Two Harbors Investment Corp. Aktie

Good morning. My name is Jennifer, and I will be your conference facilitator today. At this time, I would like to welcome everyone to TWO's First Quarter 2026 Earnings Call. [Operator Instructions] I would now like to turn the call over to Ms. Maggie Karr.

Good morning, everyone, and welcome to our call to discuss TWO's first quarter 2026 financial results. With me on the call this morning are Bill Greenberg, our President and Chief Executive Officer; Nick Letica, our Chief Investment Officer; and William Dellal, our Chief Financial Officer.

The earnings press release and presentation associated with today's call have been filed with the SEC and are available on the SEC's website as well as the Investor Relations page of our website at twoinv.com.

In our earnings release and presentation, we have provided reconciliations of GAAP to non-GAAP financial measures, and we urge you to review this information in conjunction with today's call. As a reminder, our comments today will include forward-looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These are described on Page 2 of the presentation and in our Form 10-K and subsequent reports filed with the SEC. Except as may be required by law, TWO does not update forward-looking statements and disclaims any obligation to do so.

I will now turn the call over to Bill.

Thank you, Maggie. Good morning, everyone, and welcome to our first quarter earnings call. I would like to begin by addressing the recent developments regarding the merger plans that we initially disclosed last December. As we described in detail in our proxy statement, in March, we received an unsolicited all-cash proposal from CrossCountry Mortgage. After careful consideration and in coordination with our financial and legal advisers, our Board unanimously determined that the CrossCountry proposal was superior and in the best interest of shareholders. And on March 27, 2026, we executed a new merger agreement with CrossCountry, pursuant to which CrossCountry agreed to acquire Two Harbors for $10.80 per share in cash. In connection with entering into this agreement, we terminated the prior merger agreement with UWM.

Yesterday, we announced that we signed an amendment to the new merger agreement with CCM. Under the terms of the amended agreement, CCM will increase the per share cash consideration payable to Two Harbors' stockholders to $11.30 per share, an increase from $10.80 per share under the original merger agreement. The amended agreement follows our Board's thorough evaluation of an unsolicited competing proposal received on April 20, 2026, from UWMC. After consulting with our financial and legal advisers, including assessments of the competing proposal's terms, proposed financing, regulatory path, deal certainty, and other factors, the TWO Board determined that the CCM transaction as amended, continues to be in the best interests of TWO and its stockholders.

The business combination with CCM pairs the country's leading retail originator with RoundPoint's best-in-class servicing platform, creating a fully integrated mortgage company. We are confident that this merger is in the best interest of shareholders, allowing them to receive the certainty of cash and reinvest the proceeds in a manner that best suits them. The transaction is expected to close in the second half of 2026 and is not subject to any financing condition. Prior to closing, we intend to continue paying regular quarterly dividends, but not stub dividends, consistent with past practice.

We will hold a special meeting to approve the CrossCountry merger on May 19 at 10:00 a.m. Eastern Time. If you have already submitted your vote in favor of the CCM merger, your vote remains valid. If you have not yet voted or if you previously voted only on the terminated UWM transaction, please submit your vote as soon as possible. Your vote is very important. Our Board unanimously recommends that all shareholders vote in favor of the transaction with CrossCountry.

Now let's turn to our quarterly results as summarized on Slide 3. At the start of the quarter, RMBS' performance was buoyed by the continued decline of implied volatility and the announcement on January 8 by the FHFA Director instructing the GSEs to purchase $200 billion of Agency MBS in an effort to explicitly tighten mortgage spreads as part of a larger effort to lower mortgage rates. However, mostly as a result of the outbreak of the Middle East conflict, the performance of risk assets, including RMBS, deteriorated over the balance of the quarter. Amid this backdrop, for the first quarter, we had a total economic return of negative 2.0%.

Please turn to Slide 4. Forecasts for inflation and economic growth became more uncertain as the quarter unfolded. And as a result, the Federal Reserve left rates unchanged at their February and March meetings. As you can see in Figure 1, market expectations for the Fed's effective rate at 2026 year-end rose from 3.06% on December 31 to 3.57% at quarter end, essentially wiping away any prospects of Fed cuts in 2026.

Economic statistics over the quarter were mixed, punctuated by a weaker-than-anticipated employment report on March 6, with the unemployment rate unexpectedly rising to 4.4%. Normally, such an outcome would likely result in a bull steepener with short rates falling more than long rates. In this instance, rekindled concerns over inflation, both from continued elevation of core PCE inflation and from the oil price shock were strong enough that rates did the opposite, rising into the end of the quarter.

As you can see in Figure 2, the U.S. Treasury yield curve bear flattened with 2-year yields rising 32 basis points to 3.79%, while 10-year yields increased 15 basis points to 4.32%. The Fed's median forecast released in March continued to price in 125 basis point cut in 2026, though forecasts for core PCE inflation increased from 2.5% to 2.7%, which Chairman Powell said partly reflected incoming inflation news since the last report.

Please turn to Slide 5. Our DTC platform has made excellent progress since we began making our first loan in June of 2024. In the first quarter, we funded $92 million in first and second liens, about the same as in the fourth quarter despite rising interest rates. We also brokered $38 million in second liens. At quarter end, we had an additional $57 million in our pipeline. These are still small numbers, which, to some extent, are expected given the low note rate nature of our servicing portfolio. However, we believe the upcoming combination with CrossCountry should bring the origination efforts to a new level, and we expect that our recapture efforts should improve substantially, benefiting our servicing customers.

Now I would like to hand the call over to William to discuss our financial results.

Thank you, Bill. Please turn to Slide 6. Our book value decreased to $10.57 per share at March 31 compared to $11.13 per share at December 31. Including the $0.34 common stock dividend, this resulted in a negative 2% quarterly economic return.

Please turn to Slide 7. The company incurred a comprehensive loss of $24.7 million or $0.24 per share. Net interest and servicing income, which is a sum of GAAP net interest expense and net servicing income before operating costs, decreased as a result of lower float earnings rates and lower balances due to MSR sales and seasonals, as well as lower servicing fee collections on lower UPB, partially offset by lower financing rates.

Mark-to-market losses on Agency RMBS and TBAs were due to higher interest rates and wider spreads in the first quarter versus gains in the fourth quarter driven by bull steepening in rates. The decrease in mark-to-market losses on MSR was driven by a slight favorable change in valuation inputs and assumptions used in the fair valuation of MSR versus an unfavorable change in Q4, as well as lower portfolio runoff and lower MSR balances as a result of sales and lower experienced prepayment speeds.

Other derivative instruments utilized for purposes of hedging our interest rate exposure, including swaps, futures and inverse interest-only securities, experienced net mark-to-market gains in Q1 versus net losses in Q4. You can see the individual components of net interest and servicing income and mark-to-market gains and losses on appendix Slide 20.

Please turn to Slide 8. On the left-hand side of the slide, you can see a breakdown of our balance sheet at quarter end. We ended the quarter with over $500 million of cash on the balance sheet. As we said on our last earnings call, we repaid our convertible senior notes of $261.9 million in full on January 15, 2026, maturity date. RMBS funding markets remained stable and available throughout the quarter with repurchase spreads at around SOFR plus 15 to 18 basis points. At quarter end, our weighted average days to maturity for Agency RMBS repo was 71 days. We financed our MSR, including the MSR asset and related servicing advance obligations across five lenders with $1.5 billion of outstanding borrowings under bilateral facilities. We ended the quarter with a total of $977 million in unused MSR asset financing capacity. We have $69 million drawn on our servicing advances facility with an additional $81 million of available capacity.

I will now turn the call over to Nick.

Thank you, William. Please turn to Slide 9. In his opening comments, Bill discussed the up-down nature of mortgage performance over the quarter. Ultimately, risk sentiment took an abrupt negative shift in late February with the onset of hostilities in the Middle East, leading to wider spreads for RMBS. Though mortgage spreads widened, they outperformed the increase in volatility due to favorable supply-demand technicals aided by the administration's explicit support of the mortgage basis. At quarter end and even today, the situation in the Middle East is highly fluid with a broad range of outcomes. For the near term, geopolitical tensions will remain the primary driver of market sentiment and economic outlook. That said, the widening of spreads by quarter end made performance outcomes more balanced and improved the return potential of our portfolio.

At March 31, the portfolio was $11.9 billion, including $8.9 billion in settled positions and $3 billion in TBAs. Our primary risk metrics quarter-over-quarter were not much different. Our economic debt to equity was lower at 6.4x while our portfolio sensitivity to a 25 basis point spread tightening decreased slightly from 3.7% to 3.2%. Throughout the quarter, given the elevated level of macro volatility, we kept interest rate risks low in aggregate and across the curve. You can see more details on our risk exposures on appendix Slide 17.

Please turn to Slide 10. As previously discussed, January was an excellent month for mortgage performance with the Bloomberg MBS Index delivering 52 basis points of excess return, its best month in over a year. Implied volatility as measured by 2-year options on 10-year swap rates fell to 73 basis points on January 27, its lowest level since October 2021. Spreads ratcheted tighter after the January 8 announcement directing the GSEs to buy MBS, adding to what was already a constructive supply-demand picture with money managers enjoying consistent inflows of capital, banks driving CMO demand through floater purchases and REITs raising capital in the equity markets.

