabilities, including risk. Generally, Level 3 assets and liabilities are valued using pricing models, discounted cash flow methodologies, or similar techniques that require significant judgment or estimation.
|
The following are descriptions of the valuation methodologies used to measure material assets and liabilities at fair value and details of the valuation models, key inputs to those models and significant assumptions utilized.
Available-for-sale securities
. The Company holds a portfolio of AFS securities that are carried at fair value in the
condensed consolidated
balance sheets and primarily comprised of Agency RMBS and non-Agency securities. The Company determines the fair value of its Agency RMBS based upon prices obtained from third-party pricing providers or broker quotes received using bid price, which are deemed indicative of market activity. The third-party pricing providers and brokers use pricing models that generally incorporate such factors as coupons, primary and secondary mortgage rates, rate reset period, issuer, prepayment speeds, credit enhancements and expected life of the security. In determining the fair value of its non-Agency securities, management judgment may be used to arrive at fair value that considers prices obtained from third-party pricing providers, broker quotes received and other applicable market data. If observable market prices are not available or insufficient to determine fair value due principally to illiquidity in the marketplace, then fair value is based upon internally developed models that are primarily based on observable market-based inputs but also include unobservable market data inputs (including prepayment speeds, delinquency levels, and credit losses). The Company classified
99.8%
and
0.2%
of its AFS securities as Level 2 and Level 3 fair value assets, respectively, at
September 30, 2018
. AFS securities account for
92.5%
of all assets reported at fair value at
September 30, 2018
.
Mortgage servicing rights
.
The Company holds a portfolio of MSR that are carried at fair value on the
condensed consolidated
balance sheets. The Company determines fair value of its MSR based on prices obtained from third-party pricing providers. Although MSR transactions are observable in the marketplace, the valuation is based upon cash flow models that include unobservable market data inputs (including prepayment speeds, delinquency levels and discount rates). As a result, the Company classified
100%
of its MSR as Level 3 fair value assets at
September 30, 2018
.
Residential mortgage loans held-for-sale
. The Company holds residential mortgage loans held-for-sale that are carried at fair value in the
condensed consolidated
balance sheets as a result of a fair value option election. The Company determines fair value of its residential mortgage loans based on prices obtained from third-party pricing providers and other applicable market data. If observable market prices are not available or insufficient to determine fair value due principally to illiquidity in the marketplace, then fair value is based upon cash flow models that are primarily based on observable market-based inputs but also include unobservable market data inputs (including prepayment speeds, delinquency levels and credit losses). The Company classified
1.7%
and
98.3%
of its residential mortgage loans held-for-sale as Level 2 and Level 3 fair value assets, respectively, at
September 30, 2018
.
Derivative instruments
. The Company may enter into a variety of derivative financial instruments as part of its hedging strategies. The Company principally executes over-the-counter, or OTC, derivative contracts, such as interest rate swaps, caps, swaptions, put and call options for TBAs and Markit IOS total return swaps. The Company utilizes third-party pricing providers to value its financial derivative instruments. The Company classified
100%
of the interest rate swaps, caps, swaptions, put and call options for TBAs and Markit IOS total return swaps reported at fair value as Level 2 at
September 30, 2018
.
The Company may also enter into certain other derivative financial instruments, such as TBAs, short U.S. Treasuries and inverse interest-only securities. These instruments are similar in form to the Company’s AFS securities and the Company utilizes a pricing service to value TBAs and broker quotes to value short U.S. Treasuries and inverse interest-only securities. The Company classified
100%
of its short U.S. Treasuries and inverse interest-only securities at fair value as Level 2 at
September 30, 2018
. The Company reported
100%
of its TBAs as Level 1 as of
September 30, 2018
.
The Company’s risk management committee governs trading activity relating to derivative instruments. The Company’s policy is to minimize credit exposure related to financial derivatives used for hedging by limiting the hedge counterparties to major banks, financial institutions, exchanges, and private investors who meet established capital and credit guidelines as well as by limiting the amount of exposure to any individual counterparty.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The Company has netting arrangements in place with all derivative counterparties pursuant to standard documentation developed by ISDA, or central clearing exchange agreements, in the case of centrally cleared interest rate swaps. Additionally, both the Company and the counterparty or clearing agency are required to post cash collateral based upon the net underlying market value of the Company’s open positions with the counterparty. Posting of cash collateral typically occurs daily, subject to certain dollar thresholds. Due to the existence of netting arrangements, as well as frequent cash collateral posting at low posting thresholds, credit exposure to the Company and/or to the counterparty or clearing agency is considered materially mitigated. Based on the Company’s assessment, there is no requirement for any additional adjustment to derivative valuations specifically for credit.
Equity securities.
The Company’s equity securities are carried at fair value and reported in other assets on the
condensed consolidated
balance sheets. Changes in fair value are recorded as a component of
(loss) gain on investment securities
in the
condensed consolidated statements of comprehensive (loss) income
. The Company determines fair value of its equity securities based on the closing market price of the securities at period end. The Company did not hold any equity securities at
September 30, 2018
.
The following tables display the Company’s assets and liabilities measured at fair value on a recurring basis. The Company often economically hedges the fair value change of its assets or liabilities with derivatives and other financial instruments. The tables below display the hedges separately from the hedged items, and therefore do not directly display the impact of the Company’s risk management activities.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recurring Fair Value Measurements
|
|
September 30, 2018
|
(in thousands)
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
Assets
|
|
|
|
|
|
|
|
Available-for-sale securities
|
$
|
—
|
|
|
$
|
25,898,916
|
|
|
$
|
40,000
|
|
|
$
|
25,938,916
|
|
Mortgage servicing rights
|
—
|
|
|
—
|
|
|
1,664,024
|
|
|
1,664,024
|
|
Residential mortgage loans held-for-sale
|
—
|
|
|
456
|
|
|
27,081
|
|
|
27,537
|
|
Derivative assets
|
15,212
|
|
|
388,019
|
|
|
—
|
|
|
403,231
|
|
Total assets
|
$
|
15,212
|
|
|
$
|
26,287,391
|
|
|
$
|
1,731,105
|
|
|
$
|
28,033,708
|
|
Liabilities
|
|
|
|
|
|
|
|
Derivative liabilities
|
$
|
43,314
|
|
|
$
|
754,190
|
|
|
$
|
—
|
|
|
$
|
797,504
|
|
Total liabilities
|
$
|
43,314
|
|
|
$
|
754,190
|
|
|
$
|
—
|
|
|
$
|
797,504
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recurring Fair Value Measurements
|
|
December 31, 2017
|
(in thousands)
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
Assets
|
|
|
|
|
|
|
|
Available-for-sale securities
|
$
|
—
|
|
|
$
|
21,067,678
|
|
|
$
|
153,141
|
|
|
$
|
21,220,819
|
|
Mortgage servicing rights
|
—
|
|
|
—
|
|
|
1,086,717
|
|
|
1,086,717
|
|
Residential mortgage loans held-for-sale
|
—
|
|
|
474
|
|
|
29,940
|
|
|
30,414
|
|
Derivative assets
|
913
|
|
|
309,005
|
|
|
—
|
|
|
309,918
|
|
Equity securities
|
29,413
|
|
|
—
|
|
|
—
|
|
|
29,413
|
|
Total assets
|
$
|
30,326
|
|
|
$
|
21,377,157
|
|
|
$
|
1,269,798
|
|
|
$
|
22,677,281
|
|
Liabilities
|
|
|
|
|
|
|
|
Derivative liabilities
|
1,930
|
|
|
29,973
|
|
|
—
|
|
|
31,903
|
|
Total liabilities
|
$
|
1,930
|
|
|
$
|
29,973
|
|
|
$
|
—
|
|
|
$
|
31,903
|
|
The Company may be required to measure certain assets or liabilities at fair value from time to time. These periodic fair value measures typically result from application of certain impairment measures under U.S. GAAP. These items would constitute nonrecurring fair value measures under ASC 820. As of
September 30, 2018
, the Company did not have any assets or liabilities measured at fair value on a nonrecurring basis in the periods presented.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The valuation of Level 3 instruments requires significant judgment by the third-party pricing providers and/or management. The third-party pricing providers and/or management rely on inputs such as market price quotations from market makers (either market or indicative levels), original transaction price, recent transactions in the same or similar instruments, and changes in financial ratios or cash flows to determine fair value. Level 3 instruments may also be discounted to reflect illiquidity and/or non-transferability, with the amount of such discount estimated by the third-party pricing provider in the absence of market information. Assumptions used by the third-party pricing provider due to lack of observable inputs may significantly impact the resulting fair value and therefore the Company’s
condensed consolidated
financial statements. The Company’s valuation committee reviews all valuations that are based on pricing information received from a third-party pricing provider. As part of this review, prices are compared against other pricing or input data points in the marketplace, along with internal valuation expertise, to ensure the pricing is reasonable. In addition, the Company performs back-testing of pricing information to validate price information and identify any pricing trends of a third-party price provider.
In determining fair value, third-party pricing providers use various valuation approaches, including market and income approaches. Inputs that are used in determining fair value of an instrument may include pricing information, credit data, volatility statistics, and other factors. In addition, inputs can be either observable or unobservable.
The availability of observable inputs can vary by instrument and is affected by a wide variety of factors, including the type of instrument, whether the instrument is new and not yet established in the marketplace and other characteristics particular to the instrument. The third-party pricing provider uses prices and inputs that are current as of the measurement date, including during periods of market dislocations. In periods of market dislocation, the availability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified to or from various levels within the fair value hierarchy.
