UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| ☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
For the Fiscal Year Ended: December 31, 20192021
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
Commission File Number 001-34506
TWO HARBORS INVESTMENT CORP.
(Exact Name of Registrant as Specified in Its Charter)
| 27-0312904 | ||||||||
Incorporation or Organization) | (I.R.S. Employer Identification No.) | |||||||
| 1601 Utica Avenue South, Suite 900 | |||||||||||
| St. Louis Park, | Minnesota | 55416 | |||||||||
| (Address of Principal Executive Offices) | (Zip Code) | ||||||||||
(Registrant’s Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
| Title of Each Class: | Trading Symbol(s) | Name of Exchange on Which Registered: | ||||||||||||
| Common Stock, par value $0.01 per share | TWO | New York Stock Exchange | ||||||||||||
| 8.125% Series A Cumulative Redeemable Preferred Stock | TWO PRA | New York Stock Exchange | ||||||||||||
| 7.625% Series B Cumulative Redeemable Preferred Stock | TWO PRB | New York Stock Exchange | ||||||||||||
| 7.25% Series C Cumulative Redeemable Preferred Stock | TWO PRC | New York Stock Exchange | ||||||||||||
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☒ | Accelerated filer | ☐ | ||||||||
| Non-accelerated filer | ☐ | Smaller reporting company | ☐ | ||||||||
| Emerging growth company | ☐ | ||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
As of June 30, 2019,2021, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $3.4$2.1 billion based on the closing sale price as reported on the NYSE on that date.
As of February 24, 2020,2022, there were 273,627,275343,920,330 shares of common stock, par value $.01$0.01 per share, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 20202022 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission under Regulation 14A within 120 days after the end of registrant’s fiscal year covered by this Annual Report, are incorporated by reference into Part III.
TWO HARBORS INVESTMENT CORP.
TABLE OF CONTENTS
| Page | ||||||||
| PART I | ||||||||
| PART II | ||||||||
| PART III | ||||||||
| PART IV | ||||||||
i
PART I
Item 1. Business
Overview
Two Harbors Investment Corp. is a Maryland corporation focused on 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, which we collectively refer to as our target assets. We operate as a real estate investment trust, or REIT, as defined under the Internal Revenue Code of 1986, as amended, or the Code. The terms “Two Harbors,” “we,” “our,” “us” and the “company” refer to Two Harbors Investment Corp. and its subsidiaries as a consolidated entity.
We were 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 our wholly owned indirect subsidiary as a result of the merger. Our common stock is listed on the New York Stock Exchange, or NYSE, under the symbol “TWO”.
Our objective is to provide attractive risk-adjusted total return to our stockholders over the long term, primarily through dividends and secondarily through capital appreciation. We selectively acquire and manage an investment portfolio of our target assets, which is constructed to generate attractive returns through market cycles. We focus on asset selection and implement a relative value investment approach across various sectors within the mortgage market. Our target assets include the following:
•Agency RMBS, meaning RMBS whose principal and interest payments are guaranteed by a U.S. government agency, such as the Government National Mortgage Association (or Ginnie Mae), or a U.S. government sponsored enterprise, or GSE, such as the Federal National Mortgage Association (or Fannie Mae), or the Federal Home Loan Mortgage Corporation (or Freddie Mac);
•MSR; and
•Other financial assets comprising approximately 5% to 10% of the portfolio.
We seek to deploy moderate leverage as part of our investment strategy. We generally finance our Agency RMBS and non-Agency securities through short- and long-term borrowings structured as repurchase agreements and advances from the Federal Home Loan Bank of Des Moines, or the FHLB.agreements. We also finance our MSR through repurchase agreements, revolving credit facilities, term notes payable and convertible senior notes.
We have elected to be treated as a REIT for U.S. federal income tax purposes. To qualify as a REIT, we are required to meet certain investment and operating tests and annual distribution requirements. We generally will not be subject to U.S. federal income taxes on our taxable income to the extent that we annually distribute all of our net taxable income to stockholders, do not participate in prohibited transactions and maintain our intended qualification as a REIT. However, certain activities that we may perform may cause us to earn income which will not be qualifying income for REIT purposes. We have designated certain of our subsidiaries as taxable REIT subsidiaries, or TRSs, as defined in the Code, to engage in such activities, and we may form additional TRSs in the future. We also operate our business in a manner that will permit us to maintain our exemption from registration under the Investment Company Act of 1940, as amended, or the 1940 Act.
Our dedicated team of investment professionals has broad experience in managing our target assets and has demonstrated the ability to generate attractive risk-adjusted returns under different market conditions and cycles. We have extensive long-term relationships with financial intermediaries, including prime brokers, investment banks, broker-dealers and asset custodians. We believe these relationships enhance our ability to source, finance, protect and hedge our investments and, thus, enable us to succeed in various credit and interest rate environments. We also benefit from our dedicated risk management, accounting, operations, legal, compliance and information technology teams.
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Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains, or incorporates by reference, not only historical information, but also forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act, and that are subject to the safe harbors created by such sections. Forward-looking statements involve numerous risks and uncertainties. Our actual results may differ from our beliefs, expectations, estimates, and projections and, consequently, you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as “anticipate,” “estimate,” “will,” “should,” “expect,” “target,” “believe,” “intend,” “seek,” “plan,” “goals,” “future,” “likely,” “may,” and similar expressions or their negative forms, or by references to strategy, plans, or intentions. These forward-looking statements are subject to risks and uncertainties, including, among other things, those described in this Annual Report on Form 10-K under the caption “Risk Factors.” Other risks, uncertainties, and factors that could cause actual results to differ materially from those projected are described below and may be described from time to time in reports we file with the Securities and Exchange Commission, or the SEC, including our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update or revise any such forward-looking statements, whether as a result of new information, future events, or otherwise.
Important factors, among others, that may affect our actual results include:
•changes in interest rates and the market value of our target assets;
•changes in prepayment rates of mortgages underlying our target assets;
•the state of the credit markets and other general economic conditions, particularly as they affect the price of earning assets, the credit status of borrowers and home prices;
•the concentrationongoing impact of the credit risks to which we are exposed;COVID-19 pandemic, and the actions taken by federal and state governmental authorities and GSEs in response, on the U.S. economy, financial markets and our target assets;
•legislative and regulatory actions affecting our business;
•the availability and cost of our target assets;
•the availability and cost of financing for our target assets, including repurchase agreement financing, revolving credit facilities, term notes and convertible notes and financing through notes;
•the FHLB;
impact of any increases in payment delinquencies and defaults on the mortgages comprising and underlying our target assets;assets, including additional servicing costs and servicing advance obligations on the MSR assets we own;
•changes in liquidity in the market for real estate securities, the re-pricing of credit risk in the capital markets, inaccurate ratings of securities by rating agencies, rating agency downgrades of securities, and increases in the supply of real estate securities available-for-sale;
•changes in the values of securities we own and the impact of adjustments reflecting those changes on our consolidated statements of comprehensive (loss) income (loss) and balance sheets, including our stockholders’ equity;
•our ability to generate cash flow from our target assets;
•our ability to effectively execute and realize the benefits of strategic transactions and initiatives we have pursued or may in the future pursue;
•our decision to terminate our Management Agreement with PRCM Advisers and the ongoing litigation with PRCM Advisers related to such termination;
•changes in the competitive landscape within our industry, including changes that may affect our ability to attract and retain personnel;
•our exposure to legal and regulatory claims, penalties or enforcement activities, including those related to the termination of our Management Agreement with PRCM Advisers and arising from our ownership and management of MSR and prior securitization transactions;
•our exposure to counterparties involved in our MSR business and prior securitization transactions and our ability to enforce representations and warranties made by them;
•our ability to acquire MSR and successfully operate our seller-servicer subsidiary and oversee the activities of our subservicers;
•our ability to manage various operational and regulatory risks associated with our business;
•interruptions in or impairments to our communications and information technology systems;
our ability to maintain appropriate internal controls over financial reporting;
•our ability to establish, adjust and maintain appropriate hedges for the risks in our portfolio;
•our ability to maintain our REIT qualification for U.S. federal income tax purposes; and
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•limitations imposed on our business due to our REIT status and our status as exempt from registration under the 1940 Act.
This Annual Report on Form 10-K may contain statistics and other data that, in some cases, have been obtained or compiled from information made available by mortgage loan servicers and other third-party service providers.
Our Business
Our Investment Strategy
Our investment objective is to provide attractive risk-adjusted total return to our stockholders over the long-term, primarily through dividends and secondarily through capital appreciation. We intend to achieve this objective by constructing a well-balanced portfolio consisting of Agency RMBS, non-Agency securities, MSR and other financial assets, with a focus on managing various associated risks, including interest rate, prepayment, credit, mortgage spread and financing risk. The preservation of book value is of paramount importance to our ability to generate total return on an ongoing basis. Consistent with the objective of achieving attractive risk-adjusted total return over various market cycles, we intend to maintain a balanced approach to these various risks.
Our dedicated investment team makes investment decisions based on a rigorous asset selection process that takes into consideration a variety of factors, including expected cash yield, risk-adjusted returns, current and projected credit fundamentals, current and projected macroeconomic considerations, current and projected supply and demand, credit and market risk concentration limits, liquidity, cost of financing and financing availability. It is our intention to select our assets in such a way as to maintain our REIT qualification and our exemption from registration under the 1940 Act.
Our Target Assets
Our portfolio can be categorized into two strategies based on investment characteristics, which embodies our hybrid investment approach. Both strategiesincludes assets that are primarily sensitive to changes in interest rates, prepayments and mortgage spreads, including but not limited to Agency RMBS, MSR and related hedging transactions. These assets have minimal exposure to the underlying credit performance of the investments. Our portfolio is managed by our Co-Chief Investment Officersas a whole and our resources are allocated and financial performance is assessed on a consolidated basis. The categories and their respectiveOur target asset classes are as follows:
| Agency RMBS | Agency RMBS collateralized by fixed rate mortgage loans, adjustable-rate mortgage (or ARM) loans or hybrid mortgage loans, or derivatives thereof, including: | |||||||
| • | mortgage pass-through certificates; | |||||||
| • | collateralized mortgage obligations; | |||||||
| • | uniform mortgage-backed securities; | |||||||
| • | Freddie Mac gold certificates; | |||||||
| • | Fannie Mae certificates; | |||||||
| • | Ginnie Mae certificates; | |||||||
| • | “to-be-announced” forward contracts, or TBAs, which are pools of mortgages with specific investment terms to be issued by | |||||||
| • | interest-only and inverse interest-only securities. | |||||||
| MSR | The right to control the servicing of residential mortgage loans, receive the servicing income therefrom and the obligation to service the loans in accordance with relevant standards; the actual servicing functions are outsourced to appropriately licensed third-party subservicers, which service the loans in their own names. | |||||||
Other assets may include financial and mortgage-related assets other than theour target assets, in our rates and credit strategies, including previously held commercial real estate assets, residential mortgage loansnon-Agency securities (securities that are not issued or guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac) and certain non-hedging transactions that may produce non-qualifying income for purposes of the REIT gross income tests.
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Our Investment Activities
Our Agency RMBS portfolio is comprised primarily of adjustable rate and fixed rate mortgage-backed securities backed by single-family and multi-family mortgage loans. All of our principal and interest Agency RMBS are Fannie Mae or Freddie Mac mortgage pass-through certificates or collateralized mortgage obligations that carry an implied rating of “AAA,” or Ginnie Mae mortgage pass-through certificates, which are backed by the guarantee of the U.S. government. The majority of these securities consist of whole pools in which we own all of the investment interests in the securities.
One of our wholly owned subsidiaries holds the requisite approvals from Fannie Mae and Freddie Mac to own and manage MSR, which represent a contractual right to servicecontrol the servicing of a mortgage loan, the obligation to service the loan in accordance with relevant standards and the right to collect a fee for performingthe performance of servicing activities, such as collecting principal and interest from a borrower and distributing those payments to the owner of the loan. We do not directly service the mortgage loans underlying the MSR we acquire; rather, we contract with appropriately licensed third-party subservicers to handle substantially all servicing functions in the name of the subservicer for the loans underlying our MSR.
As the servicer of record, however, we remain accountable to the GSEs for all servicing matters and, accordingly, provide substantial oversight of each of our subservicers. We believe MSR are a natural fit for our portfolio over the long term. Our MSR business leverages our core competencies in prepayment and credit risk analytics and the MSR assets provide a hedgeoffsetting risks to our Agency RMBS, hedging both interest rate and mortgage spread risk. Our goal is
In making our capital allocation decisions, we take into consideration a number of factors, including the opportunities available in the marketplace, the cost and availability of financing, and the cost of hedging interest rate, prepayment, credit and other portfolio risks. We have expertise in mortgage credit and may choose to create long-lasting relationships with high quality originatorsinvest again in both flow and bulk acquisitions of MSR.
Our Investment Guidelines
Our board of directors has approved the following investment guidelines:
•no investment shall be made that would cause us to fail to qualify as a REIT for U.S. federal income tax purposes;
•no investment shall be made that would cause us to be regulated as an investment company under the 1940 Act;
•we will primarily invest within our target assets, consisting primarily of Agency RMBS, non-Agency securities, residential mortgage loans, MSR and commercial real estate assets, inclusivecertain types of commercial real estate loans, commercial real property, CMBS, commercial corporate debt and loans and other commercial real estate related investments in the U.S;assets; approximately 5% to 10% of our portfolio may include other financial assets; and
•until appropriate investments can be identified, we will invest available cash in interest-bearing and short-term investments that are consistent with (i) our intention to qualify as a REIT and (ii) our exemption from investment company status under the 1940 Act.
These investment guidelines may be changed from time to time by our board of directors in its discretion without the approval of our stockholders.
Within the constraints of the foregoing investment guidelines, we have broad authority to select, finance and manage our investment portfolio. As a general matter, our investment strategy is designed to enable us to:
•build an investment portfolio consisting of Agency RMBS, non-Agency securities, MSR and other financial assets that will generate attractive returns while having a moderate risk profile;
•manage financing, interest, prepayment rate, credit and similar risks;
•capitalize on discrepancies in the relative valuations in the mortgage and housing markets; and
•provide regular quarterly dividend distributions to stockholders.
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Within the requirements of the investment guidelines, we make determinations as to the percentage of our assets that will be invested in each of our target assets. Our investment decisions depend on prevailing market conditions and may change over time in response to opportunities available in different interest rate, economic and credit environments. As a result, we cannot predict the percentage of our assets that will be invested in any of our target asset classes at any given time. We believe that the diversification of our portfolio of assets and the flexibility of our strategy, combined with the expertise of our dedicated investment team, will enable us to achieve attractive risk-adjusted total return under a variety of market conditions and economic cycles.
Financing Strategy
We deploy moderate leverage to fund the acquisition of our target assets and increase potential returns to our stockholders. We are not required to maintain any particular leverage ratio. The amount of leverage we deploy for particular investments in our target assets depends upon a variety of factors, including without limitation: general economic, political and financial market conditions; the anticipated liquidity and price volatility of our assets; the gap between the duration of assets and liabilities, including hedges; the availability and cost of financing our assets; our opinion of the credit worthiness of financing counterparties; the health of the U.S. residential mortgage and housing markets; our outlook for the level, slope and volatility of interest rates; the credit quality of the loans underlying our Agency and non-Agency securities;target assets; the rating assigned to securities; and our outlook for asset spreads relative to the London Interbank Offered Rate, or LIBOR, curve, the Secured Overnight Financing Rate, or SOFR, curve, the Overnight Index Swap Rate, or OIS, the U.S. federal funds rate, and other benchmark rate curves.
Our primary financing sources for Agency RMBS and non-Agency securities are repurchase agreements and FHLB advances.agreements. Repurchase agreements are financings pursuant to which one party, the seller/borrower, sells assets to the repurchase agreement counterparty, the buyer/lender, for an agreed price with the obligation to repurchase the assets from the buyer at a future date and at a price higherdifferent than the original purchase price.price, with the difference representing the borrowing rate (typically based on an index plus a spread consistent with those demanded in the market). The amount of financing available under a repurchase agreement is limited to a specified percentage of the estimated market value of the assets. The difference between the sale price and repurchase price is the interest expense of financing under a repurchase agreement. Under repurchase agreement financing arrangements, if the value of the collateral decreases, the buyer could require the seller to provide additional cash collateral to re-establish the ratio of value of the collateral to the amount of borrowing (i.e., a margin call). In the current economic climate, lenders under repurchase agreements generally advance approximately 90% to 97% of the market value of the Agency RMBS financed (a discount from market value, generally referred to as a haircut, of 3% to 10%) and 60% to 80% of the market value of the non-Agency securities financed (i.e., a haircut of 20% to 40%).
To finance MSR assets and related servicing advance obligations, we may enter into repurchase agreements, revolving credit facilities and securitization transactions collateralized by the value of the MSR pledged.and/or servicing advances pledged and with borrowing rates typically based on an index plus a spread consistent with those demanded in the market. If the value of our MSR and/or servicing advances pledged as collateral for the agreements decreases, the respective lender could require us to provide additional collateral or cash as collateral to re-establish the ratio of value of the collateral to the amount of the debt outstanding. Due to certain GSE requirements, we may be restricted as to the frequency in which we are able to pledge additional MSR and/or servicing advance collateral to counterparties. As a result, we may choose to over-collateralize certain repurchase agreements and revolving credit facilitiesfinancing arrangements in order to avoid having to provide cash as additional collateral. Lenders generally advance approximately 65% to 70% of the market value of the MSR financed (i.e., a haircut of 30% to 35%) and 80% to 95% of the value of servicing advances financed (i.e., a haircut of 5% to 20%), depending on the type of advance (corporate, escrow, etc.).
During the second quarter ofyear ended December 31, 2019, we formed a new trust entity, or the MSR Issuer Trust, for the purpose of financing MSR through securitization. On June 27, 2019, we, through the MSR Issuer Trust, completed an MSR securitization transaction pursuant to which, through two of our wholly owned subsidiaries, MSR is pledged to the MSR Issuer Trust and in return, the MSR Issuer Trust issued (i) an aggregate principal amount of $400.0 million in term notes to qualified institutional buyers and (ii) a variable funding note, or VFN, with a maximum principal balance of $1.0 billion to one of the subsidiaries, in each case secured on a pari passu basis. The term notes bear interest at a rate equal to one-month LIBOR plus 2.80% per annum. The term notes will mature on June 25, 2024 or, if extended pursuant to the terms of the related indenture supplement, June 25, 2026 (unless earlier redeemed in accordance with their terms). In connection with the transaction, we also entered into a repurchase facility that is secured by the VFN issued in connection with the MSR securitization transaction, which is collateralized by our MSR.
A significant decrease in the advance rate or an increase in the haircut could result in us having to sell assets in order to meet additional margin requirements by the lender. We expect to mitigate our risk of margin calls under financing arrangements by deploying leverage at an amount that is below what could be used under current advance rates.
In order to reduce our exposure to risks associated with lender counterparty concentration, we generally seek to diversify our exposure by entering into repurchase agreements with multiple counterparties. At December 31, 2019,2021, we had $29.1$7.7 billion of outstanding balances under repurchase agreements with 2420 counterparties, with a maximum net exposure (the difference between the amount loaned to us, including interest payable, and the value of the assets pledged by us as collateral, including accrued interest receivable on such assets) to any single lender of $310.1$354.0 million, or 6.2%12.9% of stockholders’ equity.
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Interest Rate Hedging and Risk Management Strategy
We may enter 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 our floating-rate borrowings into fixed-rate borrowings to more closely match the duration of our 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)LIBOR, OIS or SOFR) 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 our portfolio as well as our cash flows, we may, at times, enter into various forward contracts, including short securities, Agency to-be-announced securities, or TBAs, options, futures, swaps, caps, credit default swaps and total return swaps. In executing on the company’sour current interest rate risk management strategy, the company haswe have entered into TBAs, put and call options for TBAs, interest rate swap cap and swaption agreements and U.S. Treasury futures and Markit IOS total return swaps.Eurodollar futures. In addition, because MSR are negative duration assets, they provide a hedge to interest rate exposure on our Agency RMBS portfolio. In hedging interest rate risk, we seek to reduce the risk of losses on the value of our investments that may result from changes in interest rates in the broader markets, improve risk-adjusted returns and, where possible, obtain a favorable spread between the yield on our assets and the cost of our financing.
Compensation and Benefits. We use market data to benchmark and guide our compensation practices to ensure that our compensation program is competitive and rewarding, while at the same time aligning the interests of our employees with those of our boardstockholders. In addition to competitive wages and salaries, our compensation programs include cash bonus and equity incentive compensation opportunities, a 401(k) plan and profit sharing contribution, employer-paid health benefits, health savings and dependent care flexible spending accounts, generous paid time off, short- and long-term disability insurance, a variety of directors; (iii) sourcing, analyzingpersonal and executing investments, asset salesfamily leave options, life-planning financial and financings;legal resources, and (iv) performing assetother voluntary supplemental benefits.
Professional Development. We encourage the professional development of our people through regular leadership development training, talent management, duties. Our boardand tuition reimbursement programs. We also offer a wide variety of directors is responsibleeducational opportunities through our educational platforms, Two Harbors University and a learning management system. We encourage collaboration and teamwork to ensure mutual understanding of responsibilities, priorities and expectations. We thoughtfully plan for our collective success by aligning individual employee and company goals.
Health, Safety and Well-being. We sponsor a number of programs and events that emphasize the oversighthealth and reviewwell-being of PRCM Advisers performance underour employees, including relational, financial, emotional and physical. We promote a culture of health and well-being through employee assistance program services, comprehensive health care benefits and resources for preventative health, such as flu shot clinics and reduced-fee health club memberships. Throughout the course of the COVID-19 pandemic, we have put the health and safety of our employees and their families first, initially supporting comprehensive work-from-home policies and subsequently implementing a work-life integration and flexibility policy after our return to the office in-person. In addition, we established enhanced safety measures and precautions in both of our offices as recommended by the federal, state and our local agencies.
Workplace Culture. We strive to foster a workplace culture where every individual on our team brings their unique perspectives, abilities and experiences which contribute to driving our organizational value. We are committed to supporting the engagement and leadership of women (who comprise 50% of our senior management agreement.team and approximately 40% of our workforce) and providing opportunities for collaboration, development and career growth. We conduct an annual pulse survey which provides valuable insights from employees on topics involving culture, diversity and inclusion, education, benefits and engagement, and pride ourselves on having a strong participation rate. We also offer a flexible work environment, providing employees the opportunity to balance their professional obligations with that of their personal.
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Operating and Regulatory Structure
Our business is subject to extensive regulation by U.S. federal and state governmental authorities, and self-regulatory organizations. We are required to comply with numerous federal and state laws, including those described below. The laws, rules and regulations comprising this regulatory framework change frequently, as can the interpretation and enforcement of existing laws, rules and regulations. Some of the laws, rules and regulations to which we are subject are intended primarily to safeguard and protect consumers, rather than stockholders or creditors. From time to time, we may receive requests from U.S. federal and state agencies for records, documents and information regarding our policies, procedures and practices regarding our business activities. We incur significant ongoing costs to comply with these regulations.
REIT Qualification
We elected to be taxed as a REIT under the Code, commencing with our taxable period ended December 31, 2009. Our qualification as a REIT depends upon our ability to meet on a continuing basis, through actual investment and operating results, various complex requirements under the Code relating to, among other things, the sources of our gross income, the composition and value of our assets, our distribution levels and the diversity of ownership of our shares. We believe that we are organized in conformity with the requirements for qualification and taxation as a REIT under the Code, and we conduct our operations in a manner which will enable us to continue to meet the requirements for qualification and taxation as a REIT. Certain activities that we may perform may cause us to earn income that will not be qualifying income for REIT purposes. We have designated certain of our subsidiaries as TRSs to engage in such activities, and we may in the future form additional TRSs.
As long as we continue to qualify as a REIT, we generally will not be subject to U.S. federal income tax on the REIT taxable income we distribute currently to our stockholders. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax at regular corporate rates and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we lost our REIT qualification. Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income or property.
Investment Company Act of 1940
We conduct our operations so that we are not required to register as an investment company under the 1940 Act. If we were to fall within the definition of an investment company, we would be unable to conduct our business as described in this Annual Report on Form 10-K.
Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that “is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities.” Section 3(a)(1)(C) of the 1940 Act also defines an investment company as any issuer that “is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis.” Excluded from the term “investment securities,” among other things, are U.S. government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exclusion from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.
We are organized as a holding company that conducts business primarily through our subsidiaries. Any business conducted through our subsidiaries will be conducted in such a manner as to ensure that we do not meet the definition of “investment company” because less than 40% of the value of our total assets on an unconsolidated basis would consist of “investment securities.”
To avoid registration as an investment company, certain of our subsidiaries rely on certain exemptions from the 1940 Act, including Section 3(c)(5)(C), which exempts entities that are “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” Under the SEC staff’s current guidance, to qualify for this exemption, we must maintain (i) at least 55% of our assets in qualifying interests (referred to as the 55% Test) and (ii) at least 80% of our assets in qualifying interest plus other real estate related assets (referred to as the 80% Test). Qualifying interests for this purpose include mortgage loans and other assets, such as whole pool Agency and non-Agency RMBS, which are considered the functional equivalent of mortgage loans for the purposes of the 1940 Act. We expect each of our subsidiaries relyingthat may rely on Section 3(c)(5)(C) to invest at least 55% of its assets in qualifying interests in accordance with SEC staff guidance, and an additional 25% of its assets in either qualifying interests or other types of real estate related assets that do not constitute qualifying interests. We believe that we conduct our business so that we are exempt from the 1940 Act under Section 3(c)(5)(C), but rapid changes in the values of our assets could disrupt prior efforts to conduct our business to meet the 55% Test and the 80% Test. Our efforts to comply with the 55% Test and the 80% Test could require us to acquire or dispose of certain assets at unfavorable prices and limit our ability to pursue certain investment opportunities.
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Mortgage Industry Regulation
Although we do not originate or service residential mortgage loans, we must comply with various federal and state laws, rules and regulations as a result of owning MSR. These rules generally focus on consumer protection and include, among others, rules promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, and
the Gramm-Leach-Bliley Financial Modernization Act of 1999, or the Gramm-Leach-Bliley Act. We are also required to maintain qualifications, registrations and licenses in certain states in order to own certain of our assets. These requirements can and do change as statutes and regulations are enacted, promulgated or amended, or as regulatory guidance or interpretations evolve or change, and the trend in recent years among federal and state lawmakers and regulators has been toward increasing laws, regulations and investigative proceedings in relation to the mortgage industry generally.
The Dodd-Frank Act significantly changed the regulation of financial institutions and the financial services industry, including the mortgage industry. The Dodd-Frank Act tasked many agencies with issuing a variety of new regulations, including rules related to mortgage origination, mortgage servicing, securitization transactions and derivatives. The Dodd-Frank Act also created the Consumer Financial Protection Bureau, or the CFPB, which has broad rulemaking authority with respect to many of the federal consumer protection laws applicable to the mortgage industry. In addition to its rulemaking authority, the CFPB has supervision, examination and enforcement authority over consumer financial products and services by certain non-depository institutions, including our company. The CFPB has issued a series of rules and related guidance as part of ongoing efforts to effect reformsenhance consumer protections and create uniform standards for the mortgage lending and servicing industries. These mortgage lending rules include requirements addressing how lenders must evaluate a consumer’s ability to repay a mortgage loan, and what specific disclosures and communications that must be made to consumers at various stages in the mortgage lending process.and servicing processes, and specific actions servicers must take at various stages in a loan’s life cycle, including providing assistance to consumers who encounter financial hardship and struggle to make their mortgage payment. These rules have led to increased costs to originate and service loans across the mortgage industry, and given their complexity, it is anticipated thegreater regulatory scrutiny of originators, servicers and other mortgage industry participants will be exposed to greater regulatory scrutiny from federal and state regulators and increased litigation and complaints against these participants from both consumers and government officials.
The Gramm-Leach-Bliley Act imposes obligations on us to safeguard the information we maintain on mortgage loan borrowers requiresand imposes restrictions on our ability to share that we provide mortgage borrowers with notices describing how we collect, use and share their personal information, and allows mortgage borrowers to “opt-out” of sharing certain information with third parties and affiliates. In addition, certaina growing number of states have passed a variety ofor enhanced laws to further protect borrower information, including laws that regulate the use and storage of personally identifiable information, require notifications to borrowers if the security of their personal information is breached, or require us to encrypt personal information when it is transmitted and stored electronically. These evolving federal and state laws require the ongoing review and changes toof our operations, increasedincrease our compliance costs, and affect our ability to use and share information with third parties.parties as part of our business.
The Coronavirus Aid, Relief and Economic Security Act, or the CARES Act, has provided billions of dollars of relief to individuals, businesses, state and local governments, and the health care system suffering the impact of the COVID-19 pandemic, including mortgage loan forbearance and modification programs to qualifying borrowers who have difficulty making their loan payments. The CARES Act provides up to 360 days of forbearance relief from mortgage loan payments for borrowers with federally backed (e.g., Fannie Mae or Freddie Mac) mortgages who experience financial hardship related to the pandemic. Additionally, foreclosure moratorium and forbearance periods were extended for borrowers with Fannie Mae- or Freddie Mac-backed mortgages by the Federal Housing Finance Agency, or FHFA, as well as for borrowers with Federal Housing Administration, U.S. Department of Agriculture or U.S. Department of Veterans Affairs mortgages. The CARES Act and related federal and state regulation impact MSR owners, like us, that are required for certain MSR assets to advance principal, interest, taxes and insurance payments during all or some of the time when borrowers are in forbearance or while foreclosure moratorium is in effect and to adhere to additional servicing requirements designed to assist impacted borrowers, including, but not limited to, additional borrower outreach, adjusting credit reporting protocols for loans in forbearance, suspending late fees and ceasing foreclosure and eviction activity. A significant number of borrowers, who were previously eligible for forbearance plan extensions, have reached or are reaching their terminal forbearance plan expiration. This has led to improvement in actual and projected forbearance rates; however, over time, delinquencies and defaults in our MSR portfolio could increase if borrowers who were in forbearance are unable to resume making their monthly mortgage payments.
We have implemented and will continue to implement policies and procedures in order to ensure ongoing compliance with the laws, rules and regulations applicable to our business. We have incurred and expect to incur ongoing operational costs to comply with such laws, rules and regulations.
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Competition
Our netcomprehensive income depends, in large part, on our ability to acquire assets at favorable spreads over our borrowing costs. In acquiring our target assets, we compete with other REITs, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, financial institutions, governmental agencies, mortgage loan servicers, asset management firms and other entities. Some of these entities may not be subject to the same regulatory constraints that we are (i.e.e.g., REIT compliance or maintaining an exemption under the 1940 Act). Many of our competitors are significantly larger than us, have access to greater capital and other resources and may have other advantages over us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish different counterparty relationships than us. Further, we may from time to time face competition from government agencies, such as the Federal Reserve, in connection with initiatives designed to stimulate the U.S. economy or the mortgage market. Market conditions may from time to time attract more competitors for certain of our target assets, which will not only affect the supply of assets but may also increase the competition for sources of financing for these assets. An increase in the competition for sources of funding could adversely affect the availability and cost of financing, and thereby adversely affect our financial results.
Available Information
Our website can be found at www.twoharborsinvestment.com. We make available, free of charge on our website, (on the Investor Relations page under “SEC Filings”), our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as are filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as well as our proxy statement with respect to our annual meeting of stockholders, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our Exchange Act reports filed with, or furnished to, the SEC are also available at the SEC’s website at www.sec.gov. The content of any website referred to in this Annual Report on Form 10-K is not incorporated by reference into this Form 10-K unless expressly noted.
We also make available, free of charge, the charters for our Audit Committee, Compensation Committee, Nominating and Corporate Governance Committee and Risk Oversight Committee, as well as our Corporate Governance Guidelines, Code of Business Conduct and Ethics, Whistleblowing Procedures and Stockholder CommunicationCommunications Policy. Within the time period required by the SEC and the NYSE, we will post on our website any amendment to the Code of Ethics and any waiver applicable to any executive officer, director or senior officer (as defined in the Code of Ethics).
Our Investor Relations Department can be contacted at:
Two Harbors Investment Corp.
Attn: Investor Relations
(612) 629-2500453-4100
Item 1A. Risk Factors
The following is a summary of the significant risk factors known to us that we believe could have a material adverse effect on our business, financial condition and results of operations. In addition to understanding the key risks described below, investors should understand that it is not possible to predict or identify all risk factors and, consequently, the following is not a complete discussion of all potential risks or uncertainties.
Risks Related to Our Business and Operations
Difficult conditions in the residential mortgage and real estate markets, the financial markets and the economy generally may adversely impact our business, results of operations and financial condition.
Our results of operations are materially affected by conditions in the residential mortgage and real estate markets, the financial markets and the economy generally. In past years, concerns about the mortgage market, declines in home prices, increases in home foreclosures, highCOVID-19 pandemic, unemployment, the availability and cost of credit, and rising government debt levels, as well as inflation, energy costs, global supply chain disruptions, climate change, global economic lethargy, geopolitical unrest across various regions worldwide, European sovereign debt issues, U.S. budget debates, federal government shutdowns and international trade disputes, have from time to time contributed to increased volatility and uncertainty in the economy and financial markets. More recently, home prices increased modestly in 2019 and are expected to gradually appreciate over the next several years. Credit standards in the mortgage market have eased in recent years, though the availability of credit remains well below levels prior to the 2008 financial crisis. Employment market conditions remain solid as jobless claims, unemployment and payroll data continue to show improvement at this state of the business cycle, although new job creation has yet to generate meaningful wage growth. Adverse developments with respect to any of these market conditions may have an impact on new demand for homes, which may compress the home ownership rates and weigh heavily on future home price performance. There is a strong correlation between home price growth rates (or losses) and mortgage loan delinquencies. Any stagnation in or deterioration of the residential mortgage or real estate markets may limit our ability to acquire our target assets on attractive terms or cause us to experience losses related to our assets. Declines in the market values
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The COVID-19 pandemic and government actions to mitigate its spread and economic impact could have a material adverse effect on our investments may adversely affect ourbusiness, results of operations and credit availabilityfinancial condition.
The COVID-19 pandemic has caused significant disruptions to the U.S. and global economies and has contributed to volatility and negative pressure in financial markets. The impact of the pandemic and measures by governments and other authorities around the world to prevent its spread have negatively impacted and could further negatively impact our business. In March 2020, we sold substantially all of our non-Agency securities and approximately one-third of our Agency RMBS in order to reduce risk and raise cash to establish a strong defensive liquidity position to weather pandemic-driven economic and market instability. In addition, the economic impacts of the pandemic resulted in elevated delinquency levels among mortgage loan borrowers during 2020. While financial markets and mortgage delinquency levels have largely recovered to pre-pandemic levels, the losses incurred in connection with our non-Agency portfolio in 2020 are expected to have a long-term impact on our book value. It is possible that, in the event pandemic conditions worsen, mortgage loan borrower delinquency levels could again rise, adversely impacting the value of our RMBS and MSR assets and increasing the cost which may reduce earnings and, in turn, cash available for distribution to service our stockholders.MSR assets.
In addition, the CARES Act provided billions of dollars of relief to individuals, businesses, state and local governments, and the health care system suffering the impact of the pandemic, including mortgage loan forbearance and modification programs to qualifying borrowers who have difficulty making their loan payments. The CARES Act and other executive, legislative and regulatory actions taken in response to the overnight lending market as well as purchasing Treasurypandemic have created new and mortgage bonds in connection with its quantitative easing programs.complex servicing compliance obligations impacting both our business and the businesses of our subservicers. There can be no assurance as to how, in the long term, these or any future actions by the U.S. government will impactaffect our business or the efficiency, liquidity and stability of the financial and mortgage markets or U.S. financial markets. To the extent the mortgage or financial markets do not respond favorably to any of these actions or such actions do not function as intended, our business may be harmed. In addition, because the programs may be designed, in part, to improve the markets for certain of our target assets, the establishment of these programs may result in increased competition to acquire our target assets or, in the case of government-backed mortgage refinancing and modification programs, may have the effect of reducing the revenues associated with certain of our target assets. We cannot predict whether or when additional government actions or initiatives may occur or the potential impact to our business, operations and financial condition.
Our business model depends in part upon the continuing viability of Fannie Mae and Freddie Mac, or similar institutions, and any significant changes to their structure or creditworthiness could have an adverse impact on us.
We purchase Agency RMBS that are protected from the risk of default on the underlying mortgages by guarantees from Fannie Mae, Freddie Mac or, in the case of the Ginnie Mae securities, the U.S. government. Fannie Mae and Freddie Mac have from time to time reported substantial losses and a need for significant amounts of additional capital. In 2008, in response to the deteriorating financial condition of Fannie Mae and Freddie Mac, the U.S. government and U.S. Treasury undertook a series of
actions designed to stabilize these GSEs, including placing them into a federal conservatorship, under which the Federal Housing Finance Agency, or FHFA, operates Fannie Mae and Freddie Mac.conservatorship. In December 2009, the U.S. government committed virtually unlimited capital to ensure the continued existence of Fannie Mae and Freddie Mac. Despite projections that the U.S. Treasury will continue to provide financing, thereThere is no assurance that such capital will continue to be available or that the GSEs will honor their guarantees or other obligations. If these GSEs fail to honor their guarantees, the value of any Agency RMBS guaranteed by the GSEs that we hold would decline.
The continued flow of residential mortgage-backed securities from the GSEs is essential to the operation of the mortgage markets in their current form, and crucial to our business model. InA number of legislative proposals have been introduced in recent years that would phase out or reform the wakeGSEs. It is not possible to predict the scope and nature of the 2008 Financial Crisis, Fannie Mae and Freddie Mac became the dominant, and in some cases, the only source of mortgage financing inactions that the U.S. government will ultimately take with respect to the GSEs. Although any phase out or reform would be expected tolikely take several years to implement, if the structure of Fannie Mae or Freddie Mac were altered, or if they were eliminated altogether, the amount and type of Agency RMBS and other mortgage-related assets available for investment would be significantly affected. A reduction in supply of Agency RMBS and other mortgage-related assets would result in increased competition for those assets and likely lead to a significant increase in the price we would have to pay for suchour target assets.
We operate in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations.
We operate in a highly regulated environment and are subject to the rules, regulations, approvals, licensing, reporting and examination requirements of various federal, state and statelocal authorities. Any change in applicable federal, state or statelocal laws, rules and regulations, or the interpretation or enforcement thereof, could have a substantial impact on our assets, operating expenses, business strategies and results of operations. Our inability or failure to comply with the rules, regulations or reporting requirements, to obtain or maintain approvals and licenses applicable to our businesses, or to satisfy annual or periodic examinations may impact our ability to do business and expose us to fines, penalties or other claims and, as a result, could harm our business. Additionally, legislation
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Federal and state regulation of the mortgage industry is complex and constantly evolving, and any further changes to applicable laws and regulations, may be enacted orincluding those adopted in response to the future that could significantly affectCOVID-19 pandemic, may adversely impact our businessbusiness.
Although we do not originate or service residential mortgage loans, we must comply with various federal and operations, which could havestate laws, rules and regulations as a material adverse effect onresult of owning MSR. These rules include, among others, the Dodd-Frank Act, the Gramm-Leach-Bliley Act and the CARES Act. We are also required to maintain qualifications, registrations and licenses in certain states in order to own certain of our financial conditionassets. These requirements can and results of operations.do change as statutes and regulations are enacted, promulgated or amended, or as regulatory guidance or interpretations evolve or change.
The Dodd-Frank Act and regulationsits implementing such legislation have had a substantial impact on the mortgage industry and the MBS markets; these regulations, as well as newother federal and state rules and regulations that govern mortgage servicing, combine to create a complex and constantly evolving regulatory environment, and the failure by us, or our subservicers, to comply with these requirements may result in fines or the suspension or revocation of the qualifications, registrations and licenses necessary to operate as an owner of MSR. New or modified regulations implemented under Dodd-Frank may have an adverse impactat the federal or state level to address concerns on our business, results of operations and financial condition.
We have incurred and expect to continue to incur in the future operational and system costs necessary to maintain processes to ensure our compliance with theapplicable rules and regulations applicable to us as well as to monitor compliance by our business partners. Additional rules and regulations implemented by the CFPB and state regulators, as well as any changes to existing rules, as a result of the CFPB’s periodic reassessment of established regulations, could lead to changes in the way we conduct our business and increased costs of compliance, both of which may have an adverse impact on our business and financial condition.
We operate in a highly competitive market and we may not be able to compete successfully.
We operate in a highly competitive market. Our profitability depends, in large part, on our ability to acquire a sufficient supply of our target assets at favorable prices. In acquiring assets, we compete with a variety of investors, including other mortgage REITs, specialty finance companies, public and private investment funds, asset managers, commercial and investment banks, broker-dealers, commercial finance and insurance companies, the GSEs, mortgage servicers and other financial institutions. In addition, the Federal Reserve has in the past committed to purchase unlimited amounts of Agency RMBS and other assets in order to stabilize the financial markets. Many of our competitors are substantially larger and may have greater financial, technical, marketing and other resources than we do. Certain competitors may also have a broader investment mandate or higher risk tolerance, which may allow them to consider a wider variety of potential investments. Additionally, we may face competition from governmental actions and initiatives designed to stimulate the U.S. economy and mortgage market. Competition for our target assets may lead to the price of such assets increasing and their availability decreasing, which may limit our ability to generate desired returns, reduce our earnings and, in turn, decrease the cash available for distribution to our stockholders.
Our executive officers and other key employees are critical to our success and the loss of any executive officer or key employee may materially adversely affect our business.
We operate in a highly specialized industry and our success is dependent upon the efforts, experience, diligence, skill, and deep knowledge of our business and historical operations of our executive officers and key employees, as well as their industry knowledge and relationships. The departure of any of our executive officers and/or key employees could have a material adverse effect on our operations and performance.
We may change any of our strategies, policies or procedures without stockholder consent.
We may change any of our strategies, policies or procedures with respect to investments, asset allocation, growth, operations, indebtedness, financing strategy and distributions at any time without the consent of stockholders, which could result in our making investments that are different from, and possibly riskier than, the types of investments described in this Annual Report on Form 10-K.stockholders. Changes in strategy could also result in the elimination of certain investments and business activities that we no longer view as attractive or in alignment with our business model. Shifts in strategy may increase our exposure to credit risk, interest rate risk, financing risk, default risk, regulatory risk and real estate market fluctuations. We also cannot assure you that we will be able to effectively execute on or to realize the potential benefits of changes in strategy. Any such
changes could adversely affect our financial condition, risk profile, results of operations, the market price of our common stock and our ability to make distributions to stockholders.
Our risk management policies and procedures may not be effective.
We have established and maintain risk management policies and procedures designed to identify, monitor and mitigate financial risks, such as credit risk, interest rate risk, prepayment risk and liquidity risk, as well as operational and compliance risks related to our business, assets and liabilities. These policies and procedures may not sufficiently identify all of the risks to which we are or may become exposed or mitigate the risks we have identified. Any expansion of our business activities may result in our being exposed to risks to which we have not previously been exposed or may increase our exposure to certain types of risks. Alternatively, any narrowing of our business activities may increase the concentration of our exposure to certain types of risk. Any failure to effectively identify and mitigate the risks to which we are exposed could have an adverse effect on our business, results of operations and financial condition.
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Maintaining our exemptions from registration as an investment company under the 1940 Act imposes limits on our operations.
We intend to conduct our operations so as not to become required to register as an investment company under the 1940 Act. Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. Excluded from the term “investment securities,” among other things, are U.S. government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.
We are organized as a holding company that conducts its businesses primarily through our subsidiaries. We intend to conduct the operations of Two Harbors and its subsidiaries so that they do not come within the definition of an investment company, either because less than 40% of the value of their total assets on an unconsolidated basis will consist of “investment securities” or because they meet certain other exceptions or exemptions set forth in the 1940 Act based on the nature of their business purpose and activities, such as the Rule 3a-7 structured finance exemption for issuers of asset-backed securities or the Section 3(c)(3) exemption for insurance companies.activities.
Certain of our subsidiaries intend tomay rely upon the exemption set forth in Section 3(c)(5)(C) of the 1940 Act, which is available for entities “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” This exemption generally means that at least 55% of each such subsidiary’s portfolio must be comprised of qualifying assets and at least 80% of its portfolio must be comprised of qualifying assets and real estate-related assets under the 1940 Act. Qualifying assets for this purpose include mortgage loans and other assets, such as whole pool Agency and non-Agency RMBS, which are considered the functional equivalent of mortgage loans for the purposes of the 1940 Act. We expect each of our subsidiaries relying on Section 3(c)(5)(C) to invest at least 55% of its assets in whole pool Agency and non-Agency RMBS and other interests in real estate that constitute qualifying assets in accordance with SEC staff guidance and an additional 25% of its assets in either qualifying assets and other types of real estate related assets that do not constitute qualifying assets.
As a result of the foregoing restrictions, we are limited in our ability to make or dispose of certain investments. To the extent the SEC publishes new or different guidance with respect to these matters, we may be required to adjust our strategy accordingly. In addition, we may be limited in our ability to make certain investments, which could result in a subsidiary holding assets that we might wish to sell or selling assets that we might wish to hold. Although we monitor the portfolios of our subsidiaries relyingthat may rely on the Section 3(c)(5)(C) exemption periodically, and prior to each acquisition or disposition of assets, there can be no assurance that such subsidiaries will be able to maintain this exemption.
Loss of our 1940 Act exemptions would adversely affect us, the market price of shares of our common stock and our ability to distribute dividends, and could result in the termination of our management agreement with PRCM Advisers and certain of our financing or other agreements.
As described above, we intend to conduct operations so that we are not required to register as an investment company under the 1940 Act. Although we monitor our portfolio and our activities periodically, there can be no assurance that we will be able to maintain our exemption from investment company registration under the 1940 Act. The SEC has previously solicited public comment on a wide range of issues relating to the exemptions set forth in Section 3(c)(5)(C) of the 1940 Act, including what types of assets should be deemed qualifying interests and whether REITs that invest in RMBS should be regulated in a manner similar to investment companies. Although we believe that we are properly relying on Section 3(c)(5)(C) to exempt us from regulation under the 1940 Act,Furthermore, any modifications to the 1940 Act exemption rules or interpretations may require us to change our business and operations in order for us to continue to rely on such exemption. Additionally, any uncertainty regarding our 1940 Act exemption could negatively impact our ability to raise capital, borrow money, or engage in certain other types of business transactions, which could materially and adversely affect our business, operations and financial condition. There can be no assurance that the rules, regulations and interpretations governing the exemptions available under the 1940 Act will not change in a manner that adversely affects our operations. If we were no longer able to qualify for exemptions from registration under the 1940 Act, we could be required to restructure our activities or the activities of our subsidiaries, including effecting sales of assets in a manner that, or at a time when, we would not otherwise choose, which could negatively affect the value of our common stock, the sustainability of our business model, and our ability to make distributions. Such sales could occur during adverse market conditions, and we could be forced to accept prices below that which we believe are appropriate. The loss of our 1940 Act exemptions may also result in a default under or permit certain of our counterparties to terminate the many repurchase agreements, financing facilities or other agreements we have in place, including permitting PRCM Advisers to terminate our management agreement. The termination of any of these agreements could result in a material adverse effect on our business and results of operations.
The lack of liquidity of our assets may adversely affect our business, including our ability to value, finance and sell our assets.
We have and may in the future acquire assets or other instruments with limited or no liquidity, including securities, MSR and other instruments that are not publicly traded. Market conditions could also significantly and negatively affect the liquidity of our assets. It may be difficult or impossible to obtain third-party pricing on such illiquid assets and validating third-party pricing for illiquid assets may be more subjective than more liquid assets. Illiquid assets typically experience greater price volatility, as a ready market may not exist for such assets, and such assets can be more difficult to value.
Any illiquidity in our assets may make it difficult for us to sell such assets if the need or desire arises. Unlike equity securities, bonds or other exchange-traded instruments with highly liquid markets, theThe ability to quickly sell certain of our target assets, such as certain securities and MSR, may be constrained by a number of factors, including a small number of willing buyers, lack of transparency as to current market terms and price, and time delays resulting from the buyer’s desire to conduct due diligence on the assets, negotiation of a purchase and sale agreement, compliance with any applicable contractual or regulatory requirements, and for certain assets like MSR, operational and compliance considerations, including the need for certain approvals from the investor in the underlying mortgage loan (e.g., Fannie Mae or Freddie Mac), all of which can result in a sale process that takes several weeks or months. Moreover, certain of our assets may not be registered under the relevant securities laws, resulting in prohibitions against their transfer, sale, pledge or their disposition except in transactions that are exempt from registration requirements or are otherwise in accordance with such laws.considerations. Consequently, even if we identify a buyer
for certain of our securities and MSR, there is no assurance that we would be able to sell such assets in a timely manner if the need or desire arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may be forced to sell our assets at a price that is significantly less than the value at which we previously attributed to such assets.
Assets that are illiquid are typically more difficult and costly to finance. As a result, we may be required to finance the assets at unattractive rates or hold them on our balance sheet without the use of leverage. Assets tend to become less liquid during times of financial stress, which is often the time that liquidity is most needed. To the extent that we use leverage to finance assets that later become illiquid, we may lose that leverage if the financing counterparty determines that the collateral is no longer sufficient to secure the financing, or the counterparty could reduce the amount of money that it is willing to lend against the asset.
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We use leverage in executing our business strategy, which may adversely affect the return on our assets and may reduce cash available for distribution to our stockholders, as well as increase losses when economic conditions are unfavorable.
We use leverage to finance many of our investments and to enhance our financial returns. Our primary source of leverage is short-term repurchase agreement financing for our Agency RMBS and non-Agency securities. We also use revolving credit facilities, repurchase agreements and term notes payable to finance MSR. Other sources of leverage may include credit facilities (including term loans, revolving facilities and FHLB advances) as well as the public issuance of debt securities.
