Two Harbors’ investment strategy relies on buying very unique
assets. In particular, these assets help to keep prepayment rates low
and cash flows consistent.
However, if the company continues to grow its portfolio there may
not be enough supply of these assets, forcing Two Harbors to make
more “plain-vanilla” investments, and losing some of what
differentiates the business.
There is nothing proprietary about mortgage-backed securities, and
little stopping competitors from targeting similar assets.
Increases in competition would have a negative impact on prices
and valuations. Ultimately, this would make returns less attractive.
While Two Harbors has less exposure to interest rates than its
peers, the company isn’t immune to changes in rates impacting its
returns. Most importantly, since 2009, the difference between short
and longer-term interest rates, or spreads, have tightened.
If this trend continues it would have a negative impact on the
Following the financial crisis, and the enormous bailout of Fannie Mae
and Freddie Mac, several bills have been introduced to reform the
If government sponsored entities, or GSEs, are reformed or eliminated
it could have a significant impact on supply of guaranteed-against-
default mortgage products, which would increase competition, and
raise prices on Two Harbors target assets.
Two Harbors subsidiary, TH Insurance Holdings, was given
membership to the Federal Home Loan Bank (FHLB) in December
2013. This comes with two big perks, stable and very low borrowing
costs. However, in May, the Director of the Federal Housing Finance
Agency, Mel Watt, suggested he has concerns about this type of
Two Harbors noted in June, “FHLB financing [will be] important over
the long-term.” If Two Harbors is denied access in the future, it would
increase the borrowing costs, and concentrate its funding options.
As of last quarter Two Harbors was holding more than $2 billion in
subprime mortgages. Despite these assets not having a guarantee
against default, having a high rate of default, and being backed by low
credit score borrowers, if they’re price correctly they aren’t necessarily
However, if they’re priced wrong, as they were before the financial
crisis, it would have a damaging impact on Two Harbors’ portfolio.
Recently, Two Harbors has been aggressively pursuing mortgage
servicing rights, or MSRs. These assets have gained considerable
attention due to their durability in a rising interest rate environment.
However, MSRs aren’t without risks, and Two Harbors’ management
has limited experience investing in these assets.
While the company has added new and more experienced personnel, its
far from certain they will be successful competing in this market.