Securities for which market quotations are readily available are valued at the bid price (in the case of long positions) or the ask price (in the case of short positions) at the close of trading on the date as of which value is determined. Exchange-traded securities for which no bid or ask price is available are valued at the last traded price. OTC derivative contracts, including interest rate swaps, caps and swaption agreements, put and call options for TBAs and U.S. Treasuries, constant maturity swaps, credit default swaps and Markit IOS total return swaps, are valued by the Company using observable inputs, specifically quotations received from third-party pricing providers, and are therefore classified within Level 2.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following tables present the reconciliation for all of the Company’s Level 3 assets measured at fair value on a recurring basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
September 30, 2018
|
|
(in thousands)
|
Available-For-Sale Securities
|
|
Mortgage Servicing Rights
|
|
Residential Mortgage Loans Held-For-Sale
|
|
Beginning of period level 3 fair value
|
$
|
153,424
|
|
|
$
|
1,450,261
|
|
|
$
|
28,351
|
|
|
Gains (losses) included in net income:
|
|
|
|
|
|
|
Realized (losses) gains
|
—
|
|
|
(42,089
|
)
|
|
167
|
|
|
Unrealized gains
|
—
|
|
|
62,680
|
|
(1)
|
129
|
|
(3)
|
Net gains (losses) included in net income
|
—
|
|
|
20,591
|
|
|
296
|
|
|
Other comprehensive (loss) income
|
(424
|
)
|
|
—
|
|
|
—
|
|
|
Purchases
|
—
|
|
|
201,197
|
|
|
—
|
|
|
Sales
|
—
|
|
|
4
|
|
|
—
|
|
|
Settlements
|
(113,000
|
)
|
|
(8,029
|
)
|
|
(1,566
|
)
|
|
Gross transfers into level 3
|
—
|
|
|
—
|
|
|
—
|
|
|
Gross transfers out of level 3
|
—
|
|
|
—
|
|
|
—
|
|
|
End of period level 3 fair value
|
$
|
40,000
|
|
|
$
|
1,664,024
|
|
|
$
|
27,081
|
|
|
Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period
|
$
|
—
|
|
|
$
|
62,275
|
|
(2)
|
$
|
127
|
|
(4)
|
Change in unrealized gains or losses for the period included in other comprehensive (loss) income for assets held at the end of the reporting period
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
September 30, 2018
|
|
(in thousands)
|
Available-For-Sale Securities
|
|
Mortgage Servicing Rights
|
|
Residential Mortgage Loans Held-For-Sale
|
|
Beginning of period level 3 fair value
|
$
|
153,141
|
|
|
$
|
1,086,717
|
|
|
$
|
29,940
|
|
|
Gains (losses) included in net income:
|
|
|
|
|
|
|
Realized losses
|
—
|
|
|
(107,359
|
)
|
|
(41
|
)
|
|
Unrealized gains
|
—
|
|
|
209,610
|
|
(1)
|
901
|
|
(3)
|
Net gains (losses) included in net income
|
—
|
|
|
102,251
|
|
|
860
|
|
|
Other comprehensive (loss) income
|
(141
|
)
|
|
—
|
|
|
—
|
|
|
Purchases
|
—
|
|
|
480,462
|
|
|
—
|
|
|
Sales
|
—
|
|
|
(395
|
)
|
|
—
|
|
|
Settlements
|
(113,000
|
)
|
|
(5,011
|
)
|
|
(3,719
|
)
|
|
Gross transfers into level 3
|
—
|
|
|
—
|
|
|
—
|
|
|
Gross transfers out of level 3
|
—
|
|
|
—
|
|
|
—
|
|
|
End of period level 3 fair value
|
$
|
40,000
|
|
|
$
|
1,664,024
|
|
|
$
|
27,081
|
|
|
Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period
|
$
|
—
|
|
|
$
|
201,666
|
|
(2)
|
$
|
806
|
|
(4)
|
Change in unrealized gains or losses for the period included in other comprehensive (loss) income for assets held at the end of the reporting period
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
___________________
|
|
(1)
|
The change in unrealized gains or losses on MSR was recorded in
gain (loss) on servicing asset
on the
condensed consolidated statements of comprehensive (loss) income
.
|
|
|
(2)
|
The change in unrealized gains or losses on MSR that were held at the end of the reporting period was recorded in
gain (loss) on servicing asset
on the
condensed consolidated statements of comprehensive (loss) income
.
|
|
|
(3)
|
The change in unrealized gains or losses on residential mortgage loans held-for-sale was recorded in
other income
on the
condensed consolidated statements of comprehensive (loss) income
.
|
|
|
(4)
|
The change in unrealized gains or losses on residential mortgage loans held-for-sale that were held at the end of the reporting period was recorded in
other income
on the
condensed consolidated statements of comprehensive (loss) income
.
|
The Company did not incur transfers between Level 1, Level 2 or Level 3 during the
three and nine months ended
September 30, 2018
and
2017
. Transfers between Levels are deemed to take place on the first day of the reporting period in which the transfer has taken place.
The Company used broker quotes in the fair value measurement of its Level 3 available-for-sale securities. The significant unobservable inputs used by the broker included expected default, severity and discount rate. Significant increases (decreases) in any of the inputs in isolation may result in significantly lower (higher) fair value measurement.
The Company also used multiple third-party pricing providers in the fair value measurement of its Level 3 MSR. The table below presents information about the significant unobservable inputs used by the third-party pricing providers in the fair value measurement of the Company’s MSR classified as Level 3 fair value assets at
September 30, 2018
:
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
Valuation Technique
|
|
Unobservable Input
(1)
|
|
Range
|
|
Weighted Average
(2)
|
Discounted cash flow
|
|
Constant prepayment speed
|
|
6.4
|
-
|
8.1
|
%
|
|
7.3%
|
|
|
Delinquency
|
|
0.9
|
-
|
1.4
|
%
|
|
1.2%
|
|
|
Discount rate
|
|
8.6
|
-
|
10.8
|
%
|
|
9.7%
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
Valuation Technique
|
|
Unobservable Input
(1)
|
|
Range
|
|
Weighted Average
(2)
|
Discounted cash flow
|
|
Constant prepayment speed
|
|
8.2
|
-
|
11.2
|
%
|
|
9.8%
|
|
|
Delinquency
|
|
1.3
|
-
|
2.0
|
%
|
|
1.7%
|
|
|
Discount rate
|
|
8.3
|
-
|
11.2
|
%
|
|
9.9%
|
___________________
|
|
(1)
|
Significant increases (decreases) in any of the inputs in isolation may result in significantly lower (higher) fair value measurement. A change in the assumption used for discount rates may be accompanied by a directionally similar change in the assumption used for the probability of delinquency and a directionally opposite change in the assumption used for prepayment rates.
|
|
|
(2)
|
Calculated by averaging the weighted average significant unobservable inputs used by the multiple third-party pricing providers in the fair value measurement of MSR.
|
The Company used a third-party pricing provider in the fair value measurement of its Level 3 residential mortgage loans held-for-sale. The significant unobservable inputs used by the third-party pricing provider included expected default, severity and discount rate. Significant increases (decreases) in any of the inputs in isolation may result in significantly lower (higher) fair value measurement.
Fair Value Option for Financial Assets and Financial Liabilities
On July 1, 2015, the Company elected the fair value option for Agency interest-only securities acquired on or after such date. The fair value option was elected to simplify the reporting of changes in fair value. Agency interest-only securities are carried within AFS securities on the
condensed consolidated
balance sheets. The Company’s policy is to separately record interest income, net of premium amortization or including discount accretion, on these fair value elected securities. Fair value adjustments are reported in
(loss) gain on investment securities
on the
condensed consolidated statements of comprehensive (loss) income
.
The Company elected the fair value option for its previously held residential mortgage loans held-for-investment in securitization trusts and the collateralized borrowings in securitization trusts. The fair value option was elected to better reflect the economics of the Company’s retained interests. The Company’s policy was to separately record interest income on the fair value elected loans and interest expense on the fair value elected borrowings. Upfront fees and costs were not deferred or capitalized. Fair value adjustments were reported in
other income
on the
condensed consolidated statements of comprehensive (loss) income
. During the fourth quarter of 2017, the Company sold all of these retained subordinated securities thereby causing the deconsolidation of the securitization trusts from the Company’s consolidated balance sheet. The remaining retained securities are included within non-Agency AFS securities.