Current coupon spreads reached quarterly tights on January 12 with nominal and option-adjusted spreads tightening by 10 to 15 basis points from the beginning of the quarter. In response, we lowered our mortgage exposure given historically tight treasury spreads, mostly by selling 4.5% specified pools and 5% TBAs.

However, over the course of February and March, driven predominantly by the start of the conflict and the attendant increase in realized and implied volatility and the flattening of the yield curve, performance deteriorated. As you can see in Figure 1, implied volatility on 2-year 10-year swaptions finished the quarter up 5 basis points nominally to 85 basis points. Current coupon spreads versus swaps on a nominal and option-adjusted basis widened by 26 and 15 basis points, finishing the quarter at 141 and 60 basis points, respectively.

With mortgage spreads cheaper, we reversed course and managed our spread exposure higher by quarter end, simultaneously adding some 5.5% specified pools. As you can see in Figure 2, the spread curve, both nominally and risk-adjusted, steepened over the quarter with lower coupons close to unchanged, while 4.5% and higher coupons widened. Peak spreads were in the 5.5% to 6% coupons.

Please turn to Slide 11 to review our Agency RMBS portfolio. Figure 1 shows the performance of TBAs and specified pools we own throughout this quarter. Hedged performance versus swaps across the coupon stack was mixed with some belly coupons and higher coupon specified pools eking out a positive return, while the performance for most of the stack between 4.5s and 6s was negative. Hedge performance versus treasuries was better as longer-end swap spreads tightened over the quarter. Even so, the Bloomberg MBS Index, in which performance is measured against treasuries, had an excess cumulative return of minus 36 basis points over February and March.

30-year mortgage rates finished up about 25 basis points quarter-over-quarter to 6.5%, though they touched 6% in both January and February, allowing savvy and fast-acting borrowers to find the best rates in years. Prepayment rates for refinanceable loans jumped higher in March, reacting to the multiyear lows in mortgage rates. Though absolute prepayment rates refinanceable coupons reached similar levels as observed in October 2025, they were actually more benign after adjusting for rate incentive. Thus, the prepayment S curve was not as reactive as it had been in the fourth quarter when the media effect was more elevated.

With prepayment rates on higher coupon TBAs remaining fast, the call protection offered by our carefully selected specified pools was evident as can be seen in Figure 2, which shows TBAs versus the specified pools we owned by coupon. For 5.5 coupons and higher, our specified pools paid at a fraction of TBA speeds. On aggregate, pool speeds increased to 9.8% from 8.6% CPR quarter-over-quarter, mostly driven by increases in speeds from these higher coupons.

Please turn to Slide 12. Activity and demand for MSR in the first quarter remained high with servicing transfers topping $93 billion UPB, outpacing Q1 2025, though below the prior 2 quarters. We continue to see most of the supply coming from nonbank originators with a broader array of buyer types, which include other nonbank originators, banks and REITs. Figure 2 shows that with mortgage rates at their current level of around 6.5%, the share of our MSR portfolio that is considered in the money drops to 1%. If mortgage rates were to drop to around 5%, the portion of our portfolio in the money would rise to about 9%.

The housing market remains slow, and persistent inventory shortages in many markets is expected to continue to put upward pressure on prices. That said, there are pockets of weakness in Southern markets with builders continuing to offer buydowns to move inventory. Housing affordability, which had been improving since mid-2025, is likely to reverse given the rise in mortgage rates. On a broad basis, we anticipate home prices to rise in the single digits annualized and for housing turnover to continue to trend about 5% higher year-on-year, especially as primary rates today are lower than a year ago at this time.

Please turn to Slide 13, where we will discuss our MSR portfolio. Figure 1 is an overview of our portfolio at quarter end, further details of which can be found on appendix Slide 23. In the first quarter, we added $152 million UPB of MSR through flow sale and recapture channels. Given the increase in mortgage rates and wider RMBS spreads, the price multiple of our MSR increased slightly quarter-over-quarter to 5.9x. 60-plus day delinquencies remained low at under 1%.

Figure 2 compares CPRs across those implied security coupons in our portfolio of MSR versus TBAs. Quarter-over-quarter, our MSR portfolio experienced a decrease in prepayment rates to 5.6% CPR, reflecting lower housing turnover that is typical in the winter months. Importantly, prepays have remained below our projections for the majority of our portfolio, which has been a positive tailwind for returns.

Finally, please turn to Slide 14, our return potential and outlook slide, which is a forward-looking projection of our expected portfolio returns. We estimate that about 65% of our capital is allocated to servicing with a static return projection of 11% to 14%. The remaining capital is allocated to securities with a static return estimate of 11% to 15%. With our portfolio allocation shown in the top half of the table and after expenses, the static return estimate for our portfolio would be between 8% to 11.4% before applying any capital structure leverage to the portfolio.

After giving effect to our unsecured notes and preferred stock, we believe that the potential static return on common equity falls in the range of 7.3% to 12.9% or a prospective quarterly static return per share of $0.19 to $0.34.

Looking ahead, the situation in the Middle East remains highly fluid. The economic disruptions caused by this conflict are inherently hard to gauge. While technical factors in the RMBS market are a positive for the sector, the outlook for interest rate volatility is less certain. It's worth noting that while there was a substantial increase in volatility off the quarterly lows in Q1, volatility for much of the term structure only went back to levels last seen in Q4 2025. Relative to that time frame, current coupon spreads finished the quarter slightly tighter than they were then, which reflects the explicit support the sector has received from the administration.

In addition to demand from the GSEs, the latest proposals for the Basel III end game could provide a lift as banks should have more capital to use to purchase MBS and hold mortgage loans, which could reduce securitization rates and RMBS supply. In total, RMBS hedged with swaps possesses good nominal yield with a balanced performance profile, albeit with a key dependency on the direction of volatility. The MSR market remains very well supported with a broad range of buyers. We favor the portfolio construction of pairing MSR with RMBS, which we expect will deliver attractive returns over a wide range of market outcomes.

Thank you very much for joining us today. And now we will be happy to take any questions you might have.

[Operator Instructions]We will go first to Doug Harter with BTIG.

Just talking about kind of the book value performance in the quarter. Hoping you could help break that down between the 2 strategies and kind of how MSR performed and how kind of the hedged agency would have performed just as we think about those components?

Doug, this is Nick. Thank you for that question and a very good one. Over the quarter, we saw our MSR -- hedged MSR strategy performed extremely well over the quarter, that was a positive. The hedged securities part of the portfolio was an offset to that. I think over the quarter, there was a fair amount -- big pickup in both realized and implied volatility. Convexity hedging costs over the quarter were definitely a pickup from the prior quarter.

And if you look at the -- anecdotally, if you just look at the basis points traveled or the range that the market traded in, in terms of the 10-year, you definitely would see a pickup that would make sense in that context. So, it was a better quarter for hedged MSR versus hedged securities. The one thing I will say is in terms of like relative performance among the REITs, and I saw the comment you made in your note about us last night.

I would say there are 2 things. First of all, we have generally a higher expense base. So, when you actually -- I think if you look at the portfolio in isolation relative to other REIT portfolios, I think on a comparative basis, it probably looked pretty favorable. The expense -- a higher expense base because of our servicing business is an offset to that relative to some peers. And the other part of it is that unlike other peers, the peers that had raised equity over the quarter and had some accretion relative -- owing to the fact they're trading over book value and some of that adds to their performance. I think with those adjustments, I think that the portfolio performance would actually look relatively favorable, if that makes sense.

And we'll go next to Bose George with KBW.

Can we get an update on your book value quarter-to-date?

Bose, this is Nick. We are up about 2%.

Okay. Great. And then I'm not sure if you can answer this, but in terms of the merger, is the situation with UWM over? Or does that remain kind of live until the shareholder vote?

Well, as we disclosed last night, we executed a revised merger agreement with CCM, right? We are working through the process in terms of getting that merger to completion. There is a shareholder vote, which is scheduled for May 19, and we're excited about that transaction, and we're focused on doing everything we can in order to bring that to completion.

Okay. Great. But I guess that's good. I was just curious; there's still room for bids until the vote happens. Is that a fair statement?

The merger agreement is very, very prescribed and lays out the details and the circumstances for how someone should do that if they were so interested.

We'll take our next question from Jason Weaver with JonesTrading.

This is Valen Alvar here filling in for Jason Weaver. Just had a quick one for you. Can you walk us through the financing package supporting the $11.30 cash consideration, whether it's debt sponsored, private equity, internal cash? And also, whether the merger agreement contains a financing condition or a market carve-out tied to book value per share, mortgage spreads or like rate volatility at close?

Yes. Thanks for the question, and I appreciate it. As you might expect, everything that is disclosable has been disclosed in the merger agreement, which is filed publicly. So, I would refer you to that document to answer some of your questions.

And at this time, there are no further questions. I'll turn the call back to the speakers for any additional or closing remarks.

I'd like to thank everyone for joining us today. And as always, thank you for your interest in Two Harbors.

This does conclude today's conference. We thank you for your participation.

Good morning. My name is Ruth, and I will be your conference facilitator. At this time, I would like to welcome everyone to TWO's Fourth Quarter 2025 Financial Results Call. [Operator Instructions] I would now like to turn the call over to Maggie Karr.

