Two Harbors Investment Corp. (NYSE: TWO) is a mortgage REIT, or real estate investment trust, that focuses on residential loans, and like with most mortgage REITs, the past year or so has been a volatile one. In this article, we'll dig into the company's business, the recent developments investors should be aware of, its performance history, and more.
Two Harbors company profile
Two Harbors Investment Corp. is a mortgage REIT that primarily invests in mortgages, mortgage-backed securities, and other mortgage-related financial instruments. The company specializes in residential mortgage assets, and its primary goal is to generate income, with a secondary goal of delivering stock price appreciation. Two Harbors is the fourth-largest mortgage REIT by total assets and the fifth-largest by equity, as of the end of 2020.
The company's portfolio consists of two main types of investments:
- First, it invests in agency-backed residential mortgage-backed securities, or Agency RMBSs. These are mortgage securities whose principal and interest payments are guaranteed by government agencies such as Fannie Mae, Freddie Mac, and Ginnie Mae.
- Second, Two Harbors invests in mortgage servicing rights, or MSRs. As of December 31, 2020, Two Harbors had mortgage servicing rights on nearly $186 billion in unpaid mortgage balances.
If you aren't familiar with the general mortgage REIT business model, these businesses typically borrow money on a short-term basis and buy mortgage assets that pay higher, long-term interest rates. And the difference between the two is the profit margin. For example, if a mortgage REIT borrows money at 1% interest and owns a mortgage with a 3% interest rate, the 2% difference is where the company makes its money.
Since investors aren't typically happy with a 2% return, mortgage REITs tend to use large amounts of leverage to boost returns. As of the end of 2020, Two Harbors has a leverage ratio of 6.8-to-one, which means for every $1 million in equity, the company has $6.8 million in debt. To be clear, this is quite normal for a mortgage REIT, but it does add to the volatility in these stocks, so it's important for investors to understand.
Two Harbors' combination of agency RMBSs plus a portfolio of MSRs helps hedge against rising interest rates. Since mortgage REITs borrow money at short-term rates, rising interest rates can reduce the profit margins on mortgage-backed security investments. Conversely, refinancing and prepayment risk drops when rates rise, which makes MSR investments more valuable. To be sure, rising rates are still generally negative for mortgage rates (especially if rates spike higher), but this does help offset the risk considerably.
Two Harbors has been a public company since 2009, and interestingly, it went public through a SPAC merger. So if you thought SPACs were a completely new phenomenon, think again. While their popularity certainly surged in 2020, special purpose acquisition companies have been around for some time. Specifically, Two Harbors went public when merged with a blank check company run by investor Mark Ein.
Two Harbors news
By far, the top news item Two Harbors investors should be aware of is the COVID-19 pandemic and how it affected the business.
To make a long story short, when the COVID-19 pandemic first hit, it caused a panic in the financial markets, and that included mortgages. Nobody knew if Americans would be able to repay their mortgages during shutdowns, and this was before the CARES Act gave protections to homeowners.
So, the value of mortgage assets plunged. And because mortgage REITs use lots of leverage, their lenders were concerned and in many cases started to make margin calls (demands to be repaid right away). This resulted in the need for mortgage REITs to sell assets at fire-sale prices and suffer big losses.
For example, in a March 25, 2020, update, Two Harbors announced that it had sold its entire portfolio of non-agency MBSs to reduce margin call risk. Remember, even after the CARES Act, most consumer protections only applied to agency loans. Two Harbors also said that its book value had plummeted by 55% since the beginning of the year. The portfolio and the stock stabilized soon after, but the damage had been done. By the end of the year, the book value of Two Harbors' assets had started to rebound but was still 44% lower than it was at the end of 2019.
Aside from the COVID-19 pandemic, two other recent developments worth noting include the company's transition to self-management and a major leadership change.
First, Two Harbors decided to terminate its management agreement with external firm PRCM Advisers in July 2020 and become a self-managed company.
Two Harbors also had a recent management shake-up, with former co-chief investment officer Bill Greenberg taking over as CEO in June 2020 and the company's other former co-chief investment officer, Matt Koeppen, taking over the CIO role. These moves were made to help the company transition to self-management.
Two Harbors stock price
At first glance, it might not look like Two Harbors has been a great stock to own. Since its 2009 IPO, the stock price has dropped by more than 50% as of March 2021, compared with a 265% rise in the S&P 500 during that time.
However, there are two big caveats:
- First, Two Harbors is primarily an income investment and has yielded more than 10% for much of its history. When you include dividend payments, it's a different story, as you'll see in a bit.
- Second, like all mortgage REITs, Two Harbors was heavily impacted by the COVID-19 pandemic, as discussed in the last section. Prior to the pandemic, Two Harbors' stock price was actually higher for its history.
With those two things in mind, here's a look at Two Harbors' total return (dividends plus stock price) for certain time periods, compared with the S&P 500.