The Company has elected the fair value option for its residential mortgage loans held-for-sale. The fair value option was elected to mitigate earnings volatility by better matching the accounting for the assets with the related hedges. The mortgage loans are carried within residential mortgage loans held-for-sale on the
condensed consolidated
balance sheets. The Company’s policy is to separately record interest income on these fair value elected loans. Upfront fees and costs related to the fair value elected loans are not deferred or capitalized. Fair value adjustments are reported in
other income
on the
condensed consolidated statements of comprehensive (loss) income
.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following tables summarize the fair value option elections and information regarding the line items and amounts recognized in the
condensed consolidated statements of comprehensive (loss) income
for each fair value option-elected item.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2018
|
(in thousands)
|
Interest income (expense)
|
|
(Loss) gain on investment securities
|
|
Other income
|
|
Total included in net income
|
|
Change in fair value due to credit risk
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities
|
$
|
(121
|
)
|
|
|
$
|
(469
|
)
|
|
$
|
—
|
|
|
$
|
(590
|
)
|
|
N/A
|
|
|
Residential mortgage loans held-for-investment in securitization trusts
|
—
|
|
(1)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
$
|
—
|
|
(2)
|
Residential mortgage loans held-for-sale
|
332
|
|
(1)
|
|
—
|
|
|
295
|
|
|
627
|
|
|
(251
|
)
|
(3)
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized borrowings in securitization trusts
|
—
|
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
(2)
|
Total
|
$
|
211
|
|
|
|
$
|
(469
|
)
|
|
$
|
295
|
|
|
$
|
37
|
|
|
$
|
(251
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2017
|
(in thousands)
|
Interest income (expense)
|
|
(Loss) gain on investment securities
|
|
Other income
|
|
Total included in net income
|
|
Change in fair value due to credit risk
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities
|
$
|
(2,283
|
)
|
|
|
$
|
4,757
|
|
|
$
|
—
|
|
|
$
|
2,474
|
|
|
N/A
|
|
|
Residential mortgage loans held-for-investment in securitization trusts
|
29,865
|
|
(1)
|
|
—
|
|
|
14,670
|
|
|
44,535
|
|
|
$
|
—
|
|
(2)
|
Residential mortgage loans held-for-sale
|
479
|
|
(1)
|
|
—
|
|
|
355
|
|
|
834
|
|
|
(400
|
)
|
(3)
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized borrowings in securitization trusts
|
(23,970
|
)
|
|
|
—
|
|
|
(7,863
|
)
|
|
(31,833
|
)
|
|
—
|
|
(2)
|
Total
|
$
|
4,091
|
|
|
|
$
|
4,757
|
|
|
$
|
7,162
|
|
|
$
|
16,010
|
|
|
$
|
(400
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2018
|
(in thousands)
|
Interest income (expense)
|
|
(Loss) gain on investment securities
|
|
Other income
|
|
Total included in net income
|
|
Change in fair value due to credit risk
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities
|
$
|
(3,438
|
)
|
|
|
$
|
8,848
|
|
|
$
|
—
|
|
|
$
|
5,410
|
|
|
N/A
|
|
|
Residential mortgage loans held-for-investment in securitization trusts
|
—
|
|
(1)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
$
|
—
|
|
(2)
|
Residential mortgage loans held-for-sale
|
988
|
|
(1)
|
|
—
|
|
|
851
|
|
|
1,839
|
|
|
$
|
(220
|
)
|
(3)
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized borrowings in securitization trusts
|
—
|
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
(2)
|
Total
|
$
|
(2,450
|
)
|
|
|
$
|
8,848
|
|
|
$
|
851
|
|
|
$
|
7,249
|
|
|
$
|
(220
|
)
|
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2017
|
(in thousands)
|
Interest income (expense)
|
|
(Loss) gain on investment securities
|
|
Other income
|
|
Total included in net income
|
|
Change in fair value due to credit risk
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities
|
$
|
(5,565
|
)
|
|
|
$
|
9,124
|
|
|
$
|
—
|
|
|
$
|
3,559
|
|
|
N/A
|
|
|
Residential mortgage loans held-for-investment in securitization trusts
|
92,319
|
|
(1)
|
|
—
|
|
|
45,569
|
|
|
137,888
|
|
|
$
|
—
|
|
(2)
|
Residential mortgage loans held-for-sale
|
1,380
|
|
(1)
|
|
—
|
|
|
2,149
|
|
|
3,529
|
|
|
(1,281
|
)
|
(3)
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized borrowings in securitization trusts
|
(74,199
|
)
|
|
|
—
|
|
|
(30,685
|
)
|
|
(104,884
|
)
|
|
—
|
|
(2)
|
Total
|
$
|
13,935
|
|
|
|
$
|
9,124
|
|
|
$
|
17,033
|
|
|
$
|
40,092
|
|
|
$
|
(1,281
|
)
|
|
____________________
|
|
(1)
|
Interest income on residential mortgage loans held-for-sale and residential mortgage loans held-for-investment in securitization trusts is measured by multiplying the unpaid principal balance on the loans by the coupon rate and the number of days of interest due.
|
|
|
(2)
|
The change in fair value on residential mortgage loans held-for-investment in securitization trusts and collateralized borrowings in securitization trusts was due entirely to changes in market interest rates.
|
|
|
(3)
|
The change in fair value due to credit risk on residential mortgage loans held-for-sale was quantified by holding yield constant in the cash flow model in order to isolate credit risk component.
|
The table below provides the fair value and the unpaid principal balance for the Company’s fair value option-elected loans.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
(in thousands)
|
Unpaid Principal Balance
|
|
Fair
Value
(1)
|
|
Unpaid Principal Balance
|
|
Fair
Value
(1)
|
Residential mortgage loans held-for-sale
|
|
|
|
|
|
|
|
Total loans
|
$
|
33,448
|
|
|
$
|
27,537
|
|
|
$
|
37,632
|
|
|
$
|
30,414
|
|
Nonaccrual loans
|
$
|
10,129
|
|
|
$
|
8,357
|
|
|
$
|
13,511
|
|
|
$
|
10,963
|
|
Loans 90+ days past due
|
$
|
8,932
|
|
|
$
|
7,270
|
|
|
$
|
12,136
|
|
|
$
|
9,857
|
|
____________________
|
|
(1)
|
Excludes accrued interest receivable.
|
Fair Value of Financial Instruments
In accordance with ASC 820, the Company is required to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized in the
condensed consolidated
balance sheets, for which fair value can be estimated.
The following describes the Company’s methods for estimating the fair value for financial instruments.
|
|
•
|
AFS securities, MSR, residential mortgage loans held-for-sale, derivative assets and liabilities and equity securities are recurring fair value measurements; carrying value equals fair value. See discussion of valuation methods and assumptions within the
Fair Value Measurements
section of this
Note 13
.
|
|
|
•
|
Cash and cash equivalents and restricted cash have a carrying value which approximates fair value because of the short maturities of these instruments. The Company categorizes the fair value measurement of these assets as Level 1.
|
|
|
•
|
Reverse repurchase agreements have a carrying value which approximates fair value due to their short-term nature. The Company categorizes the fair value measurement of these assets as Level 2.
|
|
|
•
|
As a condition to membership in the FHLB, the Company is required to purchase and hold a certain amount of FHLB stock, which is considered a non-marketable, long-term investment, and is carried at cost. Because this stock can only be redeemed or sold at its par value, and only to the FHLB, carrying value, or cost, approximates fair value. The Company categorizes the fair value measurement of these assets as Level 3.
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
|
|
•
|
Equity investments include cost method investments for which fair value is not estimated. Carrying value, or cost, approximates fair value. The Company categorizes the fair value measurement of these assets as Level 3.
|
|
|
•
|
The carrying value of repurchase agreements, FHLB advances and revolving credit facilities that mature in less than one year generally approximates fair value due to the short maturities. As of
September 30, 2018
, the Company held
$200.0 million
of repurchase agreements,
$50.0 million
of FHLB advances and
$290.0 million
of revolving credit facilities that are considered long-term. The Company’s long-term repurchase agreements, FHLB advances and revolving credit facilities have floating rates based on an index plus a spread and, for members of the FHLB, the credit spread is typically consistent with those demanded in the market. Accordingly, the interest rates on these borrowings are at market and thus carrying value approximates fair value. The Company categorizes the fair value measurement of these liabilities as Level 2.
|
|
|
•
|
Convertible senior notes are carried at their unpaid principal balance, net of any unamortized deferred issuance costs. The Company estimates the fair value of its convertible senior notes using the market transaction price nearest to
September 30, 2018
. The Company categorizes the fair value measurement of these assets as Level 2.
|
The following table presents the carrying values and estimated fair values of assets and liabilities that are required to be recorded or disclosed at fair value at
September 30, 2018
and
December 31, 2017
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
(in thousands)
|
Carrying Value
|
|
Fair Value
|
|
Carrying Value
|
|
Fair Value
|
Assets
|
|
|
|
|
|
|
|
Available-for-sale securities
|
$
|
25,938,916
|
|
|
$
|
25,938,916
|
|
|
$
|
21,220,819
|
|
|
$
|
21,220,819
|
|
Mortgage servicing rights
|
$
|
1,664,024
|
|
|
$
|
1,664,024
|
|
|
$
|
1,086,717
|
|
|
$
|
1,086,717
|
|
Residential mortgage loans held-for-sale
|
$
|
27,537
|
|
|
$
|
27,537
|
|
|
$
|
30,414
|
|
|
$
|
30,414
|
|
Cash and cash equivalents
|
$
|
422,851
|
|
|
$
|
422,851
|
|
|
$
|
419,159
|
|
|
$
|
419,159
|
|
Restricted cash
|
$
|
888,632
|
|
|
$
|
888,632
|
|
|
$
|
635,836
|
|
|
$
|
635,836
|
|
Derivative assets
|
$
|
403,231
|
|
|
$
|
403,231
|
|
|
$
|
309,918
|
|
|
$
|
309,918
|
|
Reverse repurchase agreements
|
$
|
759,375
|
|
|
$
|
759,375
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Equity securities
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
29,413
|
|
|
$
|
29,413
|
|
Federal Home Loan Bank stock
|
$
|
40,848
|
|
|
$
|
40,848
|
|
|
$
|
53,826
|
|
|
$
|
53,826
|
|
Equity investments
|
$
|
6,529
|
|
|
$
|
6,529
|
|
|
$
|
3,000
|
|
|
$
|
3,000
|
|
Liabilities
|
|
|
|
|
|
|
|
Repurchase agreements
|
$
|
23,806,631
|
|
|
$
|
23,806,631
|
|
|
$
|
19,451,207
|
|
|
$
|
19,451,207
|
|
Federal Home Loan Bank advances
|
$
|
865,024
|
|
|
$
|
865,024
|
|
|
$
|
1,215,024
|
|
|
$
|
1,215,024
|
|
Revolving credit facilities
|
$
|
310,000
|
|
|
$
|
310,000
|
|
|
$
|
20,000
|
|
|
$
|
20,000
|
|
Convertible senior notes
|
$
|
283,555
|
|
|
$
|
296,312
|
|
|
$
|
282,827
|
|
|
$
|
306,351
|
|
Derivative liabilities
|
$
|
797,504
|
|
|
$
|
797,504
|
|
|
$
|
31,903
|
|
|
$
|
31,903
|
|
Note 14
. Repurchase Agreements
As of
September 30, 2018
and
December 31, 2017
, the Company had outstanding
$23.8 billion
and
$19.5 billion
, respectively, of repurchase agreements. Excluding the effect of the Company’s interest rate swaps and caps, the repurchase agreements had a weighted average borrowing rate of
2.45%
and
1.69%
and weighted average remaining maturities of
92
and
83
days as of
September 30, 2018
and
December 31, 2017
, respectively.
