Two Harbors Investment Corp. (TWO) Earnings Call Transcript & Summary

Good afternoon, everybody. This is Steve Glener at IMN. And I would like to thank you for joining us for another webinar from our Mortgage Servicing Rights webinar series. This is our June update. We have a wonderful group of experts lined up to address the issues. I would like to thank them for agreeing to share their expertise with us. We have a real lot of interesting content today. So let's briefly go over the webinar schedule. From 2 to 2:30, we'll be hosting an overview of the most recent developments in MSR and mortgage markets with Doug Harter from Crédit Suisse, Larry Goldstone from BSI, Jay Lown from Cherry Hill Mortgage Investment and Bill Greenberg with Two Harbors. At 2:33, we'll be talking about some of the opportunities for investors now with Alan Qureshi at Blue Water Financial, Mike Nedzbala at Hunton Andrews Kurth, Brent Nyitray at Ark Mortgage and Nicholas Smith with Rice Park Capital. And from 3 to 3:30, we'll have the session on selecting co-issuer's new buyer takeout with Nitin Dave with Nationwide Mortgage Bankers, Emanuel Santa-Donato with Better.com, Travis LaMar of Blue Water Financial Technologies and Hakan Beygo with Freddie Mac. Before I introduce the first session and hand things over to Doug, I have a few quick housekeeping items I'd like to cover. Many of you will be familiar with the functionality of Zoom and similar online conferencing platforms, but please bear with me as there will be some who are not. [Operator Instructions] The moderators and I will be monitoring this, and we'll ask audience questions throughout the webinar. The webinar will be recorded and shared with you in a follow-up e-mail from IMN tomorrow. There will also be a short survey in your browser when you leave this webinar, and we would greatly appreciate it if you could spend a couple of minutes completing this. Without further ado, I would like to hand things over to Doug Harter, who will be moderating the discussion. Doug is a Director at Crédit Suisse. Take it away, Doug.

Thanks, Steve. Yes. So as Steve mentioned, at Crédit Suisse, on the equity research side covering mortgage finance. Happy to be joined on the panel today by Larry Goldstone, Jay Lown and Bill Greenberg. Since we kind of only have 30 minutes, why don't we just kind of jump right into this.

Larry, if you could just start talking about kind of what you're seeing in terms of forbearance trends in your portfolio today.

Let me take that, Doug.

Yes, Jay.

Is that better? Okay. Sorry. So we have seen -- we have about an equally balanced portfolio between FHA, VA or Ginnie Mae servicing and GSE servicing, mostly Fannie, but I don't think that Freddie is going to be much different than Fannie. In the GSE space, we've seen forbearance rates of somewhere in the 7.5% to 8% range. And over the last 3 to 4 weeks, the amount of incremental borrowers electing forbearance has begun to slow down and flatten. In the Ginnie Mae space, we're seeing about double that percentage of loans, we're probably in the 16% neighborhood where Ginnie Mae borrowers that have elected forbearance. But interestingly, about 50% of all of those borrowers who have elected forbearance, at least up to now, are continuing to pay.

Jay, just, I guess, in your portfolio, I guess, how would you kind of characterize what you're seeing? And interestingly, on the payment rates, I think Black Knight had talked about seeing the number of forbearance customers still paying kind of declined in May. So just interested to kind of hear what you're seeing relative to what Larry just said.

Yes. I would say that our portfolio is performing within the context of what you hear about from the MBA, 7% to 8% relative to active forbearance. And then within the context of, is it stabilizing, we see that happening as well. We see the curve flattening, and we actually do see, from our perspective, a decent amount of people make payments regularly.

Got it. And Bill, just from your perspective, is there anything sort of geographic that you're seeing kind of in the forbearance trends and kind of how it is kind of -- the harder impact areas, how are they -- how is that being reflected?