Good morning, everyone, and welcome to our call to discuss TWO's fourth quarter 2025 financial results. With me on the call this morning are Bill Greenberg, our President and Chief Executive Officer; Nick Letica, our Chief Investment Officer; and William Dellal, our Chief Financial Officer.

The earnings press release and presentation associated with today's call have been filed with the SEC and are available on the SEC's website as well as the Investor Relations page of our website at twoinv.com.

In our earnings release and presentation, we have provided reconciliations of GAAP to non-GAAP financial measures, and we urge you to review this information in conjunction with today's call. As a reminder, our comments today will include forward-looking statements which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These are described on Page 2 of the presentation and in our Form 10-K and subsequent reports filed with the SEC. Except as may be required by law, TWO does not update forward-looking statements and disclaims any obligation to do so.

I will now turn the call over to Bill.

Thank you, Maggie. Good morning, everyone, and welcome to our fourth quarter earnings call. I'm very excited to be able to speak to you all publicly for the first time about our recently announced merger with United Wholesale Mortgage. The rationale for this transaction should be familiar to most mortgage market participants and observers and was especially fitting given our own history as a company.

So let me take a step back and describe why I say that. We are one of the first, if not the first, mortgage REIT to invest in MSR as part of our asset mix, obtaining our GSE approvals and state licenses to own and manage MSR and then buying our first pool in 2013. We started out using third-party subservicers to service the asset. But as our servicing portfolio grew to a certain scale, it became clear to us that we can extract even more value from the asset and increased returns by bringing the servicing in-house, which we did in 2023 through our acquisition of RoundPoint.

The last several years, really, post-COVID, have highlighted the need for investors to be able to protect their MSR portfolio by providing recapture capabilities. Hence, we spun up a direct-to-consumer lending platform in 2024. However, in 2025, the mortgage finance landscape shifted again with scale becoming more important than ever. It became clear to us that in order to succeed and compete effectively, our origination effort needed to be much, much bigger.

This merger brings us together with the #1 mortgage originator in the country in UWM and doubles the size of the MSR portfolio to a pro forma $400 billion. UWM in turn, also benefits from our expertise in capital markets and asset management, and they can leverage RoundPoint's best-in-class and low-cost servicing capabilities. In many ways, this transaction is the culmination of the business plan that we've been aiming at for some time, and it creates, I believe, a very powerful strategic alignment and positions the combined company for accelerated growth and enhanced outcomes, which should deliver meaningful upside to shareholders.

Now please just turn to Slide 3. Our investment portfolio performed well as mortgage assets significantly outperformed their hedges, and our low coupon MSR continued to behave as it was designed to do, earning its carry.

For the fourth quarter, we generated a total economic return of positive 3.9%. For the full calendar year 2025, we generated a total economic return on book value of negative 12.6%, though if you exclude the previously recorded litigation settlement expense of $3.60 per share, we returned a positive 12.1%. Mortgage assets have thus far continued to outperform into the first quarter driven in part by increased GSE buying and announcements from the administration committing to buying significant sizes of MBS.

In situations like this, we take the administration's clear desire for lower mortgage rates at face value, and we recognize the possibility that they will ultimately succeed and create increased mortgage and origination activity in 2026. One question that we've heard from investors is around our securities portfolio and if, following the merger, we intend to liquidate the portfolio.

In the short term, the answer is that we intend to manage our business in the ordinary course. Looking further out, I would say that while no decisions have been made yet, we will be thoughtful about how we proceed. There are some paths that lead to selling some or all of these assets over time, and there are other paths where the combined company will need many or even more than our existing TBA and specified pool positions. These are still early days with respect to the merger. So when those details are more clear, we will be sure to update you.

Please turn to Slide 4. Performance across fixed income was positive in the fourth quarter. The release of major conventional economic indicators were severely interrupted by the federal government shutdown, leaving the Fed and market participants without key data often used to assess the economy. Despite this and in line with market expectations seen in Figure 1, the Fed still delivered two 25 basis point cuts in October and December.

As a result, and as you can see in the figure too the yield curve steepen with 2-year treasury yields down 14 basis points to 3.47% while 10-year treasury yields rose by 2 basis points to 4.17%, returning the yield curve to its deepest level since January 2022. Equity markets continued to react positively to the Fed cuts with the S&P 500 up by 2.3% at quarter end after setting all-time record highs earlier in the quarter.

Please turn to Slide 5. We settled on the sale of an additional $10 billion UPB of MSR out of our portfolio, increasing our total third-party subservicing to $40 billion at year-end, compared to $30 billion at the end of the third quarter, while reducing our total owned servicing to approximately $162 billion from $176 billion in the prior quarter.

Despite its small size, our DTC platform is punching above its weight and had a record quarter, funding $94 million in first and second liens, a 90% increase from the third quarter. At quarter end, we had an additional $38 million in our pipeline. We also brokered $58.5 million in second liens in the quarter, which was nearly unchanged quarter-over-quarter.

Looking ahead, we are confident that the partnership with UWM will bring the benefits we have envisioned from the increased scale, and we believe this merger is extraordinarily positive for our company and for our shareholders.

Now I'd like to hand the call over to William to discuss our financial results.

Thank you, Bill. Please turn to Slide 6. Our book value increased to $11.13 per share at December 31 compared to $11.04 per share at September 30. Including the $0.34 common stock dividend, this resulted in a positive 3.9% quarterly economic return.

Please turn to Slide 7. The company generated comprehensive income of $50.4 million or $0.48 per share. Net interest and servicing income, which is a sum of GAAP net interest expense and net servicing income before operating costs, decreased as a result of MSR sales and lower float income. Float income decreased largely as a result of lower interest rates and end of ear seasonals and lowered balances.

The net overall decline in portfolio asset yields was offset by lower financing costs. Mark-to-market gains and losses were lower in the fourth quarter by $15.5 million due to MSR portfolio runoff and they both steepening in rates. You can see the individual components of net interest and servicing income and mark-to-market gains and losses on the appendix Slide 20.

Please turn to Slide 8. On the left-hand side of this slide, you can see a breakdown of our balance sheet at quarter end. We ended the quarter with over $800 million of cash on the balance sheet. And in accordance with our previously disclosed plans, we repaid our convertible senior notes of $261.9 million in full of the January 15 2026 maturity date.

RMBS funding markets remained stable and available throughout the quarter with repurchase spreads at around SOFR plus 23 basis points. At quarter end, our weighted average days to maturity for Agency RMBS repo was 54 days. As a reminder, our days to maturity are typically lower at December 31 as we intentionally roll repos on the third quarter past year-end to avoid any disruption in funding that can sometimes occur.

We finance our MSR, including the MSR assets and related servicing advanced obligations across 5 lenders with $1.6 billion of outstanding borrowings under bilateral facilities. We ended the quarter with a total of $1.1 billion in unused MSR asset financing capacity. We have $71.5 million drawn on our servicing advances facility with an additional $78.5 million of available capacity.

I will now turn the call over to Nick.

Thank you, William. Please turn to Slide 9. Our portfolio performed well in the fourth quarter as both MSR and RMBS returns benefited from the decline of interest rate volatility, together with strong demand for spread assets. At December 31, the portfolio was $13.2 billion, including $9 billion in settled positions and $4.2 billion in TBAs.

Our primary risk metrics quarter-over-quarter were not materially different. Our economic debt-to-equity was slightly lower at 7x, and our portfolio sensitivity to spread changes marginally increased from 2.3% to 3.7%, if spreads were to tighten by 25 basis points. We kept interest rate risks low in aggregate and across the yield curve. You can see more details on our risk exposures on Appendix Slide 17.

Please turn to Slide 10. The trend of lower interest rate volatility continued throughout the fourth quarter, resulting in the 1 month realized volatility of 10-year swap rates falling into the bottom fifth percentile over the past decade, dragging implied volatility down as well. As you can see in Figure 1, 2-year options on 10-year swap rates, shown by the green line, closed the quarter at 79 basis points, 4 basis points below its average level over the past 10 years.

RMBS spreads responded very positively to the decline in volatility, the steepening of the yield curve and the prospect of strong demand in 2026, primarily from banks, REITs and the GSEs. The nominal spread for current coupon RMBS tightened by 30 basis points to 114 basis points of the swap curve, while option-adjusted spreads relative to SOFR finished 23 basis points tighter at 45 basis points, as shown by the purple and blue lines, respectively.

This decline in current coupon nominal spreads brought mortgages to their tightest levels since the second quarter of 2022. Figure 1 includes data up to January 29, and as you can see, spreads have continued to tighten further into this quarter. It wasn't just current coupon mortgages that outperformed, spreads across the coupon stack, both on a static and option-adjusted basis, shifted lower, as you can see in Figure 2.

Please turn to Slide 11 to review our Agency RMBS portfolio. Figure 1 shows the performance of TBAs and specified pools we own throughout this quarter. Hedged RMBS performance was positive across the 30-year coupon stack with the best performance in 4.5% and 5% coupons, where we have our largest pool exposures. Notably, the hedge performance of RMBS was aided by the widening of swap spreads which have made up over 75% of our hedges.