Through the use of leverage, we may acquire positions with market exposure significantly greater than the amount of capital committed to the transaction. For example, by entering into repurchase agreements with advance rates, or haircut levels, of 5% (which is not an atypical haircut for Agency RMBS), we could leverage capital allocated to Agency RMBS by a ratio of as much as 20 to 1. It is not uncommon for investors in Agency RMBS to obtain leverage equal to ten or more times equity through the use of repurchase agreement financing. Subject to market conditions, we anticipate that we may deploy, on a debt-to-equity basis, up to ten times leverage on our Agency RMBS and up to two times on our non-Agency securities;RMBS; however, there is no specific limit on the amount of leverage that we may use.
Leverage will magnify both the gains and the losses of our positions. Leverage will increase our returns as long as we earn a greater return on investments purchased with borrowed funds than our cost of borrowing such funds. However, if we use leverage to acquire an asset and the value of the asset decreases, the leverage will increase our losses. Even if the asset increases in value, if the asset fails to earn a return that equals or exceeds our cost of borrowing, the leverage will decrease our returns.
We may be required to post large amounts of cash as collateral or margin to secure our leveraged positions.positions, including on our MSR financing facilities. In the event of a sudden, precipitous drop in value of our financed assets, we might not be able to liquidate assets quickly enough to repay our borrowings, further magnifying losses. Even a small decrease in the value of a leveraged asset may require us to post additional margin or cash collateral. This may adversely affect our financial condition and results of operations and decrease the cash available to us for distributions to stockholders.
We depend on repurchase agreements and other credit facilities to execute our business plan and any limitation on our ability to access funding through these sources could have a material adverse effect on our results of operations, financial condition and business.
Our ability to purchase and hold assets is affected by our ability to secure repurchase agreements and other credit facilities on acceptable terms. We currently have repurchase agreements, revolving credit facilities and other credit facilities in place with severalnumerous counterparties, including national banks and the FHLB. In the future, we may enter into additional or increase commitment amounts under our existing repurchase agreements, revolving credit facilities and credit facilities, but we can provide no assurance that lenders will be willing or ablecontinue to provide us with sufficient financing through the repurchase markets or otherwise. In addition, with respect to MSR financing, there can be no assurance that the GSEs will consent to such transactions or consent on terms consistent with prior MSR financing transactions. Because repurchase agreements and similar credit facilities are generally short-term commitments of capital, changes inchanging conditions in the financing markets may make it more difficult for us to secure continued financing during times of market stress. During certain periods of a credit cycle, lenders may lose their ability or curtail their willingness to provide financing. If we are not able to arrange for replacement financing on acceptable terms, or if we default on our covenants or are
Our ability to efficiently access financing through our repurchase agreements or otherwise may be adversely impacted by counterparty requirements regarding the type of assets that may be sold and the timing and process for such sales. In order for us to borrow funds under our repurchase agreements, counterparties must first review the assets for which we are seeking financing and approve such assets in their sole discretion. ThisCounterparty review and approval processprocesses may delay the timing in which funding may be provided, or preclude funding altogether. For MSR, delays may also occur due to the need to obtain GSE approval of the collateral to be posted, the need for third-party valuations of the MSR collateral or the agreement of the relevant servicing partysubservicers to be party to the financing agreement.
Changes in the financing markets could adversely affect the marketability of the assets in which we invest, and this could negatively affect the value of our assets. If our lenders are unwilling or unable to provide us with financing, or if the financing is only available on terms that are uneconomical or otherwise not satisfactory to us, we could be forced to sell assets when prices are depressed. The amount of financing we receive under our repurchase agreements, revolving credit facilities or other credit facilities will be directly related to the lenders’ valuation of the assets that secure the outstanding borrowings. Typically, repurchase agreements and similar lending arrangements grant the respective lender the right to reevaluate the market value of the assets that secure outstanding borrowings at any time. If a lender determines that the value of the assets has decreased, it typically has the right to initiate a margin call, requiring us to transfer additional assets to such lender, or repay a portion of the outstanding borrowings. Any such margin call could have a material adverse effect on our results of operations, financial condition, business, liquidity and ability to make distributions to stockholders, and could cause the value of our common stock to decline. We may be forced to sell assets at significantly depressed prices to meet margin calls and to maintain adequate liquidity at levels satisfactory to the counterparty, which could cause us to incur losses. Moreover, to the extent that we are forced to sell assets because of the availability of financing or changes in market conditions, other market participants may face similar pressures, which could exacerbate a difficult market environment and result in significantly greater losses on the sale of such assets. In an extreme case of market duress, a market may not exist for certain of our assets at any price.
Although we generally seek to reduce our exposure to lender concentration-related risk by entering into repurchase agreements and other credit facilitiesfinancing relationships with multiple counterparties, we are not required to observe specific diversification criteria, except as may be set forth in the investment guidelines adopted by our board of directors. To the extent that the number of or net exposure under our lending arrangements may become concentrated with one or more lenders, the adverse impacts of defaults or terminations by such lenders may be significantly greater. As
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Table of December 31, 2019, lenders for whom our net exposure (generally, the value of assets sold under repurchase agreements or posted as loan collateral, less the amount of the associated liabilities) exceeded 5% of stockholders’ equity included the Royal Bank of Canada. See Note 10 - ContentsRepurchase Agreements and Note 12 - Federal Home Loan Bank of Des Moines Advances to the consolidated financial statements, included in this Annual Report on Form 10-K, for additional information.
Our inability to meet certain financial covenants related to our repurchase agreements, revolving credit facilities or other credit facilities could adversely affect our financial condition, results of operations and cash flows.
In connection with certain of our repurchase agreements, revolving credit facilities and other credit facilities, we are required to comply with certain financial covenants, the most restrictive of which are disclosed within Item 7, “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” of this Annual Report on Form 10-K. Compliance with these financial covenants will depend on market factors and the strength of our business and operating results. Various risks, uncertainties and events beyond our control could affect our ability to comply with the financial covenants. Failure to
comply with our financial covenants could result in an event of default, termination of the lending facility, acceleration of all amounts owing under the lending facility, and may give the counterparty the right to exercise certain other remedies under the lending agreement, including without limitation the sale of the asset subject to repurchase at the time of default, unless we were able to negotiate a waiver. Any such waiver could be conditioned on an amendment to the lending agreement and any related guaranty agreement on terms thatIn addition, we may be unfavorablesubject to us. If we are unablecross-default provisions under certain financing facilities that could cause an event of default under such financing facilities to negotiate a covenant waiver or replace or refinance our assetsbe triggered by events of default under a new lending facility on favorable terms or at all, our financial condition, results of operations, cash flows and ability to pay dividends could be adversely affected.other financing arrangements.
If a counterparty to a repurchase agreement defaults on its obligation to resell the underlying security back to us at the end of the purchaserepurchase agreement term, or if the value of the underlying asset has declined as of the end of that term, or if we default on our obligations under the repurchase agreement, we may incur losses.
When we enter into repurchase agreements, we sell the assets to lenders (i.e., repurchase agreement counterparties) and receive cash from the lenders. The lenders are obligated to resell the same assets back to us at the end of the term of the repurchase agreement. Because the cash that we receive from the lender when we initially sell the assets to the lender is less than the value of those assets (the difference being the “haircut”), if the lender defaults on its obligation to resell the same assets back to us, we would incur a loss on the repurchase agreement equal to the amount of the haircut (assuming there was no change in the value of the securities). We would also incur losses on a repurchase agreement if the value of the underlying assets has declined as of the end of the repurchase agreement term, because we would have to repurchase the assets for their initial value but would receive assets worth less than that amount. Further, if we default on our obligations under a repurchase agreement, the lender will be able to terminate the repurchase agreement and may cease entering into any other repurchase agreements with us. If a default occurs under any of our repurchase agreements and a lender terminates one or more of its repurchase agreements, we may need to enter into replacement repurchase agreements with different lenders. There can be no assurance that we will be successful in entering into such replacement repurchase agreements on the same terms as the repurchase agreements that were terminated or at all. Any losses that we incur on our repurchase agreements could adversely affect our earnings and thus our cash available for distribution to stockholders.
Our rights under our repurchase agreements are subject to the effects of bankruptcy laws in the event of the bankruptcy or insolvency of us or our lenders under the repurchase agreements.
In the event of our insolvency or bankruptcy, certain repurchase agreements may qualify for special treatment under the U.S. Bankruptcy Code, the effect of which, among other things, would be to allow the lender under the applicable repurchase agreement to avoid the automatic stay provisions of the U.S. Bankruptcy Code and to foreclose on the collateral agreement without delay. In the event of the insolvency or bankruptcy of a lender during the term of a repurchase agreement, the lender may be permitted, under applicable insolvency laws, to repudiate the contract, and our claim against the lender for damages may be treated simply as an unsecured creditor.creditor claim. In addition, if the lender is a broker or dealer subject to the Securities Investor Protection Act of 1970, or an insured depository institution subject to the Federal Deposit Insurance Act, our ability to exercise our rights to recover our assets under a repurchase agreement or to be compensated for any damages resulting from the lender's insolvency may be further limited by those statutes. These claims would be subject to significant delay and, if and when received, may be substantially less than the damages we actually incur.
The impairment or negative performance of other financial institutions could adversely affect us.
We have exposure to and routinely execute transactions with numerous counterparties in the financial services industry, including broker-dealers, commercial banks, investment banks, investment funds and other institutions. The operations of U.S. and global financial services institutions are highly interconnected and a decline in the financial condition of one or more financial services institutions may expose us to credit losses or defaults, limit our access to liquidity or otherwise disrupt the operationsoperation of our businesses. While we regularly assess our exposure to different counterparties, the performance and financial strength of specific institutions are subject to rapid change, the timing and extent of which cannot be known.
We may not have the ability to raise funds necessary to pay principal amounts owed upon maturity of our outstanding convertible senior notes or to purchase such notes upon a fundamental change.
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An increase in our borrowing costs relative to the interest that we receive on our leveraged assets may adversely affect our profitability and our cash available for distribution to stockholders.profitability.
As our repurchase agreements and other short-term borrowings mature, we must enter into new borrowings, find other sources of liquidity or sell assets. An increase in short-term interest rates at the time that we seek to enter into new borrowings would reduce the spread between the returns on our assets and the cost of our borrowings. This would adversely affect the returns on our assets, which might reduce earnings and, in turn, cash available for distribution to stockholders.
We are highly dependent on information technology, and system failures or security breaches or systems failures could significantly disrupt our business, which may, in turn, negatively affect the market price of our common stock and our ability to pay dividends.business.
Our business is highly dependent on information technology. In the ordinary course of our business, we may store sensitive data, including our proprietary business information and that of our business partners, and personally identifiable information of mortgage borrowers, on our networks. The secure maintenance and transmission of this information is critical to our operations.
Computer malware, viruses, hackingransomware and phishing attacks have become more prevalentremain widespread and sophisticated in recent years and weare increasingly sophisticated. We are from time to time the target of attempted cyber threats. We continuously monitor and develop our information technology networks and infrastructure to prevent, detect, address and mitigate the risk of unauthorized access, misuse, computer viruses and other events that could have a security impact. Despite these security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, regulatory penalties, disruptdisruption to our operations, disruptor disruption to our trading activities or damage our reputation, which could have a material adverse effect on our financial results and negatively affect the market price of our common stock and our ability to pay dividends to stockholders.
The resources required to protect our information technology and infrastructure, and to comply with the laws and regulations related to data and privacy protection, are subject to uncertainty. Even in circumstances where we are able to successfully protect such technology and infrastructure from attacks, we may incur significant expenses in connection with our responses to such attacks. In addition, recent well-publicized security breaches have led to enhanced governmentGovernment and regulatory scrutiny of the measures taken by companies to protect against cyber-security attacks and may in the future resulthas resulted in heightened cyber-security requirements and/orand additional regulatory oversight. As cyber-security threats and government and regulatory oversightAny of associated risks continue to evolve, we may be required to expend additional resources to enhance or expand upon the security measures we currently maintain. Any such actionsforegoing may adversely impact our results of operations and financial condition.
We enter into hedging transactions that expose us to contingent liabilities in the future, which may adversely affect our financial results or cash available for distribution to stockholders.
We engage in transactions intended to hedge against various risks to our portfolio, including the exposure to changes in interest rates. The extent of our hedging activity varies in scope based on, among other things, the level and volatility of interest rates, the type of assets held and other market conditions. Although these transactions are intended to reduce our exposure to various risks, hedging may fail to adequately protect or could adversely affect us because, among other things:
available hedges may not correspond directly with the risks for which protection is sought;
the duration of the hedge may not match the duration of the related liability;
the amount of income that a REIT may earn from certain hedging transactions (other than through our TRSs) is limited by U.S. federal income tax provisions;
the credit quality of a hedging counterparty may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and
the hedging counterparty may default on its obligations.
Subject to maintaining our qualification as a REIT and satisfying the criteria for no-action relief from the CFTC’s CPOCommodity Futures Trading Commission’s commodity pool operator registration rules, there are no current limitations on the hedging transactions that we may undertake. Our hedging transactions could require us to fund large cash payments in certain circumstances (e.g., the early termination of the hedging instrument caused by an event of default or other early termination event, or a demand by a counterparty that we make increased margin payments).
Our ability to fund these obligations will depend on the liquidity of our assets and our access to capital at the time. The need to fund these obligations could adversely affect our financial condition. Further, hedging transactions, which are intended to limit losses, may actually result in losses, which would adversely affect our earnings and could in turn reduce cash available for distribution to stockholders.
Our financial results may experience greater fluctuations due to our decision not to elect hedge accounting treatment on our derivative instruments.
We have elected to not qualify for hedge accounting treatment under Accounting Standards Codification (ASC) 815, Derivatives and Hedging, or ASC 815, for our current derivative instruments. The economics of our derivative hedging transactions are not affected by this election; however, our earnings (losses) for U.S. GAAP purposes or GAAP net income (loss), may be subject to greater fluctuations from period to period as a result of this accounting treatment for changes in fair value of derivative instruments or for the accounting of the underlying hedged assets or liabilities in our financial statements, as it does not necessarily align with the accounting used for derivative instruments.
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We depend on third-party service providers, including mortgage loan servicers, for a variety of services related to our business. We are, therefore, subject to the risks associated with third-party service providers.
We depend on a variety of services provided by third-party service providers related to our investments in Agency RMBS non-Agency securities and MSR, as well as for general operating purposes. For example, we rely on the mortgage servicers who service the mortgage loans underlying our Agency RMBS non-Agency securities and MSR to, among other things, collect principal and interest payments on such mortgage loans and perform loss mitigation services in accordance with applicable laws and regulations. Mortgage servicers and other service providers, such as trustees, bond insurance providers, due diligence vendors and document custodians, may fail to perform or otherwise not perform in a manner that promotes our interests.
In addition, in connection with our ownership of MSR, we possess personally identifiable information that is shared with third-party service providers, including our mortgage servicers, as required or permitted by law. In the event the information technology networks and infrastructure of our third-party service providers is breached, we may be liable for losses suffered by individuals whose personal information is stolen as a result of such breach and any such liability could be material. Even if we are not liable for such losses, any breach of these third-party systems could expose us to material costs related to notifying affected individuals or other parties and providing credit monitoring services, as well as to regulatory fines or penalties. In addition, any breach of these systems could disrupt our normal business operations and expose us to reputational damage or adversely impact our financial condition and results of operations.
We may be subject to fines, penalties or other enforcement actions based on the conduct of third-party mortgage loan servicers who service the loans underlying the MSR we acquire or our failure to conduct appropriate oversight of these servicers, which could adversely impact our results of operations, financial condition and business.servicers.
We contract with third-party mortgage loan servicers to perform the actual day-to-day servicing obligations on the mortgage loans underlying our MSR. We and the mortgage loan servicers operate in a highly regulated industry and are required to comply with various federal, state and local laws and regulations, including the obligation to oversee our third-party mortgage servicers to assess their compliance with these laws and regulations. Although the servicing activity is conducted primarily in the name of the mortgage loan servicers, to the extent these servicers fail to comply with applicable laws and regulations, we could be subject to governmental actions such as denial, suspension or revocation of licenses, be fined or otherwise subject to regulatory enforcement action, or incur losses or be subject to lawsuits, any of which could adversely impact our business, financial condition, results of operations and our ability to make distributions to our stockholders. While some of these laws and regulations may not explicitly hold us responsible for the legal violations of third-party servicers, federal and state agencies have increasingly sought to impose such liability. Accordingly, the conduct of third-party mortgage loan servicers or our failure to adequately oversee their compliance with these laws and regulations may subject us to increased regulatory risk and could result in regulatory fines, penalties, civil liabilities or other limitations in our ability to acquire and manage MSR. Further, it is possible that a third-party servicer’s failure to comply with new and evolving servicing rules or standards could adversely affect the value of our MSR.
Our ability to own and manage MSR is subject to terms and conditions established by the GSEs, which are subject to change.
Our subsidiary’s continued approval from the GSEs to own and manage MSR is subject to compliance with each of their respective selling and servicing guidelines, minimum capital requirements and other conditions they may impose from time to time at their discretion. Failure to meet such guidelines and conditions could result in the unilateral termination of our subsidiary’s approved status by one or more GSEs.GSEs or result in the acceleration and termination of our MSR financing facilities. In addition, the implementation of more restrictive or operationally intensive guidance may increase the costs associated with owning and managing MSR as well as our ability to finance MSR.
Our securitization activities expose us to risk of litigation, which may materially and adversely affect our business and financial condition.
In connection with our securitization transactions, we prepare disclosure documentation, including term sheets and offering memorandums, which contain disclosures regarding the securitization transactions and the assets securitized. If our disclosure documentation is alleged or found to contain inaccuracies or omissions, we may be liable under federal securities laws, state securities laws or other applicable laws for damages to third parties that invest in these securitization transactions, including in circumstances in which we relied on a third party in preparing accurate disclosures, or we may incur other expenses and costs in connection with disputing these allegations or settling claims. We have also sold or contributed residential mortgage loans to third parties who, in turn, securitize those loans. In these circumstances, we may have also prepared disclosure documentation, including documentation that is included in term sheets and offering memorandums relating to those securitization transactions. We could be liable under federal securities laws, state securities laws, or other applicable laws for damages to third parties that invest in these securitization transactions, including liability for disclosures prepared by third parties or with respect to loans that we did not sell or contribute to the securitization.
We may be subject to representation and warranty risk in our capacity as an owner of MSR as well as in connection with our prior securitization transactions and our sales of MSR and other assets.
The MSR we acquire may be subject to existing representations and warranties made to the applicable investor (including, without limitation, the GSEs) regarding, among other things, the origination and prior servicing of those mortgage loans, as well as future servicing practices following our acquisition of such MSR. If such representations and warranties are inaccurate, we may be obligated to repurchase certain mortgage loans or indemnify the applicable investor for any losses suffered as a result of the origination or prior servicing of the mortgage loans, either of which may result in a loss.loans. As such, the applicable investor will have direct recourse to us for such origination and/or prior servicing issues.
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In connection with our prior securitization transactions and with the sales of our MSR and other assets from time to time, we may have been or may be required to make representations and warranties to the purchasers of the assets regarding certain characteristics of those assets. If our representations and warranties are inaccurate, we may be obligated to repurchase the assets, which may result in a loss. Even if we obtain representations and warranties from the parties from whom we acquired the asset, as applicable, they may not correspond with the representations and warranties we make or may otherwise not protect us from losses. Additionally, the loan originator or other parties from whom we acquired the MSR may be insolvent or otherwise unable to honor their respective indemnification or repurchase obligations for breaches of representation and warranties. For example, if representations and warranties we obtain from those parties do not exactly align with the representations and warranties we make, or if the representations and warranties made to us are not enforceable or if we cannot collect damages for a breach (e.g., due to the financial condition of the party that made the representation or warranty to us or statutes of limitations), we may incur losses.
Risks Related To Our Assets
Declines in the market values of our assets may adversely affect our results of operations and financial condition.
A substantial portion of our assets are classified for accounting purposes as “available-for-sale.” Changes in the market values of those assets will be directly charged or credited to stockholders’ equity. As a result, a decline in values may result in connection with factors that are out of our control and adversely affect our book value. Moreover, if the decline in value of an available-for-sale security is other than temporary, such decline will reduce our earnings.
be readily determinable. We seek to generate current incomevalue these assets quarterly at fair value, as determined in accordance with ASC 820, Fair Value Measurements and capital appreciation for our stockholders. However,Disclosures, which may include unobservable inputs. Because such valuations are subjective, the assets that we acquire may not appreciate infair value and, in fact, may decline in value. Additionally, the securities that we acquire, or the loans underlyingof certain of our assets may experience defaultsfluctuate over short periods of interest and/or principal payments, which could result in significant losses related to such assets. Accordingly, wetime and our determinations of fair value may notdiffer materially from the values that would have been used if a ready market for these securities existed. We may be able to realize gains or income fromadversely affected if our assets. Any gainsdeterminations regarding the fair value of these assets are materially higher than the values that we doultimately realize may not be sufficient to offset other losses that we experience. Any income that we realize may not be sufficient to offset our expenses.
Changes in mortgage prepayment rates may adversely affect the value of our assets.
The value of our assets is affected by prepayment rates on mortgage loans, and our investment strategy includes making investments based on our expectations regarding prepayment rates. A prepayment rate is the measurement of how quickly borrowers pay down the unpaid principal balance of their loans or how quickly loans are otherwise brought current, modified, liquidated or charged off.
With respect to our securities portfolio, typically the value of a mortgage-backed security includes market assumptions regarding the speed at which the underlying mortgages will be prepaid. Faster than expected prepayments could adversely affect our profitability, including in the following ways:
•We may purchase securities that have a higher interest rate than the market interest rate at the time. In exchange for this higher interest rate, we may pay a premium over the par value to acquire the security. In accordance with U.S. GAAP, we may amortize this premium over the estimated term of the security. If the security is prepaid in whole or in part prior to its maturity date, however, we may be required to expense the premium that was prepaid at the time of the prepayment.
•A substantial portion of our adjustable-rate Agency RMBS and non-Agency securities may bear interest rates that are lower than their fully indexed rates, which are equivalent to the applicable index rate plus a margin. If an adjustable-rate security is prepaid prior to or soon after the time of adjustment to a fully-indexed rate, we will have held that security while it was least profitable and lost the opportunity to receive interest at the fully indexed rate over the remainder of its expected life.
•If we are unable to acquire new Agency RMBS and non-Agency securities similar to the prepaid security, our financial condition, results of operations and cash flows wouldcould suffer.
Prepayment rates may be affected by a number of factors including mortgage rates, the availability of mortgage credit, the relative economic vitality of the area in which the related properties are located, the average remaining life of the loans, the average size of the remaining loans, the servicing of the mortgage loans, changes in tax laws, other opportunities for investment, homeowner mobility and other economic, social, geographic, demographic and legal factors. Consequently, prepayment rates cannot be predicted with certainty. In making investment decisions, we depend on certain assumptions based upon historical trends with respect to the relationship between interest rates and prepayments under normal market conditions. If dislocations in the residential mortgage market or other developments change the way that prepayment trends have historically responded to interest rate changes, our ability to (i) assess the market value of target assets, (ii) implement hedging strategies and (iii) implement techniques to hedge prepayment risks would be significantly affected, which could materially adversely affect our financial position and results of operations. If we make erroneous assumptions regarding prepayment rates in connection with our investment decisions, we may experience significant investment losses.
LIBOR and other “benchmark” indices have been the subject of recent national, international and other regulatory guidance and proposals for reform. These reforms may cause such benchmarksOn March 5, 2021, Intercontinental Exchange Inc. announced that ICE Benchmark Administration Limited, the administrator of LIBOR, intends to perform differently than instop publication of the past,majority of USD-LIBOR tenors on June 30, 2023. In the U.S., the Alternative Reference Rates Committee, or ARRC, has identified the Secured Overnight Financing Rate, or SOFR, as its preferred alternative rate for U.S. dollar-based LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. The ARRC has proposed a paced market transition plan to SOFR, and various organizations are currently working on industry wide and company-specific transition plans as it relates to derivatives and cash markets exposed to LIBOR. All of our financing arrangements and derivative instruments that incorporate LIBOR as the referenced rate either mature prior to the phase out of LIBOR or have provisions in place that provide for an alternative to LIBOR upon its phase-out. Additionally, each series of our fixed-to-floating preferred stock that becomes callable at the time the stock begins to pay a LIBOR-based rate has existing LIBOR cessation fallback language. Given the differences between LIBOR and any other alternative benchmark rate that may be established, there are many uncertainties regarding a transition from LIBOR. The consequences which cannot be predicted. In particular, regulators and law enforcement agencies in the U.K. and elsewhere are conducting criminal and civil investigations into whether the banks that contributed information to the British Bankers’ Association, or BBA, in connection with the daily calculation of LIBOR may have been under-reporting or otherwise manipulating or attempting to manipulate LIBOR. A number of BBA member banks have entered into settlements with their regulators and law enforcement agenciesthese developments with respect to this alleged manipulation of LIBOR. Actions by the regulators or law enforcement agenciesLIBOR cannot be entirely predicted, and may span multiple future periods, but could result in changes toan increase in the manner incost of our variable rate debt or derivative financial instruments which LIBOR is determined or the establishment of alternative reference rates. For example, in July 2017, the U.K. Financial Conduct Authority announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021.
Our delayed delivery transactions, including TBAs, subject us to certain risks, including price risks and counterparty risks.
We may purchase Agency RMBS throughthrough delayed delivery transactions, including TBAs. In a delayed delivery transaction, we enter into a forward purchase agreement with a counterparty to purchase either (i) an identified Agency RMBS, or (ii) a to-be-issued (or “to-be-announced”) Agency RMBS with certain terms. As with any forward purchase contract, the value of the underlying Agency RMBS may decrease between the contract date and the settlement date. Furthermore, a transaction counterparty may fail to deliver the underlying Agency RMBS at the settlement date. If any of the above risks were to occur, our financial condition and results of operations may be materially adversely affected.
It may be uneconomical to roll our TBA dollar roll transactions or we may be unable to meet margin calls on our TBA contracts, which could negatively affect our financial condition and results of operations.
We utilize TBA dollar roll transactions as a means of investing in and financing Agency RMBS. TBA contracts enable us to purchase or sell, for future delivery, Agency RMBS with certain principal and interest terms and certain types of collateral, but the specific securities to be delivered are not identified until shortly before the TBA settlement date. Prior to settlement of the TBA contract we may choose to move the settlement of the securities to a later date by entering into an offsetting position (referred to as a “pair off”), net settling the paired off positions for cash, and simultaneously purchasing a similar TBA contact for a later settlement date, collectively referred to as a “dollar roll”. The Agency RMBS purchased for a forward settlement date under the TBA contracts are typically priced at a discount to Agency RMBS for settlement in the current month. This difference (or discount) is referred to as the “price drop.” The price drop is the economic equivalent of net interest carry income on the underlying Agency RMBS over the roll period (interest income less implied financing cost) and is commonly referred to as a “dollar roll income.” Consequently, dollar roll transactions and such forward purchase of Agency RMBS represent a form of off-balance sheet financing and increase our “at-risk” leverage.
Under certain market conditions, TBA dollar roll transactions may result in negative carry income whereby the Agency RMBS purchasepurchased for a forward settlement date under TBA contract are priced at a premium to Agency RMBS for settlement in the current month. Under such conditions, it may be uneconomical to roll our TBA positions prior to the settlement date, and we couldmay have to take physical delivery of the underlying securities and settle our obligations for cash. We may not have sufficient funds or alternative financing sources available to settle such obligations. In addition, pursuant to the margin provisions established by the Mortgage-Backed Securities Division (“MBSD”)(MBSD) of the FICC, we are subject to margin calls on our TBA contracts. Further, our prime brokerage agreements may require us to post additional margin above the levels established by the MBSD. Negative carry income on TBA dollar roll transactions orAny failure to procure adequate financing to settle our obligations or meet margin calls under our TBA contracts could result in defaults or force us to sell assets under adverse market conditions or through foreclosure and adversely affect our financial condition and results of operations.
Increases in interest rates could adversely affect the value of our assets and cause our interest expense to increase, which could result in reduced earnings or losses and negatively affect our profitability as well as the cash available for distribution to stockholders.increase.
Our operating results will depend in large part on the difference between the income from our assets net of credit losses, and financing costs. We anticipate that, in many cases, the income from our assets will respond more slowly to interest rate fluctuations than the cost of our borrowings. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our financial results.
Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. For example, the Federal Reserve made several cuts to the federal funds target rate in 2019, following several years of gradual increases. We cannot predict the impact that recent rate cuts, or any future actions or non-actions by the Federal Reserve with respect to the federal funds rate or otherwise may have on the markets or the economy. Interest rate fluctuations present a variety of risks, including the risk of a narrowing of the difference between asset yields and borrowing rates, flattening or inversion of the yield curve and fluctuating prepayment rates.
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We endeavor to hedge our exposure to changes in interest rates, but there can be no assurances that our hedges will be successful, or that we will be able to enter into or maintain such hedges. As a result, interest rate fluctuations can cause significant losses, reductions in income, and limitations on our cash available for distribution to stockholders.
An increase in interest rates may cause a decrease in the availability of certain of our target assets, which could adversely affect our ability to acquire target assets that satisfy our investment objectives and to generate income and pay dividends.
Rising interest rates generally reduce the demand for mortgage loans due to the higher cost of borrowing. A reduction in the volume of mortgage loans originated may affect the volume of certain target assets available to us, which could adversely affect our ability to acquire assets that satisfy our investment and business objectives. Rising interest rates may also cause certain target assets that were issued prior to an interest rate increase to provide yields that are below prevailing market interest rates. If rising interest rates cause us to be unable to acquire a sufficient volume of our target assets with a yield that is above our borrowing cost, our ability to satisfy our investment objectives and to generate income and pay dividends may be materially and adversely affected.
The assets in our portfolio are recorded at fair value, but there may be substantial uncertainty as to the value of certain assets.
Deficiencies in servicing and foreclosure practices among servicers of residential mortgage loans have raised and may in the future raise concerns relating to such practices, including the improper execution of the documents used in foreclosure proceedings (so-called “robo signing”), inadequate documentation of transfers and registrations of mortgages and assignments of loans, improper handling of loss mitigation for mortgagors who fall behind in their payments, violations of representations and warranties at the date of securitization and failure to enforce put-backs.practices. The integrity of the servicing and foreclosure processes is critical to the value of our Agency RMBS non-Agency securities and MSR, and our financial results could be adversely affected by deficiencies in the conduct of those processes. For example, delays in the foreclosure process that may result from improper servicing practices may adversely affect the values of, and our losses on, our mortgage-related assets. Foreclosure delays may also increase the administrative expenses of the securitization trusts for non-Agency securities or result in the curtailment of payments to the GSEs, thereby resulting in additional expense and reducing the amount of funds available for distribution to investors. In addition, the subordinate classes of securities issued by the securitization trusts may continue to receive interest payments while the defaulted loans remain in the trusts, rather than absorbing the default losses. This may reduce the amount of credit support available for any senior classes we own, thus possibly adversely affecting these securities.
Risks Related to Our Organization and Structure
Certain provisions of Maryland law could inhibit changes in control.
Certain provisions of the Maryland General Corporation Law, or MGCL, may have the effect of deterring a third party from making a proposal to acquire us or of impeding a change in control under circumstances that otherwise could provide the holders of shares of our common stock with the opportunity to realize a premium over the then-prevailing market price of such shares.
We are subject to the “business combination” provisions of the MGCL that, subject to limitations, prohibit certain business combinations (including a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities) between our company and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of our then outstanding voting stock or an affiliate or associate of our company who, at any time within(as defined under the two-year period immediately prior to the date in question, was the beneficial owner of 10% or more of the voting power of our then outstanding stock)MGCL) or an affiliate thereof for five years after the most recent date on which the stockholder becomes an interested stockholder. AfterIn addition, the five-year prohibition, any business combination between our company and an interested stockholder generally must be recommended by our board of directors and approved by the affirmative vote of at least (1) 80% of the votes entitled to be cast by holders of outstanding shares of our voting stock; and (2) two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder. These super-majority vote requirements do not apply if our common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares. These provisions of the MGCL do not apply to business combinations that are approved or exempted by a board of directors prior to the time that the interested stockholder becomes an interested stockholder. Pursuant to the statute, our board of directors has by resolution exempted business combinations (1) between our company and any person, provided that such business combination is first approved by our board of directors (including a majority of our directors who are not affiliates or associates of such person) and (2) between our company and Pine River or its affiliates. Consequently, the five-year prohibition and the super-majority vote requirements will not apply to any business combination between our company and any person if such combination is approved in accordance with the foregoing procedures. As a result, any person, including Pine River, may be able to enter into business combinations with Two Harbors
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Our authorized but unissued shares of common and preferred stock and the ownership limitations contained in our charter may prevent a change in control.
Our charter authorizes Two Harbors to issue additional authorized but unissued shares of common or preferred stock. In addition, our board of directors may, with the approval of a majority of the entire board and without stockholder approval, amend our charter to increase or decrease the aggregate number of shares of our stock or the number of shares of stock of any class or series that Two Harbors has the authority to issue and classify or reclassify any unissued shares of common or preferred stock and set the terms of the classified or reclassified shares. As a result, our board may establish a series of shares of common or preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for shares of our common stock or otherwise be in the best interests of stockholders.
In addition, our charter contains restrictions limiting the ownership and transfer of shares of our common stock and other outstanding shares of capital stock. The relevant sections of our charter provide that, subject to certain exceptions, ownership of shares of our common stock by any person is limited to 9.8% by value or by number of shares, whichever is more restrictive, of our outstanding shares of common stock (the common share ownership limit), and no more than 9.8% by value or number of shares, whichever is more restrictive, of our outstanding capital stock (the aggregate share ownership limit). The common share ownership limit and the aggregate share ownership limit are collectively referred to herein as the “ownership limits.” These charter provisions will restrict the ability of persons to purchase shares in excess of the relevant ownership limits.
Our charter contains provisions that make removal of our directors difficult, which could make it difficult for stockholders to effect changes in management.
Our charter provides that, subject to the rights of any series of preferred stock, a director may be removed only by the affirmative vote of at least two-thirds of all the votes entitled to be cast generally in the election of directors. Our charter and bylaws provide that vacancies generally may be filled only by a majority of the remaining directors in office, even if less than a quorum. These requirements make it more difficult to change management by removing and replacing directors and may prevent a change in control that is in the best interests of stockholders.
Our rights and stockholders’ rights to take action against directors and officers are limited, which could limit recourse in the event of actions not in the best interests of stockholders.
As permitted by Maryland law, our charter eliminates the liability of its directors and officers to Two Harbors and its stockholders for money damages, except for liability resulting from:
actual receipt of an improper benefit or profit in money, property or services; or
a final judgment based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated.
In addition, pursuant to our charter we have agreed contractually to indemnify our present and former directors and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. Further, our bylaws require us to indemnify each present or former director or officer, to the maximum extent permitted by Maryland law, who is made, or threatened to be made, a party to any proceeding because of his or her service to Two Harbors. As part of these indemnification obligations, we may be obligated to fund the defense costs incurred by our directors and officers.
Our amended and restated bylaws designate certain Maryland courts as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.stockholders.
Our amended and restated bylaws provide that, unless we consent in writing to the selection of an alternative forum, the Circuit Court for Baltimore City, Maryland, or, if that Court does not have jurisdiction, the United States District Court for the District of Maryland, Baltimore Division, shall be the sole and exclusive forum for the following: any derivative action or proceeding brought on behalf of the corporation;company; any action asserting a claim of breach of any duty owed by any of our directors, officers or other employees to the corporationcompany or to our stockholders; any action asserting a claim against the corporationcompany or any of our directors, officers or other employees arising pursuant to any provision of the MGCL or our charter or bylaws; or any action asserting a claim against the corporationcompany or any of our directors, officers or other employees that is governed by the internal affairs doctrine. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that the stockholder believes is favorable for disputes with us or our directors, officers or other employees, which may discourage lawsuits against us and our directors, officers and employees. Alternatively, if a court were to find these provisions
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Risks Related to Our Securities
Future issuances and sales of shares of our common stock may depress the market price of our common stock or have adverse consequences for our stockholders.
We have 450,000,000 authorizedmay issue additional shares of our common stock in public offerings, private placements as well as through equity awards to our directors, officers and we may increase our authorized common stock without stockholder approval. As of December 31, 2019, 272,935,731 shares of common stock were issued and outstanding. In May 2015, our stockholders approvedemployees pursuant to our Second Restated 2009 Equity Incentive Plan or the Plan, which provides for grants of restricted common stock and other equity-based awards, subject to a ceiling of 6,500,000 shares available for issuance under the Plan. As of December 31, 2019, an aggregate of 1,713,651 shares of common stock remained available for issuance to our independent directors and Pine River employees pursuant to the2021 Equity Incentive Plan. Additionally, shares of our common stock have also been reserved for issuance in connection with the conversion of our 6.25% convertible senior notes due January 20222026 and our Series A, Series B and Series C Series D and Series E preferred stock.
We cannot predict the effect, if any, of future issuances or sales of our common stock on the market price of our common stock. We also cannot predict the amounts and timing of restricted stockequity awards to be issued pursuant to the Plan,our equity incentive plans, nor can we predict the amount and timing of any conversions of our 6.25% convertible senior notes due January 20222026 or our Series A, Series B Series C, Series D and Series EC preferred stock into shares of our common stock. Any stock offerings, awards or conversions resulting in the issuance of substantial amounts of common stock, or the perception that such awards or conversions could occur, may adversely affect the market price for our common stock.
Any future offerings of our securities could dilute our existing stockholders and may rank senior for purposes of dividend and liquidating distributions.
In the future, we may again elect to raise capital through the issuance of convertible or non-convertible debt or common or preferred equity securities. Upon liquidation, holders of our debt securities and preferred stock, if any, and lenders with respect to other borrowings will be entitled to our available assets prior to the holders of our common stock. Convertible debt and convertible preferred stock may have anti-dilution provisions which are unfavorable to our common stockholders. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. Any preferred stock could have a preference on liquidating distributions or a preference on dividend payments that could limit our ability to pay dividends to our stockholders or favorable conversion rights. Sales of substantial amounts of our common stock or the sale of securities which have rights and preferences that are superior to our common stock, or the perception that these sales could occur, may have a material adverse effect on the price of our common stock. Because our decision to issue debt or equity securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting the value of their holdings.
We have not established a minimum distribution payment level and we cannot assure you of our ability to pay distributions in the future.
We intend to continue to pay quarterly distributions and to make distributions to our stockholders in an amount such that we distribute all or substantially all of our REIT taxable income in each year, subject to certain adjustments.year. We have not established a minimum distribution payment level and our ability to pay distributions may be adversely affected by a number of factors, including the risk factors described herein. All distributions will be made, subject to Maryland law, at the discretion of our board of directors and will depend on our earnings, our financial condition, any debt covenants, maintenance of our REIT qualification and other factors as our board of directors may deem relevant from time to time.relevant. We cannot assure you that we will achieve results that will allow us to make a specified level of cash distributions and distributions in future periods may be significantly lower than in prior quarterly periods.
The market price of our common stock could fluctuate and could cause you to lose a significant part of your investment.
The market price of our common stock may be highly volatile and subject to wide fluctuations.volatile. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. The stock market has experienced and may in the future experience extreme price and volume fluctuations that have affected the market price of many companies in industries similar or related to ours and that have been unrelated to these companies’ operating performances. If the market price of our common stock declines significantly, you may be unable to resell your shares of our common stock at a gain. Further, fluctuations in the trading price of our common stock may adversely affect the liquidity of the trading market for our common stock and, in the event that we seek to raise capital through future equity financings, our ability to raise such equity capital. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly in the future.
The market price of our common stock may be influenced by many factors, some of which are beyond our control, including those described above and the following:
without limitation: changes in financial estimates by analysts;
fluctuations in our results of operations or financial condition or the results of operations or financial condition of companies perceived to be similar to us;
general economic and financial and real estate market conditions;
changes in market valuations of similar companies;
monetary policy and regulatory developments in the U.S.; and
additions or departures of key personnel at Pine River.
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Tax Risks
Our failure to qualify as a REIT would subject us to U.S. federal income tax and potentially increased state and local taxes, which would reduce the amount of our income available for distribution to our stockholders.
We operate in a manner that will enable us to qualify as a REIT and have elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2009. We have not requested and do not intend to request a ruling from the Internal Revenue Service, or IRS, that we qualify as a REIT. The U.S. federal income tax laws governing REITs and the assets they hold are complex, and judicial and administrative interpretations of the U.S. federal income tax laws governing REIT qualification are limited. To continue to qualify as a REIT, we must meet, on an ongoing basis, various tests regarding the nature of our assets and income, the ownership of our outstanding shares, and the amount of our distributions. Moreover, new legislation, court decisions, administrative guidance or actions by federal agencies or others to modify or re-characterize our assets as a whole or in part, as other than real estate assets, in each case possibly with retroactive effect, may make it more difficult or impossible for us to qualify as a REIT. Thus, while we intend to operate so that we qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations, and the possibility of future changes in our circumstances, no assurance can be given that we will so qualify for any particular year. These considerations also might restrict the types of assets that we can acquire in the future.
If we fail to qualify as a REIT in any taxable year, and do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax on our taxable income, and distributions to our stockholders would not be deductible by us in determining our taxable income. In such a case, we might need to borrow money or sell assets in order to pay taxes. Our payment of income tax would decrease the amount of income available for distribution to stockholders. Furthermore, if we fail to maintain our qualification as a REIT, we no longer would be required to distribute substantially all of our net taxable income to stockholders. In addition, unless we were eligible for certain statutory relief provisions, we could not re-elect to be taxed as a REIT until the fifth calendar year following the year in which we failed to qualify.
Complying with REIT requirements may cause us to forego otherwise attractive investment opportunities or financing or hedging strategies.
In order to qualify as a REIT for U.S. federal income tax purposes, we must continually satisfy various tests on an annual and quarterly basis regarding the sources of our income, the nature and diversification of our assets, the amounts we distribute to stockholders and the ownership of our stock. To meet these tests, we may be required to forego investments we might otherwise make. We may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution, and may be unable to pursue investments that would be otherwise advantageous to us in order to satisfy the source of income or asset diversification requirements for qualifying as a REIT.times. Thus, compliance with the REIT requirements may hinder our investment performance.
Complying with REIT requirements may force us to liquidate otherwise profitable assets.
In order to continue to qualify as a REIT, we must ensure that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and designated real estate assets, including certain mortgage loans and shares in other REITs. Subject to certain exceptions, our ownership of securities, other than government securities and securities that constitute real estate assets, generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our total assets, other than government securities and securities that constitute real estate assets, can consist of the securities of any one issuer, no more than 20% of the value of our total assets can be represented by securities of one or more TRSs, and no more than 25% of the value of our total assets can consist of debt of “publicly offered” REITs (i.e., REITs that are required to file annual and periodic reports with the SEC under the Exchange Act) that is not secured by real property or interests in real property. If we fail to comply with these requirements at the end of any calendar quarter, we must generally correct such failure within 30 days after the end of such calendar quarter to avoid losing our REIT qualification. As a result, we may be required to liquidate otherwise profitable assets prematurely, which could reduce our return on assets, which could adversely affect our results of operations and financial condition.
Potential characterization of distributions or gain on sale may be treated as unrelated business taxable income to tax exempt investors.
If (i) all or a portion of our assets are subject to the rules relating to taxable mortgage pools, (ii) we are a “pension held REIT,” (iii) a tax exempt stockholder has incurred debt to purchase or hold our common stock, or (iv) we purchase residual REMIC interests that generate “excess inclusion income,” then a portion of the distributions to and, in the case of a stockholder described in clause (iii), gains realized on the sale of common stock by such tax exempt stockholder may be subject to U.S. federal income tax as unrelated business taxable income under the Code.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Code may limit our ability to hedge our assets and liabilities. Any income from a hedging transaction will not constitute gross income for purposes of the 75% or 95% gross income test if we properly identify the transaction as specified in applicable Treasury Regulations and we enter into such transaction (i) in the normal course of our business primarily to manage risk of interest rate or price changes or currency fluctuations with respect to borrowings made or to be made, or ordinary obligations incurred or to be incurred, to acquire or carry real estate assets or (ii) primarily to manage risk of currency fluctuations with respect to any item of income or gain that would be qualifying income under the 75% or 95% gross income tests. In addition, income from certain new hedging transactions that counteract prior qualifying hedging transactions described in (i) and (ii) above may not constitute gross income for purposes of the 75% and 95% gross income tests if we properly identify the new hedging transaction as specified in applicable Treasury Regulations. To the extent that we enter into other types of hedging transactions, the income from those transactions is likely to be treated as non-qualifying income for purposes of both of these gross income tests. As a result of these rules, we intend to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities because our TRSs would be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in our TRSs, generally, will not provide any tax benefit, except for being carried forward against future taxable income in the TRSs.activities.
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The failure of our Agency RMBS and non-Agency securities that are subject to a repurchase agreement to qualify as real estate assets would adversely affect our ability to qualify as a REIT.
We may enter into repurchase agreements under which we will nominally sell certain of our Agency RMBS or non-Agency securities to a counterparty and simultaneously enter into an agreement to repurchase the sold assets. We believe that we will be treated for U.S. federal income tax purposes as the owner of the securities that are the subject of any such agreement notwithstanding that such agreement may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could assert that we did not own the securities during the term of the repurchase agreement, in which case we could fail to qualify as a REIT.
REIT distribution requirements could adversely affect our ability to execute our business plan and may require us to incur debt, sell assets or take other actions to make such distributions.
In order to continue to qualify as a REIT, we must distribute to stockholders, each calendar year, at least 90% of our REIT taxable income (including certain items of non-cash income), determined without regard to the deduction for dividends paid and excluding net capital gain. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to U.S. federal corporate income tax on our undistributed income. In addition, we will incur a 4% nondeductible excise tax on the amount, if any, by which our distributions in any calendar year are less than a minimum amount specified under U.S. federal income tax law.
We intend to distribute our net income to stockholders in a manner intended to satisfy the 90% distribution requirement and to avoid both corporate income tax and the 4% nondeductible excise tax. Our taxable income may substantially exceed our net income as determined by U.S. GAAP or differences in timing between the recognition of taxable income and the actual receipt of cash may occur in which case we may have taxable income in excess of cash flow from our operating activities. In such event, we may generate less cash flow than taxable income in a particular year and find it difficult or impossible to meet the REIT distribution requirements in certain circumstances. In such circumstances, in order to satisfy the distribution requirement and to avoid U.S. federal corporate income tax and the 4% nondeductible excise tax in that year, we may be required to: (i) sell assets in adverse market conditions, (ii) borrow on unfavorable terms, (iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt or (iv) make a taxable distribution of our shares as part of a distribution in which stockholders may elect to receive shares or (subject to a limit measured as a percentage of the total distribution) cash, in order to comply with the REIT distribution requirements. Thus, compliance with the REIT distribution requirements may require us to take actions that may not otherwise be advisable given existing market conditions and hinder our ability to grow, which could adversely affect the value of our common stock.
Our qualification as a REIT may depend on the accuracy of legal opinions or advice rendered or given or statements by the issuers of assets we acquire, including with respect to the treatment of our TBA securities and transactions for tax purposes and the inaccuracy of any such opinions, advice or statements may adversely affect our REIT qualification and result in significant corporate-level tax..purposes.
When purchasing securities, we may rely on opinions or advice of counsel for the issuer of such securities, or statements made in related offering documents, for purposes of determining, among other things, whether such securities represent debt or equity securities for U.S. federal income tax purposes, the value of such securities, and also to what extent those securities constitute qualified real estate assets for purposes of the REIT asset tests and produce qualified income for purposes of the 75% gross income test. In addition, we may from time to time obtain and rely upon opinions of counsel regarding the qualification of certain assets and income as real estate assets. The inaccuracy of any such opinions, advice or statements may adversely affect our ability to qualify as a REIT and result in significant corporate-level tax.
We may utilize TBAs as a means of investing and financing Agency RMBS. There is no direct authority with respect to the qualification of TBAs as real estate assets or U.S. government securities for purposes of the 75% asset test or the qualification of income or gains from dispositions of TBAs as gains from the sale of real property (including interests in real property and interests in mortgages on real property) or other qualifying income for purposes of the 75% gross income test. We intend to treat our TBAs as qualifying assets for purposes of the 75% asset test, to the extent set forth in an opinion from Sidley Austin LLP substantially to the effect that, for purposes of the 75% asset test, our ownership of TBAs should be treated as ownership of the underlying Agency RMBSs,RMBS, and to treat income and gains from our TBAs as qualifying income for purposes of the 75% gross income test, to the extent set forth in an opinion from Sidley Austin LLP substantially to the effect that, for purposes of the 75% gross income test, any gain recognized by us in connection with the settlement of our TBAs should be treated as gain from the sale or disposition of the underlying Agency RMBS. Such opinions of counsel are not binding on the IRS, and there can be no assurance that the IRS will not successfully challenge the conclusions set forth therein. In addition, the opinion of Sidley Austin LLP is based on various assumptions relating to our TBAs and is conditioned upon fact-based representations and covenants made by our management regarding our TBAs. If the IRS were to successfully challenge the opinion of Sidley Austin LLP, we could be subject to a penalty tax or we could fail to remain qualified as a REIT if a sufficient portion of our assets consists of TBAs or a sufficient portion of our income consists of income or gains from the disposition of TBAs.
Our ownership of, and relationship with, our TRSs will be restricted and a failure to comply with the restrictions would jeopardize our REIT status and may result in the application of a 100% excise tax.
A REIT may own up to 100% of the stock of one or more TRSs. A TRS may earn income that would not be qualifying REIT income if earned directly by the parent REIT. Both the TRS and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation of which a TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 20% of the value of a REIT’s total assets may consist of stock or securities of one or more TRSs. The value of our interests in and thus the amount of assets held in a TRS may also be restricted by our need to qualify for an exclusion from regulation as an investment company under the Investment Company Act.
Any domestic TRS we own or may form will pay U.S. federal, state and local income tax at regular corporate rates on any income that it earns.rates. In addition, the TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. The rules also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis.