At
September 30, 2018
and
December 31, 2017
, the repurchase agreement balances were as follows:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Short-term
|
$
|
23,606,631
|
|
|
$
|
19,338,707
|
|
Long-term
|
200,000
|
|
|
112,500
|
|
Total
|
$
|
23,806,631
|
|
|
$
|
19,451,207
|
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
At
September 30, 2018
and
December 31, 2017
, the repurchase agreements had the following characteristics and remaining maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
Collateral Type
|
|
|
(in thousands)
|
Agency RMBS
|
|
Non-Agency Securities
|
|
Agency Derivatives
|
|
Mortgage Servicing Rights
|
|
Total Amount Outstanding
|
Within 30 days
|
$
|
6,408,843
|
|
|
$
|
485,289
|
|
|
$
|
16,494
|
|
|
$
|
—
|
|
|
$
|
6,910,626
|
|
30 to 59 days
|
1,956,414
|
|
|
494,990
|
|
|
13,884
|
|
|
—
|
|
|
2,465,288
|
|
60 to 89 days
|
5,041
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
5,041
|
|
90 to 119 days
|
5,034,622
|
|
|
501,372
|
|
|
—
|
|
|
—
|
|
|
5,535,994
|
|
120 to 364 days
|
8,099,969
|
|
|
568,631
|
|
|
21,082
|
|
|
—
|
|
|
8,689,682
|
|
One year and over
|
—
|
|
|
—
|
|
|
—
|
|
|
200,000
|
|
|
200,000
|
|
Total
|
$
|
21,504,889
|
|
|
$
|
2,050,282
|
|
|
$
|
51,460
|
|
|
$
|
200,000
|
|
|
$
|
23,806,631
|
|
Weighted average borrowing rate
|
2.32
|
%
|
|
3.59
|
%
|
|
3.20
|
%
|
|
4.37
|
%
|
|
2.45
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
Collateral Type
|
|
|
(in thousands)
|
Agency RMBS
|
|
Non-Agency Securities
|
|
Agency Derivatives
|
|
Mortgage Servicing Rights
|
|
Total Amount Outstanding
|
Within 30 days
|
$
|
3,634,541
|
|
|
$
|
613,500
|
|
|
$
|
21,423
|
|
|
$
|
—
|
|
|
$
|
4,269,464
|
|
30 to 59 days
|
3,522,256
|
|
|
261,835
|
|
|
47,020
|
|
|
—
|
|
|
3,831,111
|
|
60 to 89 days
|
3,165,834
|
|
|
290,628
|
|
|
2,478
|
|
|
—
|
|
|
3,458,940
|
|
90 to 119 days
|
2,119,490
|
|
|
332,614
|
|
|
322
|
|
|
—
|
|
|
2,452,426
|
|
120 to 364 days
|
4,883,432
|
|
|
443,334
|
|
|
—
|
|
|
—
|
|
|
5,326,766
|
|
One year and over
|
—
|
|
|
—
|
|
|
—
|
|
|
112,500
|
|
|
112,500
|
|
Total
|
$
|
17,325,553
|
|
|
$
|
1,941,911
|
|
|
$
|
71,243
|
|
|
$
|
112,500
|
|
|
$
|
19,451,207
|
|
Weighted average borrowing rate
|
1.53
|
%
|
|
2.98
|
%
|
|
2.15
|
%
|
|
3.78
|
%
|
|
1.69
|
%
|
The following table summarizes assets at carrying values that are pledged or restricted as collateral for the future payment obligations of repurchase agreements:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Available-for-sale securities, at fair value
|
$
|
23,636,891
|
|
|
$
|
19,780,175
|
|
Mortgage servicing rights, at fair value
|
733,206
|
|
|
424,740
|
|
Cash and cash equivalents
|
—
|
|
|
15,000
|
|
Restricted cash
|
558,088
|
|
|
417,018
|
|
Due from counterparties
|
1,219,860
|
|
|
773,422
|
|
Derivative assets, at fair value
|
66,980
|
|
|
90,895
|
|
Total
|
$
|
26,215,025
|
|
|
$
|
21,501,250
|
|
Although the transactions under repurchase agreements represent committed borrowings until maturity, the respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets would require the Company to provide additional collateral or fund margin calls.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following table summarizes certain characteristics of the Company’s repurchase agreements and counterparty concentration at
September 30, 2018
and
December 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
(dollars in thousands)
|
Amount Outstanding
|
|
Net Counterparty Exposure
(1)
|
|
Percent of Equity
|
|
Weighted Average Days to Maturity
|
|
Amount Outstanding
|
|
Net Counterparty Exposure
(1)
|
|
Percent of Equity
|
|
Weighted Average Days to Maturity
|
Royal Bank of Canada
|
$
|
1,898,455
|
|
|
$
|
316,471
|
|
|
7
|
%
|
|
146
|
|
$
|
1,261,956
|
|
|
$
|
223,347
|
|
|
6
|
%
|
|
75
|
All other counterparties
(2)
|
21,908,176
|
|
|
1,590,085
|
|
|
34
|
%
|
|
87
|
|
18,189,251
|
|
|
1,519,776
|
|
|
43
|
%
|
|
84
|
Total
|
$
|
23,806,631
|
|
|
$
|
1,906,556
|
|
|
|
|
|
|
$
|
19,451,207
|
|
|
$
|
1,743,123
|
|
|
|
|
|
____________________
|
|
(1)
|
Represents the net carrying value of the assets sold under agreements to repurchase, including accrued interest plus any cash or assets on deposit to secure the repurchase obligation, less the amount of the repurchase liability, including accrued interest. Payables due to broker counterparties for unsettled securities purchases of
$421.1 million
are not included in the
September 30, 2018
amounts presented above. The Company did not have any such payables at
December 31, 2017
.
|
|
|
(2)
|
Represents amounts outstanding with
34
and
26
counterparties at
September 30, 2018
and
December 31, 2017
, respectively.
|
The Company does not anticipate any defaults by its repurchase agreement counterparties. There can be no assurance, however, that any such default or defaults will not occur.
Note 15
. Federal Home Loan Bank of Des Moines Advances
The Company’s wholly owned subsidiary, TH Insurance Holdings Company LLC, or TH Insurance, is a member of the FHLB. As a member of the FHLB, TH Insurance has access to a variety of products and services offered by the FHLB, including secured advances. As of
September 30, 2018
and
December 31, 2017
, TH Insurance had
$0.9 billion
and
$1.2 billion
in outstanding secured advances with a weighted average borrowing rate of
2.48%
and
1.79%
, respectively. As of
September 30, 2018
and
December 31, 2017
, TH Insurance had an additional
$2.7 billion
and
$2.2 billion
of available uncommitted capacity for borrowings, respectively, insofar as TH Insurance holds adequate total assets to support a new advance. To the extent TH Insurance has uncommitted capacity, it may be adjusted at the sole discretion of the FHLB.
The ability to borrow from the FHLB is subject to the Company’s continued creditworthiness, pledging of sufficient eligible collateral to secure advances, and compliance with certain agreements with the FHLB. Each advance requires approval by the FHLB and is secured by collateral in accordance with the FHLB’s credit and collateral guidelines, as may be revised from time to time by the FHLB. Eligible collateral may include conventional 1-4 family residential mortgage loans, Agency RMBS and certain non-Agency securities with a rating of A and above.
On January 11, 2016, the Federal Housing Finance Agency, or FHFA, released a final rule regarding membership in the Federal Home Loan Bank system. Among other effects, the final rule excludes captive insurers from membership eligibility, including the Company’s subsidiary member, TH Insurance. Since TH Insurance was admitted as a member in 2013, it is eligible for a membership grace period that runs through February 19, 2021, during which new advances or renewals that mature beyond the grace period will be prohibited; however, any existing advances that mature beyond this grace period will be permitted to remain in place subject to their terms insofar as the Company maintains good standing with the FHLB. If any new advances or renewals occur, TH Insurance’s outstanding advances will be limited to
40%
of its total assets.