To give a sense of magnitude, 10-year swaps spreads widened by 13 basis points to an 18-month high. Our pass-through position was largely stable quarter-over-quarter. However, although we continue to like the sector and the carefully selected prepayment-protected collateral behind our bonds, we reduced our inverse IO position by almost 50% to reduce our exposure to higher coupons.

Primary mortgage rates drifted a little lower over the quarter, stabilizing around 6.25%. The share of the universe of 30-year loans eligible for refinance returned to nearly 20% for the first time in years and as we had anticipated, speeds for refinanceable coupons continue to increase. The prepayment S curve steepened back to a more regular shape associated with periods when a larger share of mortgages are refinanceable such as in late 2019.

Figure 2 on the bottom right shows our specified pool prepayment speeds by coupon, which, in aggregate, increased only very slightly to 8.6% from 8.3% CPR coming from increases in speeds from 5.5 coupons and higher. That said, the CPR increases on our pools were small and in line with our expectations, evidencing the value of careful pool selection.

Please turn to Slide 12. You can see in Figure 1, the volume of MSR available in 2025 declined from prior years. The market continues to be well subscribed with strong demand from originators as well as bank and nonbank portfolios competing for greater scale in MSRs. Indeed, as Bill said, scale has become increasingly important for mortgage companies to compete in the MSR market.

The merger of TWO and UWM will result in a combined company that is positioned for accelerated growth and has the ability to compete effectively in this market. Figure 2 shows that with mortgage rates at their current level of around 6.25%, only about 3% of our MSR portfolio is considered in the money. If mortgage rates were to drop to around 5%, the portion of our portfolio and the money would rise to about 9%.

Given that the current administration in Washington is focused on policies to stimulate the housing market and increase home ownership, we anticipate that home prices will continue to rise and housing turnover will trend higher from its current historically low levels.

Please turn to Slide 13, where we will discuss our MSR portfolio. Figure 1 is an overview of our portfolio at quarter end, further details of which can be found on Appendix Slide 23. In the fourth quarter, we settled about $400 million UPB of MSR from flow acquisitions and recapture, and we sold $9.6 billion UPB on a servicing-retained basis.

The price multiple of our MSR was consistent quarter-over-quarter at 5.8x and 60-plus day delinquencies remained low at under 1%. Figure 2 compares CPRs across those implied security coupons in our portfolio of MSR versus TBAs. Quarter-over-quarter, our MSR portfolio experienced a minor 0.4 percentage point pickup in prepayment rates to 6.4%. Importantly, prepays have remained below our projections for the majority of our portfolio, which has been a positive tailwind for returns.

Finally, please turn to Slide 14, our return potential and outlook slide. This is a forward-looking projection of our expected portfolio returns, which takes into account the repayment of the $262 million of convertible notes that occurred in January.

We estimate that about 65% of our capital is allocated to servicing with a static return projection of 10% to 13%. The remaining capital is allocated to securities with a static return estimate of 10% to 14%. With our portfolio allocation shown in the top half of the table and after expenses, the static return estimate for our portfolio would be between 6.9% to 10.2% before applying any capital structural leverage to the portfolio.

After giving effect to our unsecured notes and preferred stock, we believe that the potential static return on common equity falls in the range of 5.8% to 11.1% or a prospective quarterly static return per share of $0.16 to $0.31. The reduction in return potential quarter-over-quarter is driven primarily by the large tightening of RMBS spreads and the sales of inversis IOs.

Since quarter end, the announcement of explicit support for MBS spreads from the FHFA director has led to more spread tightening. Spreads for Agency RMBS have now fully retraced their widening over the past 3-plus years, leaving spreads historically rich on some measures like treasury-based OAS, for example, to fare versus swaps in periods when the GSEs have been active. As RMBS spreads have normalized, the potential for more tightening and resulting book value benefit of holding RMBS has been significantly reduced.

That said, continued GSE buying and/or other future policy actions aimed at supporting mortgage spreads could keep spreads tight and limit their widening in risk-off scenarios. Given all that, we believe that this environment favors our paired portfolio construction of MSR and Agency RMBS, which has less exposure to fluctuations in mortgage spreads.

We expect that demand for MSR will remain strong among the origination and investor communities. Though RMBS spreads have tightened, the paired construction of our low mortgage rate MSR with RMBS generates attractive risk-adjusted returns with lower expected volatility than a portfolio of RMBS hedged with rates.

Thank you very much for joining us today. And now I'll be happy to take any questions you might have.

[Operator Instructions] We'll go first to Rick Shane with JPMorgan.

Congratulations on the announcement. I am curious, as we sort of move through this period, tactically how you think about portfolio construction. I realize that you guys continue to and need to, from a governance perspective, operate as an independent company. But obviously, there are strategic reasons for the acquisition. Is that shifting your tactical allocation of capital in any way as you construct the portfolio into year-end? And is that one of the other factors that's impacting your static return outlook?

Yes. Thanks for the question. No, I think you put your finger on it. We're operating as independent company, we're managing our portfolio as we normally would in the ordinary course. The changes you've seen in the portfolio have been in response to market assessments of risk and reward, and we're continuing to manage the portfolio as we ordinarily would and do and the investment decisions that we're making are in line with the way that we have always historically managed the portfolio.

Got it. Okay. And then I must have gotten up especially early today because I'm first in queue. I don't think I heard you talk about an update on book value, but I get to ask the question this time. So where is book value most recent mark?

Rick, this is Nick. It's good that you got the opportunity to ask that question this quarter. We are up about 1.5% to 2% as of Friday, January 30.

We'll go next to Doug Harter with UBS.

I was hoping you could just talk about how you're thinking about leverage, Nick, given your comments around kind of the MBS market and just how interested you would be in continuing to kind of add at these spreads kind of given the crosscurrents that you mentioned and just overall, your view on risk-reward?

Doug, sure. The -- as you alluded to from my comments, the administration has made it pretty clear that they want to do what they can to try to tighten spreads in this environment and potentially as well reduce mortgage rates. So we have become a little more defensive this quarter as a result of that and just the general movement in spreads. If you look at where spreads are now historically, I think you can say that they are -- I think you definitely say they're symmetric in terms of risk.

You might even say they're asymmetric in terms of the amount of widening versus tightening in here. That being said, there is -- there are things that the administration can do that have been to discuss, for example, raising the caps that the GSEs have in their portfolio, which they can do without congressional input and other measures to continue to drive the mortgage spread tighter or just limit it from a risk perspective of widening.

So it is very much with dual-edged sword. We have decided and our portfolio construction being what it is, we do like the pair construction overall, as you know, and it depends less on betting on which way spreads are going to go and more about just putting together hedged portfolio that extracts the spread of the combined assets. So that's what we're really focused on. But we have reduced our leverage a little bit this quarter as well as our mortgage risk.

We'll go next to Bose George with KBW.

Actually, what do you think are the chances of an LLPA guarantee fee reduction at the GSEs? And how is the agency market kind of viewing that possibility?

Bose, I think there's a reasonable reduction. There will be some reasonable chance that there will be some changes on the LLPA grid. And I think it's somewhat priced into the market, but not entirely. There just -- a lot of -- there's a lot of optionality, I think, now in terms of the policy actions can be done and it's a lot for the market to digest. So it's -- and hard consequently to fully understand whether just an LLPA change is being baked in or not. But I think there has been some amount of discounting of that.

Okay. Great. And then in terms of the MSR market, have you seen any changes in sort of bank interest or activity just given it looks like the capital rules there might make it a little more favorable for them to hold on to MSRs?

I can't say that we've seen anything notable about that. Overall, all I can say is that the interest in the MSR market continues to be rock solid and strong. So from our perspective, we haven't seen anything particularly new that we have not seen in the past year or 2.

We'll go next to Trevor Cranston with Citizens JMP.

Okay. A question on the prospective return outlook. Could you maybe give us an update on kind of where you would see those levels today subsequent to the additional spread tightening that we've seen in January? And maybe comment on if there's any kind of near-term read through from kind of where you're seeing prospective returns to sort of how you're thinking about the appropriate dividend level in the near term?

I'll talk about the -- Trevor, thank you for the question. I will talk about your first part, and I'll let William discuss the dividend part of it. The -- yes, so spreads are tighter since we published this at the end of December. So it would be reasonable to expect that our dividend levels would be in a little marginally from where they are -- they were back then on the 31st of December.

We see spreads overall as being on our whole portfolio of being in maybe about 5 basis points-or-so, so that will have an effect of lowering our dividend marginally.

On the dividend, obviously, we'll go through the normal routine of deciding that later in the quarter together with the Board. I will say still younger in the quarter, so it's too early to say what the trend will be on the dividend.

And sorry, I realized I just misspoke at the end of my -- I said lower the dividend, that's not what I meant to say, lower the return potential marginally.

Yes, I assumed. And then I guess the second question, since the news came out about the GSE buying, it seems to have had kind of a varied impact on the various coupons. Can you say if you guys have had any kind of material changes with your coupon exposures so far in January and sort of how you're thinking about the coupon stack in light of the initial announcement and the potential for kind of additional announcements aimed at targeting mortgage rates?

We haven't changed it materially. We have lowered our mortgage exposure overall to some degree. I think there are 2 effects that are going on. I think the GSEs, if I were implementing this and you wanted the effect of lowering the mortgage rate, lowering current coupon spreads, you would buy current coupons. So I think that there is a natural -- that's it where I would imagine that the GSE buying is focused.