Dividends payable by REITs generally do not qualify for the reduced tax rates on dividend income from regular corporations, which could adversely affect the value of our shares.
The maximum U.S. federal income tax rate for dividends payable to domestic stockholders that are individuals, trusts and estates is 20%. Dividends payable by REITs, however, are generally not eligible for these reduced rates. Although the reduced U.S. federal income tax rate applicable to dividend income from regular corporate dividends does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to regular corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our shares of common stock.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We lease and/or sublease administrative office space in New York, Minnesota Florida and Massachusetts. We do not own, lease or utilize any physical properties that would be considered material to our business and operations.
Item 3. Legal Proceedings
From time to time, wethe Company may be involved insubject to liability under laws and government regulations and various claims and legal claims and/or administrative proceedings that ariseactions arising in the ordinary course of our business. As previously disclosed, on April 13, 2020, the Company announced that it had elected not to renew the Management Agreement with PRCM Advisers. Subsequently, on July 15, 2020, the Company provided PRCM Advisers with a notice of termination of the dateManagement Agreement for “cause” in accordance with Section 15(a) of this filing, we are not partythe Management Agreement. The Company terminated the Management Agreement for “cause” on the basis of certain material breaches and certain events of gross negligence on the part of PRCM Advisers in the performance of its duties under the Management Agreement.
On July 21, 2020, PRCM Advisers filed a complaint against the Company in the United States District Court for the Southern District of New York, or the Court. Subsequently, PRCM Advisers filed an amended complaint, or the Federal Complaint, on September 4, 2020. The Federal Complaint alleges, among other things, the misappropriation of trade secrets in violation of both the Defend Trade Secrets Act and New York common law, breach of contract, breach of the implied covenant of good faith and fair dealing, unfair competition and business practices, unjust enrichment, conversion, and tortious interference with contract. The Federal Complaint seeks, among other things, an order enjoining the Company from making any use of or disclosing PRCM Advisers’ trade secret, proprietary, or confidential information; damages in an amount to any litigation be determined at a hearing and/or legal proceedings or,trial; disgorgement of the Company’s wrongfully obtained profits; and fees and costs incurred by PRCM Advisers in pursuing the action. On September 25, 2020, the Company filed a motion to dismiss the Federal Complaint. PRCM Advisers thereafter filed an opposition to the bestmotion to dismiss on October 16, 2020, and on October 26, 2020, the Company filed its reply. On June 23, 2021, the Court granted in part and denied in part the Company’s motion to dismiss. The Court dismissed PRCM Advisers’ claims challenging the termination of our knowledge, any threatened litigation or legal proceedings, which, in our opinion, individually orthe Management Agreement, including PRCM Advisers’ claims for breach of contract with respect to Sections 13(a) and 15 of the Management Agreement and for breach of the implied covenant of good faith and fair dealing, as well as certain of PRCM Advisers’ other claims.
On July 7, 2021, PRCM Advisers filed a motion for leave to amend the Federal Complaint for the purpose of amending certain allegations related to PRCM Advisers’ claim for breach of contract with respect to Section 15 of the Management Agreement, and the purpose of adding Pine River Domestic Management L.P. and Pine River Capital Management L.P. as plaintiffs. On July 21, 2021, the Company filed an opposition to the motion to amend, and on July 28, 2021, PRCM Advisers filed its reply. On October 18, 2021, the Court granted PRCM Advisers’ motion for leave to amend the Federal Complaint, and deemed PRCM Advisers’ second amended complaint served. On November 17, 2021, the Company filed its answer and counterclaims against PRCM Advisers and Pine River Capital Management L.P. in the aggregate, would haveCourt. On December 17, 2021, PRCM Advisers and Pine River Capital Management L.P. filed their answer to the Company’s counterclaims. The Company’s board of directors believes the Federal Complaint is without merit and that the Company has fully complied with the terms of the Management Agreement.
Separately, the staff of the SEC conducted a material adverse effectnon-public investigation in connection with the Company’s decisions not to renew its Management Agreement with PRCM Advisers on our resultsthe basis of operations or financial condition.unfair compensation payable to PRCM Advisers in accordance with Section 13(a)(ii) of the Management Agreement and to terminate its Management Agreement with PRCM Advisers for “cause” in accordance with Section 15 of the Management Agreement. The Company fully cooperated with the SEC. On January 5, 2022, the SEC informed the Company that it had concluded its investigation as to the Company and that, based on the information provided to the SEC as of such date, it did not intend to recommend any enforcement action against the Company.
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Item 4. Mine Safety Disclosures
None.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Market Information
Our common stock is listed on the NYSE under the symbol “TWO”. As of February 24, 2020, 273,627,2752022, 343,920,330 shares of common stock were issued and outstanding.
Holders
As of February 20, 2020,18, 2022, there were 621605 registered holders and approximately 119,567121,877 beneficial owners of our common stock.
Dividends
We have historically paid dividends on our common stock. All dividend distributions are authorized by our board of directors, in its discretion, and will depend on such items as our REIT taxable earnings,income, financial condition, maintenance of REIT status, and other factors that the board of directors may deem relevant from time to time. The holders of our common stock share proportionally on a per share basis in all declared dividends on our common stock. Dividends cannot be paid on our common stock unless we have paid full cumulative dividends on all classes of our preferred stock. We have paid full cumulative dividends on all classes of our preferred stock from the respective dates of issuance through December 31, 2019.2021. We intend to continue to pay quarterly dividends on our common stock and to distribute to our common stockholders as dividends 100% of our REIT taxable income,on an annual basis.
We have not established a minimum dividend distribution level for our common stock. See Item 1A, “Risk Factors” and Item 7, “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” of this Annual Report on Form 10-K for information regarding the sources of funds used for dividends and for a discussion of factors, if any, which may adversely affect our ability to pay dividends in 20202022 and thereafter.
Our stock transfer agent and registrar is Equiniti Trust Company. Requests for information from Equiniti Trust Company can be sent to Equiniti Trust Company, P.O. Box 64856, St. Paul, MN 55164-0856 and their telephone number is 1-800-468-9716.
Securities Authorized for Issuance under Equity Compensation Plans
Our Second Restated 2009 Equity Incentive Plan wasand our 2021 Equity Incentive Plan, or the Equity Incentive Plans, were adopted by our board of directors and approved by our stockholders for the purpose of enabling us to provide equity compensation to attract and retain qualified directors, officers, advisers, consultants and other personnel, including affiliates and personnel of PRCM Advisers and its affiliates, and any joint venture affiliates of ours.personnel. The Plan isEquity Incentive Plans are administered by the compensation committee of our board of directors and permitspermit the grantinggrants of restricted shares of common stock, restricted stock units, or RSUs, performance-based awards (including performance share units, or PSUs), phantom shares, dividend equivalent rights and other equity-based awards. For a detailed description of the Plan,Equity Incentive Plans, see Note 1817 - Equity Incentive PlanPlans of the consolidated financial statements included under Item 8 of this Annual Report on Form 10-K.
The following table presents certain information about the PlanEquity Incentive Plans as of December 31, 2019:
2021:
| December 31, | ||||||||||||||||||||
| Plan Category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in the first column of this table) | |||||||||||||||||
Equity compensation plans approved by stockholders (1) | — | $ | — | |||||||||||||||||
| Equity compensation plans not approved by stockholders | — | — | — | |||||||||||||||||
| Total | — | $ | — | |||||||||||||||||
___________________
(1)For a detailed description of the Equity Incentive Plans, see Note 17 - Equity Incentive Plans of the consolidated financial statements included under Item 8 of this Annual Report on Form 10-K. |
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Performance Graph
The following graph compares thea stockholder’s cumulative total return, assuming $100 invested at December 31, 2014,2016, with all reinvestment of dividends, as if such amounts had been invested in: (i) our common stock; (ii) the stocks included in the Standard and Poor’s 500 Stock Index, or S&P 500; and (iii) the stocks included in the Bloomberg REIT Mortgage Index.
COMPARISON OF CUMULATIVE TOTAL RETURN
Among Two Harbors Investment Corp.,
S&P 500 and Bloomberg REIT Mortgage Index
| December 31, | ||||||||||||||||||||||||||||||||
| Index | 2021 | 2020 | 2019 | 2018 | 2017 | |||||||||||||||||||||||||||
| Two Harbors Investment Corp. | $ | 69.68 | $ | 69.62 | $ | 145.66 | $ | 113.21 | $ | 126.47 | ||||||||||||||||||||||
| S&P 500 | $ | 233.28 | $ | 181.29 | $ | 153.13 | $ | 116.47 | $ | 121.82 | ||||||||||||||||||||||
| Bloomberg REIT Mortgage Index | $ | 132.08 | $ | 112.30 | $ | 144.35 | $ | 116.77 | $ | 120.27 | ||||||||||||||||||||||
| December 31, | ||||||||||||||||||||
| Index | 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
| Two Harbors Investment Corp. | $ | 165.05 | $ | 122.72 | $ | 137.09 | $ | 108.40 | $ | 90.23 | ||||||||||
| S&P 500 | $ | 208.05 | $ | 132.19 | $ | 138.26 | $ | 113.49 | $ | 101.37 | ||||||||||
| Bloomberg REIT Mortgage Index | $ | 154.54 | $ | 128.65 | $ | 132.51 | $ | 110.18 | $ | 90.11 | ||||||||||
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Our board of directors has adopted a share repurchase program that allows for the repurchase of up to an aggregate of 37,500,000 shares of our 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 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 December 31, 2019,2021, a total of 12,069,00012,174,300 shares had been repurchased under the program for an aggregate cost of $200.4$201.5 million. We did not repurchase shares during the three months ended December 31, 2019.2021.
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Item 6. Selected Financial Data[Reserved]
| (in thousands) | For the Years Ended December 31, | ||||||||||||||||||
| 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
| Interest income: | |||||||||||||||||||
| Available-for-sale securities | $ | 962,283 | $ | 847,325 | $ | 631,853 | $ | 414,050 | $ | 458,515 | |||||||||
| Residential mortgage loans held-for-investment in securitization trusts | — | — | 102,886 | 133,993 | 95,740 | ||||||||||||||
| Other | 32,407 | 22,707 | 10,350 | 27,037 | 38,624 | ||||||||||||||
| Total interest income | 994,690 | 870,032 | 745,089 | 575,080 | 592,879 | ||||||||||||||
| Interest expense: | |||||||||||||||||||
| Repurchase agreements | 654,280 | 469,437 | 210,430 | 88,850 | 72,653 | ||||||||||||||
| Collateralized borrowings in securitization trusts | — | — | 82,573 | 97,729 | 57,216 | ||||||||||||||
| Federal Home Loan Bank advances | 10,920 | 20,417 | 36,911 | 26,101 | 11,921 | ||||||||||||||
| Revolving credit facilities | 19,354 | 10,820 | 2,341 | 604 | — | ||||||||||||||
| Term notes payable | 10,708 | — | — | — | — | ||||||||||||||
| Convertible senior notes | 19,067 | 18,997 | 17,933 | — | — | ||||||||||||||
| Total interest expense | 714,329 | 519,671 | 350,188 | 213,284 | 141,790 | ||||||||||||||
| Net interest income | 280,361 | 350,361 | 394,901 | 361,796 | 451,089 | ||||||||||||||
| Other-than-temporary impairment losses | (14,312 | ) | (470 | ) | (789 | ) | (1,822 | ) | (535 | ) | |||||||||
| Other income (loss): | |||||||||||||||||||
| Gain (loss) on investment securities | 280,118 | (341,312 | ) | (34,695 | ) | (107,374 | ) | 363,379 | |||||||||||
| Servicing income | 501,612 | 343,096 | 209,065 | 143,579 | 127,398 | ||||||||||||||
| Loss on servicing asset | (697,659 | ) | (69,033 | ) | (91,033 | ) | (83,531 | ) | (99,584 | ) | |||||||||
| (Loss) gain on interest rate swap, cap and swaption agreements | (108,289 | ) | 16,043 | (9,753 | ) | 45,371 | (210,621 | ) | |||||||||||
| Gain (loss) on other derivative instruments | 259,998 | (54,857 | ) | (70,159 | ) | 99,379 | (5,049 | ) | |||||||||||
| Other income (loss) | 337 | 3,037 | 30,141 | 9,964 | (7,686 | ) | |||||||||||||
| Total other income (loss) | 236,117 | (103,026 | ) | 33,566 | 107,388 | 167,837 | |||||||||||||
| Expenses: | |||||||||||||||||||
| Management fees | 60,102 | 30,272 | 40,472 | 39,261 | 49,116 | ||||||||||||||
| Servicing expenses | 74,607 | 61,136 | 35,289 | 32,119 | 28,028 | ||||||||||||||
| Securitization deal costs | — | — | — | 6,152 | 8,971 | ||||||||||||||
| Other operating expenses | 57,055 | 62,983 | 54,160 | 56,605 | 56,764 | ||||||||||||||
| Acquisition transaction costs | — | 86,703 | — | — | — | ||||||||||||||
| Restructuring charges | — | 8,238 | — | 2,990 | — | ||||||||||||||
| Total expenses | 191,764 | 249,332 | 129,921 | 137,127 | 142,879 | ||||||||||||||
| Income (loss) from continuing operations before income taxes | 310,402 | (2,467 | ) | 297,757 | 330,235 | 475,512 | |||||||||||||
| (Benefit from) provision for income taxes | (13,560 | ) | 41,823 | (10,482 | ) | 12,314 | (16,560 | ) | |||||||||||
| Net income (loss) from continuing operations | 323,962 | (44,290 | ) | 308,239 | 317,921 | 492,072 | |||||||||||||
| Income from discontinued operations, net of tax | — | — | 44,146 | 35,357 | 138 | ||||||||||||||
| Net income (loss) | 323,962 | (44,290 | ) | 352,385 | 353,278 | 492,210 | |||||||||||||
| Income from discontinued operations attributable to noncontrolling interest | — | — | 3,814 | — | — | ||||||||||||||
| Net income (loss) attributable to Two Harbors Investment Corp. | 323,962 | (44,290 | ) | 348,571 | 353,278 | 492,210 | |||||||||||||
| Dividends on preferred stock | 75,801 | 65,395 | 25,122 | — | — | ||||||||||||||
| Net income (loss) attributable to common stockholders | $ | 248,161 | $ | (109,685 | ) | $ | 323,449 | $ | 353,278 | $ | 492,210 | ||||||||
| (in thousands, except share data) | For the Years Ended December 31, | ||||||||||||||||||
| 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
| Basic earnings (loss) per weighted average share: | |||||||||||||||||||
| Continuing operations | $ | 0.93 | $ | (0.53 | ) | $ | 1.62 | $ | 1.83 | $ | 2.70 | ||||||||
| Discontinued operations | — | — | 0.23 | 0.20 | — | ||||||||||||||
| Net income (loss) | $ | 0.93 | $ | (0.53 | ) | $ | 1.85 | $ | 2.03 | $ | 2.70 | ||||||||
| Diluted earnings (loss) per weighted average share: | |||||||||||||||||||
| Continuing operations | $ | 0.93 | $ | (0.53 | ) | $ | 1.60 | $ | 1.83 | $ | 2.70 | ||||||||
| Discontinued operations | — | — | 0.21 | 0.20 | — | ||||||||||||||
| Net income (loss) | $ | 0.93 | $ | (0.53 | ) | $ | 1.81 | $ | 2.03 | $ | 2.70 | ||||||||
| Dividends declared per common share | $ | 1.67 | $ | 1.88 | $ | 2.01 | $ | 1.86 | $ | 2.08 | |||||||||
| Weighted average number of shares of common stock: | |||||||||||||||||||
| Basic | 267,826,739 | 206,020,502 | 174,433,999 | 174,036,852 | 182,623,869 | ||||||||||||||
| Diluted | 267,826,739 | 206,020,502 | 188,133,341 | 174,036,852 | 182,623,869 | ||||||||||||||
| Comprehensive income (loss): | |||||||||||||||||||
| Net income (loss) | $ | 323,962 | $ | (44,290 | ) | $ | 352,385 | $ | 353,278 | $ | 492,210 | ||||||||
| Other comprehensive income (loss), net of tax: | |||||||||||||||||||
| Unrealized gain (loss) on available-for-sale securities, net | 578,583 | (233,914 | ) | 135,586 | (159,834 | ) | (496,728 | ) | |||||||||||
| Other comprehensive income (loss) | 578,583 | (233,914 | ) | 135,586 | (159,834 | ) | (496,728 | ) | |||||||||||
| Comprehensive income (loss) | 902,545 | (278,204 | ) | 487,971 | 193,444 | (4,518 | ) | ||||||||||||
| Comprehensive income attributable to noncontrolling interest | — | — | 3,814 | — | — | ||||||||||||||
| Comprehensive income (loss) attributable to Two Harbors Investment Corp. | 902,545 | (278,204 | ) | 484,157 | 193,444 | (4,518 | ) | ||||||||||||
| Dividends on preferred stock | 75,801 | 65,395 | 25,122 | — | — | ||||||||||||||
| Comprehensive income (loss) attributable to common stockholders | $ | 826,744 | $ | (343,599 | ) | $ | 459,035 | $ | 193,444 | $ | (4,518 | ) | |||||||
| At December 31, | |||||||||||||||||||
| (in thousands) | 2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||
| Available-for-sale securities | $ | 31,406,328 | $ | 25,552,604 | $ | 21,220,819 | $ | 13,116,171 | $ | 7,825,320 | |||||||||
| Mortgage servicing rights | $ | 1,909,444 | $ | 1,993,440 | $ | 1,086,717 | $ | 693,815 | $ | 493,688 | |||||||||
| Total assets | $ | 35,921,622 | $ | 30,132,479 | $ | 24,789,313 | $ | 20,112,056 | $ | 14,575,772 | |||||||||
| Repurchase agreements | $ | 29,147,463 | $ | 23,133,476 | $ | 8,865,184 | $ | 8,865,184 | $ | 4,948,926 | |||||||||
| Federal Home Loan Bank advances | $ | 210,000 | $ | 865,024 | $ | 1,215,024 | $ | 4,000,000 | $ | 3,785,000 | |||||||||
| Total stockholders’ equity | $ | 4,970,466 | $ | 4,254,489 | $ | 3,571,424 | $ | 3,401,112 | $ | 3,576,561 | |||||||||
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the consolidated financial statements and accompanying notes included elsewhere in this Annual Report on Form 10-K. This section of this Form 10-K generally discusses 20192021 and 20182020 items and year-to-year comparisons between 20192021 and 2018.2020. Discussions of 20172019 items and year-to-year comparisons between 20182020 and 20172019 that are not included in this Form 10-K can be found in “Management’s“Management’s Discussion and Analysis of Financial Condition and Results of Operations”Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.2020.
General
We are a Maryland corporation focused on investing in and managing Agency residential mortgage-backed securities, or Agency RMBS, non-Agency securities, mortgage servicing rights, or MSR, and other financial assets, which we collectively refer to as our target assets. We operate as a real estate investment trust, or REIT, as defined under the Internal Revenue Code of 1986, as amended, or the Code. We are externally managed by PRCM Advisers LLC, or PRCM Advisers, which is a wholly owned subsidiary of Pine River Capital Management L.P., or Pine River.
Our objective is to provide attractive risk-adjusted total return to our stockholders over the long term, primarily through dividends and secondarily through capital appreciation. We selectively acquire and manage an investment portfolio of our target assets, which is constructed to generate attractive returns through market cycles. We focus on asset selection and implement a relative value investment approach across various sectors within the mortgage market. Our target assets include the following:
•Agency RMBS (which includes inverse interest-only Agency securities classified as “Agency Derivatives” for purposes of U.S. generally accepted accounting principles, or U.S. GAAP), meaning RMBS whose principal and interest payments are guaranteed by a U.S. government agency, such as the Government National Mortgage Association (or Ginnie Mae), or a U.S. government sponsored enterprise, or GSE, such as the Federal National Mortgage Association (or Fannie Mae), or the Federal Home Loan Mortgage Corporation (or Freddie Mac), or collectively, the government sponsored entities, or GSEs;; and
•MSR; and
•Other financial assets comprising approximately 5% to 10% of the portfolio.
Our Agency RMBS portfolio is comprised primarily of fixed rate mortgage-backed securities backed by single-family and multi-family mortgage loans. All of our principal and interest Agency RMBS are Fannie Mae or Freddie Mac mortgage pass-through certificates or collateralized mortgage obligations that may produce non-qualifying income for purposescarry an implied rating of “AAA,” or Ginnie Mae mortgage pass-through certificates, which are backed by the guarantee of the REIT gross income tests.U.S. government. The majority of these securities consist of whole pools in which we own all of the investment interests in the securities.
Within our MSR business, we purchaseacquire MSR assets, which represent the right to control the servicing of residential mortgage loans and the obligation to service the loans in accordance with relevant standards, from high-quality originators. We do not directly service the mortgage loans underlying the MSR we acquire; rather, we contract with appropriately licensed third-party subservicers to handle substantially all servicing functions in the name of the subservicer.
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Capital Allocations(1) as of | |||||||||
| December 31, 2019 | September 30, 2019 | June 30, 2019 | March 31, 2019 | December 31, 2018 | |||||
| Rates strategy | 78% | 79% | 76% | 77% | 74% | ||||
| Credit strategy | 22% | 21% | 24% | 23% | 26% | ||||
For the three months ended December 31, 2019,2021, our net yieldspread realized on the portfolio was slightly higher than recent quarters due primarily to higher MSR servicing income, net of estimated amortization, offset by higher servicing expenses. Additionally, our higher yielding MSR now make up a larger proportion of our total portfolio due to prepayments and sales of Agency RMBS. Cost of financing for the three months ended December 31, 2021 was lower than the prior quarter, but lower than recent periodstwo quarters due to purchases of lower coupon/sales of higher coupon Agency RMBS and higher prepays on Agency RMBS, offset by a decreasean increase in our cost of financing due to decreases in LIBOR.interest rate swap spread income. The following table provides the average annualized yield on our assets including Agency RMBS, non-Agency securities and MSR for the three months ended December 31, 2019,2021, and the four immediately preceding quarters:
| Three Months Ended | Three Months Ended | |||||||||||||||||||||||||||||||||||||
| December 31, 2019 | September 30, 2019 | June 30, 2019 | March 31, 2019 | December 31, 2018 | December 31, 2021 | September 30, 2021 | June 30, 2021 | March 31, 2021 | December 31, 2020 | |||||||||||||||||||||||||||||
Average annualized portfolio yield (1) | 3.54% | 3.67% | 3.93% | 4.25% | 4.14% | Average annualized portfolio yield (1) | 3.72% | 3.33% | 2.72% | 2.25% | 2.26% | |||||||||||||||||||||||||||
Cost of financing (2) | 2.35% | 2.51% | 2.55% | 2.47% | 2.53% | Cost of financing (2) | 0.73% | 0.78% | 0.79% | 0.60% | 0.50% | |||||||||||||||||||||||||||
| Net portfolio yield | 1.19% | 1.16% | 1.38% | 1.78% | 1.61% | |||||||||||||||||||||||||||||||||
| Net spread | Net spread | 2.99% | 2.55% | 1.93% | 1.65% | 1.76% | ||||||||||||||||||||||||||||||||
____________________
(1)Average annualized yield includes interest income on Agency RMBS and non-Agency securities and MSR servicing income, net of estimated amortization, and servicing expenses.
(2)Cost of financing includes swap interest rate spread and amortization of upfront payments made or received upon entering.
We seek to deploy moderate leverage as part of our investment strategy. We generally finance our Agency RMBS and non-Agency securities through short- and long-term borrowings structured as repurchase agreements and advances from the Federal Home Loan Bank of Des Moines, or the FHLB.agreements. We also finance our MSR through repurchase agreements, revolving credit facilities, repurchase agreements, term notes payable and convertible senior notes.
Our Agency RMBS, given their liquidity and high credit quality, are eligible for higher levels of leverage, while non-Agency securities and MSR, with less liquidity and/or more exposure to credit risk and prepayment, utilize lower levels of leverage. As a result, our debt-to-equity ratio is determined by our portfolio mix as well as many additional factors, including the liquidity of our portfolio, the availability and price of our financing, the diversification of our counterparties and their available capacity to finance our assets, and anticipated regulatory developments. Over the past several quarters, we have generally maintained a debt-to-equity ratio range of 5.0 to 6.0 times to finance our securities portfolio and MSR, on a fully deployed capital basis. Our debt-to-equity ratio is also directly correlated to the composition of our portfolio; specifically, the higher percentage of Agency RMBS we hold, the higher our debt-to-equity ratio is, while the higher percentage of non-Agency securities and MSR we hold, the lower our debt-to-equity ratio is. We may alter the percentage allocation of our portfolio among our target assets depending on the relative value of the assets that are available to purchase from time to time, including at times when we are deploying proceeds from offerings we conduct. As we allocate capital toward Agency RMBS and deploy financing on MSR, our debt-to-equity ratio may increase beyond 6.0 times in the future. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Repurchase AgreementsFinancing” for further discussion.
We recognize that investing in our target assets is competitive and we compete with other entities for attractive investment opportunities. We rely on our management team and our dedicated team of investment professionals provided by our external manager to identify investment opportunities. We believe that our significant focus in the residential market, the extensive mortgage market expertise of our investment team, our operational capabilities to invest in MSR, our strong analytics and our disciplined relative value investment approach give us a competitive advantage versus our peers.
We have elected to be treated as a REIT for U.S. federal income tax purposes. To qualify as a REIT we are required to meet certain investment and operating tests and annual distribution requirements. We generally will not be subject to U.S. federal income taxes on our taxable income to the extent that we annually distribute all of our net taxable income to stockholders, do not participate in prohibited transactions and maintain our intended qualification as a REIT. However, certain activities that we may perform may cause us to earn income which will not be qualifying income for REIT purposes. We have designated certain of our subsidiaries as taxable REIT subsidiaries, or TRSs, as defined in the Code, to engage in such activities. We also operate our business in a manner that will permit us to maintain our exemption from registration under the Investment Company Act of 1940, as amended, or the 1940 Act. While we do not currently originate or directly service residential mortgage loans, certain of our subsidiaries have obtained the requisite licenses and approvals to own and manage MSR.
29
Factors Affecting our Operating Results
Our net interest income includes income from our securities portfolio, including the amortization of purchase premiums and accretion of purchase discounts. Net interest income, as well as our servicing income, net of subservicing expenses, will fluctuate primarily as a result of changes in market interest rates, our financing costs and prepayment speeds on our assets. Interest rates, financing costs and prepayment rates vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. Our operating results will also be affected by default rates
On January 1, 2020 we adopted Accounting Standards Update (ASU) No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which changed the impairment model for most financial assets and certain other instruments. Valuation allowances for credit losses with respecton available-for-sale, or AFS, debt securities are recognized, rather than direct reductions in the amortized cost of the investments, regardless of whether the impairment is considered to be other-than-temporary. We use a discounted cash flow method to estimate and recognize an allowance for credit losses on AFS securities, as detailed in Note 2 to the mortgage loans underlying our non-Agency securities.consolidated financial statements, included under Item 1 of this Annual Report on Form 10-K.
Fair Value Measurement
A significant portion of our assets and liabilities are reported at fair value and, therefore, our consolidated balance sheets and statements of comprehensive (loss) income (loss) are significantly affected by fluctuations in market prices. At December 31, 2019,2021, approximately 93.3%77.9% of our total assets, or $33.5$9.4 billion,, consisted of financial instruments recorded at fair value. See Note 10 - Fair Value to the consolidated financial statements, included in this Annual Report on Form 10-K, for descriptions of 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. Although we execute various hedging strategies to mitigate our exposure to changes in fair value, we cannot fully eliminate our exposure to volatility caused by fluctuations in market prices.
Any temporary change in the fair value of our available-for-sale, or AFS securities, excluding certain Agency interest-only mortgage-backed securities, is recorded as a component of accumulated other comprehensive income and does not impact our earnings. Our reported earningsincome (loss) for U.S. GAAP purposes, or GAAP net income (loss). However, beginning on January 1, 2020 (as discussed above), changes in the provision for credit losses on AFS securities are recognized immediately in GAAP net income (loss). Our GAAP net income (loss) is also affected however, by fluctuations in market prices on the remainder of our financial assets and liabilities recorded at fair value, including interest rate swap, cap and swaption agreements and certain other derivative instruments (i.e., TBAs, put and call options for TBAs, U.S. Treasury and Eurodollar futures, Markit IOS total return swaps and inverse interest-only securities), which are accounted for as derivative trading instruments under U.S. GAAP, Agencycertain interest-only mortgage-backed securities and MSR.
We have numerous internal controls in place to help ensure the appropriateness of fair value measurements. Significant fair value measures are subject to detailed analytics and management review and approval. Our entire investment portfolio reported at fair value is priced by third-party brokers and/or by independent pricing vendors. We generally receive three or more broker and vendor quotes on pass-through principal and interest (P&I) Agency RMBS, and generally receive multiple broker or vendor quotes on all other securities, including interest-only Agency RMBS and inverse interest-only Agency RMBS, and non-Agency securities.RMBS. We also receive three vendor quotes for the MSR in our investment portfolio. For Agency RMBS, the third-party pricing vendors and brokers use pricing models that commonly incorporate such factors as coupons, primary and secondary mortgage rates, rate reset periods, issuer, prepayment speeds, credit enhancements and expected life of the security. For non-Agency securities, the third-party pricing vendors utilize both observable and unobservable inputs such as pool-specific characteristics (e.g., loan age, loan size, credit quality of borrowers, vintage, servicer quality), floating rate indices, prepayment and default assumptions, and recent trading of the same or similar securities. For MSR, vendors use pricing models that generally incorporate observable inputs such as principal balance, note rate, geographical location, loan-to-value (LTV) ratios, FICO, appraised value and other loan characteristics, along with observed market yields and trading levels. Pricing vendors will customarily incorporate loan servicing cost, servicing fee, ancillary income, and earnings rate on escrow as observable inputs. Unobservable or model-driven inputs include forecast cumulative defaults, default curve, forecast loss severity and forecast voluntary prepayment.
We evaluate the prices we receive from both third-party brokers and pricing vendors by comparing those prices to actual purchase and sale transactions, our internally modeled prices calculated based on market observable rates and credit spreads, and to each other both in current and prior periods. We review and may challenge valuations from third-party brokers and pricing vendors to ensure that such quotes and valuations are indicative of fair value as a result of this analysis. We then estimate the fair value of each security based upon the median of the final broker quotes received, and we estimate the fair value of MSR based upon the average of prices received from third-party vendors, subject to internally-established hierarchy and override procedures.
We utilize “bid side” pricing for our Agency RMBS and, non-Agency securities and, as a result, certain assets, especially the most recent purchases, may realize a markdown due to the “bid-offer” spread. To the extent that this occurs, any economic effect of this would be reflected in accumulated other comprehensive income.
30
Considerable judgment is used in forming conclusions and estimating inputs to our Level 3 fair value measurements. Level 3 inputs such as interest rate movements, prepayments speeds, credit losses and discount rates are inherently difficult to estimate. Changes to these inputs can have a significant effect on fair value measurements. Accordingly, there is no assurance that our estimates of fair value are indicative of the amounts that would be realized on the ultimate sale or exchange of these assets. The Company classified 6.0%At December 31, 2021, 18.2% of itsour total assets were classified as Level 3 fair value assets at December 31, 2019.assets.
Critical Accounting Estimates
The preparation of financial statements in accordance with U.S. GAAP requires us to make certain judgments and assumptions, based on information available at the time of our preparation of the financial statements, in determining accounting estimates used in preparation of the statements. Our significant accounting policies are described in Note 2 to the consolidated financial statements, included under Item 8 of this Annual Report on Form 10-K.
Accounting estimates are considered critical if the estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made and if different estimates reasonably could have been used in the reporting period or changes in the accounting estimate are reasonably likely to occur from period to period that would have a material impact on our financial condition, results of operations or cash flows. Our significant accounting policies are described in Note 2 to the consolidated financial statements, included under Item 8 of this Annual Report on Form 10-K. Our most critical accounting policies involve our fair valuation of AFS securities, MSR and derivative instruments.
The methods used by us to estimate fair value for AFS securities, MSR and MSRderivative instruments may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while we believe that our valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. We use inputs that areprices obtained from third-party pricing vendors or broker quotes deemed indicative of market activity and current as of the measurement date, which in periods of market dislocation, may have reduced transparency.
Market Conditions and Outlook
RMBS funding has been stable although term funding rates moved quickly towards the end of 2021 as the market priced in faster Fed hikes. RMBS repo measured as a spread to the Fed Funds rate remained very tight at around 10 basis points, showing that markets remain deep and relatively inexpensive. The Fed’s overnight reverse repo facility remained elevated throughout the fourth quarter of 2021 and hit another all-time high at year end at $1.9 trillion.
Demand for mortgages remained strong through the end of 2021 but materially worsened in January 2022 as the market priced in a more accelerated reduction of the Fed’s actions clearly stabilized the market. This was on display on the final daybalance sheet. Many analysts are projecting a record amount of the year, when overnight repo rates cleared below the Fed’s target,supply for private markets which is highly unusual. Given the Fed’s strong response, our expectation is that the funding markets will normalize over time.
This environment, with prepayment speeds beginning to slow and current coupon mortgage spreads widening, is one for which our portfolio strategy was designed. As a narrow range.
The following table provides the carrying value of our investment portfolio by product type:
| (dollars in thousands) | December 31, 2021 | December 31, 2020 | |||||||||||||||||||||
| Agency RMBS | $ | 7,149,399 | 76.1 | % | $ | 14,637,891 | 89.7 | % | |||||||||||||||
| Mortgage servicing rights | 2,191,578 | 23.3 | % | 1,596,153 | 9.8 | % | |||||||||||||||||
| Agency Derivatives | 40,911 | 0.5 | % | 61,617 | 0.4 | % | |||||||||||||||||
| Non-Agency securities | 12,304 | 0.1 | % | 13,031 | 0.1 | % | |||||||||||||||||
| Total | $ | 9,394,192 | $ | 16,308,692 | |||||||||||||||||||
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| (dollars in thousands) | December 31, 2019 | December 31, 2018 | |||||||||||
| Agency | |||||||||||||
| Fixed Rate | $ | 27,763,471 | 83.2 | % | $ | 21,665,960 | 78.5 | % | |||||
| Hybrid ARM | 14,584 | — | % | 19,073 | 0.1 | % | |||||||
| Total Agency | 27,778,055 | 83.2 | % | 21,685,033 | 78.6 | % | |||||||
| Agency Derivatives | 68,925 | 0.2 | % | 70,257 | 0.2 | % | |||||||
| Non-Agency | |||||||||||||
| Senior | 3,073,098 | 9.2 | % | 2,854,731 | 10.3 | % | |||||||
| Mezzanine | 480,765 | 1.5 | % | 928,632 | 3.4 | % | |||||||
| Interest-only securities | 74,410 | 0.2 | % | 84,208 | 0.3 | % | |||||||
| Total Non-Agency | 3,628,273 | 10.9 | % | 3,867,571 | 14.0 | % | |||||||
| Mortgage servicing rights | 1,909,444 | 5.7 | % | 1,993,440 | 7.2 | % | |||||||
| Total | $ | 33,384,697 | $ | 27,616,301 | |||||||||
Prepayment speeds and volatility due to interest rates
Our Agency RMBS portfolio is subject to inherentmarket risks, primarily interest rate risk and prepayment risk. We seek to offset a portion of our Agency pool market value exposure to prepayment speeds through our MSR and interest-only Agency RMBS portfolios. Generally, a decline inDuring periods of decreasing interest rates that leads towith rising prepayment speeds, will cause the market value of our RMBS purchased at a discount (includingAgency pools generally increases and the market value of our interest-only securities)securities and MSR to deteriorate, and our RMBS purchased at a premium to increase.generally decreases. The inverse relationship occurs when interest rates increaserise and prepayments slow. The low interest rate environment isfall. Interest rates moved lower throughout the first nine months of 2021, but retraced higher in the fourth quarter of 2021. Looking forward, prepayment speeds are expected to persistslow with both rising rates and the recent refinance activity that has lowered mortgage rates overall. In addition to changes in the near term. However,interest rates, changes in home price performance, key employment metrics and government programs, among other macroeconomic factors, could causecan affect prepayment speeds to increase on many RMBS, which could lead to less attractive reinvestment opportunities. Nonetheless, wespeeds. We believe our portfolio management approach, including our asset selection process, positions us to respond to a variety of market scenarios, including an overall faster prepayment environment.
| Three Months Ended | |||||||||||||||
| Weighted Average CPR | December 31, 2019 | September 30, 2019 | June 30, 2019 | March 31, 2019 | December 31, 2018 | ||||||||||
| Agency RMBS | 14.3 | % | 13.4 | % | 10.1 | % | 6.5 | % | 6.8 | % | |||||
| Non-Agency securities | 6.4 | % | 5.9 | % | 5.3 | % | 4.9 | % | 5.1 | % | |||||
| Mortgage servicing rights | 20.8 | % | 20.5 | % | 13.7 | % | 7.7 | % | 7.3 | % | |||||
scenarios. Although we are unable to predict the movement infuture interest rates in 2020rate movements, our strategy of pairing Agency RMBS with MSR, with a focus on managing various associated risks, including interest rate, prepayment, credit, mortgage spread and beyond, our diversified portfolio management strategyfinancing risk, is intended to generate attractive yields with a low level of sensitivity to changes in the yield curve, prepayments and interest rate cycles.
The following table provides the three-month average constant prepayment rate, or CPR, experienced by our Agency RMBS and MSR during the three months ended December 31, 2021, and the four immediately preceding quarters:
| Three Months Ended | ||||||||||||||||||||||||||||||||
| December 31, 2021 | September 30, 2021 | June 30, 2021 | March 31, 2021 | December 31, 2020 | ||||||||||||||||||||||||||||
| Agency RMBS | 27.7 | % | 30.1 | % | 32.3 | % | 30.8 | % | 27.0 | % | ||||||||||||||||||||||
| Mortgage servicing rights | 22.1 | % | 26.7 | % | 29.0 | % | 37.7 | % | 41.2 | % | ||||||||||||||||||||||
Our Agency RMBS are primarily collateralized by pools of fixed-rate mortgage loans and hybrid adjustable-rate mortgage loans, or hybrid ARMs, which are mortgage loans that have interest rates that are fixed for an initial period and adjustable thereafter.loans. Our Agency portfolio also includes securities with implicit or explicit prepayment protection, including lower loan balances (securities collateralized by loans of less than $200,000 in initial principal balance), higher LTVs (securities collateralized by loans with LTVs greater than or equal to 80%), certain geographic concentrations, loans secured by investor-owned properties and lower FICO scores. Our overall allocation of Agency RMBS and holdings of pools with specific characteristics are viewed in the context of our aggregate rates strategy, including MSR and related derivative hedging instruments. Additionally, the selection of securities with certain attributes is driven by the perceived relative value of the securities, which factors in the opportunities in the marketplace, the cost of financing and the cost of hedging interest rate, prepayment, credit and other portfolio risks. As a result, Agency RMBS capital allocation reflects management’s flexible approach to investing in the marketplace.
The following tables provide the carrying value of our Agency RMBS portfolio by underlying mortgage loan rate type:
| December 31, 2019 | December 31, 2021 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Principal/ Current Face | Carrying Value | % of Agency Portfolio | Weighted Average CPR | % Prepayment Protected | Gross Weighted Average Coupon Rate | Amortized Cost | Weighted Average Loan Age (months) | (dollars in thousands) | Principal/ Current Face | Carrying Value | Weighted Average CPR (1) | % Prepayment Protected | Gross Weighted Average Coupon Rate | Amortized Cost | Allowance for Credit Losses | Weighted Average Loan Age (months) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Agency RMBS AFS: | Agency RMBS AFS: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 30-Year Fixed | 30-Year Fixed | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ≤ 2.5% | ≤ 2.5% | $ | 1,243,928 | $ | 1,271,382 | 5.9 | % | — | % | 3.3 | % | $ | 1,272,323 | $ | — | 3 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 3.0% | $ | 6,034,075 | $ | 6,168,095 | 22.1 | % | 3.3 | % | 98.3 | % | 3.8 | % | $ | 6,169,224 | 3 | 3.0% | 1,316,662 | 1,384,176 | 9.6 | % | 100.0 | % | 3.7 | % | 1,381,936 | — | 8 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| 3.5% | 6,174,872 | 6,451,660 | 23.2 | % | 7.0 | % | 100.0 | % | 4.3 | % | 6,386,051 | 7 | 3.5% | 739,922 | 789,499 | 27.3 | % | 100.0 | % | 4.2 | % | 769,989 | — | 29 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 4.0% | 8,455,585 | 8,993,011 | 32.3 | % | 19.4 | % | 100.0 | % | 4.6 | % | 8,808,458 | 25 | 4.0% | 1,421,793 | 1,543,595 | 26.5 | % | 100.0 | % | 4.6 | % | 1,478,444 | — | 49 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 4.5% | 4,714,844 | 5,082,166 | 18.3 | % | 25.2 | % | 100.0 | % | 5.0 | % | 4,942,234 | 20 | 4.5% | 1,307,504 | 1,435,877 | 27.7 | % | 100.0 | % | 5.0 | % | 1,373,076 | — | 47 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ≥ 5% | 741,000 | 813,503 | 2.9 | % | 23.5 | % | 100.0 | % | 5.8 | % | 786,727 | 48 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ≥ 5.0% | ≥ 5.0% | 325,485 | 361,746 | 37.6 | % | 98.0 | % | 5.9 | % | 344,543 | — | 84 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 26,120,376 | 27,508,435 | 98.8 | % | 14.4 | % | 99.6 | % | 4.5 | % | 27,092,694 | 16 | 6,355,294 | 6,786,275 | 20.5 | % | 81.2 | % | 4.3 | % | 6,620,311 | — | 31 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other P&I | 119,168 | 133,436 | 0.5 | % | 7.3 | % | 0.3 | % | 6.7 | % | 133,174 | 210 | Other P&I | 56,069 | 62,228 | 53.9 | % | — | % | 6.5 | % | 61,739 | — | 224 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-only | 2,601,693 | 136,184 | 0.5 | % | 10.9 | % | — | % | 4.4 | % | 169,811 | 104 | Interest-only | 3,198,447 | 300,896 | 20.2 | % | — | % | 3.6 | % | 305,577 | (12,851) | 47 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Agency Derivatives | 397,137 | 68,925 | 0.2 | % | 12.3 | % | — | % | 6.7 | % | 56,959 | 184 | Agency Derivatives | 247,101 | 40,911 | 18.6 | % | — | % | 6.7 | % | 33,237 | — | 206 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total Agency RMBS | $ | 29,238,374 | $ | 27,846,980 | 100.0 | % | 98.4 | % | $ | 27,452,638 | Total Agency RMBS | $ | 9,856,911 | $ | 7,190,310 | 76.6 | % | $ | 7,020,864 | $ | (12,851) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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| December 31, 2018 | ||||||||||||||||||||||||||
| (dollars in thousands) | Principal/ Current Face | Carrying Value | % of Agency Portfolio | Weighted Average CPR | % Prepayment Protected | Gross Weighted Average Coupon Rate | Amortized Cost | Weighted Average Loan Age (months) | ||||||||||||||||||
| Agency RMBS AFS: | ||||||||||||||||||||||||||
| 30-Year Fixed | ||||||||||||||||||||||||||
| 3.0% | $ | 3,255 | $ | 3,200 | — | % | 2.0 | % | 100.0 | % | 3.6 | % | $ | 3,314 | 47 | |||||||||||
| 3.5% | 231,068 | 231,321 | 1.1 | % | 6.6 | % | 100.0 | % | 4.1 | % | 232,200 | 19 | ||||||||||||||
| 4.0% | 8,640,859 | 8,846,367 | 40.7 | % | 7.2 | % | 83.0 | % | 4.4 | % | 9,047,282 | 22 | ||||||||||||||
| 4.5% | 10,237,108 | 10,686,699 | 49.1 | % | 6.3 | % | 99.0 | % | 5.0 | % | 10,765,144 | 16 | ||||||||||||||
| ≥ 5% | 1,367,700 | 1,452,170 | 6.7 | % | 7.1 | % | 74.4 | % | 5.8 | % | 1,449,256 | 24 | ||||||||||||||
| 20,479,990 | 21,219,757 | 97.6 | % | 6.7 | % | 90.7 | % | 4.8 | % | 21,497,196 | 19 | |||||||||||||||
| Other P&I | 295,800 | 289,860 | 1.3 | % | 9.6 | % | 0.3 | % | 5.7 | % | 291,290 | 151 | ||||||||||||||
| Interest-only | 3,115,967 | 175,416 | 0.8 | % | 9.3 | % | — | % | 4.5 | % | 209,901 | 92 | ||||||||||||||
| Agency Derivatives | 476,299 | 70,257 | 0.3 | % | 11.9 | % | — | % | 6.7 | % | 69,496 | 173 | ||||||||||||||
| Total Agency RMBS | $ | 24,368,056 | $ | 21,755,290 | 100.0 | % | 88.4 | % | $ | 22,067,883 | ||||||||||||||||
| December 31, 2020 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Principal/ Current Face | Carrying Value | Weighted Average CPR | % Prepayment Protected | Gross Weighted Average Coupon Rate | Amortized Cost | Allowance for Credit Losses | Weighted Average Loan Age (months) | |||||||||||||||||||||||||||||||||||||||||||||
| Agency RMBS AFS: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| 30-Year Fixed | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| ≤ 2.5% | $ | 1,878,319 | $ | 2,005,269 | 7.7 | % | 100.0 | % | 3.4 | % | $ | 1,977,388 | $ | — | 7 | ||||||||||||||||||||||||||||||||||||||
| 3.0% | 2,359,772 | 2,541,676 | 19.3 | % | 100.0 | % | 3.7 | % | 2,433,757 | — | 14 | ||||||||||||||||||||||||||||||||||||||||||
| 3.5% | 3,327,048 | 3,636,988 | 28.5 | % | 100.0 | % | 4.2 | % | 3,485,035 | — | 17 | ||||||||||||||||||||||||||||||||||||||||||
| 4.0% | 2,642,730 | 2,911,556 | 37.5 | % | 100.0 | % | 4.6 | % | 2,751,139 | — | 36 | ||||||||||||||||||||||||||||||||||||||||||
| 4.5% | 2,276,487 | 2,538,418 | 34.3 | % | 100.0 | % | 5.0 | % | 2,400,043 | — | 35 | ||||||||||||||||||||||||||||||||||||||||||
| ≥ 5.0% | 519,976 | 590,044 | 33.6 | % | 98.4 | % | 5.8 | % | 551,230 | — | 65 | ||||||||||||||||||||||||||||||||||||||||||
| 13,004,332 | 14,223,951 | 27.4 | % | 99.9 | % | 4.3 | % | 13,598,592 | — | 24 | |||||||||||||||||||||||||||||||||||||||||||
| Other P&I | 99,023 | 113,302 | 9.6 | % | — | % | 6.6 | % | 110,002 | — | 226 | ||||||||||||||||||||||||||||||||||||||||||
| Interest-only | 3,649,556 | 300,638 | 14.0 | % | — | % | 3.5 | % | 315,876 | (17,889) | 48 | ||||||||||||||||||||||||||||||||||||||||||
| Agency Derivatives | 318,162 | 61,617 | 16.5 | % | — | % | 6.7 | % | 45,618 | — | 195 | ||||||||||||||||||||||||||||||||||||||||||
| Total Agency RMBS | $ | 17,071,073 | $ | 14,699,508 | 96.7 | % | $ | 14,070,088 | $ | (17,889) | |||||||||||||||||||||||||||||||||||||||||||
____________________
(1)Weighted average actual 1-month annualized CPR released at the beginning of the following month based on RMBS held as of the preceding month-end.
We believe MSR are a natural fit for our portfolio over the long term. Our MSR business leverages our core competencies in prepayment and credit risk analytics and the MSR assets provide offsetting risk to our Agency RMBS, hedging both interest rate and mortgage spread risk. The following tables provide net unamortized discount/premium information on our non-Agency securities portfolio:
| December 31, 2019 | |||||||||||||||||||
| (in thousands) | Principal/ Current Face | Un-amortized Premium | Accretable Purchase Discount | Credit Reserve Purchase Discount | Amortized Cost | ||||||||||||||
| Principal and interest securities | |||||||||||||||||||
| Senior | $ | 4,861,854 | $ | 8,966 | $ | (445,566 | ) | $ | (1,594,480 | ) | $ | 2,830,774 | |||||||
| Mezzanine | 636,800 | 14 | (114,574 | ) | (117,471 | ) | 404,769 | ||||||||||||
| Total P&I securities | 5,498,654 | 8,980 | (560,140 | ) | (1,711,951 | ) | 3,235,543 | ||||||||||||
| Interest-only | 4,356,603 | 79,935 | — | — | 79,935 | ||||||||||||||
| Total Non-Agency | $ | 9,855,257 | $ | 88,915 | $ | (560,140 | ) | $ | (1,711,951 | ) | $ | 3,315,478 | |||||||
| December 31, 2018 | |||||||||||||||||||
| (in thousands) | Principal/ Current Face | Un-amortized Premium | Accretable Purchase Discount | Credit Reserve Purchase Discount | Amortized Cost | ||||||||||||||
| Principal and interest securities | |||||||||||||||||||
| Senior | $ | 4,227,631 | $ | 5,381 | $ | (477,682 | ) | $ | (1,204,325 | ) | $ | 2,551,005 | |||||||
| Mezzanine | 1,132,493 | 1,301 | (216,437 | ) | (118,437 | ) | 798,920 | ||||||||||||
| Total P&I securities | 5,360,124 | 6,682 | (694,119 | ) | (1,322,762 | ) | 3,349,925 | ||||||||||||
| Interest-only | 5,137,169 | 83,846 | — | — | 83,846 | ||||||||||||||
| Total Non-Agency | $ | 10,497,293 | $ | 90,528 | $ | (694,119 | ) | $ | (1,322,762 | ) | $ | 3,433,771 | |||||||
| Three Months Ended | ||||||||||||||||||||||||||||||||
| (in thousands) | December 31, 2021 | September 30, 2021 | June 30, 2021 | March 31, 2021 | December 31, 2020 | |||||||||||||||||||||||||||
| UPB at beginning of period | $ | 194,393,942 | $ | 185,209,738 | $ | 179,014,244 | $ | 177,861,483 | $ | 156,444,362 | ||||||||||||||||||||||
| Purchases of mortgage servicing rights | 13,562,240 | 29,347,318 | 22,983,402 | 22,389,501 | 43,363,541 | |||||||||||||||||||||||||||
| Sales of mortgage servicing rights | 9,065 | (3,633,709) | — | — | (33,232) | |||||||||||||||||||||||||||
| Scheduled payments | (1,441,835) | (1,407,996) | (1,283,474) | (1,233,382) | (1,161,019) | |||||||||||||||||||||||||||
| Prepaid | (11,966,741) | (14,564,141) | (15,119,403) | (20,337,506) | (21,562,076) | |||||||||||||||||||||||||||
| Other changes | (786,105) | (557,268) | (385,031) | 334,148 | 809,907 | |||||||||||||||||||||||||||
| UPB at end of period | $ | 193,770,566 | $ | 194,393,942 | $ | 185,209,738 | $ | 179,014,244 | $ | 177,861,483 | ||||||||||||||||||||||
Counterparty exposure and leverage ratio
We monitor counterparty exposure in our broker, banking and lending counterparties on a daily basis. We believe our broker and banking counterparties are well-capitalized organizations, and we attempt to manage our cash balances across these organizations to reduce our exposure to any single counterparty.