At
September 30, 2018
and
December 31, 2017
, FHLB advances had the following remaining maturities:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
≤ 1 year
|
$
|
815,024
|
|
|
$
|
—
|
|
> 1 and ≤ 3 years
|
—
|
|
|
815,024
|
|
> 3 and ≤ 5 years
|
—
|
|
|
—
|
|
> 5 and ≤ 10 years
|
—
|
|
|
—
|
|
> 10 years
|
50,000
|
|
|
400,000
|
|
Total
|
$
|
865,024
|
|
|
$
|
1,215,024
|
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The following table summarizes assets at carrying values that are pledged or restricted as collateral for the future payment obligations of FHLB advances:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Available-for-sale securities, at fair value
|
$
|
913,608
|
|
|
$
|
1,210,715
|
|
Due from counterparties
|
—
|
|
|
62,959
|
|
Total
|
$
|
913,608
|
|
|
$
|
1,273,674
|
|
The FHLB retains the right to mark the underlying collateral for FHLB advances to fair value. A reduction in the value of pledged assets would require the Company to provide additional collateral. In addition, as a condition to membership in the FHLB, the Company is required to purchase and hold a certain amount of FHLB stock, which is based, in part, upon the outstanding principal balance of advances from the FHLB. At
September 30, 2018
and
December 31, 2017
, the Company had stock in the FHLB totaling
$40.8 million
and
$53.8 million
, respectively, which is included in other assets on the
condensed consolidated
balance sheets. FHLB stock is considered a non-marketable, long-term investment, is carried at cost and is subject to recoverability testing under applicable accounting standards. This stock can only be redeemed or sold at its par value, and only to the FHLB. Accordingly, when evaluating FHLB stock for impairment, the Company considers the ultimate recoverability of the par value rather than recognizing temporary declines in value. As of
September 30, 2018
and
December 31, 2017
, the Company had not recognized an impairment charge related to its FHLB stock.
Note 16
. Revolving Credit Facilities
To finance MSR, the Company has entered into revolving credit facilities collateralized by the value of the MSR pledged. As of
September 30, 2018
and
December 31, 2017
, the Company had outstanding short- and long-term borrowings under revolving credit facilities of
$310.0 million
and
$20.0 million
with a weighted average borrowing rate of
5.36%
and
5.14%
and weighted average remaining maturities of
4.44
and
0.96
years, respectively.
At
September 30, 2018
and
December 31, 2017
, borrowings under revolving credit facilities had the following remaining maturities:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Within 30 days
|
$
|
—
|
|
|
$
|
—
|
|
30 to 59 days
|
—
|
|
|
—
|
|
60 to 89 days
|
20,000
|
|
|
—
|
|
90 to 119 days
|
—
|
|
|
—
|
|
120 to 364 days
|
—
|
|
|
20,000
|
|
One year and over
|
290,000
|
|
|
—
|
|
Total
|
$
|
310,000
|
|
|
$
|
20,000
|
|
Although the transactions under revolving credit facilities represent committed borrowings from the time of funding until maturity, the respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets below a designated threshold would require the Company to provide additional collateral or pay down the facility. As of
September 30, 2018
and
December 31, 2017
, MSR with a carrying value of
$488.5 million
and
$159.5 million
, respectively, was pledged as collateral for the Company’s future payment obligations under its revolving credit facilities. The Company does not anticipate any defaults by its revolving credit facility counterparties, although there can be no assurance that any such default or defaults will not occur.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 17
. Convertible Senior Notes
On January 19, 2017, the Company closed an underwritten public offering of
$287.5 million
aggregate principal amount of convertible senior notes due 2022. The net proceeds from the offering were approximately
$282.2 million
after deducting underwriting discounts and estimated offering expenses payable by the Company. The notes are unsecured, pay interest semiannually at a rate of
6.25%
per annum and are convertible at the option of the holder into shares of the Company’s common stock. The notes will mature in
January 2022
, unless earlier converted or repurchased in accordance with their terms. The Company does not have the right to redeem the notes prior to maturity, but may be required to repurchase the notes from holders under certain circumstances. As of
September 30, 2018
and
December 31, 2017
, the notes had a conversion rate of
62.0780
and
61.4698
shares of common stock per $1,000 principal amount of the notes, respectively
.
The outstanding amount due on the convertible senior notes as of
September 30, 2018
and
December 31, 2017
was
$283.6 million
and
$282.8 million
, respectively, net of deferred issuance costs.
Note 18
. Stockholders’ Equity
Redeemable Preferred Stock
On March 14, 2017, the Company issued
5,000,000
shares of
8.125%
Series A Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, par value
$0.01
per share, in a public offering at a price of
$25.00
per share. On March 21, 2017, an additional
750,000
shares were sold by the Company to the underwriters of the offering pursuant to an overallotment option. Holders of the preferred stock are entitled to receive, when and as declared, a dividend at a fixed rate of
8.125%
per annum of the
$25.00
liquidation preference. On and after April 27, 2027, dividends will accumulate and be payable at a floating rate of three-month LIBOR plus a spread of
5.66%
per annum of the
$25.00
liquidation preference. The preferred stock ranks senior to the Company’s common stock and on parity with the Company’s
7.625%
Series B Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock,
7.25%
Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock,
7.75%
Series D Cumulative Redeemable Preferred Stock and
7.50%
Series E Cumulative Redeemable Preferred Stock with respect to the payment of dividends and the distribution of assets upon the voluntary or involuntary liquidation, dissolution or winding up of the Company. Under certain circumstances upon a change of control, the preferred stock is convertible into shares of the Company’s common stock. The preferred stock will not be redeemable before April 27, 2027, except under certain limited circumstances. On or after April 27, 2027, the Company may, at its option, redeem, in whole or in part, at any time or from time to time, the preferred stock at a redemption price of
$25.00
per share, plus any accumulated and unpaid dividends thereon (whether or not authorized or declared) up to, but excluding, the redemption date. The net proceeds from the offering were approximately
$138.9 million
, after deducting underwriting discounts and estimated offering expenses payable by the Company.
On July 19, 2017, the Company issued
11,500,000
shares of
7.625%
Series B Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, par value
$0.01
per share, in a public offering at a price of
$25.00
per share, which included
1,500,000
shares sold to the underwriters of the offering pursuant to an overallotment option. Holders of the preferred stock are entitled to receive, when and as declared, a dividend at a fixed rate of
7.625%
per annum of the
$25.00
liquidation preference. On and after July 27, 2027, dividends will accumulate and be payable at a floating rate of three-month LIBOR plus a spread of
5.352%
per annum of the
$25.00
liquidation preference. The preferred stock ranks senior to the Company’s common stock and on parity with the Company’s
8.125%
Series A Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock,
7.25%
Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock,
7.75%
Series D Cumulative Redeemable Preferred Stock and
7.50%
Series E Cumulative Redeemable Preferred Stock with respect to the payment of dividends and the distribution of assets upon the voluntary or involuntary liquidation, dissolution or winding up of the Company. Under certain circumstances upon a change of control, the preferred stock is convertible into shares of the Company’s common stock. The preferred stock will not be redeemable before July 27, 2027, except under certain limited circumstances. On or after July 27, 2027, the Company may, at its option, redeem, in whole or in part, at any time or from time to time, the preferred stock at a redemption price of
$25.00
per share, plus any accumulated and unpaid dividends thereon (whether or not authorized or declared) up to, but excluding, the redemption date. The net proceeds from the offering were approximately
$278.1 million
, after deducting underwriting discounts and estimated offering expenses payable by the Company.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
On November 27, 2017, the Company issued
11,000,000
shares of
7.25%
Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, par value
$0.01
per share, in a public offering at a price of
$25.00
per share. On December 1, 2017, an additional
800,000
shares were sold by the Company to the underwriters of the offering pursuant to an overallotment option. Holders of the preferred stock are entitled to receive, when and as declared, a dividend at a fixed rate of
7.25%
per annum of the
$25.00
liquidation preference. On and after January 27, 2025, dividends will accumulate and be payable at a floating rate of three-month LIBOR plus a spread of
5.011%
per annum of the
$25.00
liquidation preference. The preferred stock ranks senior to the Company’s common stock and on parity with the Company’s
8.125%
Series A Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock,
7.625%
Series B Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock,
7.75%
Series D Cumulative Redeemable Preferred Stock and
7.50%
Series E Cumulative Redeemable Preferred Stock with respect to the payment of dividends and the distribution of assets upon the voluntary or involuntary liquidation, dissolution or winding up of the Company. Under certain circumstances upon a change of control, the preferred stock is convertible into shares of the Company’s common stock. The preferred stock will not be redeemable before January 27, 2025, except under certain limited circumstances. On or after January 27, 2025, the Company may, at its option, redeem, in whole or in part, at any time or from time to time, the preferred stock at a redemption price of
$25.00
per share, plus any accumulated and unpaid dividends thereon (whether or not authorized or declared) up to, but excluding, the redemption date. The net proceeds from the offering were approximately
$285.6 million
, after deducting underwriting discounts and estimated offering expenses payable by the Company.
On July 31, 2018, upon the closing of the merger with CYS, the Company issued
3,000,000
shares of newly classified
7.75%
Series D Cumulative Redeemable Preferred Stock, par value
$0.01
per share, and
8,000,000
shares of newly classified
7.50%
Series E Cumulative Redeemable Preferred Stock, par value
$0.01
per share, in exchange for all shares of CYS’s Series A and Series B cumulative redeemable preferred stock outstanding prior to the effective time of the merger. Pursuant to the terms of the merger agreement with CYS, the terms of the Company’s Series D and Series E Cumulative Redeemable Preferred Stock are substantially similar to the terms of CYS’s Series A and Series B Cumulative Redeemable Preferred Stock.
Holders of the
7.75%
Series D Cumulative Redeemable Preferred Stock are entitled to receive, when and as declared, a dividend at a fixed rate of
7.75%
per annum of the
$25.00
liquidation preference. The preferred stock ranks senior to the Company’s common stock and on parity with the Company’s
8.125%
Series A Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock,
7.625%
Series B Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock,
7.25%
Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock and
7.50%
Series E Cumulative Redeemable Preferred Stock with respect to the payment of dividends and the distribution of assets upon the voluntary or involuntary liquidation, dissolution or winding up of the Company. Under certain circumstances upon a change of control, the preferred stock is convertible into shares of the Company’s common stock. The Company may, at its option, redeem, in whole or in part, at any time or from time to time, the preferred stock at a redemption price of
$25.00
per share, plus any accumulated and unpaid dividends thereon (whether or not authorized or declared) up to, but excluding, the redemption date.