Sure. Well, I'll start by saying that our forbearance rates are around 7% of our portfolio. To remind you, we only have a GSE portfolio. We have no government servicing at all. Interestingly, for us, we have seen approximately 2 weeks of more loans in forbearance leaving the pool than entering. So right now, we have the same number of loans in forbearance as we had on May 6, right? Our forbearance rates are declining here. Related to the comments made about payments, I think as of May 1, we had around 54% of our loans and forbearance had made their April payment. As of June 1, we had 47% of our loans and forbearance had made their May payments. And sitting here on June 11, we have roughly so far, 24% of our loans and forbearance have made their June payment. Now that lower is not maybe surprising or alarming. It's only June 11. I don't know about you, I don't pay my mortgage until later in the month, anyway. So that number is going to increase as the month goes on anyway. So I think we're expecting a gentle decline from those numbers. We are also hearing from our subservicers that of the people who are leaving forbearance, around 1/3 of them are payoffs, and 2/3 of them are working out in some way. A reminder to everyone, the deferral plan goes live for everyone on July 1. So I expect that to start being a meaningful channel for people to exit forbearance, too. Geographically, I think not surprisingly, some of the states that are hardest hit with the virus have seen larger rates of forbearance. New York, which is not a large part of our portfolio, it's low single digits percentages of our portfolio, has forbearance rates at twice of our average in the high 13s, low 14s compared to our overall portfolio. And generally, I'd say the other states that you would think of that have been hardest hits from the virus are also generally above-average in that way. Surprisingly, I think if you look at the world into the prepayment speeds, New York only specified pools have generally prepaid faster than I think people have expected. They used to pay pretty squarely below HLBs of the similar coupon. Now I think they're paying above, and so I would expect that the increased rates of forbearance would slow that down. And so they're paying slower than they otherwise would, is the way that I interpret that.

Got it. And then I guess just sticking with prepay, Jay, if you could just talk about kind of what you're seeing in terms of prepays and kind of what is your expectation and kind of how much the current social distancing has impacted prepayment speeds.

I would characterize it as originators doing a great job. I would say that our prepay speeds are elevated, and I think that's coupon dependent. But for our 4% higher note rate loans, I would say that speeds today are elevated, and I would expect them to remain elevated as long as interest rates stay where they are.

Got it. And Larry, how about you? What are you -- I guess, what are you seeing or what are you expecting in terms of prepays?

Consistent with what Jay is saying on the GSE book, we've seen prepayments gradually climbing higher March than April than May. And June looks like it's going to be maybe even higher than was May. So we're definitely seeing more of an impact on the GSE portfolio or a comparable impact on the GSE portfolio. What I find to be interesting is what we're seeing on the Ginnie Mae portfolio. Those speeds accelerated dramatically in March and April, but then came down pretty dramatically in the month of May and seem to be even trending towards lower prepayments in the month of June. So I'm not quite sure what to make of what's going on in the Ginnie Mae space as compared to the GSE space. The behavior has been far more erratic than what I would have expected.

Got it, Larry. I guess, just shifting to the kind of the MSR sale market. Bill, can you just talk about kind of what you're seeing and kind of what does the activity look like in that market sort of as we've come out of kind of the liquidity challenges of March?

Yes. I would say the market is still undergoing a period of discovery and clarification. There's been very few bulk packages in the conventional space that I'm aware of, especially through the broker channels coming out to market. I'm only aware of really one post crisis, which didn't trade. I think a lot of participants are thinking that with rates at the lows and with the profits that are being made, on the origination side, the impetus to sell is as low as it's been. And so there's not a lot of people wanting us to sell. We have restarted our flow program. We have around 20 sellers in our program that we dropped our price in the middle -- in the midst of the crisis based on liquidity and so forth. We've turned them all back on, and we're accepting flow levels already today. We are producing some modest amount of MSR at current prices. But I still think that the market, I'd say, is fragmented. It's situational and price discovery is still fairly opaque.