As of December 31, 2019,2021, we had entered into repurchase agreements with 4739 counterparties, 2420 of which had outstanding balances at December 31, 2019.2021. In addition, we held long-term secured advances from the FHLB, short- and long-term borrowings under revolving credit facilities, long-term term notes payable and short- and long-term unsecured convertible senior notes. As of December 31, 2019,2021, the debt-to-equity ratio funding our AFS securities, MSR and Agency Derivatives, which includes unsecured borrowings under convertible senior notes, was 6.1:3.2:1.0.
33
As of December 31, 2019,2021, we held $558.1 million$1.2 billion in cash and cash equivalents, approximately $1.3$141.7 million of unpledged Agency securities and derivatives and $1.6 billion$11.9 million of unpledged non-Agency securities. As a result, we had an overall estimated unused borrowing capacity on our unpledged securities of approximately $1.2 billion.$133.5 million. As of December 31, 2019,2021, we held approximately $354.6$60.8 million of unpledged MSR.MSR and $96.8 million of unpledged servicing advances. Overall, we had unused committed borrowing capacity on MSR asset and servicing advance financing facilities of $1.2 billion.$313.4 million and $180.8 million, respectively. Generally, unused borrowing capacity may be the result of our election not to utilize certain financing, as well as delays in the timing in which funding is provided, insufficient collateral or the inability to meet lenders’ eligibility requirements for specific types of asset classes. If borrowing rates and collateral requirements change in the near term, we believe we are subject to less earnings volatility than if we carried higher leverage.
We also monitor exposure to our MSR counterparties. We may be required to make representations and warranties to investors in the loans underlying the MSR we own; however, some of our MSR were purchased on a bifurcated basis, meaning the representation and warranty obligations remain with the seller. If the representations and warranties we make prove to be inaccurate, we may be obligated to repurchase certain mortgage loans, which may impact the profitability of our portfolio. Although we obtain similar representations and warranties from the counterparty from which we acquired the relevant asset, if those representations and warranties do not directly mirror those we make to the investor, or if we are unable to enforce the representations and warranties against the counterparty for a variety of reasons, including the financial condition or insolvency of the counterparty, we may not be able to seek indemnification from our counterparties for any losses attributable to the breach.
LIBOR ishas been used extensively in the U.S. and globally as a “benchmark” or “reference rate” for various commercial and financial contracts, including corporate and municipal bonds and loans, floating rate mortgages, asset-backed securities, consumer loans, and interest rate swaps and other derivatives. It is expectedOn March 5, 2021, Intercontinental Exchange Inc. announced that a numberICE Benchmark Administration Limited, the administrator of private-sector banks currently reporting information used to set LIBOR, will stop doing so after 2021 when their current reporting commitment ends, which could either cause LIBORintends to stop publication immediately or cause LIBOR’s regulator to determine that its quality has degraded toof the degree that it is no longer representativemajority of its underlying market. The U.S. and other countries are currently working to replace LIBOR with alternative reference rates.USD-LIBOR tenors on June 30, 2023. In the U.S., the Alternative Reference Rates Committee, or ARRC, has identified the Secured Overnight Financing Rate, or SOFR, as its preferred alternative rate for U.S. dollar-based LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. Some market participants may continue to explore whether other U.S. dollar-based reference rates would be more appropriate for certain types of instruments. The ARRC has proposed a paced market transition plan to SOFR, and various organizations are currently working on industry wide and company-specific transition plans as it relates to derivatives and cash markets exposed to LIBOR. We have material contracts that are indexed to USD-LIBOR and are monitoring this activity, evaluating the related risks and our exposure.exposure, and have already amended terms to transition to an alternative benchmark, where necessary. All of our financing arrangements and derivative instruments that incorporate LIBOR as the referenced rate either mature prior to the phase out of LIBOR or have provisions in place that provide for an alternative to LIBOR upon its phase-out. Additionally, each series of our fixed-to-floating preferred stock that becomes callable at the time the stock begins to pay a LIBOR-based rate has existing LIBOR cessation fallback language.
Summary of Results of Operations and Financial Condition
During the first quarter of 2020, we experienced unprecedented market conditions as a result of the global COVID-19 pandemic, including unusually significant spread widening in both Agency RMBS and non-Agency securities. In response, we focused our efforts on raising excess liquidity and de-risking our portfolio. On March 25, 2020, we sold substantially all of our non-Agency securities in order to eliminate the risks posed by continued margin calls and ongoing funding concerns associated with the significant spread widening on these assets. We also sold approximately one-third of our Agency RMBS portfolio in order to reduce risk and raise cash to establish a strong defensive liquidity position to weather potential ongoing economic and market instability. These actions, occurring at a time of wide spreads and low prices, resulted in large realized losses in the first quarter of 2020 and a corresponding decline in book value.
Late in the first quarter of 2020, the Fed committed to unlimited purchases of Agency RMBS. The Fed’s actions were successful in helping to stabilize that market; however, the resulting historic spread tightening in the first half of 2021 made investments in Agency RMBS less attractive. As a result, and in anticipation of an accelerated tapering of Fed purchases, we reduced our aggregate Agency RMBS/TBA position during the year ended December 31, 2021. In the ordinary course of business, we make investment decisions and allocate capital in accordance with our views on the changing risk/reward dynamics in the market and in our portfolio.
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Certain mortgage loan forbearance programs were established in connection with the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act. As the servicer of record for the MSR assets in our portfolio, we may be responsible for continuing to advance principal, interest, taxes and insurance on mortgage loans that are in forbearance, delinquency or default. At December 31, 2021, our forbearance rate had declined to less than one percent of our MSR portfolio by loan count. We are confident in our ability to meet our servicing advance obligations and have entered into a revolving credit facility to finance these advances. Further, a significant number of borrowers, who were previously eligible for forbearance plan extensions, have reached or are reaching their terminal forbearance plan expiration. This has led to improvement in actual and projected forbearance rates in our portfolio; however, over time, delinquencies and defaults in our MSR portfolio could increase if borrowers who were in forbearance are unable to resume making their monthly mortgage payments.
Our GAAP net loss attributable to common stockholders was $15.0 million and GAAP net income attributable to common stockholders was $115.8$128.8 million ($(0.05) and $248.2 million ($0.41 and $0.93$0.43 per diluted weighted average share) for the three and twelve months ended December 31, 2019,2021, respectively, as compared to GAAP net income attributable to common stockholders of $192.2 million and GAAP net loss attributable to common stockholders of $573.5 million$1.7 billion ($0.68 and $109.7 million ($(2.31) and $(0.53)$(6.24) per diluted weighted average share) for the three and twelve months ended December 31, 2018.2020, respectively.
With our accounting treatment for AFS securities, unrealized fluctuations in the market values of AFS securities, excluding Agencycertain interest-only securities and securities with an allowance for credit losses, do not impact our GAAP net income (loss) or taxable income but are recognized on our consolidated balance sheets as a change in stockholders’ equity under “accumulated other comprehensive income.” For the three and twelve months ended December 31, 2019,2021, net unrealized losses on AFS securities recognized as other comprehensive loss, net of tax, were $59.0$113.6 million and net unrealized gains on AFS securities recognized as other comprehensive income, net of tax, were $578.6$455.3 million, respectively. This, combined with GAAP net loss attributable to common stockholders of $15.0 million and GAAP net income attributable to common stockholders of $115.8 million and $248.2 million, resulted in comprehensive income attributable to common stockholders of $56.8 million and $826.7$128.8 million for the three and twelve months ended December 31, 2019,2021, respectively, resulted in comprehensive loss attributable to common stockholders of $128.6 million and $326.5 million for the three and twelve months ended December 31, 2021, respectively. For the three and twelve months ended December 31, 2018, net unrealized gains on AFS securities recognized as other comprehensive income, net of tax, were $265.5 million and2020, net unrealized losses on AFS securities recognized as other comprehensive loss, net of tax, were $233.9$78.7 million and $47.8 million, respectively. This, combined with GAAP net income attributable to common stockholders of $192.2 million and GAAP net loss attributable to common stockholders of $573.5$1.7 billion, resulted in comprehensive income attributable to common stockholders of $113.5 million and $109.7 million, resulted in comprehensive loss attributable to common stockholders of $307.9 million and $343.6 million$1.8 billion for the three and twelve months ended December 31, 2018,2020, respectively.
Our book value per common share for U.S. GAAP purposes was $14.54$5.87 at December 31, 2019, an increase2021, a decrease from $13.11 book value$7.63 per common share at December 31, 2018. During this twelve month period,2020. For the year ended December 31, 2021, we issued 24,439,436 shares of common stock for net proceeds of $336.3 million and recognized comprehensive incomeloss attributable to common stockholders of $826.7$326.5 million and declared common dividends of $205.6 million, which drove the overall increasedecrease in book value in excessvalue.
Although some uncertainty remains regarding the future effects of the total distributions paidCOVID-19 pandemic and the actions that may be taken by federal, state and local governmental authorities and the GSEs in response, the Agency RMBS market has stabilized and there is more clarity regarding forbearance levels and deferral programs on Agency MSR. Our liquidity position is strong, with $1.2 billion in unrestricted cash as of December 31, 2021. We continue to commonbelieve the pace of economic recovery and preferred stockholders during the year.
35
The following tables present the components of our comprehensive (loss) income (loss) for the three and twelve months ended December 31, 20192021 and 2018, and the twelve months ended December 31, 2017:2020:
| (in thousands, except share data) | Three Months Ended | Year Ended | ||||||||||||||||||||||||||||||
| Income Statement Data: | December 31, | December 31, | ||||||||||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||||||
| (unaudited) | (unaudited) | |||||||||||||||||||||||||||||||
| Interest income: | ||||||||||||||||||||||||||||||||
| Available-for-sale securities | $ | 32,729 | $ | 72,071 | $ | 167,310 | $ | 515,685 | ||||||||||||||||||||||||
| Other | 276 | 429 | 1,287 | 9,365 | ||||||||||||||||||||||||||||
| Total interest income | 33,005 | 72,500 | 168,597 | 525,050 | ||||||||||||||||||||||||||||
| Interest expense: | ||||||||||||||||||||||||||||||||
| Repurchase agreements | 4,562 | 11,001 | 25,774 | 233,069 | ||||||||||||||||||||||||||||
| Revolving credit facilities | 5,050 | 3,513 | 22,425 | 12,261 | ||||||||||||||||||||||||||||
| Term notes payable | 3,251 | 3,296 | 12,936 | 14,974 | ||||||||||||||||||||||||||||
| Convertible senior notes | 7,295 | 4,831 | 28,038 | 19,197 | ||||||||||||||||||||||||||||
| Federal Home Loan Bank advances | — | — | — | 1,747 | ||||||||||||||||||||||||||||
| Total interest expense | 20,158 | 22,641 | 89,173 | 281,248 | ||||||||||||||||||||||||||||
| Net interest income | 12,847 | 49,859 | 79,424 | 243,802 | ||||||||||||||||||||||||||||
| Other income (loss): | ||||||||||||||||||||||||||||||||
| Gain (loss) on investment securities | 1,626 | 37,363 | 121,617 | (999,859) | ||||||||||||||||||||||||||||
| Servicing income | 125,511 | 100,549 | 468,406 | 443,351 | ||||||||||||||||||||||||||||
| (Loss) gain on servicing asset | (131,828) | 2,522 | (114,941) | (935,697) | ||||||||||||||||||||||||||||
| Gain (loss) on interest rate swap and swaption agreements | 36,989 | (14,689) | 42,091 | (310,806) | ||||||||||||||||||||||||||||
| (Loss) gain on other derivative instruments | (11,565) | 81,289 | (251,283) | 90,023 | ||||||||||||||||||||||||||||
| Other income (loss) | 1,856 | 474 | (3,845) | 1,422 | ||||||||||||||||||||||||||||
| Total other income (loss) | 22,589 | 207,508 | 262,045 | (1,711,566) | ||||||||||||||||||||||||||||
| Expenses: | ||||||||||||||||||||||||||||||||
| Management fees | — | — | — | 31,738 | ||||||||||||||||||||||||||||
| Servicing expenses | 21,582 | 24,217 | 86,250 | 94,266 | ||||||||||||||||||||||||||||
| Compensation and benefits | 6,396 | 11,220 | 35,041 | 37,723 | ||||||||||||||||||||||||||||
| Other operating expenses | 6,648 | 7,237 | 28,759 | 28,626 | ||||||||||||||||||||||||||||
| Restructuring charges | — | (294) | — | 5,706 | ||||||||||||||||||||||||||||
| Total expenses | 34,626 | 42,380 | 150,050 | 198,059 | ||||||||||||||||||||||||||||
| Income (loss) before income taxes | 810 | 214,987 | 191,419 | (1,665,823) | ||||||||||||||||||||||||||||
| Provision for (benefit from) income taxes | 2,104 | 3,816 | 4,192 | (35,688) | ||||||||||||||||||||||||||||
| Net (loss) income | (1,294) | 211,171 | 187,227 | (1,630,135) | ||||||||||||||||||||||||||||
| Dividends on preferred stock | 13,747 | 18,951 | 58,458 | 75,802 | ||||||||||||||||||||||||||||
| Net (loss) income attributable to common stockholders | $ | (15,041) | $ | 192,220 | $ | 128,769 | $ | (1,705,937) | ||||||||||||||||||||||||
| Basic (loss) earnings per weighted average common share | $ | (0.05) | $ | 0.70 | $ | 0.43 | $ | (6.24) | ||||||||||||||||||||||||
| Diluted (loss) earnings per weighted average common share | $ | (0.05) | $ | 0.68 | $ | 0.43 | $ | (6.24) | ||||||||||||||||||||||||
| Dividends declared per common share | $ | 0.17 | $ | 0.17 | $ | 0.68 | $ | 0.50 | ||||||||||||||||||||||||
| Weighted average number of shares of common stock: | ||||||||||||||||||||||||||||||||
| Basic | 335,100,737 | 273,699,079 | 297,772,001 | 273,600,947 | ||||||||||||||||||||||||||||
| Diluted | 335,100,737 | 291,870,229 | 298,043,538 | 273,600,947 | ||||||||||||||||||||||||||||
36
| (in thousands, except share data) | Three Months Ended | Year Ended | ||||||||||||||||||
| Income Statement Data: | December 31, | December 31, | ||||||||||||||||||
| 2019 | 2018 | 2019 | 2018 | 2017 | ||||||||||||||||
| (unaudited) | ||||||||||||||||||||
| Interest income: | ||||||||||||||||||||
| Available-for-sale securities | $ | 230,567 | $ | 242,535 | $ | 962,283 | $ | 847,325 | $ | 631,853 | ||||||||||
| Residential mortgage loans held-for-investment in securitization trusts | — | — | — | — | 102,886 | |||||||||||||||
| Other | 7,871 | 9,420 | 32,407 | 22,707 | 10,350 | |||||||||||||||
| Total interest income | 238,438 | 251,955 | 994,690 | 870,032 | 745,089 | |||||||||||||||
| Interest expense: | ||||||||||||||||||||
| Repurchase agreements | 152,919 | 146,702 | 654,280 | 469,437 | 210,430 | |||||||||||||||
| Collateralized borrowings in securitization trusts | — | — | — | — | 82,573 | |||||||||||||||
| Federal Home Loan Bank advances | 514 | 5,762 | 10,920 | 20,417 | 36,911 | |||||||||||||||
| Revolving credit facilities | 4,038 | 5,044 | 19,354 | 10,820 | 2,341 | |||||||||||||||
| Term notes payable | 5,002 | — | 10,708 | — | — | |||||||||||||||
| Convertible senior notes | 4,811 | 4,793 | 19,067 | 18,997 | 17,933 | |||||||||||||||
| Total interest expense | 167,284 | 162,301 | 714,329 | 519,671 | 350,188 | |||||||||||||||
| Net interest income | 71,154 | 89,654 | 280,361 | 350,361 | 394,901 | |||||||||||||||
| Other-than-temporary impairment losses | (3,308 | ) | (107 | ) | (14,312 | ) | (470 | ) | (789 | ) | ||||||||||
| Other income (loss): | ||||||||||||||||||||
| Gain (loss) on investment securities | 28,141 | (245,763 | ) | 280,118 | (341,312 | ) | (34,695 | ) | ||||||||||||
| Servicing income | 127,690 | 104,623 | 501,612 | 343,096 | 209,065 | |||||||||||||||
| Loss on servicing asset | (21,739 | ) | (171,284 | ) | (697,659 | ) | (69,033 | ) | (91,033 | ) | ||||||||||
| (Loss) gain on interest rate swap, cap and swaption agreements | (6,875 | ) | (239,492 | ) | (108,289 | ) | 16,043 | (9,753 | ) | |||||||||||
| (Loss) gain on other derivative instruments | (10,800 | ) | (39,122 | ) | 259,998 | (54,857 | ) | (70,159 | ) | |||||||||||
| Other income | 60 | 342 | 337 | 3,037 | 30,141 | |||||||||||||||
| Total other income (loss) | 116,477 | (590,696 | ) | 236,117 | (103,026 | ) | 33,566 | |||||||||||||
| Expenses: | ||||||||||||||||||||
| Management fees | 17,546 | 12,152 | 60,102 | 30,272 | 40,472 | |||||||||||||||
| Servicing expenses | 20,253 | 18,610 | 74,607 | 61,136 | 35,289 | |||||||||||||||
| Other operating expenses | 14,142 | 15,943 | 57,055 | 62,983 | 54,160 | |||||||||||||||
| Acquisition transaction costs | — | — | — | 86,703 | ||||||||||||||||
| Restructuring charges | — | — | — | 8,238 | — | |||||||||||||||
| Total expenses | 51,941 | 46,705 | 191,764 | 249,332 | 129,921 | |||||||||||||||
| Income (loss) before income taxes | 132,382 | (547,854 | ) | 310,402 | (2,467 | ) | 297,757 | |||||||||||||
| (Benefit from) provision for income taxes | (2,372 | ) | 6,681 | (13,560 | ) | 41,823 | (10,482 | ) | ||||||||||||
| Net income (loss) from continuing operations | 134,754 | (554,535 | ) | 323,962 | (44,290 | ) | 308,239 | |||||||||||||
| Income from discontinued operations, net of tax | — | — | — | — | 44,146 | |||||||||||||||
| Net income (loss) | 134,754 | (554,535 | ) | 323,962 | (44,290 | ) | 352,385 | |||||||||||||
| Income from discontinued operations attributable to noncontrolling interest | — | — | — | — | 3,814 | |||||||||||||||
| Net income (loss) attributable to Two Harbors Investment Corp. | 134,754 | (554,535 | ) | 323,962 | (44,290 | ) | 348,571 | |||||||||||||
| Dividends on preferred stock | 18,950 | 18,950 | 75,801 | 65,395 | 25,122 | |||||||||||||||
| Net income (loss) attributable to common stockholders | $ | 115,804 | $ | (573,485 | ) | $ | 248,161 | $ | (109,685 | ) | $ | 323,449 | ||||||||
| (in thousands) | Three Months Ended | Year Ended | ||||||||||||||||||||||||||||||
| Income Statement Data: | December 31, | December 31, | ||||||||||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||||||
| (unaudited) | (unaudited) | |||||||||||||||||||||||||||||||
| Comprehensive (loss) income: | ||||||||||||||||||||||||||||||||
| Net (loss) income | $ | (1,294) | $ | 211,171 | $ | 187,227 | $ | (1,630,135) | ||||||||||||||||||||||||
| Other comprehensive loss, net of tax: | ||||||||||||||||||||||||||||||||
| Unrealized loss on available-for-sale securities | (113,553) | (78,739) | (455,255) | (47,799) | ||||||||||||||||||||||||||||
| Other comprehensive loss | (113,553) | (78,739) | (455,255) | (47,799) | ||||||||||||||||||||||||||||
| Comprehensive (loss) income | (114,847) | 132,432 | (268,028) | (1,677,934) | ||||||||||||||||||||||||||||
| Dividends on preferred stock | 13,747 | 18,951 | 58,458 | 75,802 | ||||||||||||||||||||||||||||
| Comprehensive (loss) income attributable to common stockholders | $ | (128,594) | $ | 113,481 | $ | (326,486) | $ | (1,753,736) | ||||||||||||||||||||||||
| (in thousands) | December 31, 2021 | December 31, 2020 | ||||||||||||
| Balance Sheet Data: | ||||||||||||||
| (unaudited) | ||||||||||||||
| Available-for-sale securities | $ | 7,161,703 | $ | 14,650,922 | ||||||||||
| Mortgage servicing rights | $ | 2,191,578 | $ | 1,596,153 | ||||||||||
| Total assets | $ | 12,114,305 | $ | 19,515,921 | ||||||||||
| Repurchase agreements | $ | 7,656,445 | $ | 15,143,898 | ||||||||||
| Revolving credit facilities | $ | 420,761 | $ | 283,830 | ||||||||||
| Term notes payable | $ | 396,776 | $ | 395,609 | ||||||||||
| Convertible senior notes | $ | 424,827 | $ | 286,183 | ||||||||||
| Total stockholders’ equity | $ | 2,743,953 | $ | 3,088,926 | ||||||||||
| (in thousands) | Three Months Ended | Year Ended | ||||||||||||||||||
| Income Statement Data: | December 31, | December 31, | ||||||||||||||||||
| 2019 | 2018 | 2019 | 2018 | 2017 | ||||||||||||||||
| (unaudited) | ||||||||||||||||||||
| Basic earnings (loss) per weighted average share: | ||||||||||||||||||||
| Continuing operations | $ | 0.42 | $ | (2.31 | ) | $ | 0.93 | $ | (0.53 | ) | $ | 1.62 | ||||||||
| Discontinued operations | — | — | — | — | 0.23 | |||||||||||||||
| Net income (loss) | $ | 0.42 | $ | (2.31 | ) | $ | 0.93 | $ | (0.53 | ) | $ | 1.85 | ||||||||
| Diluted earnings (loss) per weighted average share: | ||||||||||||||||||||
| Continuing operations | $ | 0.41 | $ | (2.31 | ) | $ | 0.93 | $ | (0.53 | ) | $ | 1.60 | ||||||||
| Discontinued operations | — | — | — | — | 0.21 | |||||||||||||||
| Net income (loss) | $ | 0.41 | $ | (2.31 | ) | $ | 0.93 | $ | (0.53 | ) | $ | 1.81 | ||||||||
| Dividends declared per common share | $ | 0.40 | $ | 0.47 | $ | 1.67 | $ | 1.88 | $ | 2.01 | ||||||||||
| Weighted average number of shares of common stock: | ||||||||||||||||||||
| Basic | 272,906,815 | 248,081,168 | 267,826,739 | 206,020,502 | 174,433,999 | |||||||||||||||
| Diluted | 291,070,864 | 248,081,168 | 267,826,739 | 206,020,502 | 188,133,341 | |||||||||||||||
| Comprehensive income (loss): | ||||||||||||||||||||
| Net income (loss) | $ | 134,754 | $ | (554,535 | ) | $ | 323,962 | $ | (44,290 | ) | $ | 352,385 | ||||||||
| Other comprehensive (loss) income, net of tax: | ||||||||||||||||||||
| Unrealized (loss) gain on available-for-sale securities | (58,954 | ) | 265,546 | 578,583 | (233,914 | ) | 135,586 | |||||||||||||
| Other comprehensive (loss) income | (58,954 | ) | 265,546 | 578,583 | (233,914 | ) | 135,586 | |||||||||||||
| Comprehensive income (loss) | 75,800 | (288,989 | ) | 902,545 | (278,204 | ) | $ | 487,971 | ||||||||||||
| Comprehensive income attributable to noncontrolling interest | — | — | — | — | 3,814 | |||||||||||||||
| Comprehensive income (loss) attributable to Two Harbors Investment Corp. | 75,800 | (288,989 | ) | 902,545 | (278,204 | ) | 484,157 | |||||||||||||
| Dividends on preferred stock | 18,950 | 18,950 | 75,801 | 65,395 | 25,122 | |||||||||||||||
| Comprehensive income (loss) attributable to common stockholders | $ | 56,850 | $ | (307,939 | ) | $ | 826,744 | $ | (343,599 | ) | $ | 459,035 | ||||||||
| (in thousands) | December 31, 2019 | December 31, 2018 | ||||||
| Balance Sheet Data: | ||||||||
| Available-for-sale securities | $ | 31,406,328 | $ | 25,552,604 | ||||
| Mortgage servicing rights | $ | 1,909,444 | $ | 1,993,440 | ||||
| Total assets | $ | 35,921,622 | $ | 30,132,479 | ||||
| Repurchase agreements | $ | 29,147,463 | $ | 23,133,476 | ||||
| Federal Home Loan Bank advances | $ | 210,000 | $ | 865,024 | ||||
| Revolving credit facilities | $ | 300,000 | $ | 310,000 | ||||
| Term notes payable | $ | 394,502 | $ | — | ||||
| Convertible senior notes | $ | 284,954 | $ | 283,856 | ||||
| Total stockholders’ equity | $ | 4,970,466 | $ | 4,254,489 | ||||
Results of Operations
The following analysis focuses on financial results during the three and twelve months endedDecember 31, 20192021 and 2018.2020. The analysis of our financial results during the three and twelve months ended December 31, 20182020 and 20172019 is omitted from this Form 10-K and included in Part II Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2018.
Interest Income
Interest income decreased from $252.0 million for the three months ended December 31, 2018 to $238.4 million for the same period in 2019 due to purchases of lower coupon Agency RMBS, sales of higher coupon Agency RMBS and higher prepayments on Agency RMBS with unamortized premium. Interest income increased from $870.0 million for the year ended December 31, 2018 to $994.7 million for the same period in 2019 due to the growth of our Agency RMBS portfolio.
Interest Expense
Interest expense decreased from $22.6 million and $281.2 million for the three and twelve months ended December 31, 2020, respectively, to $20.2 million and $89.2 million for the same periods in 2021 due to lower borrowing balances related to the sale of both Agency RMBS and non-Agency securities and on MSR due to portfolio growth, and the MSR securitization completed in 2019.a lower interest rate environment.
37
Net Interest Income
The following tables present the components of interest income and average annualized net asset yield earned by asset type, the components of interest expense and average annualized cost of funds on borrowings incurred by liability and/or collateral type, and net interest income and average annualized net interest rate spread for the three and twelve months ended December 31, 20192021 and 2018:2020:
| Three Months Ended December 31, 2021 | Year Ended December 31, 2021 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Average Balance (1) | Interest Income/Expense | Net Yield/Cost of Funds (2) | Average Balance (1) | Interest Income/Expense | Net Yield/Cost of Funds (2) | |||||||||||||||||||||||||||||||||||||||||||||||
| Interest-earning assets: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Available-for-sale securities | $ | 6,067,568 | $ | 32,729 | 2.2 | % | $ | 8,450,440 | $ | 167,310 | 2.0 | % | |||||||||||||||||||||||||||||||||||||||||
| Other | — | 276 | — | % | — | 1,287 | — | % | |||||||||||||||||||||||||||||||||||||||||||||
| Total interest income/net asset yield | $ | 6,067,568 | $ | 33,005 | 2.2 | % | $ | 8,450,440 | $ | 168,597 | 2.0 | % | |||||||||||||||||||||||||||||||||||||||||
| Interest-bearing liabilities: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Borrowings collateralized by: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Available-for-sale securities | $ | 6,503,608 | $ | 2,911 | 0.2 | % | $ | 9,098,301 | $ | 20,794 | 0.2 | % | |||||||||||||||||||||||||||||||||||||||||
Agency Derivatives (3) | 38,045 | 69 | 0.7 | % | 43,910 | 349 | 0.8 | % | |||||||||||||||||||||||||||||||||||||||||||||
Mortgage servicing rights and advances (4) | 942,357 | 9,883 | 4.2 | % | 931,565 | 39,992 | 4.3 | % | |||||||||||||||||||||||||||||||||||||||||||||
| Unsecured borrowings: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Convertible senior notes | 424,641 | 7,295 | 6.9 | % | 412,107 | 28,038 | 6.8 | % | |||||||||||||||||||||||||||||||||||||||||||||
| Total interest expense/cost of funds | $ | 7,908,651 | $ | 20,158 | 1.0 | % | $ | 10,485,883 | $ | 89,173 | 0.9 | % | |||||||||||||||||||||||||||||||||||||||||
Net interest income/spread (5) | $ | 12,847 | 1.2 | % | $ | 79,424 | 1.1 | % | |||||||||||||||||||||||||||||||||||||||||||||
| Three Months Ended December 31, 2019 | Year Ended December 31, 2019 | ||||||||||||||||||||
| (dollars in thousands) | Average Balance (1) | Interest Income/Expense | Net Yield/Cost of Funds (2) | Average Balance (1) | Interest Income/Expense | Net Yield/Cost of Funds (2) | |||||||||||||||
| Interest-earning assets | |||||||||||||||||||||
| Agency available-for-sale securities | $ | 24,694,426 | $ | 178,621 | 2.9 | % | $ | 23,593,771 | $ | 763,601 | 3.2 | % | |||||||||
| Non-Agency available-for-sale securities | 3,300,836 | 51,946 | 6.3 | % | 3,278,228 | 198,682 | 6.1 | % | |||||||||||||
| Other | 9,308 | 7,871 | 4.2 | % | 15,530 | 32,407 | 4.6 | % | |||||||||||||
| Total interest income/net asset yield | $ | 28,004,570 | $ | 238,438 | 3.4 | % | $ | 26,887,529 | $ | 994,690 | 3.7 | % | |||||||||
| Interest-bearing liabilities | |||||||||||||||||||||
| Repurchase agreements, FHLB advances, revolving credit facilities and term notes payable collateralized by: | |||||||||||||||||||||
| Agency available-for-sale securities | $ | 24,728,724 | $ | 137,919 | 2.2 | % | $ | 23,018,643 | $ | 583,646 | 2.5 | % | |||||||||
| Non-Agency available-for-sale securities | 1,598,573 | 12,179 | 3.0 | % | 1,909,564 | 67,442 | 3.5 | % | |||||||||||||
Agency derivatives (3) | 50,263 | 359 | 2.9 | % | 47,824 | 1,556 | 3.3 | % | |||||||||||||
Mortgage servicing rights (4) | 956,985 | 12,016 | 5.0 | % | 807,486 | 42,618 | 5.3 | % | |||||||||||||
| Other unassignable | |||||||||||||||||||||
| Convertible senior notes | 284,848 | 4,811 | 6.8 | % | 284,413 | 19,067 | 6.7 | % | |||||||||||||
| Total interest expense/cost of funds | $ | 27,619,393 | 167,284 | 2.4 | % | $ | 26,067,930 | 714,329 | 2.7 | % | |||||||||||
Net interest income/spread (5) | $ | 71,154 | 1.0 | % | $ | 280,361 | 1.0 | % | |||||||||||||
| Three Months Ended December 31, 2018 | Year Ended December 31, 2018 | Three Months Ended December 31, 2020 | Year Ended December 31, 2020 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Average Balance (1) | Interest Income/Expense | Net Yield/Cost of Funds (2) | Average Balance (1) | Interest Income/Expense | Net Yield/Cost of Funds (2) | (dollars in thousands) | Average Balance (1) | Interest Income/Expense | Net Yield/Cost of Funds (2) | Average Balance (1) | Interest Income/Expense | Net Yield/Cost of Funds (2) | |||||||||||||||||||||||||||||||||||||||||||
| Interest-earning assets | Interest-earning assets | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Agency available-for-sale securities | $ | 21,401,757 | $ | 176,997 | 3.3 | % | $ | 19,782,775 | $ | 620,581 | 3.1 | % | ||||||||||||||||||||||||||||||||||||||||||||
| Non-Agency available-for-sale securities | 3,405,550 | 65,538 | 7.7 | % | 2,935,601 | 226,743 | 7.7 | % | ||||||||||||||||||||||||||||||||||||||||||||||||
| Available-for-sale securities | Available-for-sale securities | $ | 14,660,468 | $ | 72,071 | 2.0 | % | $ | 19,432,462 | $ | 515,685 | 2.7 | % | |||||||||||||||||||||||||||||||||||||||||||
| Other | 28,551 | 9,420 | 4.0 | % | 30,148 | 22,707 | 4.2 | % | Other | — | 429 | — | % | 2,059 | 9,365 | 3.8 | % | |||||||||||||||||||||||||||||||||||||||
| Total interest income/net asset yield | $ | 24,835,858 | $ | 251,955 | 4.1 | % | $ | 22,748,524 | $ | 870,031 | 3.8 | % | Total interest income/net asset yield | $ | 14,660,468 | $ | 72,500 | 2.0 | % | $ | 19,434,521 | $ | 525,050 | 2.7 | % | |||||||||||||||||||||||||||||||
| Interest-bearing liabilities | Interest-bearing liabilities | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Repurchase agreements, FHLB advances, revolving credit facilities and term notes payable collateralized by: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Agency available-for-sale securities | $ | 19,796,348 | $ | 125,014 | 2.5 | % | $ | 18,603,631 | $ | 396,786 | 2.1 | % | ||||||||||||||||||||||||||||||||||||||||||||
| Non-Agency available-for-sale securities | 2,569,298 | 23,802 | 3.7 | % | 2,278,651 | 79,772 | 3.5 | % | ||||||||||||||||||||||||||||||||||||||||||||||||
Agency derivatives (3) | 48,018 | 404 | 3.4 | % | 56,393 | 1,650 | 2.9 | % | ||||||||||||||||||||||||||||||||||||||||||||||||
| Borrowings collateralized by: | Borrowings collateralized by: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Available-for-sale securities | Available-for-sale securities | $ | 15,415,108 | $ | 11,091 | 0.3 | % | $ | 19,530,877 | $ | 231,491 | 1.2 | % | |||||||||||||||||||||||||||||||||||||||||||
Agency Derivatives (3) | Agency Derivatives (3) | 52,244 | 123 | 0.9 | % | 51,740 | 850 | 1.6 | % | |||||||||||||||||||||||||||||||||||||||||||||||
Mortgage servicing rights (4) | 579,348 | 8,288 | 5.7 | % | 407,085 | 22,466 | 5.5 | % | Mortgage servicing rights (4) | 678,094 | 6,596 | 3.9 | % | 729,172 | 29,710 | 4.1 | % | |||||||||||||||||||||||||||||||||||||||
| Other unassignable | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Unsecured borrowings: | Unsecured borrowings: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Convertible senior notes | 283,755 | 4,793 | 6.8 | % | 283,347 | 18,997 | 6.7 | % | Convertible senior notes | 286,070 | 4,831 | 6.8 | % | 285,592 | 19,197 | 6.7 | % | |||||||||||||||||||||||||||||||||||||||
| Total interest expense/cost of funds | $ | 23,276,767 | 162,301 | 2.8 | % | $ | 21,629,107 | 519,671 | 2.4 | % | Total interest expense/cost of funds | $ | 16,431,516 | $ | 22,641 | 0.6 | % | $ | 20,597,381 | $ | 281,248 | 1.4 | % | |||||||||||||||||||||||||||||||||
Net interest income/spread (5) | $ | 89,654 | 1.3 | % | $ | 350,360 | 1.4 | % | Net interest income/spread (5) | $ | 49,859 | 1.4 | % | $ | 243,802 | 1.3 | % | |||||||||||||||||||||||||||||||||||||||
____________________
(3)Yields on Agency Derivatives not shown as interest income is included in (loss) gain on other derivative instruments in the consolidated statements of comprehensive (loss) income.
(4)Yields on mortgage servicing rights and advances not shown as these assets do not earn interest.
(5)Net interest spread does not include the accrual and settlement of interest associated with interest rate swaps. In accordance with U.S. GAAP, those costs are included in gain (loss) on interest rate swap, cap and swaption agreements in the consolidated statements of comprehensive (loss) income. For the three and twelve months ended December 31, 2021, our total average net interest rate spread on the assets and liabilities shown in the table above, including interest spread expense associated with interest rate swaps, was 1.5% and 1.3%, respectively, compared to 1.5% and 1.5% for the same periods in 2020.
38
The slight increase in yields on AFS securities for the three months ended December 31, 2021, as compared to the same periodsperiod in 2018,2020 was predominantly driven by purchases of pools with lowerhigher yields. The decrease in yields andon AFS securities for the year ended December 31, 2021, as compared to the same period in 2020, was predominantly driven by the sale of substantially all legacy non-Agencies during the first quarter of 2020 as well as sales of Agency pools with higher yields. The decrease in cost of funds associated with the financing of Agency AFS securities for the three months ended December 31, 2019, as compared to the same period in 2018, was the result of a decrease in average LIBOR through the respective periods. The increase in cost of funds associated with the financing of Agency AFS securities for the year ended December 31, 2019, as compared to the same period in 2018, was primarily the result of the elevated repo/LIBOR spreads that persisted throughout the latter half of 2019.
The decrease in cost of funds associated with the financing of Agency Derivatives for the three and twelve months ended December 31, 2019,2021, as compared to the same periodperiods in 2018,2020, was the result of a decreasedecreases in average LIBOR through the respective periods. borrowing rates offered by counterparties.
The increase in cost of funds associated with the financing of Agency Derivatives for the year ended December 31, 2019, as compared to the same period in 2018, was primarily the result of the elevated repo/LIBOR spreads that persisted throughout the latter half of 2019.
Our convertible senior notes due 2022 were issued in January 2017. Our convertible senior notes due 2026 were issued in February 2021, and a portion of the proceeds from the offering were used to partially repurchase our senior notes due 2022. Both convertible senior notes due 2022 and 2026 are unsecured and pay interest semiannually at a rate of 6.25% per annum. The cost of funds associated with our convertible senior notes for the three and twelve months ended December 31, 2019,2021, as compared to the same periods in 2018, was consistent.2020, increased due to an increase in amortization of deferred debt issuance costs.
The following tables present the components of the yield earned by investment type on our AFS securities portfolio as a percentage of our average amortized cost of securities for the three and twelve months ended December 31, 20192021 and 2018:2020:
| Three Months Ended December 31, 2019 | Year Ended December 31, 2019 | ||||||||||||||||
Agency (1) | Non-Agency | Total | Agency (1) | Non-Agency | Total | ||||||||||||
| Gross yield/stated coupon | 3.9 | % | 4.4 | % | 4.0 | % | 4.1 | % | 4.7 | % | 4.2 | % | |||||
| Net (premium amortization) discount accretion | (1.0 | )% | 1.9 | % | (0.7 | )% | (0.9 | )% | 1.4 | % | (0.6 | )% | |||||
Net yield (2) | 2.9 | % | 6.3 | % | 3.3 | % | 3.2 | % | 6.1 | % | 3.6 | % | |||||
| Three Months Ended | Year Ended | |||||||||||||||||||||||||||||||||||||||
| Three Months Ended December 31, 2018 | Year Ended December 31, 2018 | December 31, | December 31, | |||||||||||||||||||||||||||||||||||||
Agency (1) | Non-Agency | Total | Agency (1) | Non-Agency | Total | |||||||||||||||||||||||||||||||||||
| (in thousands) | (in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||||||||||||
| Gross yield/stated coupon | 4.1 | % | 4.8 | % | 4.2 | % | 4.1 | % | 4.7 | % | 4.1 | % | Gross yield/stated coupon | 4.9 | % | 3.9 | % | 4.7 | % | 3.9 | % | |||||||||||||||||||
| Net (premium amortization) discount accretion | (0.8 | )% | 2.9 | % | (0.3 | )% | (1.0 | )% | 3.0 | % | (0.4 | )% | Net (premium amortization) discount accretion | (2.7) | % | (1.9) | % | (2.7) | % | (1.2) | % | |||||||||||||||||||
Net yield | 3.3 | % | 7.7 | % | 3.9 | % | 3.1 | % | 7.7 | % | 3.7 | % | 2.2 | % | 2.0 | % | 2.0 | % | 2.7 | % | ||||||||||||||||||||
____________________
(1)Excludes Agency Derivatives. For |
| Three Months Ended | Year Ended | ||||||||||||||
| December 31, | December 31, | ||||||||||||||
| (in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
| Other-than-temporary impairment losses | $ | (3,308 | ) | $ | (107 | ) | $ | (14,312 | ) | $ | (470 | ) | |||
| Number of non-Agency securities | 6 | 1 | 18 | 3 | |||||||||||
Gain (Loss) On Investment Securities
The following tables present the components of gain (loss) on investment securities for the three and twelve months ended December 31, 20192021 and 2018:2020:
| Three Months Ended December 31, 2021 | Year Ended December 31, 2021 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| (in thousands) | Available-For-Sale Securities | Trading Securities | Total | Available-For-Sale Securities | Trading Securities | Total | |||||||||||||||||||||||||||||||||||||||||||||||
| Proceeds from sales | $ | 1,171,299 | $ | — | $ | 1,171,299 | $ | 6,274,193 | $ | — | $ | 6,274,193 | |||||||||||||||||||||||||||||||||||||||||
| Amortized cost sold | (1,139,241) | — | (1,139,241) | (6,137,824) | — | (6,137,824) | |||||||||||||||||||||||||||||||||||||||||||||||
| Total realized gains on sales | 32,058 | — | 32,058 | 136,369 | — | 136,369 | |||||||||||||||||||||||||||||||||||||||||||||||
| Provision for credit losses | (3,347) | — | (3,347) | (9,763) | — | (9,763) | |||||||||||||||||||||||||||||||||||||||||||||||
| Other | (27,085) | — | (27,085) | (4,989) | — | (4,989) | |||||||||||||||||||||||||||||||||||||||||||||||
| Gain on investment securities | $ | 1,626 | $ | — | $ | 1,626 | $ | 121,617 | $ | — | $ | 121,617 | |||||||||||||||||||||||||||||||||||||||||
39
| Three Months Ended December 31, 2019 | Year Ended December 31, 2019 | ||||||||||||||||||||||
| (in thousands) | Available-For-Sale Securities | Equity Securities | Total | Available-For-Sale Securities | Equity Securities | Total | |||||||||||||||||
| Proceeds from sales | $ | 1,814,250 | $ | — | $ | 1,814,250 | $ | 15,879,823 | $ | — | $ | 15,879,823 | |||||||||||
| Amortized cost of securities sold | (1,786,635 | ) | — | (1,786,635 | ) | (15,595,809 | ) | — | (15,595,809 | ) | |||||||||||||
| Total realized gains | 27,615 | — | 27,615 | 284,014 | — | 284,014 | |||||||||||||||||
Change in unrealized gains (losses) (1) | 526 | — | 526 | (3,896 | ) | — | (3,896 | ) | |||||||||||||||
| Dividend income | — | — | — | — | — | — | |||||||||||||||||
| Gain (loss) on investment securities | $ | 28,141 | $ | — | $ | 28,141 | $ | 280,118 | $ | — | $ | 280,118 | |||||||||||
| Three Months Ended December 31, 2020 | Year Ended December 31, 2020 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| (in thousands) | Available-For-Sale Securities | Trading Securities | Total | Available-For-Sale Securities | Trading Securities | Total | |||||||||||||||||||||||||||||||||||||||||||||||
| Proceeds from sales | $ | 1,379,468 | $ | — | $ | 1,379,468 | 18,349,338 | $ | 1,053,477 | $ | 19,402,815 | ||||||||||||||||||||||||||||||||||||||||||
| Amortized cost sold | (1,325,981) | — | (1,325,981) | (19,273,667) | (1,052,500) | (20,326,167) | |||||||||||||||||||||||||||||||||||||||||||||||
| Total realized gains (losses) on sales | 53,487 | — | 53,487 | (924,329) | 977 | (923,352) | |||||||||||||||||||||||||||||||||||||||||||||||
| Provision for credit losses | (4,509) | — | (4,509) | (58,440) | — | (58,440) | |||||||||||||||||||||||||||||||||||||||||||||||
| Other | (11,615) | — | (11,615) | (18,067) | — | (18,067) | |||||||||||||||||||||||||||||||||||||||||||||||
| Gain (loss) on investment securities | $ | 37,363 | $ | — | $ | 37,363 | $ | (1,000,836) | $ | 977 | $ | (999,859) | |||||||||||||||||||||||||||||||||||||||||
| Three Months Ended December 31, 2018 | Year Ended December 31, 2018 | ||||||||||||||||||||||
| (in thousands) | Available-For-Sale Securities | Equity Securities | Total | Available-For-Sale Securities | Equity Securities | Total | |||||||||||||||||
| Proceeds from sales | $ | 6,045,720 | $ | — | $ | 6,045,720 | $ | 15,202,406 | $ | 31,276 | $ | 15,233,682 | |||||||||||
| Amortized cost of securities sold | (6,294,564 | ) | — | (6,294,564 | ) | (15,551,968 | ) | (30,054 | ) | (15,582,022 | ) | ||||||||||||
| Total realized (losses) gains | (248,844 | ) | — | (248,844 | ) | (349,562 | ) | 1,222 | (348,340 | ) | |||||||||||||
Change in unrealized gains(1) | 3,081 | — | 3,081 | 5,094 | 641 | 5,735 | |||||||||||||||||
| Dividend income | — | — | — | — | 1,293 | 1,293 | |||||||||||||||||
| (Loss) gain on investment securities | $ | (245,763 | ) | $ | — | $ | (245,763 | ) | $ | (344,468 | ) | $ | 3,156 | $ | (341,312 | ) | |||||||
Due to the unprecedented market conditions experienced as a result of the global COVID-19 pandemic, we sold substantially all of our portfolio of non-Agency securities and approximately one-third of our Agency RMBS during the first quarter of 2020. Late in the first quarter of 2020, the Fed committed to unlimited purchases of Agency RMBS. The Fed’s actions were successful in helping to stabilize that market; however, the resulting historic spread tightening in the first half of 2021 made investments in Agency RMBS less attractive. As a result, and in anticipation of an accelerated tapering of Fed purchases, we reduced our aggregate Agency RMBS/TBA position during the year ended December 31, 2021. In the ordinary course of business, we make investment decisions and allocate capital in accordance with our views on the changing risk/reward dynamics in the market and in our portfolio. We do not expect to sell assets on a frequent basis, but may sell assets to reallocate capital into new assets that we believe have higher risk-adjusted returns.
Subsequent to the adoption of Topic 326 on January 1, 2020, the Company uses a discounted cash flow method to estimate and recognize an allowance for credit losses on AFS securities, as detailed in Note 2 to the consolidated financial statements, included under Item 1 of this Annual Report on Form 10-K. Subsequent adverse or favorable changes in expected cash flows are recognized immediately in earnings as a provision for or reversal of provision for credit losses (within gain (loss) on investment securities).
The decrease in changemajority of the “other” component of gain (loss) on investment securities is related to changes in unrealized gains (losses) on Agencycertain interest-only mortgage-backed securities forsecurities. For the three and twelve months ended December 31, 2019, as compared to2021, the same period in 2018, wasunrealized losses recognized were primarily due to lowerfaster prepayment expectations relative to prepayment expectations in the previous quarter. The increase in change in unrealized losses (decrease in gains) on Agency interest-only mortgage-backed securities for the year ended December 31, 2019, as compared to the same period in 2018, was due to interest rates generally falling throughout the year ended December 31, 2019, as compared to interest rates generally rising throughout the year ended December 31, 2018, resulting in slower prepayment expectations.assumptions.
Servicing Income
The following table presents the components of servicing income for the three and twelve months ended December 31, 20192021 and 2018:2020:
| Three Months Ended | Year Ended | ||||||||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||||||||
| (in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||
| Servicing fee income | $ | 123,912 | $ | 98,250 | $ | 461,381 | $ | 416,936 | |||||||||||||||||||||
| Ancillary and other fee income | 548 | 557 | 2,436 | 1,945 | |||||||||||||||||||||||||
| Float income | 1,051 | 1,742 | 4,589 | 24,470 | |||||||||||||||||||||||||
| Total | $ | 125,511 | $ | 100,549 | $ | 468,406 | $ | 443,351 | |||||||||||||||||||||
| Three Months Ended | Year Ended | ||||||||||||||
| December 31, | December 31, | ||||||||||||||
| (in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
| Servicing fee income | $ | 109,403 | $ | 94,078 | $ | 436,587 | $ | 312,100 | |||||||
| Ancillary and other fee income | 499 | 276 | 1,801 | 1,280 | |||||||||||
| Float income | 17,788 | 10,269 | 63,224 | 29,716 | |||||||||||
| Total | $ | 127,690 | $ | 104,623 | $ | 501,612 | $ | 343,096 | |||||||
The increase in servicing income for the three and twelve months ended December 31, 2019,2021, as compared to the same periods in 2018,2020, was the resultdue to a higher portfolio balance and lower compensating interest, offset by lower float income.