Holders of the
7.50%
Series E Cumulative Redeemable Preferred Stock are entitled to receive, when and as declared, a dividend at a fixed rate of
7.50%
per annum of the
$25.00
liquidation preference. The preferred stock ranks senior to the Company’s common stock and on parity with the Company’s
8.125%
Series A Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock,
7.625%
Series B Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock,
7.25%
Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock and
7.75%
Series D Cumulative Redeemable Preferred Stock with respect to the payment of dividends and the distribution of assets upon the voluntary or involuntary liquidation, dissolution or winding up of the Company. Under certain circumstances upon a change of control, the preferred stock is convertible into shares of the Company’s common stock. The Company may, at its option, redeem, in whole or in part, at any time or from time to time, the preferred stock at a redemption price of
$25.00
per share, plus any accumulated and unpaid dividends thereon (whether or not authorized or declared) up to, but excluding, the redemption date.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Distributions to Preferred Stockholders
The following table presents cash dividends declared by the Company on its preferred stock since their issuances:
|
|
|
|
|
|
|
|
|
|
Declaration Date
|
|
Record Date
|
|
Payment Date
|
|
Cash Dividend Per Preferred Share
|
Series A Preferred Stock:
|
|
|
|
|
|
|
September 20, 2018
|
|
October 12, 2018
|
|
October 29, 2018
|
|
$
|
0.507810
|
|
June 19, 2018
|
|
July 12, 2018
|
|
July 27, 2018
|
|
$
|
0.507810
|
|
March 20, 2018
|
|
April 12, 2018
|
|
April 27, 2018
|
|
$
|
0.507810
|
|
December 14, 2017
|
|
January 12, 2018
|
|
January 29, 2018
|
|
$
|
0.507810
|
|
September 14, 2017
|
|
October 12, 2017
|
|
October 27, 2017
|
|
$
|
0.507810
|
|
June 15, 2017
|
|
July 12, 2017
|
|
July 27, 2017
|
|
$
|
0.750430
|
|
Series B Preferred Stock:
|
|
|
|
|
|
|
September 20, 2018
|
|
October 12, 2018
|
|
October 29, 2018
|
|
$
|
0.476560
|
|
June 19, 2018
|
|
July 12, 2018
|
|
July 27, 2018
|
|
$
|
0.476560
|
|
March 20, 2018
|
|
April 12, 2018
|
|
April 27, 2018
|
|
$
|
0.476560
|
|
December 14, 2017
|
|
January 12, 2018
|
|
January 29, 2018
|
|
$
|
0.476560
|
|
September 14, 2017
|
|
October 12, 2017
|
|
October 27, 2017
|
|
$
|
0.518920
|
|
Series C Preferred Stock:
|
|
|
|
|
|
|
September 20, 2018
|
|
October 12, 2018
|
|
October 29, 2018
|
|
$
|
0.453130
|
|
June 19, 2018
|
|
July 12, 2018
|
|
July 27, 2018
|
|
$
|
0.453130
|
|
March 20, 2018
|
|
April 12, 2018
|
|
April 27, 2018
|
|
$
|
0.453130
|
|
December 14, 2017
|
|
January 12, 2018
|
|
January 29, 2018
|
|
$
|
0.302080
|
|
Series D Preferred Stock:
|
|
|
|
|
|
|
September 20, 2018
|
|
October 1, 2018
|
|
October 15, 2018
|
|
$
|
0.484375
|
|
Series E Preferred Stock:
|
|
|
|
|
|
|
September 20, 2018
|
|
October 1, 2018
|
|
October 15, 2018
|
|
$
|
0.468750
|
|
Common Stock
Reverse Stock Split
On September 14, 2017, the Company’s board of directors approved a one-for-two reverse stock split of its outstanding shares of common stock. The reverse stock split was effected on November 1, 2017 at 5:01 p.m. Eastern Time, following the special dividend of Granite Point common stock. At the effective time, every two issued and outstanding shares of the Company’s common stock were converted into one share of common stock. No fractional shares were issued in connection with the reverse stock split; instead, each stockholder holding fractional shares was entitled to receive, in lieu of such fractional shares, cash in an amount determined on the basis of the volume weighted average price of the Company’s common stock on the NYSE on November 1, 2017. In connection with the reverse stock split, the number of authorized shares of the Company’s common stock was also reduced on a one-for-two basis, from
900 million
to
450 million
. The par value of each share of common stock remained unchanged. All per share amounts, common shares outstanding and restricted shares for all periods presented have been adjusted on a retroactive basis to reflect the reverse stock split.
Issuance of Common Stock in Connection with Acquisition of CYS Investments, Inc.
On July 31, 2018, in exchange for all of the shares of CYS common stock outstanding immediately prior to the effective time of the merger, the Company issued approximately
72.6 million
new shares of common stock, as well as aggregate cash consideration of
$15.0 million
, to CYS common stockholders.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
As of
September 30, 2018
, the Company had
248,078,170
shares of common stock outstanding. The following table presents a reconciliation of the common shares outstanding for the
nine months ended
September 30, 2018
and
2017
:
|
|
|
|
|
Number of common shares
|
Common shares outstanding, December 31, 2016
|
173,826,163
|
|
Issuance of common stock
|
19,688
|
|
Issuance of restricted stock
(1)
|
643,505
|
|
Common shares outstanding, September 30, 2017
|
174,489,356
|
|
|
|
Common shares outstanding, December 31, 2017
|
174,496,587
|
|
Issuance of common stock
|
72,608,932
|
|
Issuance of restricted stock
(1)
|
972,651
|
|
Common shares outstanding, September 30, 2018
|
248,078,170
|
|
____________________
|
|
(1)
|
Represents shares of
restricted stock granted under the Second Restated 2009 Equity Incentive Plan, net of forfeitures, of which
1,593,701
restricted shares remained subject to vesting requirements at
September 30, 2018
.
|
Distributions to Common Stockholders
The following table presents cash dividends declared by the Company on its common stock from
December 31, 2016
through
September 30, 2018
:
|
|
|
|
|
|
|
|
|
|
Declaration Date
|
|
Record Date
|
|
Payment Date
|
|
Cash Dividend Per Common Share
|
September 20, 2018
|
|
October 1, 2018
|
|
October 29, 2018
|
|
$
|
0.311630
|
|
July 13, 2018
|
|
July 25, 2018
|
|
July 30, 2018
|
|
$
|
0.158370
|
|
June 19, 2018
|
|
June 29, 2018
|
|
July 27, 2018
|
|
$
|
0.470000
|
|
March 20, 2018
|
|
April 2, 2018
|
|
April 27, 2018
|
|
$
|
0.470000
|
|
December 14, 2017
|
|
December 26, 2017
|
|
December 29, 2017
|
|
$
|
0.470000
|
|
September 14, 2017
|
|
September 29, 2017
|
|
October 27, 2017
|
|
$
|
0.520000
|
|
June 15, 2017
|
|
June 30, 2017
|
|
July 27, 2017
|
|
$
|
0.520000
|
|
March 14, 2017
|
|
March 31, 2017
|
|
April 27, 2017
|
|
$
|
0.500000
|
|
On September 14, 2017, the Company’s board of directors declared a special dividend pursuant to which the
33.1 million
shares of Granite Point common stock acquired by the Company in exchange for the contribution of its equity interests in TH Commercial Holdings LLC to Granite Point on June 28, 2017 would be distributed, on a pro rata basis, to the holders of Two Harbors common stock outstanding at the close of business on October 20, 2017. The Granite Point common stock was distributed on November 1, 2017. Due to its controlling ownership interest in Granite Point through November 1, 2017, the Company consolidated Granite Point on its financial statements. Effective November 1, 2017 (the date the
33.1 million
shares of Granite Point common stock were distributed to the Company’s common stockholders), the Company no longer had a controlling interest in Granite Point and, therefore, deconsolidated Granite Point and its subsidiaries from its financial statements and reclassified all of Granite Point’s prior period assets, liabilities and results of operations to discontinued operations.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Dividend Reinvestment and Direct Stock Purchase Plan
The Company sponsors a dividend reinvestment and direct stock purchase plan through which stockholders may purchase additional shares of the Company’s common stock by reinvesting some or all of the cash dividends received on shares of the Company’s common stock. Stockholders may also make optional cash purchases of shares of the Company’s common stock subject to certain limitations detailed in the plan prospectus. The plan allows for the issuance of up to an aggregate of
3,750,000
shares of the Company’s common stock. As of
September 30, 2018
,
220,301
shares have been issued under the plan for total proceeds of approximately
$4.3 million
, of which
8,692
and
21,160
shares were issued for total proceeds of
$0.1 million
and
$0.3 million
during the
three and nine months ended
September 30, 2018
, respectively. During the
three and nine months ended
September 30, 2017
,
6,469
and
19,688
shares were issued for total proceeds of
$0.1 million
and
$0.4 million
, respectively.
Share Repurchase Program
The Company’s share repurchase program allows for the repurchase of up to an aggregate of
37,500,000
shares of the Company’s common stock. Shares may be repurchased from time to time through privately negotiated transactions or open market transactions, pursuant to a trading plan in accordance with Rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934, as amended, or the Exchange Act, or by any combination of such methods. The manner, price, number and timing of share repurchases are subject to a variety of factors, including market conditions and applicable SEC rules. The share repurchase program does not require the purchase of any minimum number of shares, and, subject to SEC rules, purchases may be commenced or suspended at any time without prior notice. The share repurchase program does not have an expiration date. As of
September 30, 2018
, a total of
12,067,500
shares had been repurchased by the Company under the program for an aggregate cost of
$200.4 million
. No shares were repurchased during the
three and nine months ended
September 30, 2018
and
2017
.