Got it. Larry, it's just -- I guess, how would you characterize -- yes, anything else different on the FHA side? Or any other insights to kind of add to those comments?

Yes, maybe a couple of things. First of all, on the FHA, VA side, on the government side, not anywhere near the return of any number of buyers in that space. In fact, to the best of my knowledge, there may only be 2 buyers, ourselves and potentially one other buyer out there in the Ginnie Mae space. So that segment is very definitely struggling from a liquidity perspective. But again, as Bill pointed out, and if you look at MBS prices, the cash gain on sale numbers that originators are booking for FHA loans or Ginnie Mae securities are even 1 point or 1.5 points higher than what they can get on GSE loans. So there doesn't seem to be a lot of cash flow pressure on the part of originators to have to sell Ginnie Mae servicing. On the GSE side, we've definitely seen more entrants. There were a dearth of buyers in the month of March and in early April. We were one of the few folks out there posting rates. We've been sort of chasing this market as folks have come back into the space, consistently moving our prices higher to be able to get some exposure out there and to be able to try to buy some MSRs. We've also been able to pick up a number of flow clients, which has been very, very opportunistic and advantageous for us. So the GSE space is going to recover much more quickly, I suspect. But maybe I just want to throw one more comment out there. And I think that it's a little bit of a reflection that I've been thinking about that is being evidenced in the market activity of yesterday and certainly today. And I'd say it's the Fed's comments that, in my own mind, I've sort of validated what I have found to be a bit of a surprising market environment out there, particularly on the equity side. And that is, the Fed confirmed yesterday that they think the unemployment rate is going to be 9.5% at the end of this year. That is not a happy environment for mortgage credit. That's not a happy economic environment. I'm a little bit concerned that the market has been a ways ahead of itself here. And I'm not sure that we're completely out of the woods here. So I just sort of put that out there as a bit of an uncertainty.

That's fair. Jay, kind of when you're looking out at the market, what do you think it will sort of take for there to be kind of more bulk sellers or kind of more activity on the flow side?

Well, as both of these guys mentioned, I think flow is picking up again. So clearly shut down or slow down around the end of March and April. But we're definitely seeing signs of life in the flow. Nothing close to what it was. And I think the disconnect is a mark-to-model valuation versus a mark-to-market valuation. And broadly speaking, to Larry's point, earlier in the week, we thought maybe we're in a higher interest rate environment and the Fed put the clamps on that. And so while there may be hope for a better price level from the sellers, we're clearly not out of the woods relatively speaking around the economic downturn and natural holders should be holding, but natural sellers, I think, may find themselves at a point where they need to sell versus kind of wanting to think about picking the best level. So we're finding flow coming back, clearly, not at the levels precrisis. But like Bill, we're back in. We're trying to make sure that sellers understand we're here to buy servicing. And again, like Two Harbors, we're primarily focused on the GSE space. But the disconnect to me just seems to be like the price that people are looking to get versus where we are relative to this side.

I guess just before we get into pricing, I just throw that out to anyone who has an opinion. If bulk packages came to market, I guess, how many buyers do you think that are out there for both packages? I guess how is -- kind of, how is the amount of capital that's out there? How do they kind of survive kind of March? And how -- I guess, how deep would the bid be for both packages?

That's a great question. I don't think anyone knows the answer. I think I can tell you that the one bulk package, maybe you guys are familiar with, Jay and Larry. I think there are only 4 or 5 bidders on that one. We were one of the bidders. But I think the -- like everything else in this market, things are moving pretty rapidly. Things are healing pretty rapidly. I would expect that number to be higher, if a bulk package were to come today. I think, again, with my knowledge of market participants prior to the crisis and now, I think almost everyone would be back today. I would think, given the way things have unfolded on the forbearance side, I think everyone would be back. I don't know but I guess...

I agree with that. I concur. I mean given the speeds you're seeing on runoff, I think -- I guess all people are looking to add to their portfolios soon.