Commensurate with that, I think we've seen a fair amount of down in coupon trades coming out of various entities, including money managers that haven't materially lowered their allocation yet to mortgages, but do seem to have gone down in coupon. So thus far in the year, we've seen the biggest positive effect on the lower coupons followed by current coupons.

And then the higher coupons have actually winded a little bit. We've seen quite a bit of expansion of the coupon -- sorry, contraction of the coupon stack. As you go up, some of the higher coupons are actually now wider on the year.

Our next question comes from the line of Harsh Hemnani with Green Street.

So we've obviously discussed the GSE buying and its impact on spreads. But one of the other things that just the bank spreads today is how low volatility is. Maybe there's a few events upcoming on the calendar, particularly with a new Federal Reserve in the middle of this year. How would you expect any I guess, uncertainty or changes in policy on that front to, first off, impact at volatility and then also funding markets for Agency MBS?

Harsh, very good question. I can't say I really have a firm answer. I mean, volatility has drifted back to being on the historically low side that we have had periods where it's been lower than it is right now. As you mentioned, we have a new nominee for the Fed chair. And there -- it will take a little bit of time to fully assess what he wants to do at the Fed and also will take them some time likely to develop the consensus to make that happen.

So I mean, I would expect that we might see a mild amount of increase in volatility as a result of that. And we're still in an environment where -- from a macro perspective, the economy seems to be humming along, but inflation is still running a little hotter than I think the Fed would like and there -- it's not clear where those paths are going to settle out here.

So it would make sense to -- that volatility would pick up a little bit, and that's a little bit of our overall thesis of being a little more defensive here on mortgage spreads, that has kind of drifted historically low, and there could be some things that kick it off. It's always hard to say ahead of time what's going to be the catalyst to make that happen, but it's reasonable to think that we could be in for a little bit of a higher level of volatility.

What was the second part of your question, I'm sorry?

Funding markets? Any impacts on agency funding markets?

We haven't really seen much of an impact on funding markets. I mean there's been a few people have postulated that, that could be one of the things that the administration does or the Fed does to try to lower funding rates in the -- for mortgages and other spread assets to drive that tighter. That's possible. But funding markets have been stable, we don't really see any disturbance on the horizon on that front.

Got it. And then maybe on the hedge portfolio front, it feels like you moved a little bit heavier into the shorter duration hedges. Any thoughts on what's driving that and how that could evolve going forward?

No. I mean, I would say that we've continued to have a little bit of a curve steepening bias in the portfolio. It has not been big. I think there are still reasons to believe that the curve could steepen further here. So no, I don't -- we can talk about it more specifically offline, but I don't see us as having shifted our hedges very much that way.

Our next question comes from the line of Eric Hagen with BTIG.

Do you guys have a rough breakdown of the channel mix for your current MSR portfolio? Like what percentage were originated in the broker channel versus the retail channel? And how do you guys feel like the origination channel impacts the prepayment behavior of your portfolio?

Eric, I don't have those at my fingertips here. We've been, over the years, active buyers, both across flow and bulk channels. And they do have different prepayment characteristics and we attribute different prices to those loans and those characteristics. And so whatever differences there are in prepayment behaviors are generally reflected in the prices at which we acquire them at, right?

And so all of that is incorporated into the way that we manage the portfolio. But I don't have the specific numbers of what's broker versus retail versus handy with me right now.

Got you. Okay. Some recent commentary from other originators noted that the GSE cash window has been more active as a delivery execution channel for community banks and small retail originators. Are you guys seeing the same thing? And how do you guys feel like the cash window impacts volatility in MSR valuations in the market?

I think that the MSR market is reasonably diversified in terms of the products that are coming to market and so forth. And those are affected in the price. We continue to see robust MSR demand. Volumes in the MSR market are lower than what they have been in recent years. We have a chart in the deck on that. And so I think this is just a normal MSR environment as we're changing regimes to lower supply than what we've seen in the past.

Got it. But does the GSEs being active with the cash flow is that a reflection of MSR valuations in any way?

No, I don't think so.

This concludes today's question-and-answer session. I would like to turn the call over to Bill for any additional or closing comments.

I'd just like to thank you all for joining our call today. As we said in the earlier prepared remarks, we view the merger with UWM to be extremely exciting, and we expect that it's going to deliver meaningful upside for our shareholders. Have a great day, and look forward to speaking with you all again soon.

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

Good morning. My name is Taryn, and I will be your conference facilitator. At this time, I would like to welcome everyone to the TWO Third Quarter 2025 Earnings Call. [Operator Instructions]

I would now like to turn the call over to Maggie Karr.

Good morning, everyone, and welcome to our call to discuss TWO's third quarter 2025 financial results. With me on the call this morning are Bill Greenberg, our President and Chief Executive Officer; Nick Letica, our Chief Investment Officer; and William Dellal, our Chief Financial Officer.

The earnings press release and presentation associated with today's call have been filed with the SEC and are available on the SEC's website, as well as the Investor Relations page of our website at twoinv.com.

In our earnings release and presentation, we have provided reconciliation of GAAP to non-GAAP financial measures, and we urge you to review this information in conjunction with today's call. As a reminder, our comments today will include forward-looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These are described on Page 2 of the presentation and in our Form 10-K and subsequent reports filed with the SEC. Except as may be required by law, TWO does not update forward-looking statements and disclaims any obligation to do so.

I will now turn the call over to Bill.

Thank you, Maggie. Good morning, everyone, and welcome to our third quarter earnings call. In August, we reached a settlement in the litigation with our former external manager arising from our internalization in 2020. In particular, we agreed to make a onetime payment of $375 million in exchange for a release of all claims, including ownership claims related to our intellectual property. The settlement payment was funded through a combination of portfolio sales, cash on hand, and available borrowing capacity. Importantly, we continue to have ample liquidity following the payments, and our risk metrics are in line with how we have managed the portfolio historically. With this matter now fully behind us, we are glad to move forward with clarity and certainty of purpose.

During the quarter, we took a number of steps to adjust our portfolio, largely on a pro rata basis, to address our lower capital base and higher structural leverage. We sold some agency securities, bringing the RMBS portfolio to $10.9 billion from $11.4 billion. We also sold $19.1 billion UPB of MSR and another approximately $10 billion of UPB that will settle at the end of this month, in both cases slightly above our marks. Furthermore, these sales were done on a servicing-retained basis with a new subservicing client, establishing a significant and important relationship.

These transactions validate our efforts to meaningfully grow our third-party subservicing business and confirm the thesis that we envisioned when we first acquired RoundPoint, specifically that given our history as MSR investors, we are an ideal subservicing partner for other MSR owners. With those additions, we will have roughly $40 billion of true third-party clients using RoundPoint as a subservicer.

In addition, RoundPoint will soon be set up to service Ginnie Mae loans, too, allowing further growth in our subservicing business. Additionally, we intend to redeem the full $262 million UPB of our outstanding convertible notes when they mature in January 2026, which will reduce our structural leverage to be in line with historical levels. We plan to fund this redemption with cash on hand and by drawing down our MSR facilities. If we were to pay down the convertible note today, we would still have in excess of $500 million of cash on our balance sheet.

Lastly, the reduction in our capital base has also had the effect of increasing our expense ratio. While we are always intently focused on improving efficiencies and lowering costs, we are acutely aware of the impact today. We have already undertaken efforts to reduce our cost structure in light of the settlement payment, and we have line of sight into significant amounts of savings already. We will have more to say about this in coming quarters.

We are confident that after all of our portfolio adjustments, we will continue to be well positioned to execute on our MSR-focused investment strategy to enhance and grow our servicing and origination activities and to deliver long-term value for our stockholders.

Please turn to Slide 3. For the third quarter, including the litigation settlement expense of $1.68 per share, we experienced a total economic return of negative 6.3% and a positive 7.6% without the expense. For the first 9 months of the year, this results in a total economic return on book value of negative 15.6% and positive 9.3%, excluding the expense.

Please turn to Slide 4. Performance across the fixed income market was positive in the third quarter. Though inflation readings continued to run above the Fed's target and the full impact of recent increases to tariffs on forward inflation were still unclear, the Fed cut rates by 25 basis points in September, the first cut since November 2024, as Chair Powell cited emerging downside risks in the labor market. The Fed's own guidance of another 50 basis points of cuts by year end aligned with the market consensus, as you can see in the blue line in Figure 1. Net changes across the yield curve were small over the quarter, as you can see in Figure 2, with 2-year yields lower by 11 basis points to 3.61%, and 10-year yields down by 8 basis points to 4.15%. Equity markets were also buoyed by Fed cuts, with the S&P 500 up almost 8% by quarter end after setting all-time record highs early in the quarter.

Please turn to Slide 5. As I mentioned earlier, in the third quarter we signed a term sheet with a new subservicing client which will bring our combined subservicing UPB to approximately $40 billion and will bring the total of our own servicing down to approximately $165 billion. We are particularly encouraged by the robust growth in our direct-to-consumer originations platform, especially since most of our portfolio is not economically incentivized to move or refinance. Our originations team recorded the most-ever locks for the month of September and in the third quarter we funded $49 million of UPB in first and second liens, and which gives us increasing confidence that our DTC efforts are working as intended and can provide a meaningful pickup in portfolio recapture and economic returns.