At-the-Market Offering
The Company has entered into an equity distribution agreement under which the Company may sell up to an aggregate of
10,000,000
shares of its common stock from time to time in any method permitted by law deemed to be an “at the market” offering as defined in Rule 415 under the Securities Act of 1933, as amended, or the Securities Act. As of
September 30, 2018
,
3,792,935
shares of common stock have been sold under the equity distribution agreement for total accumulated net proceeds of approximately
$77.6 million
. No shares were sold during the
three and nine months ended
September 30, 2018
and
2017
.
Accumulated Other Comprehensive (Loss) Income
Accumulated other comprehensive (loss) income at
September 30, 2018
and
December 31, 2017
was as follows:
|
|
|
|
|
|
|
|
|
(in thousands)
|
September 30,
2018
|
|
December 31,
2017
|
Available-for-sale securities
|
|
|
|
Unrealized gains
|
$
|
522,365
|
|
|
$
|
475,694
|
|
Unrealized losses
|
(677,094
|
)
|
|
(140,881
|
)
|
Accumulated other comprehensive (loss) income
|
$
|
(154,729
|
)
|
|
$
|
334,813
|
|
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Reclassifications out of Accumulated Other Comprehensive (Loss) Income
The Company reclassifies unrealized gains and losses on AFS securities in accumulated other comprehensive income to
net income
upon the recognition of any other-than-temporary impairments and realized gains and losses on sales, net of income tax effects, as individual securities are impaired or sold. The following table summarizes reclassifications out of accumulated other comprehensive income for the
three and nine months ended
September 30, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Affected Line Item in the Condensed Consolidated Statements of Comprehensive (Loss) Income
|
|
Amount Reclassified out of Accumulated Other Comprehensive (Loss) Income
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
(in thousands)
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Other-than-temporary impairments on AFS securities
|
|
Total other-than-temporary impairment losses
|
|
$
|
95
|
|
|
$
|
—
|
|
|
$
|
363
|
|
|
$
|
429
|
|
Realized losses (gains) on sales of certain AFS securities, net of tax
|
|
(Loss) gain on investment securities
|
|
30,368
|
|
|
4,220
|
|
|
52,654
|
|
|
7,386
|
|
Total
|
|
|
|
$
|
30,463
|
|
|
$
|
4,220
|
|
|
$
|
53,017
|
|
|
$
|
7,815
|
|
Noncontrolling Interest
On June 28, 2017, the Company contributed its equity interests in its wholly owned subsidiary, TH Commercial Holdings LLC, to Granite Point and, in exchange for its contribution, received approximately
33.1 million
shares of common stock of Granite Point, representing approximately
76.5%
of the outstanding stock of Granite Point upon completion of the IPO of its common stock on June 28, 2017. Granite Point issued
10,000,000
shares of its common stock in the IPO at a price of
$19.50
per share, for gross proceeds of
$195.0 million
. Net proceeds were approximately
$181.9 million
, net of issuance costs of approximately
$13.1 million
.
Due to its controlling ownership interest in Granite Point through November 1, 2017 (the date the
33.1 million
shares of Granite Point common stock were distributed to the Company’s common stockholders), the Company consolidated Granite Point on its financial statements and reflected noncontrolling interest for the portion of equity and comprehensive income not attributable to the Company. During the period from June 28, 2017 through November 1, 2017, in accordance with ASC 810,
Consolidation
, the carrying amount of noncontrolling interest was adjusted to reflect (i) changes in its ownership interest in Granite Point as a result of purchases of Granite Point common stock and (ii) the portion of comprehensive income and dividends declared by Granite Point that are not attributable to the Company, with the offset to equity. Effective November 1, 2017, the Company no longer had a controlling interest in Granite Point and, therefore, deconsolidated Granite Point and its subsidiaries, including any noncontrolling interest, from its financial statements and reclassified all of Granite Point’s prior period assets, liabilities and results of operations to discontinued operations.
Note 19
. Equity Incentive Plan
The Company’s Second Restated 2009 Equity Incentive Plan, or the Plan, provides incentive compensation to attract and retain qualified directors, officers, advisors, consultants and other personnel, including PRCM Advisers and affiliates and employees of PRCM Advisers and its affiliates, and any joint venture affiliates of the Company. The Plan is administered by the compensation committee of the Company’s board of directors. The compensation committee has the full authority to administer and interpret the Plan, to authorize the granting of awards, to determine the eligibility of directors, officers, advisors, consultants and other personnel, including PRCM Advisers and affiliates and personnel of PRCM Advisers and its affiliates, and any joint venture affiliates of the Company, to receive an award, to determine the number of shares of common stock to be covered by each award (subject to the individual participant limitations provided in the Plan), to determine the terms, provisions and conditions of each award (which may not be inconsistent with the terms of the Plan), to prescribe the form of instruments evidencing awards and to take any other actions and make all other determinations that it deems necessary or appropriate in connection with the Plan or the administration or interpretation thereof. In connection with this authority, the compensation committee may, among other things, establish performance goals that must be met in order for awards to be granted or to vest, or for the restrictions on any such awards to lapse.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
The Company’s Plan provides for grants of restricted common stock, phantom shares, dividend equivalent rights and other equity-based awards, subject to a ceiling of
6,500,000
shares available for issuance under the Plan. The Plan allows for the Company’s board of directors to expand the types of awards available under the Plan to include long-term incentive plan units in the future. If an award granted under the Plan expires or terminates, the shares subject to any portion of the award that expires or terminates without having been exercised or paid, as the case may be, will again become available for the issuance of additional awards. Unless earlier terminated by the Company’s board of directors, no new award may be granted under the Plan after the tenth anniversary of the date that such Plan was initially approved by the Company’s board of directors. No award may be granted under the Plan to any person who, assuming payment of all awards held by such person, would own or be deemed to own more than 9.8% of the outstanding shares of the Company’s common stock.
All per share amounts, common shares outstanding and restricted shares for all periods presented reflect the Company’s one-for-two reverse stock split effected on November 1, 2017 (refer to
Note 18
-
Stockholders’ Equity
for additional information).
During the
nine months ended
September 30, 2018
and
2017
, the Company granted
55,553
and
34,559
shares of common stock, respectively, to its independent directors pursuant to the Plan. The estimated fair value of these awards was
$15.48
and
$19.82
per share on grant date, based on the adjusted closing price of the Company’s common stock on the NYSE on such date. The grants vested immediately.
Additionally, during the
nine months ended
September 30, 2018
and
2017
, the Company granted
941,371
and
637,286
shares of restricted common stock, respectively, to key employees of PRCM Advisers pursuant to the terms of the Plan and the associated award agreements. The estimated fair value of these awards was
$15.12
and
$17.48
per share on grant date, based on the adjusted closing market price of the Company’s common stock on the NYSE on such date. The shares underlying the grants vest in three equal annual installments commencing on the first anniversary of the grant date, as long as such grantee complies with the terms and conditions of his or her applicable restricted stock award agreement.
The following table summarizes the activity related to restricted common stock for the
nine months ended
September 30, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
Shares
|
|
Weighted Average Grant Date Fair Market Value
|
|
Shares
|
|
Weighted Average Grant Date Fair Market Value
|
Outstanding at Beginning of Period
|
1,284,010
|
|
|
$
|
17.15
|
|
|
1,319,712
|
|
|
$
|
17.10
|
|
Granted
|
996,924
|
|
|
14.96
|
|
|
671,845
|
|
|
17.60
|
|
Vested
|
(673,118
|
)
|
|
(17.12
|
)
|
|
(645,325
|
)
|
|
(17.90
|
)
|
Forfeited
|
(14,115
|
)
|
|
(15.59
|
)
|
|
(22,789
|
)
|
|
(17.90
|
)
|
Outstanding at End of Period
|
1,593,701
|
|
|
$
|
15.81
|
|
|
1,323,443
|
|
|
$
|
16.95
|
|
For the
three and nine months ended
September 30, 2018
, the Company recognized compensation related to restricted common stock granted pursuant to the Plan of
$3.4 million
and
$9.8 million
, respectively. For the
three and nine months ended
September 30, 2017
, the Company recognized compensation related to restricted common stock granted pursuant to the Plan of
$3.5 million
and
$11.7 million
, respectively.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 20
. Income Taxes
The TCJA significantly revises the U.S. corporate income tax laws by, among other things, lowering the federal income tax rate applicable to corporations from
35%
to
21%
and repealing the corporate alternative minimum tax. The Company has not completed its determination of the accounting implications of the TCJA on its tax accruals. However, the Company reasonably estimated the effects of the TCJA and recognized a tax provision of
$17.5 million
in its financial statements as of December 31, 2017. This amount represents the remeasurement of federal net deferred tax assets resulting from the permanent reduction in the U.S. statutory corporate tax rate from
35%
to
21%
. The TCJA requires complex computations to be performed that were not previously required in U.S. tax law, significant judgments to be made in interpretation of the provisions of the TCJA and significant estimates in calculations, and the preparation and analysis of information not previously relevant or regularly produced. The U.S. Treasury, the IRS, and other standard-setting bodies could interpret or issue guidance on how provisions of the TCJA will be applied or otherwise administered that is different from the Company’s interpretation. As the Company completes its analysis of the TCJA, collects and prepares necessary data, and interprets any additional guidance, it may make adjustments to the provisional amounts. Those adjustments may materially impact the Company’s provision for income taxes in the period in which the adjustments are made.