Yes. I think that's right. I also think -- I think that it appears to me that this crisis environment has caused certainly us as buyers to rethink risk in here. I think the market last year was getting pretty frothy, particularly on the GSE side. But even on the government side, it was getting pretty frothy particularly in the second half of the year. A lot of banks seem to be coming back into the space and buying pretty aggressively. But I think that this environment has definitely caused us to have to rethink and take a harder look at some of our servicing costs. Clearly, the decline in rates has impacted the economics around float income, the inability to foreclose on loans, the inability to collect late fees has definitely impacted the value of servicing as well. So I think that we're in for a period, certainly as buyers, where the economics might be a little bit more attractive for us than they had been over the last 12 to maybe 18 months of last year, precrisis.

Just sticking with the economics. I guess how do you see kind of pricing today and kind of what types of returns are you kind of targeting on an unlevered basis on acquisitions?

Bill, you start, I'll follow you.

And I'll be quiet.

So I would say our strategy is to look at MSR paired with Agency RMBS, right? And so we think that where we are acquiring flow today is basically, I'd say, on a levered paired basis in the very high teens.

So I would agree with that. I think that 2 weeks ago, it was probably a lot to handle, and we're looking at high-teens levered basis. Yes. And we're down. I mean, the GSE side is now down to 3 multiples, right? At least gross multiples seem to be around 3. We seem to be settling in there. I think Bill made an interesting comment yesterday as we were preparing for this panel discussion that there seems to be a little bit of a, I don't know, Mexican standoff, if you will, between buyers and sellers. Buyers are reluctant to push prices much higher from here. Sellers seem to be willing to sit on the sidelines in hopes of better days ahead. I think, as we mentioned earlier, maybe the market moves from yesterday and certainly today might give them something else to think about out there and that maybe just being a consistent seller as opposed to a market trader might be sort of a better strategy going forward. There are buyers out there. I think the levels are pretty fair in here for where they're at. I would call the unlevered returns in the GSE space in the low teens, not in the single digits where they were last year, but they're definitely in the low teens again.

Great. And just a reminder, if anyone in the audience has any questions, feel free to kind of ask those and we can try to get to them. All right. Can you just talk a little bit about how the financing looks in the MSR space today? It was clearly -- that was kind of an area of concern as was kind of financing across lots of different assets in March. Can you just talk about how we have -- kind of how the market has progressed from kind of mid-March through today?

Sure, I'll go. I think that depends on who your lenders are. And broadly speaking, I think the Street was probably a little harsh around counterparties than banks or regional banks. We were fortunate to have good counterparties on both sides of that. And both on the investment bank side and now on the regional bank side, everybody behaved very well. And we're finding that we're able to talk to people about new facilities, both on the MSR front and on the servicing advance front. So I would say, at least for us, it's been positive.

I would agree with what Jay said, we're having a similar experience. So we're finding participants willing and able to talk about new advanced and asset facilities. We've not -- we do not have any advanced facilities prior to coming into this. And as we've said before, we're working on a couple to accommodate our flows. I would say spreads seem to be a little bit higher than they were precrisis at the moment. But like everything else, things are moving rapidly.

Yes. And just to add to that, I actually was pleasantly surprised to see the behavior. We don't deal with any of the Wall Street finance counterparts. We deal with regional banks. And we actually had a term sheet in place precrisis and it was surprising to me to actually see the bank honor the term sheet. None of the terms were changed. None of the advance rates or advanced percentage amounts or spreads to LIBOR were changed that were repriced as a result of the crisis. And we've been moving through the documentation process, and we expect to close that facility here in the next week or so. So I think advanced financing has been a pleasant surprise despite all of the stress that's been out there in the market this past couple of months.

And then just last one on financing before we kind of get to an audience question. I guess kind of the experience that you went through, does that change the way you think about leverage against your MSR asset or the types of leverage that you might look to consider?