Indeed, at quarter end, we had an additional $52 million UPB in our origination pipeline. Additionally, we brokered $60 million UPB in second liens in the quarter, a significant pickup from the $44 million we did in Q2 and also a record high for us at RoundPoint. As interest rates have trended lower post quarter end, we are very optimistic about the additional value that RoundPoint can bring to shareholders.

Lastly, I want to mention again the improvements that we are making in the technology platform at RoundPoint. AI and other applications continue to allow us to improve customer and borrower experiences and quality. These efforts allow us to achieve more economies of scale and to recognize the benefits of our investments immediately, which are important components of our drive to reduce servicing and corporate costs.

Looking ahead, we now have a clean slate to capitalize on opportunities in our MSR and MBS portfolio and to drive growth in servicing and originations. We believe that with our stock trading at a discount to book, it is significantly undervalued. With the uncertainty created by the litigation behind us, with the quality of assets that we hold, and with several of our peers trading at premiums to book, we see no reason why we should trade at an 11% discount to book as we were at quarter end. We still see mortgage spreads as being very attractive despite the recent tightening. However, we view the risks to MBS performance as being symmetrical and therefore very supportive of our strategy, in particular with its large allocation to hedged MSR, which is designed to have less sensitivity to fluctuations in the mortgage spreads than portfolios without MSR. We're very optimistic about the attractive investment opportunities available in the market for our strategy.

And with that, I'd like to hand the call over to William to discuss our financial results.

Thank you, Bill. Please turn to Slide 6. This quarter, in connection with the settlement agreement with our former external manager, we recorded $175.1 million litigation settlement expense, or $1.68 per weighted average common share. This expense is the difference between the $375 million cash payment made to our former external manager, less the related loss contingency accrual recorded in the second quarter of $199.9 million. You can see this reflected on this slide in the callout boxes. Including this expense, our return on book value is a negative 0.63%. Excluding this expense, our return on book value would have been a positive 7.6%.

Please turn to Slide 7. Including the litigation settlement expense, the company incurred a comprehensive loss of $80.2 million, or $0.77 per share. Excluding the expense, we would have generated comprehensive income of $94.9 million, or $0.91 per share. Net interest and servicing income, which is the sum of GAAP net interest expense and net servicing income before operating costs, was slightly higher in the third quarter by $2.8 million, driven by higher float and servicing fee income and lower financing costs. This was partially offset by lower interest income on agency RMBS. Mark-to-market gains and losses were higher in the quarter by $111.3 million. As a reminder, this column represents the sum of investment securities net gains and losses and changes in OCI, net swap and other derivative gains and losses, and net servicing asset gains and losses. In the third quarter, we experienced mark-to-market gains on agency RMBS, TBAs, and swaps partially offset by mark-to-market losses on MSR and futures. You can see the individual components of net interest and servicing income and mark-to-market gains and losses on Appendix Slide 21.

Please turn to Slide 8. On the left-hand side of the slide, you can see a breakdown of our balance sheet at quarter end. After the litigation settlement payment of $375 million and after the sale of $19.1 billion UPB of MSR, we ended the quarter with cash on balance sheet of $770.5 million. As Bill mentioned, we plan to redeem the full $261.9 million of our outstanding convertible notes when they mature on January 15, 2026. As a reminder, in the second quarter we defeased part of this maturing debt with the issuance of a baby bond for net proceeds of $110.6 million. Until the maturity of the convertible debt, we will use the cash on balance sheet to lower our MSR borrowings.

Our MBS funding markets remained stable and available throughout the quarter with repurchase spreads at around SOFR plus 20 basis points. At quarter end, our weighted average days to maturity for agency RMBS repo was 88 days. We financed our MSR, including the MSR asset and related servicing advance obligations across 6 lenders with $1.7 billion of outstanding borrowings under bilateral facilities. We ended the quarter with a total of $939 million in unused MSR asset financing capacity. Our servicing advances are fully financed, and we have an additional $78 million in available capacity.

I will now turn the call over to Nick.

Thank you, William. Please turn to Slide 9. Our portfolio at September 30 was $13.5 billion, including $9.1 billion in settled positions and $4.4 billion in TBAs. After adjusting the portfolio for our lower capital base, we slightly increased our economic debt to equity to 7.2 times. We are comfortable at this current leverage level. Though spreads have contracted, they still look attractive on a levered basis versus swaps, especially in the context of diminished interest rate and spread volatility. Furthermore, positive demand technicals such as robust flows into bond funds and buying by REITs are likely to persist as the Fed continues to cut interest rates. That said, spreads have normalized quite a bit, and while they are less volatile, we see spread changes to be more 2 sided. Consequently, by quarter end, we reduced the portfolio's sensitivity to spread changes from 4.2% to 2.3% of common book value if spreads were to tighten by 25 basis points, which you can see in Chart 3. This quarter, despite leverage increasing, we actually reduced our risk exposure. You can see more details on our risk exposures on Appendix Slide 18.

Please turn to Slide 10. Given the stability of rates and broad consensus that the Fed is on a gradual path toward lowering rates further, implied volatility declined to its lowest level since mid-2022. As you can see in Figure 1, our preferred volatility gauge of 2-year options on 10-year swap rates, shown by the green line, closed the quarter at 84 basis points, down 10 basis points and back to just above its average level over the past 10 years. If you look back to 2022 when volatility was last here, spreads versus swaps were tighter. We see attractive static returns with volatility at this level between 15% and 19% for the securities portion of our portfolio, which you will see in the return potential slide shortly. RMBS performance was positive across the 30-year coupon stack, with the best performance concentrated in the belly coupons such as 4 1/2%s and 5%s. The excess return of the Bloomberg U.S. Mortgage Backed Securities Index was positive. 82 basis points, the best performance since Q4 2023. You can see spreads across the curve, both nominally and on an option-adjusted basis, in Figure 2. During the quarter, the nominal spread for current coupon RMBs tightened by 26 basis points to 145 basis points to the swap curve, while option-adjusted spreads finished 14 basis points tighter at 67 basis points.

Please turn to Slide 11 to review our agency RMBS portfolio. Figure 1 shows the performance of TBAs and specified pools we owned throughout this quarter. Specified pools outperformed TBAs led by 4 1/2%s and 5%s. We rotated the portfolio down in coupon, reducing our 6% to 6 1/2% position in TBAs and specified pools by approximately $1.8 billion, and increased our 5% to 5 1/2% position by approximately $1.6 billion. We also opportunistically sold approximately $1.3 billion of specified pools versus TBAs across several coupons. You can see this detail on Appendix Slide 17. We have continued this downward rotation into this quarter as the rally in rates continues.

In September, primary mortgage rates dropped to their lowest levels of 2025, finishing the quarter for a sustained period around 6.25%, aided by the drop in U.S. treasury rates as well as the strong performance of current coupon RMBS spreads and firm primary-secondary mortgage spreads. We are seeing the effects of the rate drop on refinancing activity with large month-over-month increases for refinanceable coupons' prepayment speeds as reported in early October. Thus far the pickup in speeds has followed the pattern seen in recent prepayment episodes such as when rates dropped about a year ago. With rates remaining about here, we expect to see further pickups and speeds as borrower refinance activity fully works its way through closings. Figure 2 on the bottom right shows our specified pool prepayment speeds by coupon, which despite the drop in primary rates decreased to 8.3% from 8.6% CPR. This is a result of having the majority of our pool holdings in lower coupons as well as in call-protected securities that did not experience the large increases seen for generic collateral.

Please turn to Slide 12. You can see that the volume of MSR in the bulk market has remained lower than in prior years. The market continues to be well subscribed, with bank and nonbank portfolios continuing to compete for greater scale in MSRs. Figure 2 is a chart we periodically update, which shows that with mortgage rates at their current level, still only about 3% of our MSR portfolio is considered in the money. If mortgage rates were to drop to 5%, the portion of our portfolio in the money would rise to about 9%. As Bill highlighted, RoundPoint's direct-to-consumer originations platform has been growing consistent with the market opportunity to recapture loans in our portfolio that may refinance. When interest rates dropped in September, we saw the benefits of these efforts and our platform is poised and ready to do more.

Please turn to Slide 13 where we will discuss our MSR portfolio. Figure 1 is an overview of our portfolio at quarter end, further details of which can be found on Appendix Slide 24. In the second quarter we settled about 700 million from flow acquisitions. As Bill said, we also committed to sell approximately $30 billion UPB of low gross WACC MSR on a servicing-retained basis as part of our portfolio reallocation. Being able to sell it retained with a large, new subservicing client benefits us not only by being able to leave those loans at RoundPoint and retain the economies of scale, but also gives us an important lever in efficiently managing our assets.

Though we like our MSR portfolio, should we want to redeploy capital away from low gross WACC MSR into, say, high gross WAC MSR, selling it to a subservicing client is ideal. The price multiple of our MSR was down slightly quarter over quarter to 5.8x, in line with the drop in mortgage rates, and 60-plus day delinquencies remained low at under 1%. Figure 2 compares CPRs across implied security coupons in our portfolio of MSR versus TBAs. Quarter over quarter, our MSR portfolio experienced a de minimis pickup in prepayment rates to 6%. Importantly, prepays have remained below our projections for the majority of our portfolio, which is a positive tailwind for returns.