40
The following table presents the components of loss on servicing asset for the three and twelve months ended December 31, 20192021 and 2018:2020:
| Three Months Ended | Year Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| (in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||
| Changes in fair value due to changes in valuation inputs or assumptions used in the valuation model | $ | 21,189 | $ | 173,447 | $ | 562,843 | $ | (396,900) | |||||||||||||||
| Changes in fair value due to realization of cash flows (runoff) | (152,450) | (170,897) | (666,160) | (538,761) | |||||||||||||||||||
| Losses on sales | (567) | (28) | (11,624) | (36) | |||||||||||||||||||
| (Loss) gain on servicing asset | $ | (131,828) | $ | 2,522 | $ | (114,941) | $ | (935,697) | |||||||||||||||
| Three Months Ended | Year Ended | ||||||||||||||
| December 31, | December 31, | ||||||||||||||
| (in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
| Changes in fair value due to changes in valuation inputs or assumptions used in the valuation model | $ | 87,561 | $ | (129,401 | ) | $ | (390,149 | ) | $ | 80,209 | |||||
| Changes in fair value due to realization of cash flows (runoff) | (109,333 | ) | (42,125 | ) | (307,918 | ) | (149,879 | ) | |||||||
| Gains on sales | 33 | 242 | 408 | 637 | |||||||||||
| Loss on servicing asset | $ | (21,739 | ) | $ | (171,284 | ) | $ | (697,659 | ) | $ | (69,033 | ) | |||
The decreaseincrease in loss (decrease in gain) on servicing asset for the three months ended December 31, 2019,2021, as compared to the same period in 2018,2020, was driven by a decrease in expected prepayment speed assumptions used in the fair valuation of MSR decreasing at a lower rate and realized losses on sales of MSR, offset by highera decrease in portfolio runoff on a larger MSR portfolio during the three months ended December 31, 2019.runoff. The increasedecrease in loss on servicing asset for the year ended December 31, 2019,2021, as compared to the same period in 2018,2020, was driven by decreasesfavorable change in interest rates, an increase in prepayment speedvaluation assumptions used in the fair market valuation of MSR, and higherincluding the impact of acquiring MSR at a cost below fair value, offset by increased portfolio runoff and realized losses on a largersales of MSR portfolio during the year ended December 31, 2019.2021.
Gain (Loss) Gain onOn Interest Rate Swap Cap andAnd Swaption Agreements
The following table summarizes the net interest spread and gains and losses associated with our interest rate swap cap and swaption positions recognized during the three and twelve months ended December 31, 20192021 and 2018:2020:
| Three Months Ended | Year Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| (in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||
| Net interest spread | $ | 5,772 | $ | 1,953 | $ | 14,262 | $ | (66,175) | |||||||||||||||
| Early termination, agreement maturation and option expiration (losses) gains | (5,143) | (2,546) | 2,369 | (387,748) | |||||||||||||||||||
| Change in unrealized gain (loss) on interest rate swap and swaption agreements, at fair value | 36,360 | (14,096) | 25,460 | 143,117 | |||||||||||||||||||
| Gain (loss) on interest rate swap and swaption agreements | $ | 36,989 | $ | (14,689) | $ | 42,091 | $ | (310,806) | |||||||||||||||
| Three Months Ended | Year Ended | ||||||||||||||
| December 31, | December 31, | ||||||||||||||
| (in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
| Net interest spread | $ | 4,768 | $ | 15,331 | $ | 70,514 | $ | 49,217 | |||||||
| Early termination, agreement maturation and option expiration (losses) gains | (1,495 | ) | (35,757 | ) | 94,929 | (3,593 | ) | ||||||||
| Change in unrealized loss on interest rate swap, cap and swaption agreements, at fair value | (10,148 | ) | (219,066 | ) | (273,732 | ) | (29,581 | ) | |||||||
| (Loss) gain on interest rate swap, cap and swaption agreements | $ | (6,875 | ) | $ | (239,492 | ) | $ | (108,289 | ) | $ | 16,043 | ||||
Net interest spread recognized for the accrual and/or settlement of the net interest expense associated with our interest rate swaps and caps results from receiving either LIBORa floating interest rate (LIBOR, OIS or SOFR) or a fixed interest rate and paying either a fixed interest rate or LIBORa floating interest rate (LIBOR, OIS or SOFR) on positions held to economically hedge/mitigate portfolio interest rate exposure (or duration) risk. We may elect to terminate certain swaps caps and swaptions to align with our investment portfolio, agreements may mature or options may expire resulting in full settlement of our net interest spread asset/liability and the recognition of realized gains and losses, including early termination penalties. During the second quarter of 2020, we elected to terminate certain swaps and swaptions in order to adjust the total notional and fixed interest rates on these instruments, as a result of adjustments made to our investment portfolio and changes in interest rates. The change in fair value of interest rate swaps caps and swaptions during the three and twelve months ended December 31, 20192021 and 20182020 was a result of changes to LIBOR,floating interest rates (LIBOR, OIS or SOFR), the swap curve and corresponding counterparty borrowing rates. Since swaps caps and swaptions are used for purposes of hedging our interest rate exposure, their unrealized valuation gains and losses (excluding the reversal of unrealized gains and losses to realized gains and losses upon termination, maturation or option expiration) are generally offset by unrealized losses and gains in our Agency RMBS AFS portfolio, which are recorded either directly to stockholders’ equity through other comprehensive (loss) income, (loss), net of tax, or to gain (loss) on investment securities, in the case of Agencycertain interest-only mortgage-backed securities.
(Loss) Gain onOn Other Derivative Instruments
The following table provides a summary of the total (loss) gainnet gains (losses) recognized on other derivative instruments we hold for purposes of both hedging and non-hedging activities, principally TBAs, put and call options for TBAs, Markit IOS total return swaps, short U.S. treasuries, U.S. Treasury and Eurodollar futures and inverse interest-only securities during the three and twelve months ended December 31, 20192021 and 2018:2020:
| Three Months Ended | Year Ended | Three Months Ended | Year Ended | |||||||||||||||||||||||||||||||||||
| December 31, | December 31, | December 31, | December 31, | |||||||||||||||||||||||||||||||||||
| (in thousands) | 2019 | 2018 | 2019 | 2018 | (in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||||||
| Interest income, net of accretion, on inverse interest-only securities | $ | 1,702 | $ | 1,437 | $ | 5,586 | $ | 6,463 | Interest income, net of accretion, on inverse interest-only securities | $ | 1,058 | $ | 2,232 | $ | 5,418 | $ | 9,479 | |||||||||||||||||||||
| Interest expense on short U.S. treasuries | — | (5,592 | ) | (1,315 | ) | (9,302 | ) | |||||||||||||||||||||||||||||||
Realized and unrealized net gains (losses) on other derivative instruments (1) | (12,502 | ) | (34,967 | ) | 255,727 | (52,018 | ) | Realized and unrealized net gains (losses) on other derivative instruments (1) | (12,623) | 79,057 | (256,701) | 80,544 | ||||||||||||||||||||||||||
| (Loss) gain on other derivative instruments | $ | (10,800 | ) | $ | (39,122 | ) | $ | 259,998 | $ | (54,857 | ) | (Loss) gain on other derivative instruments | $ | (11,565) | $ | 81,289 | $ | (251,283) | $ | 90,023 | ||||||||||||||||||
____________________
(1)As these derivative instruments are considered trading instruments, our financial results include both realized and unrealized gains (losses) associated with these instruments.
For further details regarding our use of derivative instruments and related activity, refer to Note 7 - Derivative Instruments and Hedging Activities to the consolidated financial statements, included in this Annual Report on Form 10-K.
Expenses
The following table presents the components of expenses, other income of $0.1 million and $0.3 millionthan restructuring charges, for the three and twelve months ended December 31, 20192021 and $0.3 million and $3.0 million for the three and twelve months ended December 31, 2018, respectively. The decrease in other income for the three and twelve months ended December 31, 2019, as compared2020:
| Three Months Ended | Year Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| (in thousands, except share data) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||
| Management fees | $ | — | $ | — | $ | — | $ | 31,738 | |||||||||||||||
| Servicing expenses | $ | 21,582 | $ | 24,217 | $ | 86,250 | $ | 94,266 | |||||||||||||||
| Operating expenses: | |||||||||||||||||||||||
| Compensation and benefits: | |||||||||||||||||||||||
| Non-cash equity compensation expenses | $ | 2,525 | $ | 2,243 | $ | 11,485 | $ | 9,730 | |||||||||||||||
| All other compensation and benefits | 3,871 | 8,977 | 23,556 | 27,993 | |||||||||||||||||||
| Total compensation and benefits | $ | 6,396 | $ | 11,220 | $ | 35,041 | $ | 37,723 | |||||||||||||||
| Other operating expenses: | |||||||||||||||||||||||
| Nonrecurring expenses | $ | 665 | $ | 1,541 | $ | 5,220 | $ | 5,205 | |||||||||||||||
| All other operating expenses | 5,983 | 5,696 | 23,539 | 23,421 | |||||||||||||||||||
| Total other operating expenses | $ | 6,648 | $ | 7,237 | $ | 28,759 | $ | 28,626 | |||||||||||||||
| Annualized operating expense ratio | 1.9 | % | 2.4 | % | 2.3 | % | 2.0 | % | |||||||||||||||
| Annualized operating expense ratio, excluding non-cash equity compensation and other nonrecurring expenses | 1.4 | % | 1.9 | % | 1.7 | % | 1.5 | % | |||||||||||||||
Prior to the same periods in 2018,termination of the Management Agreement on August 14, 2020, a management fee was driven by losses on extinguishment of debt and lower dividend income on our FHLB stock due to a decrease in the average balance held.
| Three Months Ended | Year Ended | ||||||||||||||
| December 31, | December 31, | ||||||||||||||
| (in thousands, except share data) | 2019 | 2018 | 2019 | 2018 | |||||||||||
| Management fees | $ | 17,546 | $ | 12,152 | $ | 60,102 | $ | 30,272 | |||||||
| Servicing expenses | $ | 20,253 | $ | 18,610 | $ | 74,607 | $ | 61,136 | |||||||
| Other operating expenses: | |||||||||||||||
Officers’ compensation incurred by PRCM Advisers on our behalf and reimbursed by us (1) | $ | 141 | $ | 242 | $ | 3,054 | $ | 1,785 | |||||||
| Other direct and allocated costs incurred by PRCM Advisers on our behalf and reimbursed by us | 4,423 | 5,263 | 24,548 | 24,512 | |||||||||||
| Non-cash equity compensation expenses | |||||||||||||||
Amortization of executive officers’ restricted stock (2) | 1,221 | 1,791 | 3,395 | 6,791 | |||||||||||
| Amortization of other restricted stock | 1,202 | 1,420 | 5,265 | 5,501 | |||||||||||
| Total non-cash equity compensation expenses | 2,423 | 3,211 | 8,660 | 12,292 | |||||||||||
| All other operating expenses | 7,155 | 7,227 | 20,793 | 24,394 | |||||||||||
| Total other operating expenses | $ | 14,142 | $ | 15,943 | $ | 57,055 | $ | 62,983 | |||||||
| Annualized other operating expense ratio | 1.1 | % | 1.4 | % | 1.2 | % | 1.6 | % | |||||||
| Annualized other operating expense ratio, excluding non-cash equity compensation expenses | 0.9 | % | 1.1 | % | 1.0 | % | 1.3 | % | |||||||
We also incur servicing expenses generally related to the subservicing of MSR and other operating expenses.MSR. The increasedecrease in servicing expenses during the three and twelve months ended December 31, 2019,2021, as compared to the same periods in 2018,2020, was largely thea result of an increasea decrease in loan forbearance and adjustments for preliquidation claims.
42
Prior to the sizetermination of our MSR portfolio. Includedthe Management Agreement, included in compensation and benefits and other operating expenses arewere direct and allocated costs incurred by PRCM Advisers on our behalf and reimbursed by us, includingus. For the year ended December 31, 2020 these direct and allocated costs totaled approximately $19.3 million. Included in these reimbursed costs was compensation paid to employees of Pine River serving as our principal financial officer and general counsel. The allocationan affiliate of compensation paid to employees of Pine RiverPRCM Advisers serving as our principal financial officer and general counsel isof $1.4 million respectively for the year ended December 31, 2020. We did not reimburse PRCM Advisers for compensation paid to our principal financial officer and general counsel for the three months ended December 31, 2020. Prior to termination of the Management Agreement, the allocation of compensation paid to employees of an affiliate of PRCM Advisers serving as our principal financial officer and general counsel was based on time spent overseeing our activities in accordance with the management agreement;Management Agreement; we dodid not reimburse PRCM Advisers for any expenses related to the compensation of our chief executive officer or chief investment officer. Additionally, included in compensation and benefits is non-cash equity compensation expense, which represents amortization of the restricted stock awarded to our independent directors, executive officers and other eligible individuals. Included in non-cash equity compensation expense for the three and twelve months ended December 31, 2020 was amortization of restricted stock awarded to our executive officers, including our chief executive officer, chief investment officer, principal financial officer and general counsel of $0.9 million and $3.9 million, respectively.
Following the termination of the Management Agreement, we no longer pay a management fee to, or reimburse the expenses of, PRCM Advisers. Expenses for which we previously reimbursed PRCM Advisers are now paid directly by us. We have direct relationships withare also now responsible for the majoritycash compensation and employee benefits of our third-party vendors. We will continuechief executive officer, chief investment officer and investment professionals, which were previously the responsibility of PRCM Advisers. Prior to the termination of the Management Agreement, we were only responsible for the equity compensation paid to such individuals.
Restructuring Charges
On April 13, 2020, we announced that we had elected to not renew the Management Agreement with PRCM Advisers on the basis of unfair compensation payable to the manager pursuant to Section 13(a)(ii) of the Management Agreement. As a result, we had expected the Management Agreement to terminate on September 19, 2020, at which time we would have certain costs allocatedbeen required to uspay a termination fee equal to three times the sum of the average annual base management fee earned by PRCM Advisers during the 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination, pursuant to the terms of the Management Agreement. The termination fee was calculated to be $139.8 million based on results as of June 30, 2020 and recorded during the three months ended June 30, 2020.
On July 15, 2020, we provided PRCM Advisers with a notice of termination of the Management Agreement for compensation, data services, technology“cause” on the basis of certain material breaches of the Management Agreement by PRCM Advisers, its agents and/or its assignees that are incapable of being cured within the time period set forth therein and certain office lease payments, but mostevents of our expenses with third-party vendors are paid directly by us.
In connection with the transaction were recognized intermination of the consolidated statements of comprehensive income (loss) as acquisition transaction costs.Management Agreement, we reversed the $139.8 million accrued termination fee during the three months ended September 30, 2020. For the year ended December 31, 2018, these acquisition transaction costs totaled approximately $86.7 million.
Income Taxes
During the three and other associated costs,twelve months ended December 31, 2021, our TRSs recognized a provision for income taxes of $8.2$2.1 million and $4.2 million, respectively, which was primarily due to income from MSR servicing activity and gains recognized on MSR, offset by net losses recognized on derivative instruments and operating expenses. During the three and twelve months ended December 31, 2020, our TRSs recognized a provision for income taxes of $3.8 million and a benefit from income taxes of $35.7 million, respectively. The provision recognized for the three months ended December 31, 2020 was primarily due to gains recognized on MSR, offset by net losses recognized on derivative instruments held in our TRSs. The benefit recognized for the year ended December 31, 2018.
43
Financial Condition
Available-for-Sale Securities, at Fair Value
The tables below summarizesummarizes certain characteristics of our Agency RMBS AFS at December 31, 20192021 and December 31, 2018:2020:
| December 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands, except purchase price) | Principal/ Current Face | Net (Discount) Premium | Amortized Cost | Allowance for Credit Losses | Unrealized Gain | Unrealized Loss | Carrying Value | Weighted Average Coupon Rate | Weighted Average Purchase Price | ||||||||||||||||||||||||||||||||||||||||||||
| P&I securities | $ | 6,411,363 | $ | 270,687 | $ | 6,682,050 | $ | — | $ | 171,308 | $ | (4,855) | $ | 6,848,503 | 3.65 | % | $ | 104.66 | |||||||||||||||||||||||||||||||||||
| Interest-only securities | 3,198,447 | 305,577 | 305,577 | (12,851) | 20,699 | (12,529) | 300,896 | 2.93 | % | $ | 14.09 | ||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 9,609,810 | $ | 576,264 | $ | 6,987,627 | $ | (12,851) | $ | 192,007 | $ | (17,384) | $ | 7,149,399 | |||||||||||||||||||||||||||||||||||||||
| December 31, 2019 | ||||||||||||||||||||||||||||||
| (dollars in thousands, except purchase price) | Principal/ Current Face | Net (Discount) Premium | Amortized Cost | Unrealized Gain | Unrealized Loss | Carrying Value | Weighted Average Coupon Rate | Weighted Average Purchase Price | ||||||||||||||||||||||
| P&I securities | ||||||||||||||||||||||||||||||
| Fixed | $ | 26,225,918 | $ | 985,699 | $ | 27,211,617 | $ | 424,428 | $ | (8,758 | ) | $ | 27,627,287 | 3.80 | % | $ | 103.96 | |||||||||||||
| Hybrid ARM | 13,626 | 625 | 14,251 | 390 | (57 | ) | 14,584 | 5.81 | % | $ | 107.58 | |||||||||||||||||||
| Total P&I securities | 26,239,544 | 986,324 | 27,225,868 | 424,818 | (8,815 | ) | 27,641,871 | 3.80 | % | $ | 103.96 | |||||||||||||||||||
| Interest-only securities | ||||||||||||||||||||||||||||||
| Fixed | 609,012 | 44,970 | 44,970 | 3,482 | (676 | ) | 47,776 | 3.13 | % | $ | 34.16 | |||||||||||||||||||
Fixed Other (1) | 1,992,681 | 124,841 | 124,841 | 10,242 | (46,675 | ) | 88,408 | 1.68 | % | $ | 8.72 | |||||||||||||||||||
| Total | $ | 28,841,237 | $ | 1,156,135 | $ | 27,395,679 | $ | 438,542 | $ | (56,166 | ) | $ | 27,778,055 | |||||||||||||||||
| December 31, 2018 | ||||||||||||||||||||||||||||||
| (dollars in thousands, except purchase price) | Principal/ Current Face | Net (Discount) Premium | Amortized Cost | Unrealized Gain | Unrealized Loss | Carrying Value | Weighted Average Coupon Rate | Weighted Average Purchase Price | ||||||||||||||||||||||
| Principal and interest securities: | ||||||||||||||||||||||||||||||
| Fixed | $ | 20,757,850 | $ | 1,011,781 | $ | 21,769,631 | $ | 60,819 | $ | (339,906 | ) | $ | 21,490,544 | 4.33 | % | $ | 105.19 | |||||||||||||
| Hybrid ARM | 17,940 | 915 | 18,855 | 309 | (91 | ) | 19,073 | 5.12 | % | $ | 107.63 | |||||||||||||||||||
| Total P&I Securities | 20,775,790 | 1,012,696 | 21,788,486 | 61,128 | (339,997 | ) | 21,509,617 | 4.33 | % | $ | 105.20 | |||||||||||||||||||
| Interest-only securities | ||||||||||||||||||||||||||||||
| Fixed | 794,144 | 58,886 | 58,886 | 4,880 | (403 | ) | 63,363 | 2.84 | % | $ | 33.15 | |||||||||||||||||||
Fixed Other (1) | 2,321,823 | 151,015 | 151,015 | 9,290 | (48,252 | ) | 112,053 | 1.55 | % | $ | 8.82 | |||||||||||||||||||
| Total | $ | 23,891,757 | $ | 1,222,597 | $ | 21,998,387 | $ | 75,298 | $ | (388,652 | ) | $ | 21,685,033 | |||||||||||||||||
| December 31, 2019 | |||||||||||||||||||||||||||||||
| (in thousands) | Principal/Current Face | Un-amortized Premium | Accretable Purchase Discount | Credit Reserve Purchase Discount | Amortized Cost | Unrealized Gain | Unrealized Loss | Carrying Value | |||||||||||||||||||||||
| P&I securities | |||||||||||||||||||||||||||||||
| Senior | $ | 4,861,854 | $ | 8,966 | $ | (445,566 | ) | $ | (1,594,480 | ) | $ | 2,830,774 | $ | 262,527 | $ | (20,203 | ) | $ | 3,073,098 | ||||||||||||
| Mezzanine | 636,800 | 14 | (114,574 | ) | (117,471 | ) | 404,769 | 79,056 | (3,060 | ) | 480,765 | ||||||||||||||||||||
| Total P&I | 5,498,654 | 8,980 | (560,140 | ) | (1,711,951 | ) | 3,235,543 | 341,583 | (23,263 | ) | 3,553,863 | ||||||||||||||||||||
| Interest-only securities | 4,356,603 | 79,935 | — | — | 79,935 | 3,039 | (8,564 | ) | 74,410 | ||||||||||||||||||||||
| Total | $ | 9,855,257 | $ | 88,915 | $ | (560,140 | ) | $ | (1,711,951 | ) | $ | 3,315,478 | $ | 344,622 | $ | (31,827 | ) | $ | 3,628,273 | ||||||||||||
| December 31, 2018 | |||||||||||||||||||||||||||||||
| (in thousands) | Principal/Current Face | Un-amortized Premium | Accretable Purchase Discount | Credit Reserve Purchase Discount | Amortized Cost | Unrealized Gain | Unrealized Loss | Carrying Value | |||||||||||||||||||||||
| P&I securities | |||||||||||||||||||||||||||||||
| Senior | $ | 4,227,631 | $ | 5,381 | $ | (477,682 | ) | $ | (1,204,325 | ) | $ | 2,551,005 | $ | 343,358 | $ | (39,632 | ) | $ | 2,854,731 | ||||||||||||
| Mezzanine | 1,132,493 | 1,301 | (216,437 | ) | (118,437 | ) | 798,920 | 134,737 | (5,025 | ) | 928,632 | ||||||||||||||||||||
| Total P&I | 5,360,124 | 6,682 | (694,119 | ) | (1,322,762 | ) | 3,349,925 | 478,095 | (44,657 | ) | 3,783,363 | ||||||||||||||||||||
| Interest-only securities | 5,137,169 | 83,846 | — | — | 83,846 | 3,655 | (3,293 | ) | 84,208 | ||||||||||||||||||||||
| Total | $ | 10,497,293 | $ | 90,528 | $ | (694,119 | ) | $ | (1,322,762 | ) | $ | 3,433,771 | $ | 481,750 | $ | (47,950 | ) | $ | 3,867,571 | ||||||||||||
| December 31, 2020 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands, except purchase price) | Principal/ Current Face | Net (Discount) Premium | Amortized Cost | Allowance for Credit Losses | Unrealized Gain | Unrealized Loss | Carrying Value | Weighted Average Coupon Rate | Weighted Average Purchase Price | ||||||||||||||||||||||||||||||||||||||||||||
| P&I securities | $ | 13,103,355 | $ | 605,239 | $ | 13,708,594 | $ | — | $ | 629,079 | $ | (420) | $ | 14,337,253 | 3.64 | % | $ | 104.95 | |||||||||||||||||||||||||||||||||||
| Interest-only securities | 3,649,556 | 315,876 | 315,876 | (17,889) | 15,680 | (13,029) | 300,638 | 2.72 | % | $ | 14.42 | ||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 16,752,911 | $ | 921,115 | $ | 14,024,470 | $ | (17,889) | $ | 644,759 | $ | (13,449) | $ | 14,637,891 | |||||||||||||||||||||||||||||||||||||||
| December 31, 2019 | December 31, 2018 | ||||
| AAA | 0.4 | % | 0.5 | % | |
| AA | — | % | — | % | |
| A | — | % | 0.1 | % | |
| BBB | — | % | 2.1 | % | |
| BB | — | % | 0.6 | % | |
| B | 1.3 | % | 5.3 | % | |
| Below B | 78.5 | % | 73.3 | % | |
| Not rated | 19.8 | % | 18.1 | % | |
| Total | 100.0 | % | 100.0 | % | |
| December 31, 2019 | ||||||||||||
| Non-Agency P&I Securities | Senior | Mezzanine | Total | |||||||||
| Carrying value (in thousands) | $ | 3,073,098 | $ | 480,765 | $ | 3,553,863 | ||||||
| % of total | 86.5 | % | 13.5 | % | 100.0 | % | ||||||
Weighted average purchase price (1) | $ | 63.63 | $ | 65.36 | $ | 63.86 | ||||||
| Weighted average coupon | 2.9 | % | 2.5 | % | 2.8 | % | ||||||
| Weighted average fixed coupon | 5.8 | % | 5.5 | % | 5.8 | % | ||||||
| Weighted average floating coupon | 2.5 | % | 2.3 | % | 2.5 | % | ||||||
| Weighted average hybrid coupon | 4.6 | % | 5.4 | % | 4.6 | % | ||||||
| Collateral attributes | ||||||||||||
| Weighted average loan age (months) | 160 | 167 | 161 | |||||||||
| Weighted average current loan size (in thousands) | $ | 207 | $ | 255 | $ | 214 | ||||||
| Weighted average current loan-to-value | 60.5 | % | 58.3 | % | 60.2 | % | ||||||
| Current performance | ||||||||||||
| 60+ day delinquencies | 18.1 | % | 16.5 | % | 17.9 | % | ||||||
Average credit enhancement (2) | 1.9 | % | 8.1 | % | 2.8 | % | ||||||
3-month CPR (3) | 6.1 | % | 8.5 | % | 6.4 | % | ||||||
CDR (4) | 5.0 | % | 4.5 | % | 4.9 | % | ||||||
Severity (5) | 48.6 | % | 33.2 | % | 46.6 | % | ||||||
Cumulative loss (6) | 36.3 | % | 21.9 | % | 34.3 | % | ||||||
| December 31, 2018 | ||||||||||||
| Non-Agency P&I Securities | Senior | Mezzanine | Total P&I | |||||||||
| Carrying value (in thousands) | $ | 2,854,731 | $ | 928,632 | $ | 3,783,363 | ||||||
| % of total | 75.5 | % | 24.5 | % | 100.0 | % | ||||||
Weighted average purchase price (1) | $ | 60.79 | $ | 67.51 | $ | 62.44 | ||||||
| Weighted average coupon | 3.4 | % | 3.2 | % | 3.3 | % | ||||||
| Weighted average fixed coupon | 5.7 | % | 4.0 | % | 5.0 | % | ||||||
| Weighted average floating coupon | 3.1 | % | 3.1 | % | 3.1 | % | ||||||
| Weighted average hybrid coupon | 4.6 | % | — | % | 4.6 | % | ||||||
| Collateral Attributes | ||||||||||||
| Weighted average loan age (months) | 147 | 144 | 147 | |||||||||
| Weighted average current loan size (in thousands) | $ | 215 | $ | 180 | $ | 206 | ||||||
| Weighted average current loan-to-value | 64.4 | % | 55.0 | % | 62.2 | % | ||||||
| Current Performance | ||||||||||||
| 60+ day delinquencies | 19.5 | % | 15.9 | % | 18.6 | % | ||||||
Average credit enhancement (2) | 5.1 | % | 15.0 | % | 7.5 | % | ||||||
3-month CPR (3) | 5.0 | % | 5.7 | % | 5.1 | % | ||||||
CDR (4) | 4.8 | % | 4.2 | % | 4.7 | % | ||||||
Severity (5) | 48.5 | % | 39.7 | % | 46.4 | % | ||||||
Cumulative loss (6) | 34.9 | % | 17.4 | % | 30.8 | % | ||||||
| December 31, 2019 | |||||||||||||||||||||
| Non-Agency P&I Securities | |||||||||||||||||||||
| (dollars in thousands) | Senior | Mezzanine | Total | ||||||||||||||||||
| Collateral Type | Carrying Value | % of Senior | Carrying Value | % of Mezzanine | Carrying Value | % of Total | |||||||||||||||
| Prime | $ | 26,840 | 0.9 | % | $ | 3,482 | 0.7 | % | $ | 30,322 | 0.9 | % | |||||||||
| Alt-A | 385,414 | 12.5 | % | 72,434 | 15.1 | % | 457,848 | 12.9 | % | ||||||||||||
| Pay-option ARM | 234,603 | 7.6 | % | 166,777 | 34.7 | % | 401,380 | 11.3 | % | ||||||||||||
| Subprime | 2,421,860 | 78.9 | % | 238,072 | 49.5 | % | 2,659,932 | 74.8 | % | ||||||||||||
| Other | 4,381 | 0.1 | % | — | — | % | 4,381 | 0.1 | % | ||||||||||||
| Total | $ | 3,073,098 | 100.0 | % | $ | 480,765 | 100.0 | % | $ | 3,553,863 | 100.0 | % | |||||||||
| December 31, 2018 | |||||||||||||||||||||
| Non-Agency P&I Securities | |||||||||||||||||||||
| (dollars in thousands) | Senior | Mezzanine | Total | ||||||||||||||||||
| Collateral Type | Carrying Value | % of Senior | Carrying Value | % of Mezzanine | Carrying Value | % of Total | |||||||||||||||
| Prime | $ | 35,519 | 1.2 | % | $ | 13,797 | 1.5 | % | $ | 49,316 | 1.3 | % | |||||||||
| Alt-A | 367,985 | 12.9 | % | 89,785 | 9.7 | % | 457,770 | 12.1 | % | ||||||||||||
| Pay-option ARM | 214,683 | 7.5 | % | 171,348 | 18.4 | % | 386,031 | 10.2 | % | ||||||||||||
| Subprime | 2,232,166 | 78.2 | % | 525,009 | 56.5 | % | 2,757,175 | 72.9 | % | ||||||||||||
| Other | 4,378 | 0.2 | % | 128,693 | 13.9 | % | 133,071 | 3.5 | % | ||||||||||||
| Total | $ | 2,854,731 | 100.0 | % | $ | 928,632 | 100.0 | % | $ | 3,783,363 | 100.0 | % | |||||||||
| December 31, 2019 | |||||||||||||||||||||
| Non-Agency P&I Securities | |||||||||||||||||||||
| (dollars in thousands) | Senior | Mezzanine | Total | ||||||||||||||||||
| Coupon Type | Carrying Value | % of Senior | Carrying Value | % of Mezzanine | Carrying Value | % of Total | |||||||||||||||
| Fixed rate | $ | 250,189 | 8.1 | % | $ | 27,387 | 5.7 | % | $ | 277,576 | 7.8 | % | |||||||||
| Hybrid or floating | 2,822,909 | 91.9 | % | 453,378 | 94.3 | % | 3,276,287 | 92.2 | % | ||||||||||||
| Total | $ | 3,073,098 | 100.0 | % | $ | 480,765 | 100.0 | % | $ | 3,553,863 | 100.0 | % | |||||||||
| December 31, 2018 | |||||||||||||||||||||
| Non-Agency P&I Securities | |||||||||||||||||||||
| (dollars in thousands) | Senior | Mezzanine | Total | ||||||||||||||||||
| Coupon Type | Carrying Value | % of Senior | Carrying Value | % of Mezzanine | Carrying Value | % of Total | |||||||||||||||
| Fixed rate | $ | 228,939 | 8.0 | % | $ | 149,089 | 16.1 | % | $ | 378,028 | 10.0 | % | |||||||||
| Hybrid or floating | 2,625,792 | 92.0 | % | 779,543 | 83.9 | % | 3,405,335 | 90.0 | % | ||||||||||||
| Total | $ | 2,854,731 | 100.0 | % | $ | 928,632 | 100.0 | % | $ | 3,783,363 | 100.0 | % | |||||||||
| December 31, 2019 | |||||||||||||||||||||
| Non-Agency P&I Securities | |||||||||||||||||||||
| (dollars in thousands) | Senior | Mezzanine | Total | ||||||||||||||||||
| Origination Year | Carrying Value | % of Senior | Carrying Value | % of Mezzanine | Carrying Value | % of Total | |||||||||||||||
| 2006 and thereafter | $ | 2,848,895 | 92.7 | % | $ | 260,819 | 54.3 | % | $ | 3,109,714 | 87.5 | % | |||||||||
| 2002-2005 | 223,597 | 7.3 | % | 219,848 | 45.7 | % | 443,445 | 12.5 | % | ||||||||||||
| Pre-2002 | 606 | — | % | 98 | — | % | 704 | — | % | ||||||||||||
| Total | $ | 3,073,098 | 100.0 | % | $ | 480,765 | 100.0 | % | $ | 3,553,863 | 100.0 | % | |||||||||
| December 31, 2018 | |||||||||||||||||||||
| Non-Agency P&I Securities | |||||||||||||||||||||
| (dollars in thousands) | Senior | Mezzanine | Total | ||||||||||||||||||
| Origination Year | Carrying Value | % of Senior | Carrying Value | % of Mezzanine | Carrying Value | % of Total | |||||||||||||||
| 2006 and thereafter | $ | 2,630,095 | 92.1 | % | $ | 444,007 | 47.8 | % | $ | 3,074,102 | 81.2 | % | |||||||||
| 2002-2005 | 219,183 | 7.7 | % | 483,061 | 52.0 | % | 702,244 | 18.6 | % | ||||||||||||
| Pre-2002 | 5,453 | 0.2 | % | 1,564 | 0.2 | % | 7,017 | 0.2 | % | ||||||||||||
| Total | $ | 2,854,731 | 100.0 | % | $ | 928,632 | 100.0 | % | $ | 3,783,363 | 100.0 | % | |||||||||
| December 31, 2019 | December 31, 2018 | ||||||||||||
| (dollars in thousands) | Carrying Value | % of Total Non-Agency Securities | Carrying Value | % of Total Non-Agency Securities | |||||||||
| California | $ | 1,051,536 | 29.0 | % | $ | 1,041,464 | 26.9 | % | |||||
| New York | 545,407 | 15.0 | % | 393,936 | 10.2 | % | |||||||
| Florida | 360,696 | 9.9 | % | 529,738 | 13.7 | % | |||||||
| New Jersey | 165,501 | 4.6 | % | 153,687 | 4.0 | % | |||||||
| Texas | 157,307 | 4.3 | % | 176,265 | 4.6 | % | |||||||
| Total | $ | 2,280,447 | 62.8 | % | $ | 2,295,090 | 59.4 | % | |||||
Mortgage Servicing Rights, at Fair Value
One of our 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. We do not 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 our MSR. As of December 31, 20192021 and December 31, 2018,2020, our MSR had a fair market value of $1.9$2.2 billion and $2.0$1.6 billion, respectively.
44
As of December 31, 20192021 and December 31, 2018,2020, our MSR portfolio included MSR on 793,470796,205 and 717,167781,905 loans with an unpaid principal balance of approximately $175.9$193.8 billion and $163.1$177.9 billion, respectively. The following tables summarize certain characteristics of the loans underlying our MSR by gross weighted average coupon rate types and ranges at December 31, 20192021 and December 31, 2018:2020:
| December 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Number of Loans | Unpaid Principal Balance | Weighted Average Gross Coupon Rate | Weighted Average Current Loan Size | Weighted Average Loan Age (months) | Weighted Average Original FICO | Weighted Average Original LTV | 60+ Day Delinquencies | 3-Month CPR | Net Servicing Fee (bps) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 30-Year Fixed: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ≤ 3.25% | 215,128 | $ | 72,197,662 | 2.8 | % | $ | 395 | 11 | 767 | 70.7 | % | 0.3 | % | 10.7 | % | 25.7 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 3.25 - 3.75% | 167,615 | 43,576,971 | 3.4 | % | 321 | 28 | 755 | 74.2 | % | 0.8 | % | 24.0 | % | 26.3 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 3.75 - 4.25% | 125,831 | 26,250,276 | 3.9 | % | 263 | 54 | 753 | 75.7 | % | 2.3 | % | 34.0 | % | 27.4 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 4.25 - 4.75% | 79,107 | 14,291,435 | 4.4 | % | 239 | 58 | 737 | 77.5 | % | 4.4 | % | 36.4 | % | 26.3 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 4.75 - 5.25% | 38,902 | 6,318,470 | 4.9 | % | 230 | 52 | 722 | 78.9 | % | 6.4 | % | 37.4 | % | 27.3 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 5.25% | 15,796 | 2,176,065 | 5.5 | % | 211 | 51 | 705 | 79.2 | % | 9.2 | % | 37.6 | % | 30.5 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 642,379 | 164,810,879 | 3.4 | % | 332 | 29 | 756 | 73.4 | % | 1.5 | % | 22.7 | % | 26.3 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 15-Year Fixed: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ≤ 2.25% | 16,525 | 5,397,141 | 2.0 | % | 371 | 9 | 778 | 57.1 | % | 0.1 | % | 8.3 | % | 25.2 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 2.25 - 2.75% | 41,168 | 9,901,133 | 2.4 | % | 294 | 13 | 774 | 58.0 | % | 0.2 | % | 14.2 | % | 25.6 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 2.75 - 3.25% | 46,236 | 7,568,257 | 2.9 | % | 220 | 40 | 768 | 61.3 | % | 0.4 | % | 21.6 | % | 26.1 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 3.25 - 3.75% | 28,010 | 3,485,491 | 3.4 | % | 172 | 55 | 758 | 64.3 | % | 1.1 | % | 26.6 | % | 27.4 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 3.75 - 4.25% | 12,685 | 1,302,862 | 3.9 | % | 152 | 55 | 742 | 65.3 | % | 2.1 | % | 28.5 | % | 28.8 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 4.25% | 5,965 | 513,255 | 4.5 | % | 130 | 47 | 727 | 66.1 | % | 2.6 | % | 29.4 | % | 31.2 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 150,589 | 28,168,139 | 2.7 | % | 264 | 27 | 769 | 60.0 | % | 0.5 | % | 18.1 | % | 26.1 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total ARMs | 3,237 | 791,548 | 3.0 | % | 315 | 54 | 762 | 68.0 | % | 2.9 | % | 29.5 | % | 25.2 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | 796,205 | $ | 193,770,566 | 3.3 | % | $ | 322 | 28 | 758 | 71.5 | % | 1.3 | % | 22.1 | % | 26.3 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| December 31, 2020 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Number of Loans | Unpaid Principal Balance | Weighted Average Gross Coupon Rate | Weighted Average Current Loan Size | Weighted Average Loan Age (months) | Weighted Average Original FICO | Weighted Average Original LTV | 60+ Day Delinquencies | 3-Month CPR | Net Servicing Fee (bps) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 30-Year Fixed: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ≤ 3.25% | 87,561 | $ | 29,304,400 | 2.9 | % | $ | 390 | 4 | 769 | 71.8 | % | 0.1 | % | 9.0 | % | 25.5 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 3.25 - 3.75% | 148,065 | 39,634,267 | 3.5 | % | 322 | 30 | 764 | 73.1 | % | 1.6 | % | 38.2 | % | 26.3 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 3.75 - 4.25% | 188,805 | 43,124,073 | 3.9 | % | 282 | 44 | 757 | 76.3 | % | 3.8 | % | 49.1 | % | 27.5 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 4.25 - 4.75% | 130,598 | 26,096,168 | 4.4 | % | 257 | 45 | 741 | 78.3 | % | 6.2 | % | 49.2 | % | 26.6 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 4.75 - 5.25% | 64,424 | 11,727,196 | 4.9 | % | 249 | 39 | 727 | 79.6 | % | 8.5 | % | 46.5 | % | 27.8 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 5.25% | 25,637 | 3,958,181 | 5.5 | % | 228 | 36 | 707 | 79.7 | % | 10.8 | % | 41.2 | % | 30.8 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 645,090 | 153,844,285 | 3.8 | % | 305 | 32 | 755 | 75.3 | % | 3.5 | % | 42.7 | % | 26.8 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 15-Year Fixed: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ≤ 2.25% | 1,996 | 665,514 | 2.0 | % | 367 | 2 | 780 | 59.6 | % | — | % | 7.8 | % | 25.0 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 2.25 - 2.75% | 19,260 | 5,256,640 | 2.5 | % | 324 | 7 | 778 | 59.5 | % | 0.1 | % | 12.4 | % | 25.8 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 2.75 - 3.25% | 47,710 | 8,571,486 | 2.9 | % | 239 | 37 | 771 | 61.9 | % | 1.1 | % | 27.6 | % | 26.1 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 3.25 - 3.75% | 36,327 | 5,223,663 | 3.4 | % | 196 | 45 | 759 | 64.9 | % | 2.2 | % | 33.7 | % | 27.6 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 3.75 - 4.25% | 17,611 | 2,148,413 | 3.9 | % | 176 | 43 | 745 | 65.6 | % | 3.4 | % | 35.1 | % | 29.2 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| > 4.25% | 9,149 | 958,531 | 4.5 | % | 153 | 34 | 731 | 66.3 | % | 3.6 | % | 37.0 | % | 31.2 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 132,053 | 22,824,247 | 3.1 | % | 243 | 32 | 766 | 62.5 | % | 1.4 | % | 28.8 | % | 26.8 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total ARMs | 4,762 | 1,192,951 | 3.3 | % | 312 | 47 | 762 | 67.2 | % | 4.3 | % | 45.4 | % | 25.2 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | 781,905 | $ | 177,861,483 | 3.7 | % | $ | 297 | 32 | 756 | 73.6 | % | 3.2 | % | 41.2 | % | 26.8 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
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| December 31, 2019 | ||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Number of Loans | Unpaid Principal Balance | Fair Value | % Fannie Mae | Gross Weighted Average Coupon Rate | Weighted Average Loan Age (months) | Weighted Average Original FICO | Weighted Average Original LTV | 60+ Day Delinquencies | 3-Month CPR | Net Servicing Fee (bps) | |||||||||||||||||||||||
| 30-Year Fixed | ||||||||||||||||||||||||||||||||||
| ≤ 3.75% | 106,097 | $ | 27,627,966 | $ | 329,685 | 71.3 | % | 3.5 | % | 47 | 771 | 70.5 | % | 0.1 | % | 10.5 | % | 26.4 | ||||||||||||||||
| > 3.75 - 4.25% | 241,274 | 59,172,782 | 672,441 | 64.5 | % | 3.9 | % | 39 | 761 | 76.3 | % | 0.2 | % | 16.1 | % | 26.9 | ||||||||||||||||||
| > 4.25 - 4.75% | 194,543 | 43,611,524 | 454,666 | 65.2 | % | 4.4 | % | 33 | 745 | 78.9 | % | 0.4 | % | 26.4 | % | 26.3 | ||||||||||||||||||
| > 4.75 - 5.25% | 95,468 | 19,780,323 | 206,745 | 65.9 | % | 4.9 | % | 26 | 732 | 80.4 | % | 0.5 | % | 32.9 | % | 28.0 | ||||||||||||||||||
| > 5.25% | 34,524 | 5,987,442 | 61,447 | 70.5 | % | 5.5 | % | 24 | 709 | 80.2 | % | 1.0 | % | 30.8 | % | 30.8 | ||||||||||||||||||
| 671,906 | 156,180,037 | 1,724,984 | 66.3 | % | 4.2 | % | 37 | 753 | 76.7 | % | 0.3 | % | 21.4 | % | 26.9 | |||||||||||||||||||
| 15-Year Fixed | ||||||||||||||||||||||||||||||||||
| ≤ 2.75% | 2,325 | 464,650 | 4,263 | 80.8 | % | 2.6 | % | 46 | 778 | 59.7 | % | — | % | 8.6 | % | 26.1 | ||||||||||||||||||
| > 2.75 - 3.25% | 39,977 | 6,893,458 | 63,318 | 79.9 | % | 2.9 | % | 48 | 772 | 62.2 | % | 0.1 | % | 11.2 | % | 25.8 | ||||||||||||||||||
| > 3.25 - 3.75% | 40,052 | 6,311,291 | 61,207 | 74.0 | % | 3.4 | % | 40 | 760 | 65.0 | % | 0.1 | % | 15.0 | % | 27.6 | ||||||||||||||||||
| > 3.75 - 4.25% | 21,243 | 2,990,294 | 29,517 | 64.2 | % | 3.9 | % | 32 | 747 | 66.0 | % | 0.2 | % | 19.2 | % | 29.4 | ||||||||||||||||||
| > 4.25% | 11,644 | 1,423,018 | 13,774 | 61.9 | % | 4.5 | % | 23 | 734 | 66.6 | % | 0.2 | % | 24.8 | % | 31.4 | ||||||||||||||||||
| 115,241 | 18,082,711 | 172,079 | 73.9 | % | 3.4 | % | 40 | 761 | 64.0 | % | 0.1 | % | 15.0 | % | 27.5 | |||||||||||||||||||
| Total ARMs | 6,323 | 1,619,394 | 12,381 | 69.9 | % | 3.6 | % | 44 | 762 | 65.8 | % | 0.3 | % | 27.3 | % | 25.2 | ||||||||||||||||||
| Total | 793,470 | $ | 175,882,142 | $ | 1,909,444 | 67.1 | % | 4.1 | % | 37 | 754 | 75.3 | % | 0.3 | % | 20.8 | % | 27.0 | ||||||||||||||||
| December 31, 2018 | ||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Number of Loans | Unpaid Principal Balance | Fair Value | % Fannie Mae | Gross Weighted Average Coupon Rate | Weighted Average Loan Age (months) | Weighted Average Original FICO | Weighted Average Original LTV | 60+ Day Delinquencies | 3-Month CPR | Net Servicing Fee (bps) | |||||||||||||||||||||||
| 30-Year Fixed | ||||||||||||||||||||||||||||||||||
| ≤ 3.75% | 87,201 | $ | 22,717,526 | $ | 298,599 | 76.6 | % | 3.5 | % | 43 | 770 | 69.4 | % | 0.2 | % | 5.6 | % | 25.1 | ||||||||||||||||
| > 3.75 - 4.25% | 205,718 | 50,363,220 | 648,969 | 69.8 | % | 3.9 | % | 34 | 760 | 75.8 | % | 0.3 | % | 6.9 | % | 25.4 | ||||||||||||||||||
| > 4.25 - 4.75% | 190,095 | 44,614,930 | 545,197 | 66.7 | % | 4.4 | % | 24 | 745 | 79.0 | % | 0.4 | % | 7.5 | % | 25.6 | ||||||||||||||||||
| > 4.75 - 5.25% | 93,283 | 20,802,919 | 247,663 | 65.3 | % | 4.9 | % | 15 | 732 | 80.7 | % | 0.5 | % | 7.5 | % | 26.7 | ||||||||||||||||||
| > 5.25% | 31,535 | 5,911,778 | 66,482 | 70.2 | % | 5.5 | % | 14 | 709 | 80.5 | % | 0.6 | % | 9.5 | % | 29.1 | ||||||||||||||||||
| 607,832 | 144,410,373 | 1,806,910 | 69.3 | % | 4.2 | % | 29 | 751 | 76.7 | % | 0.3 | % | 7.0 | % | 25.8 | |||||||||||||||||||
| 15-Year Fixed | ||||||||||||||||||||||||||||||||||
| ≤ 2.75% | 2,271 | 505,880 | 5,174 | 83.5 | % | 2.6 | % | 35 | 777 | 59.3 | % | 0.1 | % | 5.7 | % | 26.1 | ||||||||||||||||||
| > 2.75 - 3.25% | 36,431 | 6,505,051 | 63,300 | 87.0 | % | 2.9 | % | 42 | 771 | 61.5 | % | 0.1 | % | 7.2 | % | 25.3 | ||||||||||||||||||
| > 3.25 - 3.75% | 37,409 | 6,144,286 | 62,870 | 79.4 | % | 3.4 | % | 33 | 758 | 64.4 | % | 0.2 | % | 8.6 | % | 26.5 | ||||||||||||||||||
| > 3.75 - 4.25% | 18,608 | 2,781,505 | 29,387 | 68.6 | % | 3.9 | % | 25 | 746 | 65.8 | % | 0.2 | % | 9.1 | % | 28.7 | ||||||||||||||||||
| > 4.25% | 8,209 | 1,102,846 | 11,426 | 63.8 | % | 4.5 | % | 14 | 739 | 67.1 | % | 0.3 | % | 9.4 | % | 31.3 | ||||||||||||||||||
| 102,928 | 17,039,568 | 172,157 | 79.6 | % | 3.4 | % | 34 | 760 | 63.6 | % | 0.2 | % | 8.1 | % | 26.7 | |||||||||||||||||||
| Total ARMs | 6,407 | 1,652,367 | 14,373 | 72.1 | % | 3.6 | % | 40 | 763 | 65.5 | % | 0.4 | % | 17.1 | % | 25.2 | ||||||||||||||||||
| Total | 717,167 | $ | 163,102,308 | $ | 1,993,440 | 70.4 | % | 4.1 | % | 29 | 752 | 75.2 | % | 0.3 | % | 7.3 | % | 25.9 | ||||||||||||||||
Financing
Our borrowings consist primarily of repurchase agreements, FHLB advances, revolving credit facilities and term notes payable. These borrowings are collateralized by our pledge of AFS securities, derivative instruments, MSR, servicing advances and certain cash balances. Substantially all of our Agency RMBS are currently pledged as collateral, and the majoritya portion of our non-Agency securities have been pledged as collateral either throughfor repurchase agreements. Additionally, a substantial portion of our MSR is currently pledged as collateral for repurchase agreements, or FHLB advances.revolving credit facilities and term notes payable, and a portion of our servicing advances have been pledged as collateral for revolving credit facilities.
During the second quarter ofyear ended December 31, 2019, we formed a new trust entity, or the MSR Issuer Trust, for the purpose of financing MSR through securitization. On June 27, 2019, we, through the Issuer Trust, completed an MSR securitization, transaction pursuant to which, through two of our wholly owned subsidiaries, MSR is pledged to the MSR Issuer Trust and in return, the MSR Issuer Trust issued (a) an aggregate principal amount of $400.0 million inissues term notes to qualified institutional buyers and (b) a variable funding note, or VFN, with a maximum principal balance of $1.0 billion to one of the subsidiaries, in each case secured on a pari passu basis. The term notes bear interest atIn connection with the transaction, we also entered into a rate equal to one-month LIBOR plus 2.80% per annum. The term notes will mature on June 25, 2024 or, if extended pursuant torepurchase facility that is secured by the terms ofVFN issued in connection with the related indenture supplement, June 25, 2026 (unless earlier redeemed in accordance with their terms).MSR securitization transaction, which is collateralized by our MSR.