For the
three and nine months ended
September 30, 2018
and
2017
, the Company qualified to be taxed as a REIT under the Code for U.S. federal income tax purposes. As long as the Company qualifies as a REIT, the Company generally will not be subject to U.S. federal income taxes on its taxable income to the extent it annually distributes its net taxable income to stockholders, and does not engage in prohibited transactions. The Company intends to distribute
100%
of its REIT taxable income and comply with all requirements to continue to qualify as a REIT. The majority of states also recognize the Company’s REIT status. The Company’s TRSs file separate tax returns and are fully taxed as standalone U.S. C-corporations. It is assumed that the Company will retain its REIT status and will incur no REIT level taxation as it intends to comply with the REIT regulations and annual distribution requirements.
During the
three and nine months ended
September 30, 2018
, the Company’s TRSs recognized a provision for income taxes of
$37.4 million
and
$35.1 million
, respectively, which was primarily due to realized gains on sales of AFS securities and gains recognized on MSR held in the TRSs as well as the write-down of net deferred tax assets resulting from the deemed liquidation of one of the Company’s TRSs due to its TRS election revocation, offset by net losses incurred on derivative instruments held in the TRSs. During the
three and nine months ended
September 30, 2017
, the Company’s TRSs recognized a benefit from income taxes of
$5.3 million
and
$21.1 million
, respectively, which was primarily due to realized losses on sales of AFS securities and net losses incurred on derivative instruments held in the TRSs. As of
September 30, 2018
and
December 31, 2017
, a
$2.4 million
and a
$2.7 million
valuation allowance was recorded, respectively, because the Company determined that it is more likely than not that the associated deferred tax asset will not be realized.
Based on the Company’s evaluation, it has been concluded that there are no significant uncertain tax positions requiring recognition in the Company’s
condensed consolidated
financial statements of a contingent tax liability for uncertain tax positions. Additionally, there were no amounts accrued for penalties or interest as of or during the periods presented in these consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 21
. Earnings Per Share
The following table presents a reconciliation of the
earnings
and shares used in calculating
basic and diluted earnings per share
for the
three and nine months ended
September 30, 2018
and
2017
. All per share amounts, common shares outstanding and restricted shares for all periods presented reflect the Company’s one-for-two reverse stock split effected on November 1, 2017 (refer to
Note 18
-
Stockholders’ Equity
for additional information).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
(in thousands, except share data)
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Numerator:
|
|
|
|
|
|
|
|
Net income from continuing operations
|
$
|
35,946
|
|
|
$
|
93,220
|
|
|
$
|
510,245
|
|
|
$
|
146,212
|
|
Income from discontinued operations, net of tax
|
—
|
|
|
11,518
|
|
|
—
|
|
|
39,169
|
|
Net income
|
35,946
|
|
|
104,738
|
|
|
510,245
|
|
|
185,381
|
|
Income from discontinued operations attributable to noncontrolling interest
|
—
|
|
|
2,674
|
|
|
—
|
|
|
2,714
|
|
Net income attributable to Two Harbors Investment Corp.
|
35,946
|
|
|
102,064
|
|
|
510,245
|
|
|
182,667
|
|
Dividends on preferred stock
|
18,951
|
|
|
8,888
|
|
|
46,445
|
|
|
13,173
|
|
Net income attributable to common stockholders - basic
|
16,995
|
|
|
93,176
|
|
|
463,800
|
|
|
169,494
|
|
Interest expense attributable to convertible notes
(1)
|
—
|
|
|
4,727
|
|
|
14,151
|
|
|
—
|
|
Net income attributable to common stockholders - diluted
|
$
|
16,995
|
|
|
$
|
97,903
|
|
|
$
|
477,951
|
|
|
$
|
169,494
|
|
Denominator:
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
222,805,735
|
|
|
173,162,988
|
|
|
190,229,850
|
|
|
173,022,717
|
|
Weighted average restricted stock shares
|
1,593,701
|
|
|
1,325,308
|
|
|
1,616,362
|
|
|
1,392,515
|
|
Basic weighted average shares outstanding
|
224,399,436
|
|
|
174,488,296
|
|
|
191,846,212
|
|
|
174,415,232
|
|
Effect of dilutive shares issued in an assumed conversion
|
—
|
|
|
14,419,060
|
|
|
17,760,934
|
|
|
—
|
|
Diluted weighted average shares outstanding
|
224,399,436
|
|
|
188,907,356
|
|
|
209,607,146
|
|
|
174,415,232
|
|
Basic Earnings Per Share:
|
|
|
|
|
|
|
|
|
|
Continuing operations
|
$
|
0.08
|
|
|
$
|
0.48
|
|
|
$
|
2.42
|
|
|
$
|
0.76
|
|
Discontinued operations
|
—
|
|
|
0.05
|
|
|
—
|
|
|
0.21
|
|
Net income
|
$
|
0.08
|
|
|
$
|
0.53
|
|
|
$
|
2.42
|
|
|
$
|
0.97
|
|
Diluted Earnings Per Share:
|
|
|
|
|
|
|
|
Continuing operations
|
$
|
0.08
|
|
|
$
|
0.47
|
|
|
$
|
2.28
|
|
|
$
|
0.76
|
|
Discontinued operations
|
—
|
|
|
0.05
|
|
|
—
|
|
|
0.21
|
|
Net income
|
$
|
0.08
|
|
|
$
|
0.52
|
|
|
$
|
2.28
|
|
|
$
|
0.97
|
|
___________________
|
|
(1)
|
Includes a nondiscretionary adjustment for the assumed change in the management fee calculation.
|
For the
three months ended
September 30, 2018
, excluded from the calculation of diluted earnings per share is the effect of adding back
$4.8 million
of interest expense, net of a nondiscretionary adjustment for the assumed change in the management fee calculation, and
17,847,425
weighted average common share equivalents related to the assumed conversion of the Company’s convertible senior notes, as their inclusion would be antidilutive.
For the
nine months ended
September 30, 2017
, excluded from the calculation of diluted earnings per share is the effect of adding back
$13.1 million
of interest expense, net of a nondiscretionary adjustment for the assumed change in the management fee calculation, and
13,447,072
weighted average common share equivalents related to the assumed conversion of the Company’s convertible senior notes, as their inclusion would be antidilutive.
TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)
Note 22
. Related Party Transactions
The following summary provides disclosure of the material transactions with affiliates of the Company.
In accordance with the Management Agreement between the Company and PRCM Advisers dated as of October 28, 2009 and subsequently amended, the Company incurred
$12.4 million
and
$35.6 million
as a management fee to PRCM Advisers for the
three and nine months ended
September 30, 2018
, respectively, and
$10.1 million
and
$29.8 million
as a management fee to PRCM Advisers for the
three and nine months ended
September 30, 2017
, respectively, which represents approximately
1.5%
of stockholders’ equity on an annualized basis as defined by the Management Agreement. For purposes of calculating the management fee, stockholders’ equity is adjusted as discussed below, and to exclude the consolidated stockholders’ equity of Granite Point and its subsidiaries previously included in the Company’s
condensed consolidated
balance sheet and any common stock repurchases, as well as any unrealized gains, losses or other items that do not affect realized
net income
, among other adjustments, in accordance with the Management Agreement.
In connection with the acquisition of CYS, the Management Agreement was amended to (i) reduce PRCM Advisers’ base management fee with respect to the additional equity under management resulting from the merger to
0.75%
from the effective time through the first anniversary of the effective time and (ii) for the fiscal quarter in which closing of the merger occurs, to make a one-time downward adjustment of Pine River’s management fees payable by Two Harbors for such quarter by
$15.0 million
to offset the cash consideration payable to stockholders of CYS, plus an additional downward adjustment of up to
$3.3 million
for certain transaction-related expenses. For both the
three and nine months ended
September 30, 2018
, the total downward adjustment to management fees was
$17.5 million
. The Company does not anticipate any further downward adjustments to management fees for transaction-related expenses.
In addition, the Company reimbursed PRCM Advisers for direct and allocated costs incurred by PRCM Advisers on behalf of the Company. These direct and allocated costs totaled approximately
$5.3 million
and
$16.1 million
for the
three and nine months ended
September 30, 2018
, respectively, and
$4.8 million
and
$13.1 million
for the
three and nine months ended
September 30, 2017
, respectively.
The Company has direct relationships with the majority of its third-party vendors. The Company will continue to have certain costs allocated to it by PRCM Advisers for compensation, data services, technology and certain office lease payments, but most direct expenses with third-party vendors are paid directly by the Company.
The Company recognized
$3.4 million
and
$9.8 million
of compensation during the
three and nine months ended
September 30, 2018
, respectively, and
$3.5 million
and
$11.7 million
of compensation during the
three and nine months ended
September 30, 2017
, respectively, related to restricted common stock issued to employees of PRCM Advisers and the Company’s independent directors pursuant to the Plan.
During the year ended December 31, 2017, the Company purchased
1,658,008
shares of Granite Point common stock in the open market for a cost of
$30.0 million
. These equity securities were carried at fair value and reported in other assets on the
condensed consolidated
balance sheets. As of
December 31, 2017
, the carrying value of the equity securities was
$29.4 million
, which included
$0.6 million
in unrealized losses. During the three months ended
September 30, 2018
, the Company sold all of the Granite Point common stock it held for
$31.2 million
, resulting in a realized gain of
$1.2 million
for both the
three and nine months ended
September 30, 2018
.
Note 23
. Subsequent Events
Events subsequent to
September 30, 2018
, were evaluated through the date these financial statements were issued and no additional events were identified requiring further disclosure in these
condensed consolidated
financial statements.