Finally, please turn to Slide 14, our return potential and outlook slide. This is a forward-looking projection of our expected portfolio returns, which incorporates all of our recent portfolio adjustments. Please note While the $262 million convertible note is shown in the table, the projections assume that it is redeemed at its maturity in January. As you can see on this slide, the top half of the table is meant to show what returns we believe are available on the assets in our portfolio. We estimate that about 68% of our capital is allocated to servicing, with a static return projection of 11% to 14%. The remaining capital is allocated to securities with a static return estimate of 15% to 19%.

With our portfolio allocation shown in the top half of the table and after expenses, the static return estimate for our portfolio would be between 9.1% to 12.6% before applying any capital structure leverage to the portfolio. After giving effect to our unsecured notes and preferred stock, we believe that the potential static return on common equity falls in the range of 9.5% to 15.2%, or a prospective quarterly static return per share of $0.26 to $0.42. With agency securities showing a higher range of prospective static returns in MSR, astute investors might ask the question as to why we don't sell more MSR and rotate into MBS. One reason is that the marginal cost of owning MSR is lower than its average cost and so lowering our exposure there would have the effect of increasing costs. Another reason is that we believe that the quality of the returns on the MSR side is higher, mostly consisting of very low rate, easy-to-hedge cash flows, with lower convexity risk than MBS. While we do think there is a lot of opportunity in MBS, especially given the level of implied volatility, we think our capital allocation is just where we want it to be.

To conclude, returns remain attractive in support of our core strategy of low mortgage rate MSR paired with agency RMBS. The MSR market continues to benefit from historically high levels of interest and participation from bank and nonbank originators and investors. Though mortgage rates have dropped and prepayment rates for refinanceable coupons are on the rise, our low mortgage rate MSR portfolio remains hundreds of basis points out of the money. Thus far the exposure the portfolio has to higher rate, newer production servicing has grown very modestly. Given RoundPoint's capability to refinance and recapture these loans, we look forward to continued growth in this part of our MSR portfolio. We continue to be optimistic that our portfolio construction of MSR, paired with agency RMBS, should generate attractive risk-adjusted returns over a wide range of market scenarios.

Thank you very much for joining us today and now we will be happy to take any questions you might have.

[Operator Instructions] We'll take our first question from Bose George with KBW.

Actually, first, what are the key drivers of the increase in the EAD in the third quarter relative to the second quarter? And then can you just remind us what are the drivers that take you from the low end to the high end of your guided range?

On the EAD, I think it's the -- if we look at the cost of our financing securities, that's what has come down to allow the EAD to go up. The asset yields on EAD are roughly constant, but the financing rates have come down. Of course, there's no mark-to-market. So this is just as a result of rejiggering the portfolio.

And actually just as a follow up to that. With short rates coming down as the Fed cuts, does that trend continue or just in terms of what happens to the EAD over the next, say, quarter or two?

I don't think it's a trend that will continue. It's largely as a result of the change in the mix of the liabilities between TBAs and -- the financing on TBAs and spec pools.

And then can you give us an update on your book value quarter to date?

Bose, as of last Friday, our book value was up about 1%.

We'll take our next question from Doug Harter with UBS.

I know leverage is just one metric you look at, but can you talk about the various risk metrics as you think about the size of the portfolio following the settlement?

Doug, this is Nick. Thank you for the question. Yes, as you know, we look at a lot of risk metrics in managing the portfolio. And as I said in my prepared remarks, this quarter our economic debt-to-equity did go up while we, by quarter end, had taken down our overall spread risk. It's a slew of things that we look at when we manage a portfolio. It's clearly first and foremost the returns that are available on the asset classes that we have in the portfolio and what seems to be the ideal mix in the context of the market that we are in. All of those things come into play, whether it's the amount of leverage that's available in the market, the financing rates clearly, but just most importantly, the asset yields versus the risk that each security sector has. And each quarter and each and every day we look to maximize the return that we can generate from the portfolio versus the amount of risk that each asset has.

I might just add here, Doug. Nick made a comment in his prepared remarks about the difference between leverage ticking up a little bit while our mortgage spread risk went down. And that's a good example of not being too focused on one metric versus another. Both of those things are important as we look at the overall leverage, the overall liquidity, overall what I will call drawdown risk, different scenario analyses that we look at depending on volatility of interest rates, the volatility of spreads, and so forth. So all those things get mixed into our decisions about how we manage the risk of the portfolio, especially in the context of the returns available, as Nick said.

And Bill, you mentioned that you were looking at -- to try to implement some cost saves on the corporate expense side. On your return potential slide, does that factor in potential cost saves, or is that where your costs are today or there's potential up...?

No, that's where they are today.

So there would be potential upside to that number as those cost saves are realized?

Yes, I think so.

We'll take our next question from Rick Shane with JP Morgan.

In looking at Slide 17, what stands out to me is that for the third quarter in a row at least, you are tactically net short the coupon 50 basis points below the coupon where you are you have the highest concentration. Can you help us understand -- again, as an equity guy, I'm just trying to understand what's going on there, what drives that strategy.

Rick, thank you for that question. A lot of what drives that coupon exposure, and we do manage it, of course, but it is how rates move and where the current coupon sits relative to our risk exposures and our MSR and the rest of our portfolio. So as rates rally, you can see in that table we do show what we believe is the effective offset to our mortgage longs by the current coupon exposure of the MSR and other negatively derated assets in our portfolio.

And as rates rally, that negative number migrates down in coupon, and we manage that through time. And as I said in my prepared remarks, we had gone down in coupon in terms of our mortgage holdings and a lot of that was just in response to the fact that rates are rallying, and we need to offset the current coupon risk in our MSR portfolio as that happens. So I will say that we don't get overly -- I think the word I typically use is -- fussed with 50 basis point coupon swap. There are times when there can be an extreme value difference in 50 basis points. But the truth of the matter is that we look at these risks a little bit on a bucketed basis, and there's not really a -- I wouldn't say that there's a strong strategic reason why that 50 basis point exposure is the way it is. It's just looking at the overall context of where spreads are and where spec pools are for those respective coupons and managing that risk on an overall basis.

But we try to keep the exposure relatively tight around those current coupons because if tomorrow we walked in and rates were up 25 basis points, that exposure in our MSR would shift up in coupon and that chart would change to a reasonable degree. So we look at it in that sense of nearby coupons rather than just looking at a specific coupon, if that makes sense.

It totally does. And I have learned 2 new words to add to my mortgage glossary, derated and fuss.

We'll take our next question from Trevor Cranston with Citizens JMP.

Can you guys give us a little bit of color in terms of what you're seeing on growth opportunities of the subservicing business? And in particular, I guess I'm curious if you think further growth in subservicing is likely to be in combination with MSR sales like we saw this quarter, or if you're seeing other opportunities beyond that.

Yes, thanks very much for the question. I think growing a subservicing business typically takes a long time. These are pretty sticky relationships that people have with their subservicers. And so we've been doing the hard work of maintaining and developing relationships and explaining to the world why we are an ideal partner for this sort of thing. So I think as other consolidation has occurred in the subservicing market, there are opportunities for us to pick up either some clients that are dissatisfied with their current subservicer or people who might feel that they have too much concentration risk as the number of subservicers in the world has decreased.

And so we're out there trying to attract those customers with the value proposition that as investors ourselves, as MSR owners, as someone who can be more nimble with the portfolio and who knows where the money is contained in subservicing and can extract that for the benefit of owners, I think that's a story that's resonating and starting to resonate with other subservicing clients.

We sold $30 billion of MSR to a client to seed a relationship like this. That was good. We sold the amount of servicing that we wanted to sell at this time. That's not to say that we wouldn't be open in the future for other sorts of opportunities to seed other subservicing relationships. One way that we can effectuate being able to modify our servicing portfolio, say, if we wanted to move up in coupon from low gross WACC to high gross WACC, one very good way to do that would be to see another subservicing relationship and then recycle that capital into new servicing that's higher WACC, that gives us different opportunities, or might be cheaper in some ways. So it's another tool in our toolbelt in order to be able to manage the portfolio and to grow the business together.

And then looking at the return estimates on Slide 14, I was just curious specifically on the securities portfolio. Looks like it went up a couple hundred basis points from last quarter, even though spreads are tighter. I was wondering if you just walk us through the math on why that went up.

Trevor, I'd be happy to do that, and that's a very good question. I just want to remind everyone that the spreads that we use in that calculation are actually on our -- it's on our actual portfolio at quarter end, as opposed to a stylized version of a levered spread that you see elsewhere in the market. And as you know, there's a wide variation of mortgage spreads available. And for mortgage-backed securities, it depends where you are on the coupon stack. Obviously, lower coupons have tighter static returns. Higher coupons have higher static returns, generally.

So from quarter to quarter as the portfolio shifts around and spreads shift around, even if spreads move in one direction or another those numbers can go in opposite directions. And of course, it does include, as I said, everything we have in our portfolio. Our portfolio is predominantly mortgage-backed security pools, TBAs, things of that nature. But we do have other things in our portfolio like DUS bonds. We have derivatives like IOs or inverse IOs, for example. And that's a sector that we have added to in the last 6 months. Still a small portion of the portfolio, but have added to that. All those things mix in to generate those yields from quarter to quarter. And of course, we also have assumptions that we apply to generate those ranges. As we've said before, we have some financing assumptions up and down, we have some leverage assumptions up and down, and some prepay assumptions up and down. And all of those things go into that mix to generate that return estimate that you see on that page.