Additionally, on January 19, 2017, we closed an underwritten public offering of $287.5 million aggregate principal amount of 6.25%our convertible senior notes due 2022. The net2022 were issued in January 2017. Our convertible senior notes due 2026 were issued in February 2021, and a portion of the proceeds from the offering were approximately $282.2 million after deducting underwriting discounts and estimated offering expenses. The majority of these proceeds were used to help fundpartially repurchase our MSR assets, which previously had largely been funded with cash.
Many of our financing arrangements incorporate LIBOR as the referenced rate; however all arrangements either mature prior to the phase out of LIBOR or have provisions in place that provide for an alternative to LIBOR upon its phase-out. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Market Conditions and Outlook - LIBOR transition” for further discussion.
At December 31, 20192021 and December 31, 2018,2020, borrowings under repurchase agreements, FHLB advances, revolving credit facilities, term notes payable and convertible senior notes had the following characteristics:
| (dollars in thousands) | December 31, 2021 | December 31, 2020 | ||||||||||||||||||||||||||||||||||||
| Borrowing Type | Amount Outstanding | Weighted Average Borrowing Rate | Weighted Average Years to Maturity | Amount Outstanding | Weighted Average Borrowing Rate | Weighted Average Years to Maturity | ||||||||||||||||||||||||||||||||
| Repurchase agreements | $ | 7,656,445 | 0.24 | % | 0.2 | $ | 15,143,898 | 0.28 | % | 0.2 | ||||||||||||||||||||||||||||
| Revolving credit facilities | 420,761 | 3.46 | % | 1.2 | 283,830 | 2.95 | % | 1.1 | ||||||||||||||||||||||||||||||
| Term notes payable | 396,776 | 2.90 | % | 2.5 | 395,609 | 2.95 | % | 3.5 | ||||||||||||||||||||||||||||||
Convertible senior notes (1) | 424,827 | 6.25 | % | 2.7 | 286,183 | 6.25 | % | 1.0 | ||||||||||||||||||||||||||||||
| Total | $ | 8,898,809 | 0.80 | % | 0.5 | $ | 16,109,520 | 0.50 | % | 0.3 | ||||||||||||||||||||||||||||
| (dollars in thousands) | December 31, 2021 | December 31, 2020 | ||||||||||||||||||||||||||||||||||||
| Collateral Type | Amount Outstanding | Weighted Average Borrowing Rate | Weighted Average Haircut on Collateral Value | Amount Outstanding | Weighted Average Borrowing Rate | Weighted Average Haircut on Collateral Value | ||||||||||||||||||||||||||||||||
| Agency RMBS | $ | 7,495,230 | 0.17 | % | 4.2 | % | $ | 15,089,726 | 0.28 | % | 4.4 | % | ||||||||||||||||||||||||||
| Non-Agency securities | 171 | 1.24 | % | 43.9 | % | 1,899 | 2.33 | % | 34.3 | % | ||||||||||||||||||||||||||||
| Agency Derivatives | 36,044 | 0.74 | % | 17.8 | % | 52,273 | 0.89 | % | 21.6 | % | ||||||||||||||||||||||||||||
| Mortgage servicing rights | 923,337 | 3.30 | % | 27.9 | % | 670,439 | 2.95 | % | 24.6 | % | ||||||||||||||||||||||||||||
| Mortgage servicing advances | 19,200 | 3.23 | % | 13.8 | % | 9,000 | 3.26 | % | 12.0 | % | ||||||||||||||||||||||||||||
Other (1) | 424,827 | 6.25 | % | N/A | 286,183 | 6.25 | % | N/A | ||||||||||||||||||||||||||||||
| Total | $ | 8,898,809 | 0.80 | % | 6.6 | % | $ | 16,109,520 | 0.50 | % | 5.2 | % | ||||||||||||||||||||||||||
____________________
(1)Includes unsecured convertible senior notes due 2022 and 2026 paying interest semiannually at a rate of 6.25% per annum on the aggregate principal amount of $431.3 million.
46
| (dollars in thousands) | December 31, 2019 | December 31, 2018 | ||||||||||||||||||
| Borrowing Type | Amount Outstanding | Weighted Average Borrowing Rate | Weighted Average Years to Maturity | Amount Outstanding | Weighted Average Borrowing Rate | Weighted Average Years to Maturity | ||||||||||||||
| Repurchase agreements | $ | 29,147,463 | 2.14 | % | 0.2 | $ | 23,133,476 | 2.68 | % | 0.2 | ||||||||||
| Federal Home Loan Bank advances | 210,000 | 2.00 | % | 3.5 | 865,024 | 2.53 | % | 1.3 | ||||||||||||
| Revolving credit facilities | 300,000 | 4.26 | % | 1.2 | 310,000 | 5.60 | % | 4.2 | ||||||||||||
| Term notes payable | 394,502 | 4.59 | % | 4.5 | — | — | % | — | ||||||||||||
Convertible senior notes (1) | 284,954 | 6.25 | % | 2.0 | 283,856 | 6.25 | % | 3.0 | ||||||||||||
| Total | $ | 30,336,919 | 2.23 | % | 3.9 | $ | 24,592,356 | 2.76 | % | 3.7 | ||||||||||
| (dollars in thousands) | December 31, 2019 | December 31, 2018 | ||||||||||||||||||
| Collateral Type | Amount Outstanding | Weighted Average Borrowing Rate | Weighted Average Haircut on Collateral Value | Amount Outstanding | Weighted Average Borrowing Rate | Weighted Average Haircut on Collateral Value | ||||||||||||||
| Agency RMBS | $ | 27,512,526 | 2.08 | % | 4.1 | % | $ | 20,954,730 | 2.53 | % | 4.6 | % | ||||||||
| Non-Agency securities | 1,531,608 | 2.90 | % | 24.9 | % | 2,697,254 | 3.65 | % | 24.2 | % | ||||||||||
| Agency Derivatives | 50,714 | 2.70 | % | 26.4 | % | 46,516 | 3.34 | % | 26.4 | % | ||||||||||
| Mortgage servicing rights | 957,117 | 4.19 | % | 31.7 | % | 610,000 | 5.06 | % | 40.6 | % | ||||||||||
Other (1) | 284,954 | 6.25 | % | NA | 283,856 | 6.25 | % | NA | ||||||||||||
| Total | $ | 30,336,919 | 2.23 | % | 6.0 | % | $ | 24,592,356 | 2.76 | % | 7.6 | % | ||||||||
As of December 31, 2019,2021, the debt-to-equity ratio funding our AFS securities, MSR, servicing advances and Agency Derivatives, which includes unsecured borrowings under convertible senior notes, was 6.1:3.2:1.0. As previously discussed, our Agency RMBS, given their liquidity and high credit quality, are eligible for higher levels of leverage, while MSR, with less liquidity and/or more exposure to prepayment risk, utilize lower levels of leverage. Generally, our debt-to-equity ratio is directly correlated to the composition of our portfolio; typically, the higher the percentage of Agency RMBS we hold, the higher our debt-to-equity ratio will be. However, in addition to portfolio mix, our debt-to-equity ratio is a function of many other factors, including the liquidity of our portfolio, the availability and price of our financing, the diversification of our counterparties and their available capacity to finance our assets, and anticipated regulatory developments. We may alter the percentage allocation of our portfolio among our target assets depending on the relative value of the assets that are available to purchase from time to time, including at times when we are deploying proceeds from offerings we conduct. We believe the current degree of leverage within our portfolio helps ensure that we have access to unused borrowing capacity, thus supporting our liquidity and the strength of our balance sheet.
The following table provides a summary of our borrowings under repurchase agreements, FHLB advances, revolving credit facilities, term notes payable and convertible senior notes, our net TBA notional amounts and our debt-to-equity ratios for the three months ended December 31, 2019,2021, and the four immediately preceding quarters:
| (dollars in thousands) | ||||||||||||||||||||||||||||||||||||||
| For the Three Months Ended | Quarterly Average | End of Period Balance | Maximum Balance of Any Month-End | End of Period Total Borrowings to Equity Ratio | End of Period Net Long (Short) TBA Notional | End of Period Economic Debt-to-Equity Ratio (1) | ||||||||||||||||||||||||||||||||
| December 31, 2021 | $ | 7,908,651 | $ | 8,898,809 | $ | 8,898,809 | 3.2:1.0 | $ | 4,116,000 | 4.7:1.0 | ||||||||||||||||||||||||||||
| September 30, 2021 | $ | 8,888,607 | $ | 8,365,211 | $ | 9,060,624 | 3.1:1.0 | $ | 8,742,000 | 6.1:1.0 | ||||||||||||||||||||||||||||
| June 30, 2021 | $ | 11,129,575 | $ | 9,704,066 | $ | 12,837,520 | 3.9:1.0 | $ | 6,854,000 | 6.5:1.0 | ||||||||||||||||||||||||||||
| March 31, 2021 | $ | 14,016,694 | $ | 12,938,748 | $ | 14,525,894 | 4.8:1.0 | $ | 4,800,000 | 6.4:1.0 | ||||||||||||||||||||||||||||
| December 31, 2020 | $ | 16,431,516 | $ | 16,109,520 | $ | 16,842,273 | 5.2:1.0 | $ | 5,197,000 | 6.8:1.0 | ||||||||||||||||||||||||||||
____________________
(1)Defined as total borrowings under repurchase agreements, revolving credit facilities, term notes payable and convertible senior notes, plus implied debt on net TBA notional, divided by total equity.
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| (dollars in thousands) | ||||||||||||||||||||
| For the Three Months Ended | Quarterly Average | End of Period Balance | Maximum Balance of Any Month-End | End of Period Total Borrowings to Equity Ratio | End of Period Net Long (Short) TBA Notional | End of Period Economic Debt-to-Equity Ratio (1) | ||||||||||||||
| December 31, 2019 | $ | 27,619,393 | $ | 30,336,919 | $ | 30,336,919 | 6.1:1.0 | $ | 7,427,000 | 7.5:1.0 | ||||||||||
| September 30, 2019 | $ | 27,349,719 | $ | 26,596,006 | $ | 28,168,892 | 5.3:1.0 | $ | 9,863,000 | 7.2:1.0 | ||||||||||
| June 30, 2019 | $ | 26,640,949 | $ | 28,896,436 | $ | 29,132,756 | 5.9:1.0 | $ | 9,422,000 | 7.8:1.0 | ||||||||||
| March 31, 2019 | $ | 22,661,656 | $ | 21,254,108 | $ | 23,685,031 | 4.5:1.0 | $ | 10,168,000 | 6.5:1.0 | ||||||||||
| December 31, 2018 | $ | 23,276,768 | $ | 24,592,356 | $ | 24,592,356 | 5.8:1.0 | $ | 6,484,000 | 7.2:1.0 | ||||||||||
Equity
The tables below provide details of our changes in stockholders’ equity from December 31, 20182020 to December 31, 20192021 as well as a reconciliation of comprehensive income and GAAP net income to non-GAAP measures. Beginning with the reporting period for the three months ended September 30, 2021, the previously reported non-GAAP measure Core Earnings will be referred to as Earnings Available for Distribution, or EAD.(1) Also beginning with the three months ended September 30, 2021, EAD includes U.S. Treasury futures income. U.S. Treasury futures income is the economic equivalent to holding and financing a relevant cheapest-to-deliver U.S. Treasury note or bond using short-term repurchase agreements.
| (dollars in millions, except per share amounts) | Book Value | Common Shares Outstanding | Common Book Value Per Share | ||||||||||||||
| Common stockholders' equity at December 31, 2020 | $ | 2,087.7 | 273.7 | $ | 7.63 | ||||||||||||
Earnings available for distribution, net of tax benefit of $1.5 million (1) | 302.7 | ||||||||||||||||
| Dividends on preferred stock | (58.5) | ||||||||||||||||
Earnings available for distribution to common stockholders, net of tax benefit of $1.5 million (1) | 244.2 | ||||||||||||||||
| Realized and unrealized gains and losses, net of tax expense of $5.7 million | (115.4) | ||||||||||||||||
| Other comprehensive loss, net of tax | (455.3) | ||||||||||||||||
| Dividend declarations | (205.6) | ||||||||||||||||
| Other | 11.5 | 0.1 | |||||||||||||||
| Issuance of common stock, net of offering costs | 450.6 | 70.1 | |||||||||||||||
| Common stockholders' equity at December 31, 2021 | $ | 2,017.7 | 343.9 | $ | 5.87 | ||||||||||||
| Total preferred stock liquidation preference | 726.3 | ||||||||||||||||
| Total stockholders' equity at December 31, 2021 | $ | 2,744.0 | |||||||||||||||
| (dollars in millions, except per share amounts) | Book Value | Common Shares Outstanding | Common Book Value Per Share | |||||||
| Common stockholders' equity at December 31, 2018 | $ | 3,253.2 | 248.1 | $ | 13.11 | |||||
| Reconciliation of non-GAAP measures to GAAP net income and Comprehensive income: | ||||||||||
| Core Earnings, including dollar roll income, net of tax expense of $6.8 million ⁽¹⁾ | 437.2 | |||||||||
| Dividends on preferred stock | (75.8 | ) | ||||||||
| Core Earnings attributable to common stockholders, including dollar roll income, net of tax expense of $6.8 million ⁽¹⁾⁽²⁾ | 361.4 | |||||||||
| Realized and unrealized gains and losses, net of tax benefit of $20.3 million | (113.3 | ) | ||||||||
| Other comprehensive income, net of tax | 578.6 | |||||||||
| Dividend declaration | (455.7 | ) | ||||||||
| Other | 8.7 | 0.4 | ||||||||
| Issuance of common stock, net of offering costs | 336.3 | 24.4 | ||||||||
| Common stockholders' equity at December 31, 2019 | $ | 3,969.2 | 272.9 | $ | 14.54 | |||||
| Total preferred stock liquidation preference | 1,001.3 | |||||||||
| Total stockholders' equity at December 31, 2019 | $ | 4,970.5 | ||||||||
| Year Ended | |||
| (in millions) | December 31, 2019 | ||
| Comprehensive income attributable to common stockholders | $ | 826.7 | |
| Adjustment for other comprehensive income attributable to common stockholders: | |||
| Unrealized gains on available-for-sale securities | (578.6 | ) | |
| Net income attributable to common stockholders | 248.1 | ||
| Adjustments for non-Core Earnings: | |||
| Other-than-temporary impairments and loss recovery adjustments | 22.6 | ||
| Realized gain on investment securities | (284.0 | ) | |
| Unrealized loss on investment securities | 3.9 | ||
| Realized and unrealized losses on mortgage servicing rights | 408.6 | ||
| Realized gain on termination or expiration of interest rate swaps, caps and swaptions | (94.9 | ) | |
| Unrealized loss on interest rate swaps, caps and swaptions | 273.7 | ||
| Gains on other derivative instruments | (205.6 | ) | |
| Other loss | 1.3 | ||
| Change in servicing reserves | (0.7 | ) | |
| Non-cash equity compensation expense | 8.7 | ||
| Net benefit for income taxes on non-Core Earnings | (20.3 | ) | |
Core Earnings attributable to common stockholders, including dollar roll income (1)(2) | $ | 361.4 | |
| Year Ended | ||||||||||||||
| (in millions) | December 31, 2021 | |||||||||||||
| Comprehensive loss attributable to common stockholders | $ | (326.5) | ||||||||||||
| Adjustment for other comprehensive loss attributable to common stockholders: | ||||||||||||||
| Unrealized losses on available-for-sale securities | 455.3 | |||||||||||||
| Net income attributable to common stockholders | 128.8 | |||||||||||||
Adjustments for non-EAD (1): | ||||||||||||||
| Realized gains on investment securities | (134.7) | |||||||||||||
| Unrealized losses on investment securities | 3.4 | |||||||||||||
| Provision for credit losses on investment securities | 9.8 | |||||||||||||
| Realized and unrealized gains on mortgage servicing rights, net | (144.6) | |||||||||||||
| Realized gain on termination or expiration of interest rate swaps and | (2.4) | |||||||||||||
| Unrealized gains on interest rate swaps and swaptions | (25.5) | |||||||||||||
| Realized and unrealized | 382.7 | |||||||||||||
| Other loss | 3.9 | |||||||||||||
| 0.4 | ||||||||||||||
| Non-cash equity compensation expense | 11.5 | |||||||||||||
| Other nonrecurring expenses | 5.2 | |||||||||||||
Net provision for income taxes on non-EAD (1) | 5.7 | |||||||||||||
Earnings | $ | 244.2 | ||||||||||||
(1)EAD is a non-GAAP measure that we define as comprehensive (loss) income attributable to common stockholders, excluding “realized and unrealized gains and losses” (provision for (reversal of) credit losses, realized and unrealized gains and losses on the aggregate portfolio, reserve expense for representation and warranty obligations on MSR, non-cash compensation expense related to restricted common stock, other nonrecurring expenses and restructuring charges). As defined, EAD includes net interest income, accrual and settlement of interest on derivatives, dollar roll income on TBAs, U.S. Treasury futures income, servicing income, net of estimated amortization on MSR and recurring cash related operating expenses. Dollar roll income is the economic equivalent to holding and financing Agency RMBS using short-term repurchase agreements. U.S. Treasury futures income is the economic equivalent to holding and financing a relevant cheapest-to-deliver U.S. Treasury note or bond using short-term repurchase agreements. EAD provides supplemental information to assist investors in analyzing the Company’s results of operations and helps facilitate comparisons to industry peers. EAD is one of several measures our board of directors considers to determine the amount of dividends to declare on our common stock and should not be considered an indication of our taxable income or as a proxy for the amount of dividends we may declare.
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U.S. GAAP to Estimated Taxable Income
The following tables provide reconciliations of our GAAP net income (loss) to our estimated taxable income (loss) split between our REIT and TRSs for the years ended December 31, 20192021 and 2018:2020:
| Year Ended December 31, 2021 | |||||||||||||||||||||||
| (dollars in millions) | TRS | REIT | Eliminations | Consolidated | |||||||||||||||||||
| GAAP net income, pre-tax | $ | 60.1 | $ | 131.3 | $ | — | $ | 191.4 | |||||||||||||||
| State taxes | 10.6 | — | — | 10.6 | |||||||||||||||||||
| Adjusted GAAP net income, pre-tax | 70.7 | 131.3 | — | 202.0 | |||||||||||||||||||
| Permanent differences | |||||||||||||||||||||||
| State deferred tax benefit | (9.0) | — | — | (9.0) | |||||||||||||||||||
| Other permanent differences | — | 0.1 | — | 0.1 | |||||||||||||||||||
| Temporary differences | |||||||||||||||||||||||
| Net accretion of OID and market discount | (53.7) | (59.4) | — | (113.1) | |||||||||||||||||||
| Net unrealized gains and losses | (137.3) | (31.6) | — | (168.9) | |||||||||||||||||||
| Net realized gains and losses on sales of RMBS | — | (4.9) | — | (4.9) | |||||||||||||||||||
| Credit loss impairment | — | 9.8 | — | 9.8 | |||||||||||||||||||
| Other temporary differences | 5.8 | 2.0 | — | 7.8 | |||||||||||||||||||
| Capital loss carryforward deferral | — | 16.6 | — | 16.6 | |||||||||||||||||||
| Estimated taxable (loss) income | (123.5) | 63.9 | — | (59.6) | |||||||||||||||||||
| Dividend paid deduction | — | (63.9) | — | (63.9) | |||||||||||||||||||
| Estimated taxable loss post-dividend deduction | $ | (123.5) | $ | — | $ | — | $ | (123.5) | |||||||||||||||
| Year Ended December 31, 2019 | Year Ended December 31, 2020 | |||||||||||||||||||||||||||||||||||||
| (dollars in millions) | TRS | REIT | Eliminations | Consolidated | (dollars in millions) | TRS | REIT | Eliminations | Consolidated | |||||||||||||||||||||||||||||
| GAAP net income (loss), pre-tax | $ | (75.1 | ) | $ | 347.1 | $ | 38.4 | $ | 310.4 | |||||||||||||||||||||||||||||
| GAAP net (loss) income, pre-tax | GAAP net (loss) income, pre-tax | $ | (175.7) | $ | (1,508.9) | $ | 18.8 | $ | (1,665.8) | |||||||||||||||||||||||||||||
| State taxes | (2.1 | ) | (0.5 | ) | — | (2.6 | ) | State taxes | (1.2) | (0.1) | — | (1.3) | ||||||||||||||||||||||||||
| Adjusted GAAP net income (loss), pre-tax | (77.2 | ) | 346.6 | 38.4 | 307.8 | |||||||||||||||||||||||||||||||||
| Adjusted GAAP net (loss) income, pre-tax | Adjusted GAAP net (loss) income, pre-tax | (176.9) | (1,509.0) | 18.8 | (1,667.1) | |||||||||||||||||||||||||||||||||
| Permanent differences | Permanent differences | |||||||||||||||||||||||||||||||||||||
| Intercompany RMBS sales | — | — | (38.4 | ) | (38.4 | ) | Intercompany RMBS sales | — | — | (18.8) | (18.8) | |||||||||||||||||||||||||||
| Dividends from TRSs | — | 50.0 | — | 50.0 | ||||||||||||||||||||||||||||||||||
| Other permanent differences | — | (8.3 | ) | — | (8.3 | ) | Other permanent differences | 0.2 | 1.3 | — | 1.5 | |||||||||||||||||||||||||||
| Temporary differences | Temporary differences | |||||||||||||||||||||||||||||||||||||
| Net accretion of OID and market discount | (39.3 | ) | 45.8 | — | 6.5 | Net accretion of OID and market discount | (48.7) | (148.5) | — | (197.2) | ||||||||||||||||||||||||||||
| Net unrealized gains and losses on derivatives | 231.0 | 557.9 | — | 788.9 | Net unrealized gains and losses on derivatives | 237.7 | 38.9 | — | 276.6 | |||||||||||||||||||||||||||||
| Net realized gains and losses on sales of RMBS | Net realized gains and losses on sales of RMBS | — | (247.9) | — | (247.9) | |||||||||||||||||||||||||||||||||
| Credit loss impairment | Credit loss impairment | — | 60.5 | — | 60.5 | |||||||||||||||||||||||||||||||||
| Other temporary differences | 4.8 | 20.9 | — | 25.7 | Other temporary differences | 2.7 | 5.7 | — | 8.4 | |||||||||||||||||||||||||||||
| Capital loss carryforward (utilized) deferral | (0.1 | ) | (490.6 | ) | — | (490.7 | ) | |||||||||||||||||||||||||||||||
| Net operating loss carryforward (utilized) deferral | (77.9 | ) | (11.7 | ) | — | (89.6 | ) | |||||||||||||||||||||||||||||||
| Estimated taxable income | 41.3 | 510.6 | — | 551.9 | ||||||||||||||||||||||||||||||||||
| Prior year undistributed taxable income | — | — | — | — | ||||||||||||||||||||||||||||||||||
| Dividend declaration deduction | — | (510.6 | ) | — | (510.6 | ) | ||||||||||||||||||||||||||||||||
| Estimated taxable income post-dividend deduction | $ | 41.3 | $ | — | $ | — | $ | 41.3 | ||||||||||||||||||||||||||||||
| Capital loss carryforward deferral | Capital loss carryforward deferral | — | 1,158.5 | — | 1,158.5 | |||||||||||||||||||||||||||||||||
| Estimated taxable income (loss) | Estimated taxable income (loss) | 15.0 | (640.5) | — | (625.5) | |||||||||||||||||||||||||||||||||
| Dividend paid deduction | Dividend paid deduction | — | — | — | — | |||||||||||||||||||||||||||||||||
| Estimated taxable income (loss) post-dividend deduction | Estimated taxable income (loss) post-dividend deduction | $ | 15.0 | $ | (640.5) | $ | — | $ | (625.5) | |||||||||||||||||||||||||||||
| Year Ended December 31, 2018 | |||||||||||||||
| (dollars in millions) | TRS | REIT | Eliminations | Consolidated | |||||||||||
| GAAP net income (loss), pre-tax | $ | 114.2 | $ | (59.4 | ) | $ | (57.3 | ) | $ | (2.5 | ) | ||||
| State taxes | — | — | — | — | |||||||||||
| Adjusted GAAP net income (loss), pre-tax | 114.2 | (59.4 | ) | (57.3 | ) | (2.5 | ) | ||||||||
| Permanent differences | |||||||||||||||
| Intercompany RMBS sales | — | — | 57.3 | 57.3 | |||||||||||
| Other permanent differences | — | (0.8 | ) | — | (0.8 | ) | |||||||||
| Temporary differences | |||||||||||||||
| Acquisition transaction costs | — | 82.4 | — | 82.4 | |||||||||||
| Net accretion of OID and market discount | 0.1 | 76.3 | — | 76.4 | |||||||||||
| Net unrealized gains and losses on derivatives | (68.0 | ) | (1.3 | ) | — | (69.3 | ) | ||||||||
| Other temporary differences | (13.3 | ) | (0.6 | ) | — | (13.9 | ) | ||||||||
| Capital loss carryforward (utilized) deferral | (8.0 | ) | 393.7 | — | 385.7 | ||||||||||
| Net operating loss carryforward (utilized) deferral | (15.3 | ) | — | — | (15.3 | ) | |||||||||
| Estimated taxable income | 9.7 | 490.3 | — | 500.0 | |||||||||||
| Dividend declaration deduction | — | (490.3 | ) | — | (490.3 | ) | |||||||||
| Estimated taxable income post-dividend deduction | $ | 9.7 | $ | — | $ | — | $ | 9.7 | |||||||
The permanent tax differences recorded in 20192021 include a difference related to officer’s compensation deduction limitations, a recurring difference in compensation expense related to restricted stock dividends paid from the Company’s TRSs to the REIT. Additionally,and vesting and state deferred tax benefit. The permanent tax differences recorded in both 2019 and 20182020 include a recurring difference related to the intercompany sales of RMBS and a recurring difference in compensation expense related to restricted stock dividends.dividends and vesting. Temporary differences recorded in 2021 and 2020 are principally timing differences between U.S. GAAP and tax accounting related to unrealized gains and losses from derivative instruments, realized and unrealized gains and losses from MSR and RMBS, accretion and amortization from Agency RMBS and non-Agency securities. Additionally,changes in reserves related to servicing advances and allowance for the year ended December 31, 2018, there were both permanent and temporary tax differences resulting from the treatmentcredit losses on certain RMBS.
49
Change in Accumulated Other Comprehensive Income
With our accounting treatment for AFS securities, unrealized fluctuations in the market values of AFS securities, excluding Agency interest-only securities, do not impact our GAAP net (loss) income or taxable income but are recognized on our consolidated balance sheets as a change in stockholders’ equity under “accumulated other comprehensive income.” As a result of this fair value accounting through stockholders’ equity, we expect our net income to have less significant fluctuations and result in less U.S. GAAP to taxable income timing differences, than if the portfolio were accounted for as trading instruments.
Dividends
For the year ended December 31, 2019,2021, we declared cash dividends totaling $1.67$0.68 per share. As a REIT, we are required to distribute at least 90% of our taxable income to stockholders, subject to certain distribution requirements. For the year ended December 31, 2019,2021, our board of directors elected to distribute the majoritymake cash distributions in excess of ourREIT taxable income to avoid U.S. Federal Income taxes. As such, temporaryfor the year. Temporary differences between GAAP net income (loss) and taxable income can generate deterioration in book value on a permanent and temporary basis as taxable income is distributed that has not been earned for U.S. GAAP purposes.
Liquidity and Capital Resources
Our liquidity and capital resources are managed and forecasted on a daily basis. We believe this ensures that we have sufficient liquidity to absorb market events that could negatively impact collateral valuations and result in margin calls. We also believe that it gives us the flexibility to manage our portfolio to take advantage of market opportunities.
Our principal sources of cash consist of borrowings under repurchase agreements, FHLB advances, revolving credit facilities, term notes payable, payments of principal and interest we receive on our target assets, cash generated from our operating results, and proceeds from capital market transactions. We typically use cash to repay principal and interest on our repurchase agreements, FHLB advances, revolving credit facilities and term notes payableborrowings, to purchase our target assets, to make dividend payments on our capital stock, and to fund our operations.
To the extent that we raise additional equity capital through capital market transactions, we anticipate using cash proceeds from such transactions to purchase additional Agency RMBS, non-Agency securities, MSR and otherour target assets and for other general corporate purposes. Such general corporate purposes may include the refinancing or repayment of debt, the repurchase or redemption of common and preferred equity securities, and other capital expenditures.
As of December 31, 2019,2021, we held $558.1 million$1.2 billion in cash and cash equivalents available to support our operations; $33.5$9.4 billion of AFS securities, MSR, and derivative assets held at fair value; and $30.3$8.9 billion of outstanding debt in the form of repurchase agreements, FHLB advances, borrowings under revolving credit facilities, term notes payable and convertible senior notes. During the three and twelve months ended December 31, 2019,2021, the debt-to-equity ratio funding our AFS securities, MSR and Agency Derivatives, which includes unsecured borrowings under convertible senior notes, increased from 5.3:3.1:10 to 6.1:3.2:1.0 and increaseddecreased from 5.8:5.2:1.0 to 6.1:3.2:1.0, respectively. The slight increase for the three months ended December 31, 2021 was driven bydue to increased financing on Agency RMBS purchases. The decrease for the year ended December 31, 2021 was driven by decreased financing on Agency RMBS due to sales and prepayments on the related assets. During the three and twelve months ended December 31, 2019,2021, our economic debt-to-equity ratio funding our AFS securities, MSR and Agency Derivatives, which includes unsecured borrowings under convertible senior notes and implied debt on net TBA notional, increaseddecreased from 7.2:106.1:1.0 to 7.5:4.7:1.0 for both periods.
As of December 31, 2019,2021, we held approximately $1.3$141.7 million of unpledged Agency securities and derivatives and $1.6 billion$11.9 million of unpledged non-Agency securities. As a result, we had an overall estimated unused borrowing capacity on unpledged securities of approximately $1.2 billion.$133.5 million. As of December 31, 2019,2021, we held approximately $354.6$60.8 million of unpledged MSR.MSR and $96.8 million of unpledged servicing advances. Overall, we had unused committed borrowing capacity on MSR asset and servicing advance financing facilities of $1.2 billion, which includes the repurchase facility pursuant to which the Company may finance the VFN issued in connection with the MSR securitization transaction completed on June 27, 2019.$313.4 million and $180.8 million, respectively. Generally, unused borrowing capacity may be the result of our election not to utilize certain financing, as well as delays in the timing in which funding is provided, insufficient collateral or the inability to meet lenders’ eligibility requirements for specific types of asset classes. On a daily basis, we monitor and forecast our available, or excess, liquidity. Additionally, we frequently perform shock analyses against various market events to monitor the adequacy of our excess liquidity. If borrowing rates and/or collateral requirements change in the near term, we believe we are subject to less earnings volatility than a more leveraged organization.
During the year ended December 31, 2019,2021, we did not experience any restrictions tomaterial issues accessing our funding sources, although balance sheet capacity of counterparties have tightened due to compliance with the Basel III regulatory capital reform rules as well as management of perceived risk in the current interest rate environment.sources. We expect ongoing sources of financing to be primarily repurchase agreements, FHLB advances, revolving credit facilities, term notes payable, convertible notes and similar financing arrangements. We plan to finance our assets with a moderate amount of leverage, the level of which may vary based upon the particular characteristics of our portfolio and market conditions.
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As of December 31, 2019,2021, we had master repurchase agreements in place with 4739 counterparties (lenders), the majority of which are U.S. domiciled financial institutions, and we continue to evaluate additional counterparties to manage and optimize counterparty risk. Under our repurchase agreements, we are required to pledge additional assets as collateral to our lenders when the estimated fair value of the existing pledged collateral under such agreements declines and such lenders, through a margin call, demand additional collateral. Lenders generally make margin calls because of a perceived decline in the value of our assets collateralizing the repurchase agreements. This may occur following the monthly principal reduction of assets due to scheduled amortization and prepayments on the underlying mortgages, or may be caused by changes in market interest rates, a perceived decline in the market value of the investments and other market factors. To cover a margin call, we may pledge additional assets or cash. At maturity, any cash on deposit as collateral is generally applied against the repurchase agreement balance, thereby reducing the amount borrowed. Should the value of our assets suddenly decrease, significant margin calls on our repurchase agreements could result, causing an adverse change in our liquidity position.
| December 31, 2019 | December 31, 2018 | ||||||||||||||||||||
| (dollars in thousands) | Amount Outstanding | Net Counterparty Exposure(1) | Percent of Funding | Amount Outstanding | Net Counterparty Exposure(1) | Percent of Funding | |||||||||||||||
| North America | $ | 16,165,067 | $ | 1,026,474 | 57.6 | % | $ | 12,061,693 | $ | 1,120,101 | 55.4 | % | |||||||||
Europe (2) | 7,519,258 | 521,804 | 29.3 | % | 6,728,245 | 646,000 | 31.9 | % | |||||||||||||
Asia (2) | 5,463,138 | 234,180 | 13.1 | % | 4,343,538 | 255,973 | 12.7 | % | |||||||||||||
| Total | $ | 29,147,463 | $ | 1,782,458 | 100.0 | % | $ | 23,133,476 | $ | 2,022,074 | 100.0 | % | |||||||||
In addition to our master repurchase agreements to fund our Agency and non-Agency securities, we have twoone repurchase facilitiesfacility and onethree revolving credit facilityfacilities that provide short- and long-term financing for our MSR portfolio. We also have one revolving credit facility that provides short-term financing for our servicing advances. An overview of the facilities is presented in the table below:
| (dollars in thousands) | ||||||||||||||||
| December 31, 2019 | ||||||||||||||||
Expiration Date (1) | Committed | Amount Outstanding | Unused Capacity | Total Capacity | Eligible Collateral | |||||||||||
| June 21, 2021 | Yes (2) | $ | — | $ | 1,000,000 | $ | 1,000,000 | Mortgage servicing rights (3) | ||||||||
| December 1, 2020 | Yes (2) | $ | 262,615 | $ | 137,385 | $ | 400,000 | Mortgage servicing rights (4) | ||||||||
| March 12, 2021 | Yes (2) | $ | 300,000 | $ | 50,000 | $ | 350,000 | Mortgage servicing rights | ||||||||
| (dollars in thousands) | ||||||||||||||||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||||||||||
Expiration Date (1) | Amount Outstanding | Unused Committed Capacity (2) | Unused Uncommitted Capacity | Total Capacity | Eligible Collateral | |||||||||||||||||||||||||||
| August 31, 2022 | $ | 255,311 | $ | 94,689 | $ | 350,000 | $ | 700,000 | Mortgage servicing rights | |||||||||||||||||||||||
| June 30, 2022 | $ | 125,000 | $ | — | $ | 275,000 | $ | 400,000 | Mortgage servicing rights (3) | |||||||||||||||||||||||
| March 20, 2024 | $ | 146,250 | $ | 78,750 | $ | 75,000 | $ | 300,000 | Mortgage servicing rights (4) | |||||||||||||||||||||||
| January 31, 2022 | $ | — | $ | 140,000 | $ | — | $ | 140,000 | Mortgage servicing rights | |||||||||||||||||||||||
| September 28, 2022 | $ | 19,200 | $ | 180,800 | $ | — | $ | 200,000 | Mortgage servicing advances | |||||||||||||||||||||||
____________________
(1)The facilities are set to mature on the stated expiration date, unless extended pursuant to their terms. (2)Represents unused capacity amounts to which commitment fees are charged. (3)This repurchase facility |
(4)The revolving period of this facility ceases on March 17, 2023, at which time to time by the FHLB. Eligible collateral may include conventional 1-4 family residential mortgage loans, Agency RMBS and certain non-Agency securities withfacility starts a rating of A and above.12-month amortization period.
We are subject to a variety of financial covenants under our lending agreements. The following represent the most restrictive financial covenants across theour lending agreements as of December 31, 2019:2021:
•Total indebtedness to tangible net worth must be less than 8.0:1.0. As of December 31, 2019,2021, our total indebtedness to tangible net worth, as defined, was 6.2:3.3:1.0.
•Cash liquidity must be greater than $100.0$200.0 million. As of December 31, 2019,2021, our liquidity, as defined, was $558.1 million.$1.2 billion.
•Net worth must be greater than the higher of $1.5 billion or 50% of the highest net worth during the 24 calendar months prior, whichever is higher.measured beginning March 31, 2020. As of December 31, 2019,2021, 50% of the highest net worth during the 24 calendar months prior, as defined, was $2.6$1.6 billion and our net worth, as defined, was $5.0$2.7 billion.
We are also subject to additional financial covenants in connection with various other agreements we enter into in the normal course of our business. We intend to continue to operate in a manner which complies with all of our financial covenants.
The following table summarizes assets at carrying values that were pledged or restricted as collateral for the future payment obligations of repurchase agreements, FHLB advances, revolving credit facilities, term notes payable and derivative instruments at December 31, 20192021 and December 31, 2018:2020:
| (in thousands) | December 31, 2021 | December 31, 2020 | |||||||||
| Available-for-sale securities, at fair value | $ | 7,009,449 | $ | 14,633,217 | |||||||
| Mortgage servicing rights, at fair value | 2,130,807 | 1,146,710 | |||||||||
| Restricted cash | 747,979 | 1,126,439 | |||||||||
| Due from counterparties | 33,718 | 21,312 | |||||||||
| Derivative assets, at fair value | 39,608 | 61,557 | |||||||||
| Other assets | 33,767 | 28,540 | |||||||||
| Total | $ | 9,995,328 | $ | 17,017,775 | |||||||
| (in thousands) | December 31, 2019 | December 31, 2018 | |||||
| Available-for-sale securities, at fair value | $ | 29,802,456 | $ | 25,157,999 | |||
| Mortgage servicing rights, at fair value | 1,554,825 | 1,143,918 | |||||
| Restricted cash | 919,010 | 416,696 | |||||
| Due from counterparties | 102,365 | 110,695 | |||||
| Derivative assets, at fair value | 68,874 | 70,191 | |||||
U.S. Treasuries, at fair value (1) | — | 6,457 | |||||
| Total | $ | 32,447,530 | $ | 26,905,956 | |||
Although we generally intend to hold our target assets as long-term investments, we may sell certain of our assets in order to manage our interest rate risk and liquidity needs, to meet other operating objectives and to adapt to market conditions. Our Agency RMBS and non-Agency securities are generally actively traded and thus, in most circumstances, readily liquid. However, certain of our assets, including MSR, are subject to longer trade timelines, and, as a result, market conditions could significantly and adversely affect the liquidity of our assets. Any illiquidity of our assets may make it difficult for us to sell such assets if the need or desire arises. Our ability to quickly sell certain assets, such as MSR may be limited by delays encountered while obtaining certain regulatory approvals required for such dispositions and may be further limited by delays due to the time period needed for negotiating transaction documents, conducting diligence, and complying with regulatory requirements regarding the transfer of such assets before settlement may occur. Consequently, even if we identify a buyer for our MSR, there is no assurance that we would be able to quickly sell such assets if the need or desire arises.
In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we previously recorded our assets. Assets that are illiquid are more difficult to finance, and to the extent that we use leverage to finance assets that become illiquid, we may lose that leverage or have it reduced. Assets tend to become less liquid during times of financial stress, which is often the time that liquidity is most needed. As a result, our ability to sell assets or vary our portfolio in response to changes in economic and other conditions may be limited by liquidity constraints, which could adversely affect our results of operations and financial condition.
We cannot predict the timing and impact of future sales of our assets, if any. Because many of our assets are financed with repurchase agreements, FHLB advances, revolving credit facilities and term notes payable, a significant portion of the proceeds from sales of our assets (if any), prepayments and scheduled amortization are used to repay balances under these financing sources.
The following table provides the maturities of our repurchase agreements, FHLB advances, revolving credit facilities, term notes payable and convertible senior notes as of December 31, 20192021 and December 31, 20182020:
| (in thousands) | December 31, 2021 | December 31, 2020 | |||||||||
| Within 30 days | $ | 1,771,027 | $ | 5,370,506 | |||||||
| 30 to 59 days | 1,807,544 | 4,292,861 | |||||||||
| 60 to 89 days | 1,981,056 | 2,062,234 | |||||||||
| 90 to 119 days | 1,249,435 | 1,610,198 | |||||||||
| 120 to 364 days | 1,265,638 | 1,868,099 | |||||||||
| One to three years | 543,026 | 510,013 | |||||||||
| Three to five years | 281,083 | 395,609 | |||||||||
| Total | $ | 8,898,809 | $ | 16,109,520 | |||||||
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| (in thousands) | December 31, 2019 | December 31, 2018 | |||||
| Within 30 days | $ | 5,465,916 | $ | 7,488,869 | |||
| 30 to 59 days | 6,300,372 | 5,077,598 | |||||
| 60 to 89 days | 6,687,285 | 5,655,060 | |||||
| 90 to 119 days | 4,740,217 | 1,938,859 | |||||
| 120 to 364 days | 6,113,673 | 3,508,114 | |||||
| One to three years | 584,954 | 300,000 | |||||
| Three to five years | 394,502 | 573,856 | |||||
| Five to ten years | — | — | |||||
| Ten years and over | 50,000 | 50,000 | |||||
| Total | $ | 30,336,919 | $ | 24,592,356 | |||
For the year ended December 31, 2019,2021, our restricted and unrestricted cash balance increaseddecreased approximately $519.1$557.8 million to $1.6$2.1 billion at December 31, 2019.2021. The cash movements can be summarized by the following:
•Cash flows from operating activities. For the year ended December 31, 2021, operating activities increased our cash balances by approximately $423.5 million, primarily driven by our financial results |
•Cash flows from financing activities. For the year ended December 31, 2021, financing activities decreased our cash balance by approximately $7.3 billion, primarily driven by decreases in repurchase agreements FHLB advances, revolving credit facilities, convertible senior notes, interest expenseas a result of sales of and principal payments on borrowings, our non-cancelable office leases, net of contractual subleases, and management fees payable under our management agreement:AFS securities.
| Due During the Year Ended December 31, | |||||||||||||||||||||||||||
| (in thousands) | 2020 | 2021 | 2022 | 2023 | 2024 | Thereafter | Total | ||||||||||||||||||||
| Repurchase agreements | $ | 29,147,463 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 29,147,463 | |||||||||||||
| Federal Home Loan Bank advances | 160,000 | — | — | — | — | 50,000 | 210,000 | ||||||||||||||||||||
| Revolving credit facilities | — | 300,000 | — | — | — | — | 300,000 | ||||||||||||||||||||
| Convertible senior notes | — | — | 284,954 | — | — | — | 284,954 | ||||||||||||||||||||
Interest expense on borrowings(1) | 153,525 | 21,761 | 2,043 | 1,305 | 1,305 | 12,785 | 192,724 | ||||||||||||||||||||
| Long-term operating lease obligations | 1,616 | 1,523 | 1,003 | 327 | — | — | 4,469 | ||||||||||||||||||||
Management fee - PRCM Advisers(2) | 245,826 | — | — | — | — | — | 245,826 | ||||||||||||||||||||
| Total | $ | 29,708,430 | $ | 323,284 | $ | 288,000 | $ | 1,632 | $ | 1,305 | $ | 62,785 | $ | 30,385,436 | |||||||||||||
Recently Issued Accounting Standards
Refer to Note 2 - Basis of Presentation and Significant Accounting Policies of the notes to the consolidated financial statements included in Item 8 of this Form 10-K.
Inflation
Substantially all of our assets and liabilities are financial in nature. As a result, changes in interest rates and other factors impact our performance far more than does inflation.inflation, although inflation rates can often have a meaningful influence over the direction of interest rates. Our financial statements are prepared in accordance with U.S. GAAP and dividends are based upon net ordinary income and capital gains as calculated for tax purposes; in each case, our results of operations and reported assets, liabilities and equity are measured with reference to historical cost or fair value without considering inflation.
Other Matters
We intend to conduct our business so as to maintain our exempt status under, and not to become regulated as, an investment company for purposes of the 1940 Act. If we failed to maintain our exempt status under the 1940 Act and became regulated as an investment company, our ability to, among other things, use leverage would be substantially reduced and, as a result, we would be unable to conduct our business as described in Item 1, “Business - Other Business - Regulation” of this Annual Report on Form 10-K. Accordingly, we monitor our compliance with both the 55% Test and the 80% Tests of the 1940 Act in order to maintain our exempt status. As of December 31, 2019,2021, we determined that we maintained compliance with both the 55% Test and the 80% Test requirements.
We calculate that at least 75% of our assets were qualified REIT assets, as defined in the Code for the year ended December 31, 2019.2021. We also calculate that our revenue qualifiesqualified for the 75% source of income test and for the 95% source of income test rules for the year ended December 31, 2019.2021. Consequently, we met the REIT income and asset tests. We also met all REIT requirements regarding the ownership of our common stock and the distribution of our net income. Therefore, for the year ended December 31, 2019,2021, we believe that we qualified as a REIT under the Code.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while providing an opportunity to stockholders to realize attractive risk-adjusted total return through ownership of our capital stock. Although we do not seek to avoid risk completely, we believe that risk can be quantified from historical experience, and we seek to manage our risk levels in order to earn sufficient compensation to justify the risks we undertake and to maintain capital levels consistent with taking such risks.
To reducemanage the risks to our portfolio, we employ portfolio-wide and asset-specific risk measurement and management processes in our daily operations. Risk management tools include software and services licensed or purchased from third parties as well as proprietary and third-party analytical tools and models. There can be no guarantee that these tools and methods will protect us from market risks.
53
Interest Rate Risk
Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond our control. We are subject to interest rate risk in connection with our assets and related financing obligations.
LIBOR and other indices which had been deemed “benchmarks” for various commercial and financial contracts have been the subject of recent national, international, and other regulatory guidance and proposals for reform, and it appears likely that LIBOR will be phased out or the methodology for determining LIBOR will be modified by June 2023. We currently have agreements that are indexed to LIBOR and are monitoring related reform proposals and evaluating the related risks; however, it is not possible to predict the effects of any of these developments, and any future initiatives to regulate, reform or change the manner of administration of LIBOR could result in adverse consequences to the rate of interest payable and receivable on, market value of and market liquidity for LIBOR-based financial instruments. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Market Conditions and Outlook - LIBOR transition” for further discussion.
Subject to maintaining our qualification as a REIT, we engage in a variety of interest rate risk management techniques that seek to mitigate the influence of interest rate changes on the values of our assets.
We may enter 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 our floating-rate borrowings into fixed-rate borrowings to more closely match the duration of our 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)LIBOR, OIS or SOFR) 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 our portfolio as well as our cash flows, we may, at times, enter into various forward contracts, including short securities, Agency to-be-announced securities, or TBAs, options, futures, swaps, caps, credit default swaps and total return swaps. In executing on the Company’sour current interest rate risk management strategy, the Company haswe have entered into TBAs, put and call options for TBAs, interest rate swap cap and swaption agreements and U.S. Treasury futures and Markit IOS total return swaps.Eurodollar futures. In addition, because MSR are negative duration assets, they provide a hedge to interest rate exposure on our Agency RMBS portfolio. In hedging interest rate risk, we seek to reduce the risk of losses on the value of our investments that may result from changes in interest rates in the broader markets, improve risk-adjusted returns and, where possible, obtain a favorable spread between the yield on our assets and the cost of our financing.
We intend to treat our TBAs as qualifying assets for purposes of the 75% asset test, to the extent set forth in an opinion from Sidley Austin LLP substantially to the effect that, for purposes of the 75% asset test, our ownership of a TBA should be treated as ownership of the underlying Agency RMBS, and toRMBS. We also treat income and gains from our TBAs as qualifying income for purposes of the 75% gross income test, to the extent set forth in an opinion from Sidley Austin LLP substantially to the effect that, for purposes of the 75% gross income test, any gain recognized by us in connection with the settlement of our TBAs should be treated as gain from the sale or disposition of the underlying Agency RMBS.
Interest Rate Effect on Net Interest Income
Our operating results depend in large part on differences between the income earned on our assets and our cost of borrowing and hedging activities. The costs associated with our borrowings are generally based on prevailing market interest rates. During a period of rising interest rates, our borrowing costs generally will increase while the coupon interest earned on our existing portfolio of leveraged fixed-rate Agency RMBS and non-Agency securities will remain static. Moreover, interest rates may rise at a faster pace than the yields earned on our leveraged adjustable-rate and hybrid securities. Both of these factors could result in a decline in our net interest spread and net interest margin. The inverse result may occur during a period of falling interest rates. The severity of any such decline or increase in our net interest spread and net interest margin would depend on our asset/liability composition at the time, as well as the magnitude and duration of the interest rate increase or decrease. Additionally, an increase in short-term interest rates could have a negative impact on the market value of our target assets, while a decrease in short-term interest rates could have a positive impact on the market value of our target assets. Any resulting negative impact to net income could adversely affect our liquidity and results of operations.
Our hedging techniques are partly based on assumed levels of prepayments of our target assets. If prepayments are slower or faster than assumed, the life of the investment will be longer or shorter, which could reduce the effectiveness of any hedging strategies we may use and may cause losses on such transactions. Hedging strategies involving the use of derivative securities are highly complex and may produce volatile returns.
| December 31, 2019 | December 31, 2018 | |||||||||||||||||||||||||||||
| Index Type | Floating | Hybrid (1) | Total | Index % | Floating | Hybrid (1) | Total | Index % | ||||||||||||||||||||||
| CMT | $ | — | $ | 11,884 | $ | 11,884 | — | % | $ | 9,502 | $ | 15,423 | $ | 24,925 | 1 | % | ||||||||||||||
| LIBOR | 3,247,387 | 8,400 | 3,255,787 | 94 | % | 3,374,141 | 9,278 | 3,383,419 | 93 | % | ||||||||||||||||||||
Other (2) | 44,824 | 164,635 | 209,459 | 6 | % | 50,597 | 165,054 | 215,651 | 6 | % | ||||||||||||||||||||
| Total | $ | 3,292,211 | $ | 184,919 | $ | 3,477,130 | 100 | % | $ | 3,434,240 | $ | 189,755 | $ | 3,623,995 | 100 | % | ||||||||||||||
The following analyses of risks are based on our experience, estimates, models and assumptions. The analysis is based on models which utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of decisions may produce results that differ significantly from the estimates and assumptions used in our models.