It does. I mean I think that an asset that is a level 3 asset that is not as liquid as something like an MBS security, definitely makes you think about how levered you want to be on that security. But also within the context of how much you want to take on a leverage relative to the maximum allowed to leverage in that facility. And I think you have to think about that going forward, given how fast and furious and violent things happen to everybody in March. That's just my perspective though.

Great. Well, let me start moving to some audience questions. One, you guys talked about your forbearance experiences. I guess how do those compare to kind of how you were modeling that? And I guess, where do you see the trend, kind of how are you modeling that now? And then also, sort of along that, if unemployment is kind of north of 10% versus better than 10%, how much sensitivity does that kind of ultimately have on the performance of your MSRs? Larry, why don't you take that one?

Sure. Yes, I think as I think back from what we were modeling in March, without any information, just anecdotal information and intuition, I think we were thinking that forbearance rates could go to 25%, plus or minus a little bit. There were some folks advocating that the numbers could go much higher than that. One of the objections, I think that I certainly had, and I suspect many in the mortgage industry had, was the fact that the government really made a policy prescription that was an invitation for like the ultimate moral hazard, right? Basically, a borrower could elect to forbear his mortgage loan, elect to forbear up to 12 months and didn't have to provide any documentation to substantiate the fact that they've been negatively impacted. I think that kind of a broad mandate or a broad policy caused us a lot of concern. Thankfully, we didn't see even the 20% type numbers, at least not so far. The second thing I sort of worry about though is, is there a second leg down here? Is there something we need to be thinking about in the months ahead as the country reopens? And we are definitely seeing an increase in cases. We're seeing an increase in hospitalization rates, we're definitely forecasting more unemployment than maybe a lot of folks were anticipating. So I think that -- I think, as Jay and Bill have both sort of said as well, I think we got to be careful in here. I don't think it's a slam dunk that we're out of the woods just yet.

I was just going to add, Larry, you're more optimistic than I was when this thing first started. I was looking at 40% scenario of sort. I didn't know what to expect, obviously. I said, we're sitting here at 7% gross, 4% net, without any delinquent in forbearance. We are -- since the crisis, we took an approach of hope for the best, plan for the worst. And so we are mentioning the advancing facilities that we're setting up and the asset finance facilities that we're setting up, we are certainly set up for that number to go a bunch higher. So if there's a second leg down, which there very may well could be, we're prepared for that.

Great. And then I got another question. I guess how do you guys see the mortgage spread, primary, secondary spreads playing out? Kind of when do you -- when might we see a return to normal? And kind of how does that factor into your expectations on prepays? Jay, do you want to take that one?

Sure. I think Bill will tell us the next time he has a call with Powell. But really, broadly speaking, if I -- we always say on our side, don't fight the Fed. And until the Fed kind of pauses, I'm not really sure that anything in MBS land around primary or secondary spreads takes breather. We've seen a lot of movement around OIS, but broadly speaking, with gain on sales margins as healthy as they are today, there's been real no -- no real need on either end to kind of move things in a different direction. Bill, do you have a different view?

No, I don't. I think primary, secondaries are going to stay at this level until the phone stop ringing, as I'd like to say, right? When all the borrowers were refinanced at this level are done, if we're still here in rates, then that spread will start to tighten in mortgage rates. Primary mortgage rates will start to come back. And then it's just a question of timing as to, does that happen first or do interest rates rise before that?

Yes, I'm sort of concerned. In the back of my mind, I'm concerned about like a second wave of prepayments after the wave that we're currently in right now. Because I definitely think that some of these loans are newly originated loans that we're buying today could be refinanced at 50 basis points lower coupon if the primary, secondary spread comes in and MBS yields stay where they are today.

Yes, I agree with that.

All right. With that, it actually looks like we're out of time. So thank you to Larry, Jay and Bill. And with that, I will turn it back over to Steve.

All right. Thanks, everybody.