We'll take our next question from Harsh Hemnani with Green Street.

Maybe on the direct-to-consumer origination platform, originations have been growing, and I think the strategic story there is, as prepayment speeds rise, the origination business could be a good hedge to MSRs. Given the cost saving strategies you've highlighted, does that impede the ability at all of the origination business to ramp up at the right time to be able to provide that hedge?

Harsh, thanks for the question. I have 2 thoughts about your question. The first is that we've always said that the DTC platform isn't meant to hedge the entire interest rate risk of the MSR portfolio, but only to hedge that part of it which is faster than expected speeds. And so we all know that when rates go lower, prepayments are going to go up and originations are going to go up and MSR values are going to go down. And we hedge that with financial instruments. It's only the part where speeds are faster than expected that we are expecting the DTC origination business in order to be able to add materially.

Look, certainly I'm well aware that you can't cut cost -- you can't cut your way to growth. And we have to be very smart about how we're going to invest in technology and our ability to scale as mortgage rates go lower. And so that's why it's not a simple exercise of just cutting a certain amount across the board. Technology investments and improvements are going to be key to be able to maintain or retain that ability in order to get those benefits as rates fall. And so we're going to be careful about that and continue to make the investments that we need to make as well.

One thing I will say about the DTC platform and the recapture rates that we've seen so far, while it is small, Nick said in his prepared remarks that only 3% of our portfolio is refinanceable from a rate and term perspective with mortgage rates here. But we've already seen recapture rates, not just record amounts in absolute levels, as I said in my prepared remarks, but also the recapture rates are higher than we have been modeling into our cash flows for these level of rates and for the portfolio composition that we have. So we're real excited and optimistic about the benefits that program is already producing.

And then maybe as I look at the coupon positioning, it seems like the higher coupons, you mentioned this in the prepared remarks, there seems to be a [ spread trade ] there where your long-specified pools and short TBAs to be able to capitalize on differences in prepay speeds there. But it seems like it's not necessarily the opposite but somewhat flipped in the intermediate coupons at the 5%s and the 5 1/2%s where exposure to TBA is higher. Can I maybe read into that, assuming that where current mortgage rates are, you feel like for the next quarter or so they hang out around [ here ].

Harsh, no, I don't think you should read into that that conclusion. The TBAs, as I mentioned, rates have moved a reasonable amount, and we did rehedge -- with rates going down, we did migrate our exposure down along with our MSR and current coupon exposure. As far as the TBA concentration in those 5%s, 5 1/2%s, it's a mix of the fact of adjusting the portfolio a moment in time and also just how we see where specified pools are relative to TBAs at that juncture.

We do employ a lot of TBAs to hedge our current coupon risk because it's easy to transact, easy and fast, and just allows us maximum flexibility with that stuff. But it's not necessarily a long-term commitment or a statement to how we feel about the specific -- the tradeoffs between spec pools and TBAs and those coupons. It's a moment in time, and as we see value in specified pools and depending on how rolls are trading, we'll make the determination as to whether we want that exposure in one or the other. But we do typically leave a fair amount of TBA exposure in those current [ coupon-esque ] type securities, so we have that flexibility.

We'll take our next question from Merrill Ross with Compass Points Research.

I wanted to talk about the MSR sales first. It seems like that was broken into [ $19 billion ] in the third quarter and there's a balance that will be transacted or has been transacted in the fourth quarter here. Is that right?

That other $10 billion is scheduling the end of this month.

Okay. And then what were the characteristics of those MSRs? As I look at it, it seems like this is a financial investor, right? That makes sense. And they're looking for a very low coupon. Is that correct?

These were low-coupon sales, yes. Look, our entire portfolio is really centered around the low coupon. This was in that part of the portfolio for sure, yes.

It just seems that the ones that you added on a flow basis can't be that low because mortgage rates are not that low anymore. So you've got a little bit of a rotation from these sales into slightly higher coupons. But it seems from what you said, you're willing to do that because the DTC is a better hedge against that decline in MSR value that you spoke about. Is that right?

That's correct. In fact, if you look at Slide 13, you can see the gross coupon rate of our portfolio increased from 3.53% to 3.59%. So this is a small change given that the additions that we've added weren't that big. But it also speaks a little bit to the fact that we sold generally stuff that was on average lower than the average -- at lower rate. And so that was the impact was the 6 basis point rise in the gross coupon. But given what I said about the DTC thing, this is something that we are totally comfortable with and desirous of because we think that higher coupon part of the MSR curve can be attractive to us given the recapture rates that we're seeing on the portfolio that we have.

And so the sales that are going to settle will be pretty similar and have a smaller but directionally correct impact on the gross coupon, right?

Yes.

We'll move to our next question from Eric Hagen with BTIG.

Maybe following up a little bit there. How do you see MSR valuations responding to a further drop in interest rates? MSR valuations seem to be really strong right now. Do you see the same sources of demand holding up in a refi event? And how would you guys potentially respond to even higher MSR valuations at lower interest rates?

Yes. So, first of all, I would say that with our gross WACC of our portfolio at 3.60%, that is still almost 300 basis points out of the money. So at these level of mortgage rates, even 50 bps lower, 100 bps lower, this is still not going to have large impacts on the refinanceability of that portfolio. Certainly the way the MSR market and the mortgage market works is that when rates decline, prepayment expectations do go up, even albeit slightly given the gross WACC of the portfolio, but the MSR prices will go down. And we all know that. And it's in our models, in our estimates, it's in the way that we hedge the asset. And so, that seems to be something that I'm not worried about at the moment.

If you're asking about how I think supply or demand will function in a 50 bps lower, 100 bps lower, I don't see it particularly changing given, what I said, the low gross WACC nature of it, the cash flows are still slow and stable and easy to hedge. Typically, what you see in refinance environments is that originators are able to hold their MSR as they're originating it. And the supply-demand switch really only reverses once rates start to rise after refi waves. So I think we're a long way from that. There continues to be very strong demand from various market participants for the low gross WACC MSR that we hold.

Yes, and I'll follow up with what Bill said, Eric, and that's just that if you look at the progression of technology and the ability to reach mortgage holders and be able to recapture, I think that there has been substantial improvements in that, I think, across the industry. So I think there's a greater ability by holders of servicing to recapture and retain the value of MSR compared to other points in the last 20 years of refi events. Not that it's perfect, but it is definitely better. So I completely agree with everything Bill said. I think that the hands that the MSR are in are very solid.

On that point about market evolution, a question about the MSR repo financing. It feels like the MSR market has matured a lot. The size and the scale for you guys has improved considerably. Can you remind us the maturity on that MSR repo and the revolving credit facility. And do you think there's going to be any opportunities to maybe optimize the financing there next year?

Our maturities are roughly in the range from 1 to 2 years. They do roll. When they roll closer, we do renew them. We will look for opportunities to see if we can improve the yield on the MSR, but basically it seems to be static right now.

Yes. To follow up on that, we continue to field incoming calls from people wanting to enter this space and provide financing on the asset. So I agree with your comment there, Eric, that the market has matured a lot since the financing on the asset really opened up in 2018-2019, and there continues to be more and more participants wanting to participate. And spreads are well supported. I wouldn't say that they're really going down a lot here, but they're well supported and stable at the levels that we're at.

[Operator Instructions] We'll move to Bose George with KBW for our next question.

Just wanted to follow up on the MSR discussion. What's the valuation of the flow MSRs that you are originating versus your existing portfolio? And also can you remind us, can you reflect the value of recapture in the value of the originated MSR? And how does that differ for originated versus bulk MSR that you purchase?

Well, so I'm not sure I understood the second part of the question about whether we include recapture in our valuations. We mark our portfolio to the market price to where we think the thing would transact in the market. And so whether the cash flows include recapture cash flows or not is something that impacts the yield or the prospective return of the thing. It doesn't impact the price or the mark, if that makes sense.

Yes, it does. But I guess there's not a specific recapture assumption that goes in there. There's just a broader cash flow assumption that has an embedded recapture feature. Is that a way to think about it?

Yes, I guess. But again, I would just reiterate that that doesn't impact the mark that we value the asset at. Because if we had a different assumption, we would have other different assumptions, typically in discount rates, which would get us to the same market price estimates.

And then just in terms of the valuation, where is the originated MSR valued at now versus the lower coupon stuff?

Yes. If you look at the price multiple that we have on the whole portfolio, it's 5.8x on a weighted average basis for the whole portfolio. And there's a whole curve of price multiples as coupons change. So certainly, as the WACC -- as the note rate increases, that [ mult ] on those servicing levels will go down. So high WACC stuff over long periods of time, you can look at-the-money servicing typically trades on average between 4.5x and 5x [ mult ] depending on lots of things. But as a base rule of thumb, that's something where at-the-money servicing always trades, and this market is not inconsistent with that level.

There are no further questions at this time. I'd like to turn the conference back over to Bill for any additional or closing remarks.

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

This concludes today's call. Thank you again for your participation. You may now disconnect and have a great day.