We perform interest rate sensitivity analyses on various measures of our financial results and condition by examining how our assets, financing, and hedges will perform in various interest rate “shock” scenarios. Two of these measures are presented below in more detail. The first measure is change in annualized net interest income over the next 12 months, including interest spread from our interest rate swaps and caps and float income from custodial accounts associated with our MSR. The second measure is change in value of financial position, including the value of our derivative assets and liabilities. All changes in value are measured as the change from the December 31, 20192021 financial position. All projected changes in annualized net interest income are measured as the change from the projected annualized net interest income based off current performance returns.
Computation of the cash flows for the rate-sensitive assets underpinning change in annualized net interest income are based on assumptions related to, among other things, prepayment speeds, yield on future acquisitions, slope of the yield curve, and size of the portfolio. (The assumption for prepayment speeds for Agency RMBS, non-Agency securities, and MSR, for example, is that they do not change in response to changes in interest rates.) Assumptions for the interest rate sensitive liabilities relate to, among other things, collateral requirements as a percentage of borrowings and amount/term of borrowing. These assumptions may not hold in practice; realized net interest income results may therefore be significantly different from the net interest income produced in scenario analyses. We also note that the uncertainty associated with the estimate of a change in net interest income is directly related to the size of interest rate move considered.
Computation of results for portfolio value involves a two-step process. The first is the use of models to project how the value of interest rate sensitive instruments will change in the scenarios considered. The second, and equally important, step is the improvement of the model projections based on application of our experience in assessing how current market and macroeconomic conditions will affect the prices of various interest rate sensitive instruments. Judgment is best applied to localized (less than 25 basis points, or bps) interest rate moves. The more an instantaneous interest rate move exceeds 25 bps, the greater the likelihood that accompanying market events are significant enough to warrant reconsideration of interest rate sensitivities. As with net interest income, the uncertainty associated with the estimate of change in portfolio value is therefore directly related to the size of interest rate move considered.
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The following interest rate sensitivity table displays the potential impact of instantaneous, parallel changes in interest rates of +/- 25 and +/- 50 bps on annualized net interest income and portfolio value, based on our interest sensitive financial instruments at December 31, 2019.2021. The preceding discussion shows that the results for the 25 bps move scenarios are the best representation of our interest rate exposure, followed by those for the 50 bps move scenarios. This hierarchy reflects our localized approach to managing interest rate risk: monitoring rates and rebalancing our hedges on a day to day basis, where rate moves only rarely exceed 25 bps in either direction.
| Changes in Interest Rates | Changes in Interest Rates | |||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | -50 bps | -25 bps | +25 bps | +50 bps | (dollars in thousands) | -50 bps | -25 bps | +25 bps | +50 bps | |||||||||||||||||||||||||||||||||||||||||
Change in annualized net interest income (1): | $ | (14,670 | ) | $ | (7,363 | ) | $ | 7,345 | $ | 14,690 | Change in annualized net interest income (1): | $ | (8,777) | $ | (4,229) | $ | 3,655 | $ | 7,381 | |||||||||||||||||||||||||||||||
% change in net interest income (1) | (3.0 | )% | (1.5 | )% | 1.5 | % | 3.0 | % | % change in net interest income (1) | (4.4) | % | (2.1) | % | 1.8 | % | 3.7 | % | |||||||||||||||||||||||||||||||||
| Change in value of financial position: | Change in value of financial position: | |||||||||||||||||||||||||||||||||||||||||||||||||
| Available-for-sale securities | $ | 384,030 | $ | 190,968 | $ | (222,976 | ) | $ | (507,398 | ) | Available-for-sale securities | $ | 49,639 | $ | 28,076 | $ | (35,802) | $ | (79,717) | |||||||||||||||||||||||||||||||
| As a % of common equity | 9.7 | % | 4.8 | % | (5.6 | )% | (12.8 | )% | As a % of common equity | 2.5 | % | 1.4 | % | (1.8) | % | (4.0) | % | |||||||||||||||||||||||||||||||||
| Mortgage servicing rights | $ | (270,100 | ) | $ | (135,821 | ) | $ | 130,899 | $ | 250,616 | ||||||||||||||||||||||||||||||||||||||||
| As a % of common equity | (6.8 | )% | (3.4 | )% | 3.3 | % | 6.3 | % | ||||||||||||||||||||||||||||||||||||||||||
Mortgage servicing rights (2) | Mortgage servicing rights (2) | $ | (250,133) | $ | (114,470) | $ | 103,076 | $ | 183,561 | |||||||||||||||||||||||||||||||||||||||||
As a % of common equity (2) | As a % of common equity (2) | (12.4) | % | (5.6) | % | 5.1 | % | 9.1 | % | |||||||||||||||||||||||||||||||||||||||||
| Derivatives, net | $ | (100,978 | ) | $ | (40,174 | ) | $ | 46,526 | $ | 126,802 | Derivatives, net | $ | 138,563 | $ | 75,018 | $ | (84,127) | $ | (173,752) | |||||||||||||||||||||||||||||||
| As a % of common equity | (2.5 | )% | (1.0 | )% | 1.2 | % | 3.2 | % | As a % of common equity | 6.9 | % | 3.7 | % | (4.2) | % | (8.6) | % | |||||||||||||||||||||||||||||||||
| Reverse repurchase agreements | $ | 46 | $ | 23 | $ | (23 | ) | $ | (46 | ) | Reverse repurchase agreements | $ | 28 | $ | 14 | $ | (14) | $ | (28) | |||||||||||||||||||||||||||||||
| As a % of common equity | — | % | — | % | — | % | — | % | As a % of common equity | — | % | — | % | — | % | — | % | |||||||||||||||||||||||||||||||||
| Repurchase agreements | $ | (30,532 | ) | $ | (15,266 | ) | $ | 15,266 | $ | 30,532 | Repurchase agreements | $ | (7,535) | $ | (3,767) | $ | 3,767 | $ | 7,471 | |||||||||||||||||||||||||||||||
| As a % of common equity | (0.8 | )% | (0.4 | )% | 0.4 | % | 0.8 | % | As a % of common equity | (0.4) | % | (0.2) | % | 0.2 | % | 0.4 | % | |||||||||||||||||||||||||||||||||
| Federal Home Loan Bank advances | $ | (44 | ) | $ | (22 | ) | $ | 22 | $ | 44 | ||||||||||||||||||||||||||||||||||||||||
| As a % of common equity | — | % | — | % | — | % | — | % | ||||||||||||||||||||||||||||||||||||||||||
| Revolving credit facilities | $ | (63 | ) | $ | (31 | ) | $ | 31 | $ | 63 | Revolving credit facilities | $ | (62) | $ | (31) | $ | 31 | $ | 62 | |||||||||||||||||||||||||||||||
| As a % of common equity | — | % | — | % | — | % | — | % | As a % of common equity | — | % | — | % | — | % | — | % | |||||||||||||||||||||||||||||||||
| Term notes payable | $ | (126 | ) | $ | (63 | ) | $ | 63 | $ | 126 | Term notes payable | $ | (1,054) | $ | (382) | $ | 205 | $ | 335 | |||||||||||||||||||||||||||||||
| As a % of common equity | — | % | — | % | — | % | — | % | As a % of common equity | (0.1) | % | — | % | — | % | — | % | |||||||||||||||||||||||||||||||||
| Convertible senior notes | $ | (2,518 | ) | $ | (1,255 | ) | $ | 1,248 | $ | 2,487 | Convertible senior notes | $ | (2,149) | $ | (1,075) | $ | 1,039 | $ | 2,077 | |||||||||||||||||||||||||||||||
| As a % of common equity | (0.1 | )% | — | % | — | % | 0.1 | % | As a % of common equity | (0.1) | % | (0.1) | % | 0.1 | % | 0.1 | % | |||||||||||||||||||||||||||||||||
| Total Net Assets | $ | (20,285 | ) | $ | (1,641 | ) | $ | (28,944 | ) | $ | (96,774 | ) | Total Net Assets | $ | (72,703) | $ | (16,617) | $ | (11,825) | $ | (59,991) | |||||||||||||||||||||||||||||
| As a % of total assets | (0.1 | )% | — | % | (0.1 | )% | (0.3 | )% | As a % of total assets | (0.6) | % | (0.1) | % | (0.1) | % | (0.5) | % | |||||||||||||||||||||||||||||||||
| As a % of common equity | (0.5 | )% | — | % | (0.7 | )% | (2.4 | )% | As a % of common equity | (3.6) | % | (0.8) | % | (0.6) | % | (3.0) | % | |||||||||||||||||||||||||||||||||
____________________
(1)Amounts include the effect of interest spread from our interest rate swaps and float income from custodial accounts associated with our MSR, but do not reflect any potential changes to dollar roll income associated with our TBA positions, which are accounted for as derivative instruments in accordance with U.S. GAAP.
(2)Includes the effect of unsettled MSR.
Certain assumptions have been made in connection with the calculation of the information set forth in the foregoing interest rate sensitivity table and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. The base interest rate scenario assumes interest rates at December 31, 2019.2021. As discussed, the analysis utilizes assumptions and estimates based on our experience and judgment. Furthermore, future purchases and sales of assets could materially change our interest rate risk profile.
The information set forth in the interest rate sensitivity table above and all related disclosures constitutes forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. While this table reflects the estimated impact of interest rate changes on the static portfolio, we actively manage our portfolio and continuously make adjustments to the size and composition of our asset and hedge portfolio. Actual results could differ significantly from those estimated in the foregoing interest rate sensitivity table.
Prepayment Risk
Prepayment risk is the risk that principal will be repaid at a different rate than anticipated. As we receive prepayments of principal on our Agency RMBS, and non-Agency securities, premiums paid on such assets will be amortized against interest income. In general, an increase in prepayment rates will accelerate the amortization of purchase premiums, thereby reducing the interest income earned on the assets. Conversely, discounts on such assets are accreted into interest income. In general, an increase in prepayment rates will accelerate the accretion
56
We believe that we will be able to reinvest proceeds from scheduled principal payments and prepayments at acceptable yields; however, no assurances can be given that, should significant prepayments occur, market conditions would be such that acceptable investments could be identified and the proceeds timely reinvested.
MSR are also subject to prepayment risk in that, generally, an increase in prepayment rates would result in a decline in value of the MSR.
Market Risk
Market Value Risk. Our AFS securities are reflected at their estimated fair value, with the difference between amortized cost net of allowance for credit losses and estimated fair value for all AFS securities except Agencycertain interest-only securities reflected in accumulated other comprehensive income. The estimated fair value of these securities fluctuates primarily due to changes in interest rates, market valuation of credit risks, and other factors. Generally, in a rising interest rate environment, we would expect the fair value of these securities to decrease; conversely, in a decreasing interest rate environment, we would expect the fair value of these securities to increase. As market volatility increases or liquidity decreases, the fair value of our assets may be adversely impacted.
Our MSR are reflected at their estimated fair value. The estimated fair value fluctuates primarily due to changes in interest rates and other factors. Generally, in a rising interest rate environment, we would expect prepayments to decrease resulting in an increase inand the fair value of our MSR.MSR to increase. Conversely, in a decreasing interest rate environment, we would expect prepayments to increase resulting in a decline inand the fair value.value of our MSR to decrease.
Real estate riskEstate Risk. Residential property values are subject to volatility and may be affected adversely by a number of factors, including national, regional and local economic conditions; local real estate conditions (such as the supply of housing); changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; retroactive changes to building or similar codes; and natural disasters and other catastrophes. Decreases in property values reduce the value of the collateral for residential mortgage loans and the potential proceeds available to borrowers to repay the loans, which could cause us to suffer losses on our non-Agency securities and may increase costs to service the residential mortgage loans underlying our MSR.
Liquidity Risk
Our liquidity risk is principally associated with our financing of long-maturity assets with shorter-term borrowings in the form of repurchase agreements FHLB advances and borrowings under revolving credit facilities. Although the interest rate adjustments of these assets and liabilities fall within the guidelines established by our operating policies, maturities are not required to be, nor are they, matched.
Should the value of our assets pledged as collateral suddenly decrease, lender margin calls could increase, causing an adverse change in our liquidity position. Moreover, the portfolio construction of MSR, which generally have negative duration, combined with levered RMBS, which generally have positive duration, may in certain market scenarios lead to variation margin calls, which could negatively impact our excess cash position. Additionally, if the FHLB or one or more of our repurchase agreement or revolving credit facility counterparties chose not to provide ongoing funding, our ability to finance would decline or exist at possibly less advantageous terms. As such, we cannot assureprovide assurance that we will always be able to roll over our repurchase agreements FHLB advances and revolving credit facilities. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” in this Annual Report on 10-K 10-K for further information about our liquidity and capital resource management.
Credit Risk
We believe that our investment strategy will generally keep our risk of credit losses low to moderate. However, we retain the risk of potential credit losses on all of the loans underlying our non-Agency securities. With respect to our non-Agency securities that are senior in the credit structure, credit support contained in deal structures provide a level of protection from losses. We seek to manage the remaining credit risk through our pre-acquisition due diligence process, which includes comprehensive underwriting, and by factoring assumed credit losses into the purchase prices we pay for non-Agency securities. In addition, with respect to any particular target asset, we evaluate relative valuation, supply and demand trends, shape of yield curves, prepayment rates, delinquency and default rates, recovery of various sectors and vintage of collateral. At times, we enter into credit default swaps or other derivative instruments in an attempt to manage our credit risk. Nevertheless, unanticipated credit losses could adversely affect our operating results.
57
Item 8. Financial Statements and Supplementary Data
TWO HARBORS INVESTMENT CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
| Page | ||||||||
58
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors
of Two Harbors Investment Corp.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Two Harbors Investment Corp. (the Company) as of December 31, 20192021 and 2018,2020, the related consolidated statements of comprehensive (loss) income, (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2019,2021, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 20192021 and 2018,2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019,2021, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019,2021, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 26, 202028, 2022 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Valuation of Level 3 Fair Value Measurement | |||||
| Description of the Matter | At December 31, Auditing the Company’s valuation of | ||||
| How We Addressed the Matter in Our Audit | Our audit procedures related to the fair value of To test the fair value of the Company’s | ||||
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2009.
Minneapolis, Minnesota
February 26, 2020
60
TWO HARBORS INVESTMENT CORP.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
| December 31, 2019 | December 31, 2018 | ||||||
| ASSETS | |||||||
| Available-for-sale securities, at fair value | $ | 31,406,328 | $ | 25,552,604 | |||
| Mortgage servicing rights, at fair value | 1,909,444 | 1,993,440 | |||||
| Cash and cash equivalents | 558,136 | 409,758 | |||||
| Restricted cash | 1,058,690 | 688,006 | |||||
| Accrued interest receivable | 92,634 | 86,589 | |||||
| Due from counterparties | 318,963 | 154,626 | |||||
| Derivative assets, at fair value | 188,051 | 319,981 | |||||
| Reverse repurchase agreements | 220,000 | 761,815 | |||||
| Other assets | 169,376 | 165,660 | |||||
Total Assets (1) | $ | 35,921,622 | $ | 30,132,479 | |||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
| Liabilities | |||||||
| Repurchase agreements | $ | 29,147,463 | $ | 23,133,476 | |||
| Federal Home Loan Bank advances | 210,000 | 865,024 | |||||
| Revolving credit facilities | 300,000 | 310,000 | |||||
| Term notes payable | 394,502 | — | |||||
| Convertible senior notes | 284,954 | 283,856 | |||||
| Derivative liabilities, at fair value | 6,740 | 820,590 | |||||
| Due to counterparties | 259,447 | 130,210 | |||||
| Dividends payable | 128,125 | 135,551 | |||||
| Accrued interest payable | 149,626 | 160,005 | |||||
| Other liabilities | 70,299 | 39,278 | |||||
Total Liabilities (1) | 30,951,156 | 25,877,990 | |||||
| Stockholders’ Equity | |||||||
| Preferred stock, par value $0.01 per share; 50,000,000 shares authorized and 40,050,000 and 40,050,000 shares issued and outstanding, respectively ($1,001,250 and $1,001,250 liquidation preference, respectively) | 977,501 | 977,501 | |||||
| Common stock, par value $0.01 per share; 450,000,000 shares authorized and 272,935,731 and 248,085,721 shares issued and outstanding, respectively | 2,729 | 2,481 | |||||
| Additional paid-in capital | 5,154,764 | 4,809,616 | |||||
| Accumulated other comprehensive income | 689,400 | 110,817 | |||||
| Cumulative earnings | 2,655,891 | 2,332,371 | |||||
| Cumulative distributions to stockholders | (4,509,819 | ) | (3,978,297 | ) | |||
| Total Stockholders’ Equity | 4,970,466 | 4,254,489 | |||||
| Total Liabilities and Stockholders’ Equity | $ | 35,921,622 | $ | 30,132,479 | |||
| December 31, 2021 | December 31, 2020 | ||||||||||
| ASSETS | |||||||||||
| Available-for-sale securities, at fair value (amortized cost $7,005,013 and $14,043,175, respectively; allowance for credit losses $14,238 and $22,528, respectively) | $ | 7,161,703 | $ | 14,650,922 | |||||||
| Mortgage servicing rights, at fair value | 2,191,578 | 1,596,153 | |||||||||
| Cash and cash equivalents | 1,153,856 | 1,384,764 | |||||||||
| Restricted cash | 934,814 | 1,261,667 | |||||||||
| Accrued interest receivable | 26,266 | 47,174 | |||||||||
| Due from counterparties | 168,449 | 146,433 | |||||||||
| Derivative assets, at fair value | 80,134 | 95,937 | |||||||||
| Reverse repurchase agreements | 134,682 | 91,525 | |||||||||
| Other assets | 262,823 | 241,346 | |||||||||
Total Assets (1) | $ | 12,114,305 | $ | 19,515,921 | |||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||
| Liabilities: | |||||||||||
| Repurchase agreements | $ | 7,656,445 | $ | 15,143,898 | |||||||
| Revolving credit facilities | 420,761 | 283,830 | |||||||||
| Term notes payable | 396,776 | 395,609 | |||||||||
| Convertible senior notes | 424,827 | 286,183 | |||||||||
| Derivative liabilities, at fair value | 53,658 | 11,058 | |||||||||
| Due to counterparties | 196,627 | 135,838 | |||||||||
| Dividends payable | 72,412 | 65,480 | |||||||||
| Accrued interest payable | 18,382 | 21,666 | |||||||||
| Commitments and contingencies (see Note 15) | — | — | |||||||||
| Other liabilities | 130,464 | 83,433 | |||||||||
Total Liabilities (1) | 9,370,352 | 16,426,995 | |||||||||
| Stockholders’ Equity: | |||||||||||
| Preferred stock, par value $0.01 per share; 100,000,000 shares authorized and 29,050,000 and 40,050,000 shares issued and outstanding, respectively ($726,250 and $1,001,250 liquidation preference, respectively) | 702,550 | 977,501 | |||||||||
| Common stock, par value $0.01 per share; 700,000,000 shares authorized and 343,911,324 and 273,703,882 shares issued and outstanding, respectively | 3,439 | 2,737 | |||||||||
| Additional paid-in capital | 5,625,179 | 5,163,794 | |||||||||
| Accumulated other comprehensive income | 186,346 | 641,601 | |||||||||
| Cumulative earnings | 1,212,983 | 1,025,756 | |||||||||
| Cumulative distributions to stockholders | (4,986,544) | (4,722,463) | |||||||||
| Total Stockholders’ Equity | 2,743,953 | 3,088,926 | |||||||||
| Total Liabilities and Stockholders’ Equity | $ | 12,114,305 | $ | 19,515,921 | |||||||
____________________
(1) |
The accompanying notes are an integral partconsolidated balance sheets include assets and liabilities of these consolidated financial statements.variable interest entities, or VIEs. At December 31, 2021 and December 31, 2020, assets of the VIEs totaled $454,596 and $496,810, and liabilities of the VIEs totaled $440,030 and $477,270, respectively. See Note 3 - Variable Interest Entities for additional information.
| Year Ended | |||||||||||
| December 31, | |||||||||||
| 2019 | 2018 | 2017 | |||||||||
| Interest income: | |||||||||||
| Available-for-sale securities | $ | 962,283 | $ | 847,325 | $ | 631,853 | |||||
| Residential mortgage loans held-for-investment in securitization trusts | — | — | 102,886 | ||||||||
| Other | 32,407 | 22,707 | 10,350 | ||||||||
| Total interest income | 994,690 | 870,032 | 745,089 | ||||||||
| Interest expense: | |||||||||||
| Repurchase agreements | 654,280 | 469,437 | 210,430 | ||||||||
| Collateralized borrowings in securitization trusts | — | — | 82,573 | ||||||||
| Federal Home Loan Bank advances | 10,920 | 20,417 | 36,911 | ||||||||
| Revolving credit facilities | 19,354 | 10,820 | 2,341 | ||||||||
| Term notes payable | 10,708 | — | — | ||||||||
| Convertible senior notes | 19,067 | 18,997 | 17,933 | ||||||||
| Total interest expense | 714,329 | 519,671 | 350,188 | ||||||||
| Net interest income | 280,361 | 350,361 | 394,901 | ||||||||
| Other-than-temporary impairments: | |||||||||||
| Total other-than-temporary impairment losses | (14,312 | ) | (470 | ) | (789 | ) | |||||
| Other income (loss): | |||||||||||
| Gain (loss) on investment securities | 280,118 | (341,312 | ) | (34,695 | ) | ||||||
| Servicing income | 501,612 | 343,096 | 209,065 | ||||||||
| Loss on servicing asset | (697,659 | ) | (69,033 | ) | (91,033 | ) | |||||
| (Loss) gain on interest rate swap, cap and swaption agreements | (108,289 | ) | 16,043 | (9,753 | ) | ||||||
| Gain (loss) on other derivative instruments | 259,998 | (54,857 | ) | (70,159 | ) | ||||||
| Other income | 337 | 3,037 | 30,141 | ||||||||
| Total other income (loss) | 236,117 | (103,026 | ) | 33,566 | |||||||
| Expenses: | |||||||||||
| Management fees | 60,102 | 30,272 | 40,472 | ||||||||
| Servicing expenses | 74,607 | 61,136 | 35,289 | ||||||||
| Other operating expenses | 57,055 | 62,983 | 54,160 | ||||||||
| Acquisition transaction costs | — | 86,703 | — | ||||||||
| Restructuring charges | — | 8,238 | — | ||||||||
| Total expenses | 191,764 | 249,332 | 129,921 | ||||||||
| Income (loss) from continuing operations before income taxes | 310,402 | (2,467 | ) | 297,757 | |||||||
| (Benefit from) provision for income taxes | (13,560 | ) | 41,823 | (10,482 | ) | ||||||
| Net income (loss) from continuing operations | 323,962 | (44,290 | ) | 308,239 | |||||||
| Income from discontinued operations, net of tax | — | — | 44,146 | ||||||||
| Net income (loss) | 323,962 | (44,290 | ) | 352,385 | |||||||
| Income from discontinued operations attributable to noncontrolling interest | — | — | 3,814 | ||||||||
| Net income (loss) attributable to Two Harbors Investment Corp. | 323,962 | (44,290 | ) | 348,571 | |||||||
| Dividends on preferred stock | 75,801 | 65,395 | 25,122 | ||||||||
| Net income (loss) attributable to common stockholders | $ | 248,161 | $ | (109,685 | ) | $ | 323,449 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
61
TWO HARBORS INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (LOSS), continued
(in thousands, except share data)
| Year Ended | ||||||||||||||||||||||||||||||||
| December 31, | ||||||||||||||||||||||||||||||||
| 2021 | 2020 | 2019 | ||||||||||||||||||||||||||||||
| Interest income: | ||||||||||||||||||||||||||||||||
| Available-for-sale securities | $ | 167,310 | $ | 515,685 | $ | 962,283 | ||||||||||||||||||||||||||
| Other | 1,287 | 9,365 | 32,407 | |||||||||||||||||||||||||||||
| Total interest income | 168,597 | 525,050 | 994,690 | |||||||||||||||||||||||||||||
| Interest expense: | ||||||||||||||||||||||||||||||||
| Repurchase agreements | 25,774 | 233,069 | 654,280 | |||||||||||||||||||||||||||||
| Revolving credit facilities | 22,425 | 12,261 | 19,354 | |||||||||||||||||||||||||||||
| Term notes payable | 12,936 | 14,974 | 10,708 | |||||||||||||||||||||||||||||
| Convertible senior notes | 28,038 | 19,197 | 19,067 | |||||||||||||||||||||||||||||
| Federal Home Loan Bank advances | — | 1,747 | 10,920 | |||||||||||||||||||||||||||||
| Total interest expense | 89,173 | 281,248 | 714,329 | |||||||||||||||||||||||||||||
| Net interest income | 79,424 | 243,802 | 280,361 | |||||||||||||||||||||||||||||
| Other-than-temporary impairments: | ||||||||||||||||||||||||||||||||
| Total other-than-temporary impairment losses | — | — | (14,312) | |||||||||||||||||||||||||||||
| Other income (loss): | ||||||||||||||||||||||||||||||||
| Gain (loss) on investment securities | 121,617 | (999,859) | 280,118 | |||||||||||||||||||||||||||||
| Servicing income | 468,406 | 443,351 | 501,612 | |||||||||||||||||||||||||||||
| Loss on servicing asset | (114,941) | (935,697) | (697,659) | |||||||||||||||||||||||||||||
| Gain (loss) on interest rate swap, cap and swaption agreements | 42,091 | (310,806) | (108,289) | |||||||||||||||||||||||||||||
| (Loss) gain on other derivative instruments | (251,283) | 90,023 | 259,998 | |||||||||||||||||||||||||||||
| Other (loss) income | (3,845) | 1,422 | 337 | |||||||||||||||||||||||||||||
| Total other income (loss) | 262,045 | (1,711,566) | 236,117 | |||||||||||||||||||||||||||||
| Expenses: | ||||||||||||||||||||||||||||||||
| Management fees | — | 31,738 | 60,102 | |||||||||||||||||||||||||||||
| Servicing expenses | 86,250 | 94,266 | 74,607 | |||||||||||||||||||||||||||||
| Compensation and benefits | 35,041 | 37,723 | 33,229 | |||||||||||||||||||||||||||||
| Other operating expenses | 28,759 | 28,626 | 23,826 | |||||||||||||||||||||||||||||
| Restructuring charges | — | 5,706 | — | |||||||||||||||||||||||||||||
| Total expenses | 150,050 | 198,059 | 191,764 | |||||||||||||||||||||||||||||
| Income (loss) before income taxes | 191,419 | (1,665,823) | 310,402 | |||||||||||||||||||||||||||||
| Provision for (benefit from) income taxes | 4,192 | (35,688) | (13,560) | |||||||||||||||||||||||||||||
| Net income (loss) | 187,227 | (1,630,135) | 323,962 | |||||||||||||||||||||||||||||
| Dividends on preferred stock | 58,458 | 75,802 | 75,801 | |||||||||||||||||||||||||||||
| Net income (loss) attributable to common stockholders | $ | 128,769 | $ | (1,705,937) | $ | 248,161 | ||||||||||||||||||||||||||
| Basic earnings (loss) per weighted average common share | $ | 0.43 | $ | (6.24) | $ | 0.93 | ||||||||||||||||||||||||||
| Diluted earnings (loss) per weighted average common share | $ | 0.43 | $ | (6.24) | $ | 0.93 | ||||||||||||||||||||||||||
| Weighted average number of shares of common stock: | ||||||||||||||||||||||||||||||||
| Basic | 297,772,001 | 273,600,947 | 267,826,739 | |||||||||||||||||||||||||||||
| Diluted | 298,043,538 | 273,600,947 | 267,826,739 | |||||||||||||||||||||||||||||
| Year Ended | |||||||||||
| December 31, | |||||||||||
| 2019 | 2018 | 2017 | |||||||||
| Basic earnings (loss) per weighted average common share: | |||||||||||
| Continuing operations | $ | 0.93 | $ | (0.53 | ) | $ | 1.62 | ||||
| Discontinued operations | — | — | 0.23 | ||||||||
| Net income (loss) | $ | 0.93 | $ | (0.53 | ) | $ | 1.85 | ||||
| Diluted earnings (loss) per weighted average common share: | |||||||||||
| Continuing operations | $ | 0.93 | $ | (0.53 | ) | $ | 1.60 | ||||
| Discontinued operations | — | — | 0.21 | ||||||||
| Net income (loss) | $ | 0.93 | $ | (0.53 | ) | $ | 1.81 | ||||
| Weighted average number of shares of common stock: | |||||||||||
| Basic | 267,826,739 | 206,020,502 | 174,433,999 | ||||||||
| Diluted | 267,826,739 | 206,020,502 | 188,133,341 | ||||||||
| Comprehensive income (loss): | |||||||||||
| Net income (loss) | $ | 323,962 | $ | (44,290 | ) | $ | 352,385 | ||||
| Other comprehensive income (loss), net of tax: | |||||||||||
| Unrealized gain (loss) on available-for-sale securities | 578,583 | (233,914 | ) | 135,586 | |||||||
| Other comprehensive income (loss) | 578,583 | (233,914 | ) | 135,586 | |||||||
| Comprehensive income (loss) | 902,545 | (278,204 | ) | 487,971 | |||||||
| Comprehensive income attributable to noncontrolling interest | — | — | 3,814 | ||||||||
| Comprehensive income (loss) attributable to Two Harbors Investment Corp. | 902,545 | (278,204 | ) | 484,157 | |||||||
| Dividends on preferred stock | 75,801 | 65,395 | 25,122 | ||||||||
| Comprehensive income (loss) attributable to common stockholders | $ | 826,744 | $ | (343,599 | ) | $ | 459,035 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME, continued
(in thousands, except share data)
| Year Ended | ||||||||||||||||||||||||||||||||
| December 31, | ||||||||||||||||||||||||||||||||
| 2021 | 2020 | 2019 | ||||||||||||||||||||||||||||||
| Comprehensive (loss) income: | ||||||||||||||||||||||||||||||||
| Net income (loss) | $ | 187,227 | $ | (1,630,135) | $ | 323,962 | ||||||||||||||||||||||||||
| Other comprehensive (loss) income, net of tax: | ||||||||||||||||||||||||||||||||
| Unrealized (loss) gain on available-for-sale securities | (455,255) | (47,799) | 578,583 | |||||||||||||||||||||||||||||
| Other comprehensive (loss) income | (455,255) | (47,799) | 578,583 | |||||||||||||||||||||||||||||
| Comprehensive (loss) income | (268,028) | (1,677,934) | 902,545 | |||||||||||||||||||||||||||||
| Dividends on preferred stock | 58,458 | 75,802 | 75,801 | |||||||||||||||||||||||||||||
| Comprehensive (loss) income attributable to common stockholders | $ | (326,486) | $ | (1,753,736) | $ | 826,744 | ||||||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
63
TWO HARBORS INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
| Preferred Stock | Common Stock Par Value | Additional Paid-in Capital | Accumulated Other Comprehensive Income (Loss) | Cumulative Earnings | Cumulative Distributions to Stockholders | Total Stockholders’ Equity | |||||||||||||||||||||||||||||||||||||||||||||||
| Balance, December 31, 2018 | $ | 977,501 | $ | 2,481 | $ | 4,809,616 | $ | 110,817 | $ | 2,332,371 | $ | (3,978,297) | $ | 4,254,489 | |||||||||||||||||||||||||||||||||||||||
| Cumulative effect of adoption of new accounting principle | — | — | — | — | (442) | — | (442) | ||||||||||||||||||||||||||||||||||||||||||||||
| Adjusted balance, January 1, 2019 | 977,501 | 2,481 | 4,809,616 | 110,817 | 2,331,929 | (3,978,297) | 4,254,047 | ||||||||||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | 323,962 | — | 323,962 | ||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income before reclassifications, net of tax | — | — | — | 796,346 | — | — | 796,346 | ||||||||||||||||||||||||||||||||||||||||||||||
| Amounts reclassified from accumulated other comprehensive income, net of tax | — | — | — | (217,763) | — | — | (217,763) | ||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income, net of tax | — | — | — | 578,583 | — | — | 578,583 | ||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock, net of offering costs | — | 244 | 336,009 | — | — | — | 336,253 | ||||||||||||||||||||||||||||||||||||||||||||||
| Repurchase of common stock | — | — | (19) | — | — | — | (19) | ||||||||||||||||||||||||||||||||||||||||||||||
| Preferred dividends declared | — | — | — | — | — | (75,801) | (75,801) | ||||||||||||||||||||||||||||||||||||||||||||||
| Common dividends declared | — | — | — | — | — | (455,721) | (455,721) | ||||||||||||||||||||||||||||||||||||||||||||||
| Non-cash equity award compensation | — | 4 | 9,158 | — | — | — | 9,162 | ||||||||||||||||||||||||||||||||||||||||||||||
| Balance, December 31, 2019 | $ | 977,501 | $ | 2,729 | $ | 5,154,764 | $ | 689,400 | $ | 2,655,891 | $ | (4,509,819) | $ | 4,970,466 | |||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | (1,630,135) | — | (1,630,135) | ||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income before reclassifications, net of tax | — | — | — | 482,663 | — | — | 482,663 | ||||||||||||||||||||||||||||||||||||||||||||||
| Amounts reclassified from accumulated other comprehensive income, net of tax | — | — | — | (530,462) | — | — | (530,462) | ||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss, net of tax | — | — | — | (47,799) | — | — | (47,799) | ||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock, net of offering costs | — | — | 372 | — | — | — | 372 | ||||||||||||||||||||||||||||||||||||||||||||||
| Repurchase of common stock | — | (1) | (1,063) | — | — | — | (1,064) | ||||||||||||||||||||||||||||||||||||||||||||||
| Preferred dividends declared | — | — | — | — | — | (75,802) | (75,802) | ||||||||||||||||||||||||||||||||||||||||||||||
| Common dividends declared | — | — | — | — | — | (136,842) | (136,842) | ||||||||||||||||||||||||||||||||||||||||||||||
| Non-cash equity award compensation | — | 9 | 9,721 | — | — | — | 9,730 | ||||||||||||||||||||||||||||||||||||||||||||||
| Balance, December 31, 2020 | $ | 977,501 | $ | 2,737 | $ | 5,163,794 | $ | 641,601 | $ | 1,025,756 | $ | (4,722,463) | $ | 3,088,926 | |||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | 187,227 | — | 187,227 | ||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss before reclassifications, net of tax | — | — | — | (319,694) | — | — | (319,694) | ||||||||||||||||||||||||||||||||||||||||||||||
| Amounts reclassified from accumulated other comprehensive income, net of tax | — | — | — | (135,561) | — | — | (135,561) | ||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss, net of tax | — | — | — | (455,255) | — | — | (455,255) | ||||||||||||||||||||||||||||||||||||||||||||||
| Redemption of preferred stock | (274,951) | — | — | — | — | — | (274,951) | ||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock, net of offering costs | — | 700 | 449,902 | — | — | — | 450,602 | ||||||||||||||||||||||||||||||||||||||||||||||
| Preferred dividends declared | — | — | — | — | — | (58,458) | (58,458) | ||||||||||||||||||||||||||||||||||||||||||||||
| Common dividends declared | — | — | — | — | — | (205,623) | (205,623) | ||||||||||||||||||||||||||||||||||||||||||||||
| Non-cash equity award compensation | — | 2 | 11,483 | — | — | — | 11,485 | ||||||||||||||||||||||||||||||||||||||||||||||
| Balance, December 31, 2021 | $ | 702,550 | $ | 3,439 | $ | 5,625,179 | $ | 186,346 | $ | 1,212,983 | $ | (4,986,544) | $ | 2,743,953 | |||||||||||||||||||||||||||||||||||||||
| Preferred Stock | Common Stock Par Value | Additional Paid-in Capital | Accumulated Other Comprehensive Income (Loss) | Cumulative Earnings | Cumulative Distributions to Stockholders | Total Stockholders’ Equity | Non- controlling Interest | Total Equity | |||||||||||||||||||||||||||
| Balance, December 31, 2016 | $ | — | $ | 1,739 | $ | 3,661,711 | $ | 199,227 | $ | 2,038,033 | $ | (2,499,599 | ) | $ | 3,401,111 | $ | — | $ | 3,401,111 | ||||||||||||||||
| Net income | — | — | — | — | 348,571 | — | 348,571 | 3,814 | 352,385 | ||||||||||||||||||||||||||
| Other comprehensive income before reclassifications, net of tax expense of $45,157 | — | — | — | 129,590 | — | — | 129,590 | — | 129,590 | ||||||||||||||||||||||||||
| Amounts reclassified from accumulated other comprehensive income, net of tax benefit of $2,722 | — | — | — | 5,996 | — | — | 5,996 | — | 5,996 | ||||||||||||||||||||||||||
| Other comprehensive income, net of tax expense of $42,435 | — | — | — | 135,586 | — | — | 135,586 | — | 135,586 | ||||||||||||||||||||||||||
| Contribution of TH Commercial Holdings LLC to Granite Point | — | — | (13,771 | ) | — | — | — | (13,771 | ) | 195,646 | 181,875 | ||||||||||||||||||||||||
| Acquisition of noncontrolling interests | — | — | 182 | — | — | — | 182 | (11,542 | ) | (11,360 | ) | ||||||||||||||||||||||||
| Issuance of preferred stock, net of offering costs | 702,537 | — | — | — | — | — | 702,537 | — | 702,537 | ||||||||||||||||||||||||||
| Issuance of common stock, net of offering costs | — | — | 449 | — | — | — | 449 | — | 449 | ||||||||||||||||||||||||||
| Preferred dividends declared | — | — | — | — | — | (25,122 | ) | (25,122 | ) | — | (25,122 | ) | |||||||||||||||||||||||
| Common dividends declared | — | — | — | — | — | (350,709 | ) | (350,709 | ) | (3,177 | ) | (353,886 | ) | ||||||||||||||||||||||
| Special dividend of Granite Point Mortgage Trust Inc. common stock | — | — | 11,267 | — | — | (650,848 | ) | (639,581 | ) | (184,741 | ) | (824,322 | ) | ||||||||||||||||||||||
| Non-cash equity award compensation | — | 6 | 12,165 | — | — | — | 12,171 | — | 12,171 | ||||||||||||||||||||||||||
| Balance, December 31, 2017 | 702,537 | 1,745 | 3,672,003 | 334,813 | 2,386,604 | (3,526,278 | ) | 3,571,424 | — | 3,571,424 | |||||||||||||||||||||||||
| Cumulative effect of adoption of new accounting principle | — | — | 25 | 9,918 | (9,943 | ) | — | — | — | — | |||||||||||||||||||||||||
| Adjusted balance, January 1, 2018 | 702,537 | 1,745 | 3,672,028 | 344,731 | 2,376,661 | (3,526,278 | ) | 3,571,424 | — | 3,571,424 | |||||||||||||||||||||||||
| Net loss | — | — | — | — | (44,290 | ) | — | (44,290 | ) | — | (44,290 | ) | |||||||||||||||||||||||
| Other comprehensive loss before reclassifications, net of tax benefit of $14,890 | — | — | — | (488,253 | ) | — | — | (488,253 | ) | — | (488,253 | ) | |||||||||||||||||||||||
| Amounts reclassified from accumulated other comprehensive income, net of tax benefit of $0 | — | — | — | 254,339 | — | — | 254,339 | — | 254,339 | ||||||||||||||||||||||||||
| Other comprehensive loss, net of tax benefit of $14,890 | — | — | — | (233,914 | ) | — | — | (233,914 | ) | — | (233,914 | ) | |||||||||||||||||||||||
| Acquisition of CYS Investments, Inc. | 274,950 | 726 | 1,124,388 | — | — | — | 1,400,064 | — | 1,400,064 | ||||||||||||||||||||||||||
| Issuance of preferred stock, net of offering costs | 14 | — | — | — | — | — | 14 | — | 14 | ||||||||||||||||||||||||||
| Issuance of common stock, net of offering costs | — | — | 215 | — | — | — | 215 | — | 215 | ||||||||||||||||||||||||||
| Preferred dividends declared | — | — | — | — | — | (65,395 | ) | (65,395 | ) | — | (65,395 | ) | |||||||||||||||||||||||
| Common dividends declared | — | — | — | — | — | (386,624 | ) | (386,624 | ) | — | (386,624 | ) | |||||||||||||||||||||||
| Non-cash equity award compensation | — | 10 | 12,985 | — | — | — | 12,995 | — | 12,995 | ||||||||||||||||||||||||||
| Balance, December 31, 2018 | 977,501 | 2,481 | 4,809,616 | 110,817 | 2,332,371 | (3,978,297 | ) | 4,254,489 | — | 4,254,489 | |||||||||||||||||||||||||
| Cumulative effect of adoption of new accounting principle | — | — | — | — | (442 | ) | — | (442 | ) | — | (442 | ) | |||||||||||||||||||||||
| Adjusted balance, January 1, 2019 | 977,501 | 2,481 | 4,809,616 | 110,817 | 2,331,929 | (3,978,297 | ) | 4,254,047 | — | 4,254,047 | |||||||||||||||||||||||||
| Net income | — | — | — | — | 323,962 | — | 323,962 | — | 323,962 | ||||||||||||||||||||||||||
| Other comprehensive income before reclassifications, net of tax expense of $39 | — | — | — | 796,346 | — | — | 796,346 | — | 796,346 | ||||||||||||||||||||||||||
| Amounts reclassified from accumulated other comprehensive income, net of tax benefit of $0 | — | — | — | (217,763 | ) | — | — | (217,763 | ) | — | (217,763 | ) | |||||||||||||||||||||||
| Other comprehensive income, net of tax expense of $39 | — | — | — | 578,583 | — | — | 578,583 | — | 578,583 | ||||||||||||||||||||||||||
| Issuance of common stock, net of offering costs | — | 244 | 336,009 | — | — | — | 336,253 | — | 336,253 | ||||||||||||||||||||||||||
| Repurchase of common stock | — | — | (19 | ) | — | — | — | (19 | ) | — | (19 | ) | |||||||||||||||||||||||
| Preferred dividends declared | — | — | — | — | — | (75,801 | ) | (75,801 | ) | — | (75,801 | ) | |||||||||||||||||||||||
| Common dividends declared | — | — | — | — | — | (455,721 | ) | (455,721 | ) | — | (455,721 | ) | |||||||||||||||||||||||
| Non-cash equity award compensation | — | 4 | 9,158 | — | — | — | 9,162 | — | 9,162 | ||||||||||||||||||||||||||
| Balance, December 31, 2019 | $ | 977,501 | $ | 2,729 | $ | 5,154,764 | $ | 689,400 | $ | 2,655,891 | $ | (4,509,819 | ) | $ | 4,970,466 | $ | — | $ | 4,970,466 | ||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
64
TWO HARBORS INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| Year Ended | ||||||||||||||||||||
| December 31, | ||||||||||||||||||||
| 2021 | 2020 | 2019 | ||||||||||||||||||
| Cash Flows From Operating Activities: | ||||||||||||||||||||
| Net income (loss) | $ | 187,227 | $ | (1,630,135) | $ | 323,962 | ||||||||||||||
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | ||||||||||||||||||||
| Amortization of premiums and discounts on investment securities, net | 228,344 | 238,840 | 167,097 | |||||||||||||||||
| Amortization of deferred debt issuance costs on term notes payable and convertible senior notes | 2,999 | 2,336 | 1,680 | |||||||||||||||||
| Other-than-temporary impairment losses | — | — | 14,312 | |||||||||||||||||
| Provision for credit losses on investment securities | 9,763 | 58,440 | — | |||||||||||||||||
| Realized and unrealized (gains) losses on investment securities | (131,380) | 941,419 | (280,118) | |||||||||||||||||
| Loss on servicing asset | 114,941 | 935,697 | 697,659 | |||||||||||||||||
| Realized and unrealized (gains) losses on interest rate swaps, caps and swaptions | (27,830) | 244,631 | 178,803 | |||||||||||||||||
| Unrealized gains on other derivative instruments | (5,217) | (25,530) | (34,745) | |||||||||||||||||
| (Gains) losses on mortgage loans held-for-sale | (1,812) | (580) | 669 | |||||||||||||||||
| Equity based compensation | 11,485 | 9,730 | 9,162 | |||||||||||||||||
| Purchases of mortgage loans held-for-sale | (64,008) | — | — | |||||||||||||||||
| Proceeds from sales of mortgage loans held-for-sale | 65,772 | 9,001 | 16,806 | |||||||||||||||||
| Proceeds from repayment of mortgage loans held-for-sale | 8 | 212 | 914 | |||||||||||||||||
| Net change in assets and liabilities: | ||||||||||||||||||||
| Decrease (increase) in accrued interest receivable | 20,908 | 45,460 | (6,045) | |||||||||||||||||
| Decrease (increase) in deferred income taxes, net | 5,960 | (40,267) | (24,912) | |||||||||||||||||
| Decrease in accrued interest payable | (3,284) | (127,960) | (10,379) | |||||||||||||||||
| Change in other operating assets and liabilities, net | 9,634 | (29,691) | 1,772 | |||||||||||||||||
| Net cash provided by operating activities | 423,510 | 631,603 | 1,056,637 | |||||||||||||||||
| Cash Flows From Investing Activities: | ||||||||||||||||||||
| Purchases of available-for-sale securities | (2,494,603) | (7,120,871) | (24,656,050) | |||||||||||||||||
| Proceeds from sales of available-for-sale securities | 6,274,193 | 18,349,338 | 15,879,823 | |||||||||||||||||
| Principal payments on available-for-sale securities | 3,147,647 | 4,239,445 | 3,599,834 | |||||||||||||||||
| Purchases of trading securities | — | (1,052,500) | — | |||||||||||||||||
| Proceeds from sales of trading securities | — | 1,053,477 | — | |||||||||||||||||
| Purchases of mortgage servicing rights, net of purchase price adjustments | (742,153) | (620,394) | (611,765) | |||||||||||||||||
| Proceeds from (payments for) sales of mortgage servicing rights | 31,787 | (2,012) | (1,898) | |||||||||||||||||
| Short sales (purchases) of derivative instruments, net | 51,438 | (29,286) | (76,752) | |||||||||||||||||
| Proceeds from sales and settlement (payments for termination and settlement) of derivative instruments, net | 40,012 | (93,383) | (749,226) | |||||||||||||||||
| Payments for reverse repurchase agreements | (1,174,883) | (2,208,977) | (2,056,825) | |||||||||||||||||
| Proceeds from reverse repurchase agreements | 1,131,726 | 2,337,452 | 2,598,640 | |||||||||||||||||
| Increase (decrease) in due to counterparties, net | 38,773 | 48,921 | (35,100) | |||||||||||||||||
| Change in other investing assets and liabilities, net | 10,000 | 2,508 | 31,575 | |||||||||||||||||
| Net cash provided by (used in) investing activities | $ | 6,313,937 | $ | 14,903,718 | $ | (6,077,744) | ||||||||||||||
| Year Ended | |||||||||||
| December 31, | |||||||||||
| 2019 | 2018 | 2017 | |||||||||
| Cash Flows From Operating Activities: | |||||||||||
| Net income (loss) from continuing operations | $ | 323,962 | $ | (44,290 | ) | $ | 308,239 | ||||
| Adjustments to reconcile net income (loss) from continuing operations to net cash provided by operating activities: | |||||||||||
| Amortization of premiums and discounts on investment securities, net | 167,097 | 93,830 | 67,651 | ||||||||
| Amortization of deferred debt issuance costs on term notes payable and convertible senior notes | 1,680 | 1,029 | 714 | ||||||||
| Other-than-temporary impairment losses | 14,312 | 470 | 789 | ||||||||
| Realized and unrealized (gains) losses on investment securities | (280,118 | ) | 344,468 | 35,401 | |||||||
| Loss on servicing asset | 697,659 | 69,033 | 91,033 | ||||||||
| Gain on residential mortgage loans held-for-investment and collateralized borrowings in securitization trusts | — | — | (22,683 | ) | |||||||
| Realized and unrealized losses on interest rate swaps, caps and swaptions | 178,803 | 33,174 | 930 | ||||||||
| Unrealized (gain) loss on other derivative instruments | (34,745 | ) | 23,489 | 50,099 | |||||||
| Equity based compensation | 9,162 | 12,995 | 11,330 | ||||||||
| Excess consideration in the acquisition of CYS Investments, Inc. | — | 77,602 | — | ||||||||
| Net change in assets and liabilities: | |||||||||||
| (Increase) decrease in accrued interest receivable | (6,045 | ) | 12,366 | (24,689 | ) | ||||||
| (Increase) decrease in deferred income taxes, net | (24,912 | ) | 41,988 | (11,030 | ) | ||||||
| (Decrease) increase in accrued interest payable | (10,379 | ) | 44,820 | 67,118 | |||||||
| Change in other operating assets and liabilities, net | 20,161 | (8,104 | ) | (229 | ) | ||||||
| Net cash provided by operating activities from discontinued operations | — | — | 32,108 | ||||||||
| Net cash provided by operating activities | 1,056,637 | 702,870 | 606,781 | ||||||||
| Cash Flows From Investing Activities: | |||||||||||
| Purchases of available-for-sale securities | (24,656,050 | ) | (12,621,282 | ) | (18,232,105 | ) | |||||
| Proceeds from sales of available-for-sale securities | 15,879,823 | 15,202,406 | 8,708,941 | ||||||||
| Principal payments on available-for-sale securities | 3,599,834 | 2,434,071 | 1,553,051 | ||||||||
| Purchases of mortgage servicing rights, net of purchase price adjustments | (611,765 | ) | (976,393 | ) | (484,261 | ) | |||||
| (Payments for) proceeds from sales of mortgage servicing rights | (1,898 | ) | 637 | 355 | |||||||
| (Purchases) short sales of derivative instruments, net | (76,752 | ) | (83,887 | ) | (103,175 | ) | |||||
| (Payments for termination and settlement) proceeds from sales and settlement of derivative instruments, net | (749,226 | ) | 354,822 | 85,811 | |||||||
| Proceeds from sales of beneficial interests in securitization trusts | — | — | 190,160 | ||||||||
| Proceeds from repayment of residential mortgage loans held-for-investment in securitization trusts | — | — | 332,085 | ||||||||
| Payments for reverse repurchase agreements | (2,056,825 | ) | (4,085,482 | ) | — | ||||||
| Proceeds from reverse repurchase agreements | 2,598,640 | 4,085,127 | — | ||||||||
| Net cash paid for the acquisition of CYS Investments, Inc. | — | (13,552 | ) | — | |||||||
| (Decrease) increase in due to counterparties, net | (35,100 | ) | 449,274 | (805,158 | ) | ||||||
| Change in other investing assets and liabilities, net | 31,575 | 44,257 | 83,976 | ||||||||
| Net cash used in investing activities of discontinued operations | — | — | (813,939 | ) | |||||||
| Net cash (used in) provided by investing activities | $ | (6,077,744 | ) | $ | 4,789,998 | $ | (9,484,259 | ) | |||
The accompanying notes are an integral part of these consolidated financial statements.
TWO HARBORS INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
(in thousands)
| Year Ended | ||||||||||||||||||||
| December 31, | ||||||||||||||||||||
| 2021 | 2020 | 2019 | ||||||||||||||||||
| Cash Flows From Financing Activities: | ||||||||||||||||||||
| Proceeds from repurchase agreements | $ | 29,934,379 | $ | 83,480,699 | $ | 236,071,952 | ||||||||||||||
| Principal payments on repurchase agreements | (37,421,832) | (97,484,264) | (230,057,965) | |||||||||||||||||
| Proceeds from revolving credit facilities | 296,500 | 152,000 | 450,000 | |||||||||||||||||
| Principal payments on revolving credit facilities | (159,569) | (168,170) | (460,000) | |||||||||||||||||
| Proceeds from issuance of term notes payable | — | — | 393,920 | |||||||||||||||||
| Proceeds from issuance of convertible senior notes | 279,930 | — | — | |||||||||||||||||
| Repurchase of convertible senior notes | (143,118) | — | — | |||||||||||||||||
| Proceeds from Federal Home Loan Bank advances | — | 585,000 | 160,000 | |||||||||||||||||
| Principal payments on Federal Home Loan Bank advances | — | (795,000) | (815,024) | |||||||||||||||||
| Redemption of preferred stock | (274,951) | — | — | |||||||||||||||||
| Proceeds from issuance of common stock, net of offering costs | 450,602 | 372 | 336,253 | |||||||||||||||||
| Repurchase of common stock | — | (1,064) | (19) | |||||||||||||||||
| Dividends paid on preferred stock | (63,661) | (75,802) | (75,801) | |||||||||||||||||
| Dividends paid on common stock | (193,488) | (199,487) | (463,147) | |||||||||||||||||
| Net cash (used in) provided by financing activities | (7,295,208) | (14,505,716) | 5,540,169 | |||||||||||||||||
| Net (decrease) increase in cash, cash equivalents and restricted cash | (557,761) | 1,029,605 | 519,062 | |||||||||||||||||
| Cash, cash equivalents and restricted cash at beginning of period | 2,646,431 | 1,616,826 | 1,097,764 | |||||||||||||||||
| Cash, cash equivalents and restricted cash at end of period | $ | 2,088,670 | $ | 2,646,431 | $ | 1,616,826 | ||||||||||||||
| Supplemental Disclosure of Cash Flow Information: | ||||||||||||||||||||
| Cash paid for interest | $ | 81,248 | $ | 404,261 | $ | 720,213 | ||||||||||||||
| Cash (received) paid for taxes, net | $ | (23,322) | $ | 9,574 | $ | 28,202 | ||||||||||||||
| Noncash Activities: | ||||||||||||||||||||
| Cumulative-effect adjustment to equity for adoption of new accounting principle | $ | — | $ | — | $ | 442 | ||||||||||||||
| Dividends declared but not paid at end of period | $ | 72,412 | $ | 65,480 | $ | 128,125 | ||||||||||||||
| Year Ended | |||||||||||
| December 31, | |||||||||||
| 2019 | 2018 | 2017 | |||||||||
| Cash Flows From Financing Activities: | |||||||||||
| Proceeds from repurchase agreements | $ | 236,071,952 | $ | 151,887,922 | $ | 139,559,059 | |||||
| Principal payments on repurchase agreements | (230,057,965 | ) | (156,949,180 | ) | (128,973,036 | ) | |||||
| Principal payments on collateralized borrowings in securitization trusts | — | — | (328,978 | ) | |||||||
| Proceeds from Federal Home Loan Bank advances | 160,000 | — | — | ||||||||
| Principal payments on Federal Home Loan Bank advances | (815,024 | ) | (350,000 | ) | (2,784,976 | ) | |||||
| Proceeds from revolving credit facilities | 450,000 | 397,400 | 123,000 | ||||||||
| Principal payments on revolving credit facilities | (460,000 | ) | (107,400 | ) | (173,000 | ) | |||||
| Proceeds from issuance of term notes payable | 393,920 | — | — | ||||||||
| Proceeds from convertible senior notes | — | — | 282,113 | ||||||||
| Proceeds from issuance of preferred stock, net of offering costs | — | (36 | ) | 702,537 | |||||||
| Proceeds from issuance of common stock, net of offering costs | 336,253 | 215 | 449 | ||||||||
| Repurchase of common stock | (19 | ) | — | — | |||||||
| Dividends paid on preferred stock | (75,801 | ) | (58,394 | ) | (13,173 | ) | |||||
| Dividends paid on common stock | (463,147 | ) | (270,626 | ) | (422,885 | ) | |||||
| Net cash provided by financing activities from discontinued operations | — | — | 1,146,168 | ||||||||
| Net cash provided by (used in) financing activities | 5,540,169 | (5,450,099 | ) | 9,117,278 | |||||||
| Net increase in cash, cash equivalents and restricted cash | 519,062 | 42,769 | 239,800 | ||||||||
| Cash, cash equivalents and restricted cash of continuing operations at beginning of period | 1,097,764 | 1,054,995 | 758,916 | ||||||||
| Cash, cash equivalents and restricted cash of discontinued operations at beginning of period | — | — | 56,279 | ||||||||
| Cash, cash equivalents and restricted cash at beginning of period | 1,097,764 | 1,054,995 | 815,195 | ||||||||
| Cash, cash equivalents and restricted cash at end of period | $ | 1,616,826 | $ | 1,097,764 | $ | 1,054,995 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
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| Year Ended | |||||||||||
| December 31, | |||||||||||
| 2019 | 2018 | 2017 | |||||||||
| Supplemental Disclosure of Cash Flow Information: | |||||||||||
| Cash paid for interest | $ | 720,213 | $ | 419,878 | $ | 227,518 | |||||
| Cash paid (received) for taxes, net | $ | 28,202 | $ | 397 | $ | (856 | ) | ||||
| Noncash Activities: | |||||||||||
| Acquisition of the assets and liabilities of CYS Investments, Inc. | |||||||||||
| Available-for-sale securities | $ | — | $ | 10,034,557 | $ | — | |||||
| Cash and cash equivalents | $ | — | $ | 386 | $ | — | |||||
| Restricted cash | $ | — | $ | 1,062 | $ | — | |||||
| Accrued interest receivable | $ | — | $ | 30,646 | $ | — | |||||
| Reverse repurchase agreements | $ | — | $ | 761,460 | $ | — | |||||
| Other assets | $ | — | $ | 11,977 | $ | — | |||||
| Repurchase agreements | $ | — | $ | (8,743,527 | ) | $ | — | ||||
| Derivative liabilities, net | $ | — | $ | (451,026 | ) | $ | — | ||||
| Due to counterparties, net | $ | — | $ | (279,715 | ) | $ | — | ||||
| Accrued interest payable | $ | — | $ | (27,487 | ) | $ | — | ||||
| Other liabilities | $ | — | $ | (821 | ) | $ | — | ||||
| Issuance of preferred stock in connection with the acquisition of CYS Investments, Inc. | $ | — | $ | 275,000 | $ | — | |||||
| Issuance of common stock in connection with the acquisition of CYS Investments, Inc. | $ | — | $ | 1,125,114 | $ | — | |||||
| Deconsolidation of the assets and liabilities of variable interest entities | |||||||||||
| Residential mortgage loans held-for-investment in securitization trusts | $ | — | $ | — | $ | 2,894,507 | |||||
| Accrued interest receivable | $ | — | $ | — | $ | 15,386 | |||||
| Collateralized borrowings in securitization trusts | $ | — | $ | — | $ | 2,920,970 | |||||
| Accrued interest payable | $ | — | $ | — | $ | 8,271 | |||||
| Accrued expenses and other liabilities | $ | — | $ | — | $ | 10,826 | |||||
| Recognition of beneficial interests in securitization trusts | $ | — | $ | — | $ | 59,826 | |||||
| Distribution of TH Commercial Holdings LLC to Granite Point Mortgage Trust Inc. in exchange for common shares | $ | — | $ | — | $ | 651,000 | |||||
| Distribution of Granite Point Mortgage Trust Inc. common stock | $ | — | $ | — | $ | 650,848 | |||||
| Cumulative-effect adjustment to equity for adoption of new accounting principle | $ | 442 | $ | 9,918 | $ | — | |||||
| Dividends declared but not paid at end of period | $ | 128,125 | $ | 135,551 | $ | 12,552 | |||||
TWO HARBORS INVESTMENT CORP.
Notes to the Consolidated Financial Statements
Note 1. Organization and Operations
Two Harbors Investment Corp., or the Company, is a Maryland corporation investingthat, through its wholly owned subsidiaries (collectively, the Company), invests in and managingmanages Agency residential mortgage-backed securities, or Agency RMBS, non-Agency securities, mortgage servicing rights, or MSR, and other financial assets. The investment portfolio is managed as a whole is managed by the Company’s Co-Chief Investment Officers 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 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.
Through August 14, 2020, the Company was treated asexternally managed and advised by PRCM Advisers LLC, a REIT for U.S. federal income tax purposes. The transaction was approved bysubsidiary of Pine River Capital Management L.P., under the stockholdersterms of botha Management Agreement between the Company and CYS on July 27, 2018,PRCM Advisers. The Company terminated the Management Agreement effective August 14, 2020 for “cause” in accordance with Section 15(a) thereof. On August 15, 2020, the Company completed its transition to self-management and directly hired 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 priorsenior management team and other personnel who had historically provided services 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.Company.
Note 2. Basis of Presentation and Significant Accounting Policies
Consolidation and Basis of Presentation
The accompanying consolidated financial statements include the accounts of all subsidiaries; inter-company accounts and
transactions have been eliminated. The accounting and reporting policies ofAll trust entities in which the Company conform to U.S. generally accepted accounting principles, or U.S. GAAP. 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 17 - Stockholders’ Equity for additional information).
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 in the market, 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.
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Significant Accounting Policies
During the second quarter ofyear ended December 31, 2019, the Company formed a new trust entity, or the MSR Issuer Trust, for the purpose of financing MSR through securitization. On June 27, 2019, the Company, through the MSR Issuer Trust, completed an MSR securitization transaction pursuant to which, through two of the Company’s wholly owned subsidiaries, MSR is pledged to the MSR Issuer Trust and in return, the MSR Issuer Trust issued (a) an aggregate principal amount of $400.0 million in term notes to qualified institutional buyers and (b) a variable funding note, or VFN, with a maximum principal balance of $1.0 billion to one of the subsidiaries, in each case secured on a pari passu basis. The term notes bear interest at a rate equal to one-month LIBOR plus 2.80% per annum. The term notes will mature on June 25, 2024 or, if extended pursuant to the terms of the related indenture supplement, June 25, 2026 (unless earlier redeemed in accordance with their terms).
Both the MSR Issuer Trust and the Servicing Advance Receivables Issuer Trust are considered a VIEVIEs for financial reporting purposes and, thus, waswere reviewed for consolidation under the applicable consolidation guidance. As the Company has both the power to direct the activities of the Issuer Trusttrusts that most significantly impact the entity’sentities’ performance, and the obligation to absorb losses or the right to receive benefits of the entityentities that could be significant, the Company consolidates the trust.trusts.
Available-for-Sale Securities, at Fair Value
The Company invests primarily in mortgage pass-through certificates, collateralized mortgage obligations and other residential mortgage-backed securities representing interests in or obligations backed by pools of mortgage loans issued by a U.S. government sponsored enterprise, or GSE, such as the Federal National Mortgage Association or(or Fannie Mae,Mae) or the Federal Home Loan Mortgage Corporation (or Freddie Mac), or Freddie Mac, anda U.S. government agency such as the Government National Mortgage Association or(or Ginnie Mae, or collectively, the government sponsored entities, or GSEsMae) (collectively “Agency RMBS”). The Company also invests inholds securities that are not issued by the GSEs,a GSE or U.S government agency, or non-Agency securities, and, from time to time, U.S. Treasuries.
The Company classifies its Agency RMBS and non-Agency securities, excluding inverse interest-only Agency securities which are classified as derivatives for purposes of U.S. GAAP, as available-for-sale, or AFS, investments. Although the Company generally intends to hold most of its investment securities until maturity, it may, from time to time, sell any of its investment securities as part of its overall management of its portfolio. Accordingly, the Company classifies all of its securities as AFS, including its interest-only strips, which represent the Company’s right to receive a specified portion of the contractual interest flows of specific Agency or non-Agency securities. All assets classified as AFS, excluding certain Agency interest-only mortgage-backed securities, are reported at estimated fair value with unrealized gains and losses excluding other-than-temporary impairments, included in accumulated other comprehensive income, on an after-tax basis.
On July 1, 2015, the Company elected the fair value option for Agency interest-only securities acquired on or after such date. On July 1, 2021, the Company elected the fair value option for non-Agency interest-only securities acquired on or after such date. All Agency interest-only securities acquired on or after July 1, 2015 and all non-Agency interest-only securities acquired on or after July 1, 2021 are carried at estimated fair value with changes in fair value excluding other-than-temporary impairments, recorded as a component of gain (loss) on investment securities in the consolidated statements of comprehensive income (loss). income.
Fair value is determined under the guidance of Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures, or ASC 820. The Company determines the fair value of its RMBS that are issued or guaranteed as to principal and/or interest by a GSE or U.S. government agency, based upon prices obtained from third-party pricing vendors or broker quotes received using the bid price, which are both deemed indicative of market activity. In determining the fair value of its non-Agency securities, management judgment is used to arrive at fair value that considers prices obtained from third-party pricing vendors, broker quotes received and other applicable market data. If listed price data is not available or insufficient, 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. See Note 10 - Fair Value of these notes to the consolidated financial statements for details on fair value measurement.
Investment securities transactions are recorded on the trade date. The cost basis for realized gains and losses on sales of investment securities are determined on the first-in, first-out, or FIFO, method.
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Interest income (i.e., gross yield/stated coupon) on securities is accrued based on the outstanding principal balance and their contractual terms. Premiums and discounts associated with Agency RMBS and non-Agency securities rated AA and higher at the time of purchase, are amortized intoand accreted, respectively, as an adjustment to interest income over the life of such securities using the contractual method under ASC 310-20, Nonrefundable Fees and Other Costs, which is applied at the individual security level based upon each security’s effective yield method. Adjustments to premium amortization are made for actual prepayment activity.interest rate. The Company estimatescalculates each security’s effective interest rate at the time of purchase by solving for the discount rate that equates the present value of that security's remaining contractual cash flows, assuming no principal prepayments, forto its Agency interest-only securities, which representpurchase price. When applying the Company’s right to receive a specified portioncontractual effective interest method, as principal prepayments occur, an amount of the unamortized premium or discount is recognized in interest income such that the contractual effective interest flows of specific Agency securities. As a result, if prepayments increase (or are expected to increase), the Company will accelerate the rate of amortization on the premiums.remaining security balance is unaffected.
Actual maturities of the AFS securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, and prepayments of principal. Therefore actual maturities of AFS securities are generally shorter than stated contractual maturities. Stated contractual maturities are generally greater than ten years.
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Mortgage Servicing Rights, at Fair Value
The Company’s MSR represent the right to service 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. However, as an owner and manager of MSR, the Company may be obligated to fund advances of principal and interest payments due to third-party owners of the loans, but not yet received from the individual borrowers. These advances are reported as servicing advances within the other assets line item on the consolidated balance sheets.
MSR are reported at fair value on the consolidated balance sheets. Although MSR transactions are observable in the marketplace, the valuation includes unobservable market data inputs (prepayment speeds,speeds; delinquency levels, discount rateslevels; option-adjusted spread, or OAS, which represents the incremental spread added to the risk-free rate to reflect the effects of any embedded options and other risk inherent in MSR; and cost to service). Changes in the fair value of MSR as well as servicing fee income and servicing expenses are reported on the consolidated statements of comprehensive income (loss). income.
Cash and Cash Equivalents
Cash and cash equivalents include cash held in bank accounts and cash held in money market funds on an overnight basis.
Restricted Cash
Restricted cash represents cash balances the Company is required to maintain with counterparties for securities and derivatives trading activity, servicing activities and collateral for the Company’s cash held by counterparties as collateral against the Company’s securities, certain derivative instruments and/or repurchase agreements.borrowings. Also included is the cash balance held pursuant to a letter of credit on the New York office lease. Cash held bybalances required to be maintained with counterparties as collateral, which resides in non-interest bearing accounts, isare not available to the Company for general corporate purposes, but may be applied against amounts due to security, derivative, servicing or repurchasefinancing counterparties or returned to the Company when the collateral requirements are exceeded, or at the maturity of the derivative or repurchase agreement.financing arrangement.
Accrued Interest Receivable
Accrued interest receivable represents interest that is due and payable to the Company. Cash interest is generally received within 30 days of recording the receivable.
Due from/to Counterparties, net
Due from counterparties includes cash held by counterparties for payment of principal and interest as well as cash held by counterparties asfor securities and derivatives trading activity, servicing activities and collateral against certain offor the Company’s derivatives and/or repurchase agreementsborrowings but represents excess capacity and deemed unrestricted and a receivable from the counterparty as of the balance sheet date. Due from counterparties also includes cash receivable from counterparties for sales of MSR pending final transfer and settlement. Due to counterparties includes cash payable by the Company upon settlement of trade positions as well as cash deposited to and held by the Company asfor securities and derivatives trading activity, servicing activities and collateral against certain offor the Company’s derivatives and/or repurchase agreementsborrowings but represents a payable to the counterparty as of the balance sheet date. Due to counterparties also includes purchase price holdbacks on MSR acquisitions for early prepayment or default provisions, collateral exceptions and other contractual terms.
Derivative Financial Instruments, at Fair Value
In accordance with ASC 815, Derivatives and Hedging as amended and interpreted,, or ASC 815, all derivative financial instruments, whether designated for hedging relationships or not, are recorded on the consolidated balance sheets as assets or liabilities and carried at fair value.
At the inception of a derivative contract, the Company determines whether the instrument will be part of a qualifying hedge accounting relationship or whether the Company will account for the contract as a trading instrument. Due to the volatility of the credit markets and difficulty in effectively matching pricing or cash flows, the Company has elected to treat all current derivative contracts as trading instruments. Changes in fair value as well as the accrual and settlement of interest associated with derivatives accounted for as trading instruments are reported in the consolidated statements of comprehensive (loss) income (loss) as gain (loss) gain on interest rate swap, cap and swaption agreements or (loss) gain (loss) on other derivative instruments depending on the type of derivative instrument.
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The Company enters into interest rate derivative contracts for a variety of reasons, including minimizing fluctuations in earnings or market values on certain assets or liabilities that may be caused by changes in interest rates. The Company may, at times, enter into various forward contracts including short securities, Agency to-be-announced securities, or TBAs, options, futures, swaps, and caps. Due to the nature of these instruments, they may be in a receivable/asset position or a payable/liability position at the end of an accounting period. Amounts payable to and receivable from the same party under contracts may be offset as long as the following conditions are met: (a) each of the two parties owes the other determinable amounts; (b) the reporting party has the right to offset the amount owed with the amount owed by the other party; (c) the reporting party intends to offset; and (d) the right of offset is enforceable by law. If the aforementioned conditions are not met, amounts payable to and receivable from are presented by the Company on a gross basis in its consolidated balance sheets. 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, theThe 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 on interest rate swaps as a direct reduction to the carrying value of the interest rate swap asset or liability. As of December 31, 2019 and December 31, 2018, variationVariation margin pledged or received is netted on a counterparty basis and classified within restricted cash, due from counterparties, or due to counterparties on the Company’s consolidated balance sheets.
The Company has provided specific disclosure regarding the location and amounts of derivative instruments in the consolidated financial statements and how derivative instruments and related hedged items are accounted for. See Note 7 - Derivative Instruments and Hedging Activities of these notes to the consolidated financial statements.
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 their contractual amounts, as specified in the respective agreements.
Repurchase Agreements
The Company financesmay finance certain of its investment securities and MSR through the use of repurchase agreements. These repurchase agreements are generally short-term debt, which expire within one year. As of December 31, 2019,At times, certain of the Company’s repurchase agreements hadmay have contractual terms of greater than one year, and, werethus, would be considered long-term debt. Borrowings under repurchase agreements generally bear interest rates ofbased on an index plus a specified margin over one-month LIBORspread and are generally uncommitted. The repurchase agreements are treated as collateralized financing transactions and are carried at their contractual amounts, as specified in the respective agreements.
Revolving Credit Facilities
To finance MSR assets and related servicing advance obligations, the Company enters into revolving credit facilities collateralized by pledged MSR.the value of the MSR and/or servicing advances pledged. Borrowings under these revolving credit facilities that expire within one year are considered short-term debt. As of December 31, 2019,2021, the Company’s revolving credit facilities that had contractual terms of greater than one year were considered long-term debt. The Company’s revolving credit facilities generally bear interest rates ofbased on an index plus a specified margin over one-month LIBOR.spread. Borrowings under revolving credit facilities are treated as collateralized financing transactions and are carried at contractual amounts, as specified in the respective agreements.
Term Notes Payable
Term notes payable related to the Company’s consolidated securitization are recorded at outstanding principal balance, net of any unamortized deferred debt issuance costs, on the Company’s consolidated balance sheets.
Convertible Senior Notes
Convertible senior notes include unsecured convertible debt that are carried at their unpaid principal balance, net of any unamortized deferred issuance costs, on the Company’s consolidated balance sheet. Interest on the notes is payable semiannually until such time the notes mature or are converted into shares of the Company’s common stock.
Accrued Interest Payable
Accrued interest payable represents interest that is due and payable to third parties. Interest is generally paid within 30 days to three months of recording the payable, based upon the Company’s remittance requirements.
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Deferred Tax Assets and Liabilities
Income recognition for U.S. GAAP and tax differ in certain respects. These differences often reflect differing accounting treatments for tax and U.S. GAAP, such as accounting for discount and premium amortization, credit losses, asset impairments, recognition of certain operating expenses and certain valuation estimates. Some of these differences are temporary in nature and create timing mismatches between when taxable income is earned and the tax is paid versus when the earnings (losses) for U.S. GAAP purposes, or GAAP net income (loss), are recognized and the tax provision is recorded. Some of these differences are permanent since certain income (or expense) may be recorded for tax purposes but not for U.S. GAAP purposes (or vice-versa). One such significant permanent difference is the Company’s ability as a REIT to deduct dividends paid to stockholders as an expense for tax purposes, but not for U.S. GAAP purposes.
As a result of these temporary differences, the Company’s TRSs may recognize taxable income in periods prior or subsequent to when it recognizes income for U.S. GAAP purposes. When this occurs, the TRSs pay or defer the tax liability and establish deferred tax assets or deferred tax liabilities, respectively, for U.S. GAAP purposes.
Income Taxes
The Company has elected to be taxed as a REIT under the Code and the corresponding provisions of state law. To qualify as a REIT, the Company must distribute at least 90% of its annual REIT taxable income to stockholders (not including taxable income retained in its taxable subsidiaries) within the time frame set forth in the tax Code and the Company must also meet certain other requirements. In addition, because certain activities, if performed by the Company, may cause the Company to earn income which is not qualifying for the REIT gross income tests, the Company has formed TRSs, as defined in the Code, to engage in such activities. These TRSs’ activities are subject to income taxes as well as any REIT taxable income not distributed to stockholders.
The Company assesses its tax positions for all open tax years and determines whether the Company has any material unrecognized liabilities in accordance with ASC 740, Income Taxes, or ASC 740. The Company records these liabilities to the extent the Company deems them more likely than not to be incurred. The Company classifies interest and penalties on material uncertain tax positions as interest expense and operating expense, respectively, in its consolidated statements of comprehensive income (loss). income.
Expenses on the consolidated statements of comprehensive (loss) income typically consist of management fees, servicing expenses generally related to the subservicing of MSR, compensation and benefits and other operating expenses. Prior to the termination of the Tax CutsManagement Agreement on August 14, 2020, management fees were payable to PRCM Advisers under the agreement. The management fee was calculated based on the Company’s stockholders’ equity with certain adjustments outlined in the management agreement (see Note 21 - Related Party Transactions for further detail). Also prior to the termination of the Management Agreement, included in compensation and Jobs Actbenefits and other operating expenses were direct and allocated costs incurred by PRCM Advisers on the Company’s behalf and reimbursed by the Company. Included in these reimbursed costs was (a) the Company’s allocable share of 2017 (“TCJA”),the compensation paid by PRCM Advisers to its personnel serving as the Company’s principal financial officer and general counsel and personnel employed by PRCM Advisers as in-house legal, tax, accounting, consulting, auditing, administrative, information technology, valuation, computer programming and development and back-office resources to the Company, (b) any amounts for personnel of PRCM Advisers’ affiliates arising under a shared facilities and services agreement, and (c) certain costs allocated to the Company by PRCM Advisers for data services and technology. Subsequent to the transition to self-management, the Company no longer pays a management fee to, or reimburses the expenses of, PRCM Advisers. Expenses for which the Company previously reimbursed PRCM Advisers are now borne directly by the Company. The Company is also now responsible for the cash compensation and employee benefits of the Company’s Chief Executive Officer, Chief Investment Officer and investment professionals, which were previously the responsibility of PRCM Advisers. Prior to the termination of the Management Agreement, the Company was signed into law on December 22, 2017 significantly revisedonly responsible for the U.S. corporate income tax by, among other things, lowering the federal income tax rate applicable to corporations from 35% to 21% and repealing the corporate alternative minimum tax. In addition, the deduction of net interest expense is limited for all businesses; provided that certain businesses, including real estate businesses, may elect not to be subjectequity compensation paid to such limitations and insteadindividuals.
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TWO HARBORS INVESTMENT CORP.
Notes to depreciate their real property related assets over longer depreciable lives. This limitation could adversely affect our TRSs.the Consolidated Financial Statements
Other Comprehensive Income (Loss)
Current period net unrealized gains and losses on AFS securities, excluding Agency interest-only securities, are reported as components of accumulated other comprehensive income on the consolidated statements of stockholders’ equity and in the consolidated statements of comprehensive income (loss). income. Net unrealized gains and losses on securities held by our taxable subsidiaries that are reported in accumulated other comprehensive income are adjusted for the effects of taxation and may create deferred tax assets or liabilities.
Earnings Per Share
Basic earnings (loss) per share areis computed by dividing net income (loss) attributable to common stockholders, less income allocated to participating securities pursuant to the two-class method, by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed by dividing basic net income (loss) attributable to common stockholders by the weighted average number of common shares and potential common shares outstanding during the period. For both basicperiod, further adjusted for the dilutive effect, if any, of share-based payment awards and diluted per share calculations, potential common shares represents issued and unvested shares of restricted stock, which have full rights to the common stock dividend declarations of the Company. If the assumed conversion of convertible notes into common shares is dilutive,shares.
Unvested equity-based awards are included in the calculation of diluted earnings (loss) per share under either the two-class method or the treasury stock method, depending upon which method produces the more dilutive result. The two-class method is adjustedan earnings allocation formula under which earnings (loss) per share is calculated for common stock and participating securities according to dividends declared and participating rights in undistributed earnings. Under this method, all earnings (distributed and undistributed) are allocated between participating securities and common shares based on their respective rights to receive dividends or dividend equivalents. Under the treasury stock method, common equivalent shares are calculated assuming that any share-based payment awards vest according to their respective agreements and unrecognized compensation cost is used to repurchase shares of the Company’s outstanding common stock at the average market price during the reported period. Under the if-converted method, the assumed conversion of each convertible note into common shares is calculated by adding back the respective periodic interest expense (net of any tax effects) associated with dilutive convertible notes to net income (loss) attributable to common stockholders and adding the shares issued in an assumed conversion to the diluted weighted average share count. 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 17 - Stockholders’ Equity for additional information).
Equity Incentive PlanPlans
The Company’s Second Restated 2009 Equity Incentive Plan, or the 2009 Plan, providesand the Company’s 2021 Equity Incentive Plan, or the 2021 Plan, or collectively, the Equity Incentive Plans, provide incentive compensation to attract and retain qualified directors, officers, advisors, consultantspersonnel and other personnel, including PRCM Advisers and its affiliates.parties who may provide significant services to the Company. The Plan isEquity Incentive Plans are administered by the compensation committee of the Company’s board of directors. The Plan permitsEquity Incentive Plans permit the grantinggrants of restricted shares of common stock, restricted stock units, or RSUs, performance-based awards (including performance share units, or PSUs), phantom shares, dividend equivalent rights and other equity-based awards. See Note 1817 - Equity Incentive PlanPlans for further details regarding the Plan.Equity Incentive Plans.
Equity-based compensation costs are initially measured at the estimated fair value of the awards on the grant date. Valuation methods used and subsequent expense recognition is dependent upon each award’s service and performance conditions. The cost ofCompany has elected not to estimate forfeitures when valuing equity-based awards and adjusts compensation awardedcosts as actual forfeitures occur. Compensation costs for equity-based awards subject only to employees provided by our manager isservice conditions are measured at the closing stock price on the grant date and fixedare recognized as expense on a straight-line basis over the requisite service periods for the awards, adjusted for any forfeitures. Compensation costs for equity-based awards subject to market-based performance metrics are measured at the grant date basedusing Monte Carlo simulations which incorporate assumptions for stock return volatility, dividend yield and risk-free interest rates. These initial valuation amounts are recognized as expense over the requisite performance periods, subject to adjustments only for actual forfeitures. Amortization of equity-based awards (non-cash equity compensation expense) is included within compensation and benefits on the priceconsolidated statements of the Company’s stock as of period end and amortized over the vesting term. Prior to the early adoption of Accounting Standards Update (ASU) No. 2018-07, Improvements to Nonemployee Share-Based Payment Accounting, on July 1, 2018 (applied by recording a cumulative-effect adjustment to cumulative 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), the cost of equity-based compensation awarded to employees provided by our manager was measured at fair value at each reporting date based on the price of the Company’s stock as of period end and amortized over the vesting term.
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Recently Issued and/or Adopted Accounting Standards
Measurement of Credit Losses on Financial Instruments
On January 1, 2020, the Company will adoptadopted ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which changeschanged the impairment model for most financial assets and certain other instruments. Valuation allowancesAllowances for credit losses on AFS debt securities will beare 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.
The Company will useuses a discounted cash flow method to estimate and recognize an allowance for credit losses on AFS securities. The estimated allowance for credit losses will beis equal to the difference between the prepayment adjusted contractual cash flows with no credit losses and the prepayment adjusted expected cash flows with credit losses, discounted at the effective interest rate on the AFS security that iswas in effect upon adoption of the standard. The contractual cash flows and expected cash flows will beare based on management’s best estimate and take into consideration current prepayment assumptions, lifetime expected losses based on past loss experience, current market conditions, and reasonable and supportable forecasts of future conditions. The allowance for credit losses is expected tocauses an increase in the AFS security amortized cost and recognizerecognizes an allowance for credit losses in the same amount. AnyThe allowance for credit losses recognized in connection with adopting the guidance in Topic 326 that is different fromon January 1, 2020 was equal to the currentpresent value of the credit reserve will be recognized asin place on December 31, 2019. As a result, no cumulative effect adjustment to opening cumulative earnings. The Company has determined that the adoption will have no impact to cumulative earnings as of January 1, 2020.
The adoption of this ASU will impactimpacts the Company’s accounting for the purchase of certain beneficial interests with purchased credit deterioration or when there is a “significant” difference between contractual cash flows and expected cash flows. For these securities, the Company will recordrecords an allowance for credit losses with an increase in amortized cost above the purchase price of the same amount. Subsequent adverse or favorable changes in expected cash flows will beare recognized immediately in earnings as a provision for or reduction inreversal of provision for credit losses, respectively. Adverse changes will beare reflected as an increase to the allowance for credit losses and favorable changes will beare reflected as a decrease to the allowance for credit losses. The allowance for credit losses is limited to the difference between the beneficial interest’s fair value and its amortized cost, and any remaining adverse changes in these circumstances are reflected as a prospective adjustment to accretable yield. If the allowance for credit losses has been reduced to zero, the remaining favorable changes are reflected as a prospective adjustment to accretable yield. The Company willdoes not adjust the effective interest rate in subsequent periods for prepayment assumption changes and the Company will not adjust the effective interest rate in subsequent periods foror variable-rate changes. Any changes in the allowance for credit losses due to the time-value-of-money will beare accounted for in the consolidated statements of comprehensive (loss) income statement as provision for credit loss expenselosses rather than a reduction to interest income. Any portion of the AFS securities that is deemed uncollectible results in a write-off of the uncollectible amortized cost with a corresponding reduction to the allowance for credit losses. Recoveries of amounts previously written off results in an increase to the allowance for credit losses.
The Company expects the standard to applyapplies to Agency and non-Agency securities that are accounted for as beneficial interests under ASCAccounting Standards Codification (ASC) 325-40, Investments-Other: Beneficial Interests in Securitized Financial Assets, or ASC 325-40, and ASC 310-30, Receivables: Loans and Debt Securities Acquired with Deteriorated Credit Quality, or ASC 310-30. Only beneficial interests that were previouspreviously accounted for as purchased credit impaired under ASC 310-30 will bewere accounted for as purchased credit deteriorated under Topic 326 on the transition date.
The Company will useused a prospective transition approach for debt securities for which OTTI had been recognized prior to January 1, 2020. As a result, the amortized cost basis remainsremained the same before and after the effective date. The effective interest rate on these debt securities will not be changed.also remained unchanged. Amounts previously recognized in accumulated other comprehensive income as of January 1, 2020 relating to improvements in cash flows expected to be collected will beare accreted into income over the remaining life of the asset. Recoveries of amounts previously written off relating to improvements in cash flows after January 1, 2020 will beare recorded in earnings when received.
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Facilitation of the Effects of Reference Rate Reform on Financial Reporting
London Interbank Offered Rate, or LIBOR, has been used extensively in the U.S. and globally as a “benchmark” or “reference rate” for various commercial and financial contracts, including corporate and municipal bonds and loans, floating rate mortgages, asset-backed securities, consumer loans, and interest rate swaps and other derivatives. On March 5, 2021, Intercontinental Exchange Inc. announced that ICE Benchmark Administration Limited, the administrator of LIBOR, intends to stop publication of the majority of USD-LIBOR tenors on June 30, 2023. In the U.S., the Alternative Reference Rates Committee, or ARRC, has identified the Secured Overnight Financing Rate, or SOFR, as its preferred alternative rate for U.S. dollar-based LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. The ARRC has proposed a paced market transition plan to SOFR, and various organizations are currently working on industry wide and company-specific transition plans as it relates to derivatives and cash markets exposed to LIBOR.
In March 2020, the FASB issued ASU No. 2020-04, which provides temporary optional expedients and exceptions on accounting for contract modifications and hedging relationships in anticipation of the replacement of the LIBOR with another reference rate. The guidance also provides a one-time election to sell held-to-maturity debt securities or to transfer such securities to the available-for-sale or trading category. The Company has developed new processes, policiesmaterial contracts that are indexed to USD-LIBOR and controlsis monitoring this activity, evaluating the related risks and the Company’s exposure, and has already amended terms to implementtransition to an alternative benchmark, where necessary. All of the standardCompany’s financing arrangements and performed testsderivative instruments that incorporate LIBOR as the referenced rate either mature prior to validate the internally developed cash flow models.phase out of LIBOR or have provisions in place that provide for an alternative to LIBOR upon its phase-out. Additionally, each series of the Company’s fixed-to-floating preferred stock that becomes callable at the time the stock begins to pay a LIBOR-based rate has existing LIBOR cessation fallback language. The processes, policies, controls and model validation were completed by the adoption date.
In August 2020, the FASB issued ASU No. 2020-06 to simplify an issuer’s accounting for convertible instruments and its application of the derivatives scope exception for contracts in its own equity. Under the new guidance, only conversion features associated with a convertible debt instrument issued at a substantial premium and those that are considered embedded derivatives in accordance with derivatives guidance will be accounted for separate from the convertible instrument. Additionally, for contracts in an entity’s own equity, the new guidance eliminates some of the requirements for equity classification. The guidance also addresses how convertible instruments are accounted for in the diluted earnings per share calculation and requires enhanced disclosures about the terms of convertible instruments and contracts in an entity’s own equity. The ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2021, with early adoption permitted. The early adoption of the ASU’s guidance results in the Company accounting for a convertible debt instrument without separately presenting in stockholders’ equity an embedded conversion feature. The Company accounts for a convertible debt instrument wholly as debt unless (a) a convertible instrument contains features that require bifurcation as a derivative under ASC 815, Derivatives and Hedging, or ASC 815, or (b) a convertible debt instrument was issued at a substantial premium. The Company’s early adoption of this ASU did not have an impact on the Company’s financial condition, results of operations or financial statement disclosures.
Note 3. Variable Interest Entities
During the year ended December 31, 2020, the Company formed a trust entity, or the Servicing Advance Receivables Issuer Trust, for the purpose of financing servicing advances through a revolving credit facility, pursuant to which the Servicing Advance Receivables Issuer Trust issued a VFN backed by servicing advances pledged to the financing counterparty.
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Both the MSR Issuer Trust and Significant Accounting Policies) isthe Servicing Advance Receivables Issuer Trust are considered a VIEVIEs for financial reporting purposes and, thus, waswere reviewed for consolidation under the applicable consolidation guidance. As the Company has both the power to direct the activities of the Issuer Trusttrusts that most significantly impact the entity’sentities’ performance, and the obligation to absorb losses or the right to receive benefits of the entityentities that could be significant, the Company consolidates the trust.trusts. Additionally, in accordance with arrangements entered into in connection with the securitization transaction and the servicing advance revolving credit facility, the Company has direct financial obligations payable to both the MSR Issuer Trust and the Servicing Advance Receivables Issuer Trust, which, in turn, support the MSR Issuer Trust’s obligations to noteholders under the securitization transaction.
The following table presents a summary of the assets and liabilities of all consolidated trusts as reported on the consolidated balance sheets as of December 31, 20192021 and December 31, 2018:2020:
| (in thousands) | December 31, 2021 | December 31, 2020 | |||||||||
Note receivable (1) | $ | 396,776 | $ | 395,609 | |||||||
| Restricted cash | 23,892 | 72,530 | |||||||||
Accrued interest receivable (1) | 161 | 131 | |||||||||
| Other assets | 33,767 | 28,540 | |||||||||
| Total Assets | $ | 454,596 | $ | 496,810 | |||||||
| Term notes payable | $ | 396,776 | $ | 395,609 | |||||||
| Revolving credit facilities | 19,200 | 9,000 | |||||||||
| Accrued interest payable | 216 | 156 | |||||||||
| Other liabilities | 23,838 | 72,505 | |||||||||
| Total Liabilities | $ | 440,030 | $ | 477,270 | |||||||
| (in thousands) | December 31, 2019 | December 31, 2018 | |||||
Note receivable (1) | $ | 394,502 | $ | — | |||
| Cash and cash equivalents | 200 | — | |||||
Accrued interest receivable (1) | 306 | — | |||||
| Total Assets | $ | 395,008 | $ | — | |||
| Term notes payable | $ | 394,502 | $ | — | |||
| Accrued interest payable | 306 | — | |||||
| Other liabilities | 200 | — | |||||
| Total Liabilities | $ | 395,008 | $ | — | |||
(1)Receivables due from a wholly owned subsidiary of the Company to the trusts are eliminated in consolidation in accordance with U.S. GAAP.
Note 4. Available-for-Sale Securities, at Fair Value
The Company holds both Agency and non-Agency AFS investment securities which are carried at fair value on the consolidated balance sheets. The following table presents the Company’s AFS investment securities by collateral type as of December 31, 20192021 and December 31, 2018:2020:
| (in thousands) | December 31, 2021 | December 31, 2020 | |||||||||
| Agency: | |||||||||||
| Federal National Mortgage Association | $ | 5,040,988 | $ | 11,486,658 | |||||||
| Federal Home Loan Mortgage Corporation | 1,922,809 | 2,837,103 | |||||||||
| Government National Mortgage Association | 185,602 | 314,130 | |||||||||
| Non-Agency | 12,304 | 13,031 | |||||||||
| Total available-for-sale securities | $ | 7,161,703 | $ | 14,650,922 | |||||||
| (in thousands) | December 31, 2019 | December 31, 2018 | |||||
| Agency | |||||||
| Federal National Mortgage Association | $ | 21,252,575 | $ | 15,812,696 | |||
| Federal Home Loan Mortgage Corporation | 6,070,500 | 4,930,963 | |||||
| Government National Mortgage Association | 454,980 | 941,374 | |||||
| Non-Agency | 3,628,273 | 3,867,571 | |||||
| Total available-for-sale securities | $ | 31,406,328 | $ | 25,552,604 | |||
At December 31, 20192021 and December 31, 2018,2020, the Company pledged AFS securities with a carrying value of $29.8$7.0 billion and $25.2$14.6 billion, respectively, as collateral for repurchase agreements and advances from the Federal Home Loan Bank of Des Moines, or the FHLB.agreements. See Note 11 - Repurchase Agreementsand Note 12 - Federal Home Loan Bank of Des Moines Advances.
At December 31, 20192021 and December 31, 2018,2020, the Company did not have any securities purchased from and financed with the same counterparty that did not meet the conditions of Accounting Standards Codification (ASC)ASC 860,Transfers and Servicing, to be considered linked transactions and, therefore, classified as derivatives.
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The Company is not required to consolidate variable interest entities, or 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 consolidated balance sheets. As of December 31, 20192021 and December 31, 2018,2020, the carrying value, which also represents the maximum exposure to loss, of all non-Agency securities in unconsolidated VIEs was $3.6 billion$12.3 million and $3.9 billion,$13.0 million, respectively.
The following tables present the amortized cost and carrying value of AFS securities by collateral type as of December 31, 20192021 and December 31, 2018:2020:
| December 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| (in thousands) | Principal/ Current Face | Un-amortized Premium | Accretable Purchase Discount | Amortized Cost | Allowance for Credit Losses | Unrealized Gain | Unrealized Loss | Carrying Value | |||||||||||||||||||||||||||||||||||||||||||||
| Agency: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Principal and interest | $ | 6,411,363 | $ | 270,699 | $ | (12) | $ | 6,682,050 | $ | — | $ | 171,308 | $ | (4,855) | $ | 6,848,503 | |||||||||||||||||||||||||||||||||||||
| Interest-only | 3,198,447 | 305,577 | — | 305,577 | (12,851) | 20,699 | (12,529) | 300,896 | |||||||||||||||||||||||||||||||||||||||||||||
| Total Agency | 9,609,810 | 576,276 | (12) | 6,987,627 | (12,851) | 192,007 | (17,384) | 7,149,399 | |||||||||||||||||||||||||||||||||||||||||||||
| Non-Agency | 1,940,815 | 16,533 | (27) | 17,386 | (1,387) | 33 | (3,728) | 12,304 | |||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 11,550,625 | $ | 592,809 | $ | (39) | $ | 7,005,013 | $ | (14,238) | $ | 192,040 | $ | (21,112) | $ | 7,161,703 | |||||||||||||||||||||||||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (in thousands) | (in thousands) | Principal/ Current Face | Un-amortized Premium | Accretable Purchase Discount | Amortized Cost | Allowance for Credit Losses | Unrealized Gain | Unrealized Loss | Carrying Value | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Agency: | Agency: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Principal and interest | Principal and interest | $ | 13,103,355 | $ | 605,253 | $ | (14) | $ | 13,708,594 | $ | — | $ | 629,079 | $ | (420) | $ | 14,337,253 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-only | Interest-only | 3,649,556 | 315,876 | — | 315,876 | (17,889) | 15,680 | (13,029) | 300,638 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total Agency | Total Agency | 16,752,911 | 921,129 | (14) | 14,024,470 | (17,889) | 644,759 | (13,449) | 14,637,891 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| December 31, 2019 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (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 | $ | 26,239,544 | $ | 986,343 | $ | (19 | ) | $ | — | $ | 27,225,868 | $ | 424,818 | $ | (8,815 | ) | $ | 27,641,871 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-only | 2,601,693 | 169,811 | — | — | 169,811 | 13,724 | (47,351 | ) | 136,184 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total Agency | 28,841,237 | 1,156,154 | (19 | ) | — | 27,395,679 | 438,542 | (56,166 | ) | 27,778,055 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Non-Agency | Non-Agency | 2,095,365 | 16,408 | (36) | 18,705 | (4,639) | 109 | (1,144) | 13,031 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Principal and interest | 5,498,654 | 8,980 | (560,140 | ) | (1,711,951 | ) | 3,235,543 | 341,583 | (23,263 | ) | 3,553,863 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-only | 4,356,603 | 79,935 | — | — | 79,935 | 3,039 | (8,564 | ) | 74,410 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total Non-Agency | 9,855,257 | 88,915 | (560,140 | ) | (1,711,951 | ) | 3,315,478 | 344,622 | (31,827 | ) | 3,628,273 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 38,696,494 | $ | 1,245,069 | $ | (560,159 | ) | $ | (1,711,951 | ) | $ | 30,711,157 | $ | 783,164 | $ | (87,993 | ) | $ | 31,406,328 | Total | $ | 18,848,276 | $ | 937,537 | $ | (50) | $ | 14,043,175 | $ | (22,528) | $ | 644,868 | $ | (14,593) | $ | 14,650,922 | ||||||||||||||||||||||||||||||||||||||||||||||||
| December 31, 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 | $ | 20,775,790 | $ | 1,037,781 | $ | (25,085 | ) | $ | — | $ | 21,788,486 | $ | 61,128 | $ | (339,997 | ) | $ | 21,509,617 | |||||||||||||
| Interest-only | 3,115,967 | 209,901 | — | — | 209,901 | 14,170 | (48,655 | ) | 175,416 | ||||||||||||||||||||||
| Total Agency | 23,891,757 | 1,247,682 | (25,085 | ) | — | 21,998,387 | 75,298 | (388,652 | ) | 21,685,033 | |||||||||||||||||||||
| Non-Agency | |||||||||||||||||||||||||||||||
| Principal and interest | 5,360,124 | 6,682 | (694,119 | ) | (1,322,762 | ) | 3,349,925 | 478,095 | (44,657 | ) | 3,783,363 | ||||||||||||||||||||
| Interest-only | 5,137,169 | 83,846 | — | — | 83,846 | 3,655 | (3,293 | ) | 84,208 | ||||||||||||||||||||||
| Total Non-Agency | 10,497,293 | 90,528 | (694,119 | ) | (1,322,762 | ) | 3,433,771 | 481,750 | (47,950 | ) | 3,867,571 | ||||||||||||||||||||
| Total | $ | 34,389,050 | $ | 1,338,210 | $ | (719,204 | ) | $ | (1,322,762 | ) | $ | 25,432,158 | $ | 557,048 | $ | (436,602 | ) | $ | 25,552,604 | ||||||||||||
| December 31, 2019 | |||||||||||
| (in thousands) | Agency | Non-Agency | Total | ||||||||
| Adjustable Rate | $ | 14,584 | $ | 3,344,287 | $ | 3,358,871 | |||||
| Fixed Rate | 27,763,471 | 283,986 | 28,047,457 | ||||||||
| Total | $ | 27,778,055 | $ | 3,628,273 | $ | 31,406,328 | |||||
| December 31, 2018 | |||||||||||
| (in thousands) | Agency | Non-Agency | Total | ||||||||
| Adjustable Rate | $ | 19,073 | $ | 3,475,171 | $ | 3,494,244 | |||||
| Fixed Rate | 21,665,960 | 392,400 | 22,058,360 | ||||||||
| Total | $ | 21,685,033 | $ | 3,867,571 | $ | 25,552,604 | |||||
The following table presents the Company’s AFS securities according to their estimated weighted average life classifications as of December 31, 2019:2021:
| December 31, 2021 | |||||||||||||||||
| (in thousands) | Agency | Non-Agency | Total | ||||||||||||||
| < 1 year | $ | 2,367 | $ | — | $ | 2,367 | |||||||||||
| ≥ 1 and < 3 years | 91,141 | 1,335 | 92,476 | ||||||||||||||
| ≥ 3 and < 5 years | 3,572,838 | 1,364 | 3,574,202 | ||||||||||||||
| ≥ 5 and < 10 years | 3,482,051 | 9,605 | 3,491,656 | ||||||||||||||
| ≥ 10 years | 1,002 | — | 1,002 | ||||||||||||||
| Total | $ | 7,149,399 | $ | 12,304 | $ | 7,161,703 | |||||||||||
| December 31, 2019 | |||||||||||
| (in thousands) | Agency | Non-Agency | Total | ||||||||
| < 1 year | $ | 380 | $ | 41,192 | $ | 41,572 | |||||
| ≥ 1 and < 3 years | 57,403 | 191,255 | 248,658 | ||||||||
| ≥ 3 and < 5 years | 3,071,314 | 211,767 | 3,283,081 | ||||||||
| ≥ 5 and < 10 years | 24,357,478 | 2,780,858 | 27,138,336 | ||||||||
| ≥ 10 years | 291,480 | 403,201 | 694,681 | ||||||||
| Total | $ | 27,778,055 | $ | 3,628,273 | $ | 31,406,328 | |||||