TWO - NYSE

Good morning. My name is Klement, and I will be your conference facilitator. At this time, I would like to welcome everyone to Two Harbors' Second Quarter 2023 Financial Results Conference Call. All participants will be in a listen-only mode. After the speakers' remarks, there will be a question-and-answer period. I would now like to turn over the call to Maggie Karr.

Good morning, everyone, and welcome to our call to discuss Two Harbors' second quarter 2023 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 Mary Riskey, our Chief Financial Officer. The 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 twoharborsinvestment.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 Harbors 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 second quarter earnings call. Today, I'll provide an overview of our quarterly performance and I'll review our decision to reduce our second quarter dividend. Then, after summarizing the current market environment, I'll take a few moments to illustrate our thoughts on the effects of hedging in an inverted yield curve environment. Mary will cover our financial results in detail and Nick will discuss our portfolio activity, positioning, and return outlook. Let's begin with Slide 3. Much like the first quarter of this year, market sentiment at the end of the second quarter was very different than where it began. Initially, risk assets underperformed and RMBS spreads widened as investors were faced with ongoing concerns about stress in the banking system, coupled with how a divided government would address lifting the debt ceiling ahead of an early June deadline. However, that sentiment shifted at the end of May as bipartisan legislation was passed to raise the debt ceiling and confidence began to grow that the worst of the bank stress was in the past. This resulted in strong performance for both equities and spread assets by the end of June, as investors returned their focus to economic fundamentals like growth and inflation. Book value at June 30th was $16.39 per share, representing a 2.2% total economic return. We opportunistically repurchased shares of both our common and preferred stock in the second quarter, which positively benefited our book value. Income excluding market-driven value changes, or IXM was $0.60 per share, representing a 14.8% annualized return on average common equity. This backward looking metric of realized return is meant to be viewed together with the forward-looking metrics on Slide 15. This quarter, our Board of Directors approved a reduction in our dividend to $0.45 per share from $0.60. Importantly, this decision was neither a reflection of downward pressure on current earnings nor our earnings outlook. We believe that the current investing environment for Agency RMBS and MSR is very attractive and retaining additional capital to put to work should result in positive returns. Further, by definition, reducing the dividend will allow more of an opportunity for book value to increase, which we also view as positive for shareholders. The new dividend level translates to an 11% return on book value, which remains a competitive return and is in line with our historical dividend yields. We believe that this level is sustainable given our current market outlook while allowing a strategic flexibility. Please turn to Slide 4. I'd like to spend a few minutes on the markets in the second quarter. Amid ongoing concerns about stress on the banking system and the debt ceiling debate, the Fed raised its target rate only once to 5.25%, while pausing at the June meeting. Last week, the Fed raised rates again to 5.5% and signal that any future rate hikes will be data dependent. The market considers this to be about as high as the Fed funds rates will go, and there are no more hikes priced in the market in 2023 as seen in chart one on the left hand side of the slide. From a longer term perspective, the Fed's aggressive rate hiking has led to short-term rates at levels not seen since 2001, and many market participants are expecting a recession. As future interest rate cuts are priced into the market beginning in 2024, longer term interest rates are lower than short-term rates. Indeed, as of June 30th, two-year treasury rates were 4.87%, while 10-year treasury rates were 3.82%, a spread of a negative 105 basis points, which is near the most inverted in more than 40 years. This spread is shown by the green line in chart two, where the widening of the spread between the short-term and long-term rates has reached extreme levels towards the bottom of the chart. The blue line shows the spread between the current coupon mortgage rates and general collateral repo rates. As of the end of June, this spread was 23 basis points with funding rates at or above the yield of the asset, many investors have wondered how does Two Harbors or any mortgage REIT for that matter, generate positive returns in such an inverted yield curve environment. Please turn to Slide 5 and I'll take a few moments to illustrate at a high level how we think about that. Let's first consider a hypothetical mortgage REIT consisting of a portfolio of Agency RMBS that has a debt-to-equity ratio of 9x and funded with short-term funding such as repurchase agreement, but that is otherwise unhedged as shown on the left hand side of Slide 5. For simplicity, let's assume that short-term funding rate is overnight SOFR, which applies a funding spread of zero. Also, for concreteness, let's assume that the REIT has equity of a $100, the yield on the RMBS asset is 5%, and SOFR is 5.5%. These are not current rates, but they illustrate the point well. This REIT receives the yield on the invested assets, say a 1,000x the asset yield and has to pay funding on the amount that it borrows. In this example, $900 at 5.5% as seen in equation one. These economics can be rephrased to say that the REIT earns the asset yield on its equity of a $100, and then additionally, the spread between the asset yield and the funding rate multiplied by the amount borrowed of $900 as seen in equation two. We can easily turn these numbers into rates of return by dividing by the equity balance of a $100. With the illustrative interest rates that we have chosen, the spread between the asset yield and SOFR is negative 0.5%, and the expected return of this REIT is only positive 0.5% as seen in equation three. Indeed, if the yield curve were further inverted, this expected return could even be negative. For instance, if SOFR were to raise a 100 basis points and mortgage yields were unchanged, then the expected return would decline to minus 8.5% or generally the expected return of this portfolio as it's constructed, is significantly exposed to changes in interest rates in either direction. This is due to the positive duration gap that exists between the RMBS asset and the repurchase agreement liability. The duration of the RMBS asset is long, say five years, and the duration of the liability is short, we assumed only one day. Now, let's consider the same hypothetical mortgage REIT, but let's add in some hedges to eliminate the duration gap between the RMBS asset and short-term funding. In this example, let's use a fixed rate payer interest rate swap. The situation is shown on the right hand side of Slide 5. The reality of hedging the duration gap is more complex than this example. We typically hedge multiple points along the yield curve, but for the purposes of this example, let's assume we hedge with a single interest rate swap instrument that pays a fixed rate of say, 3.5% and receives a floating interest rate of SOFR flat. The interest rate swap is constructed to hedge or transform the short-term nature of the funding into a longer term maturity that more closely matches the duration of the assets. The expected static return of the hedge portfolio is the same as on the left hand side, but also includes the cash flows from the swap. The economics shown in the equation five can be expressed as earning SOFR on the REIT equity of a $100, and then additionally, the leveraged balance of a $1,000 multiplied by the spread between the asset yield and the fixed rate and the swap, converting again to returns instead of dollars. If we use the interest rates that we chose in this hypothetical example, the expected static return is 20.5%, even though the curve is inverted and funding rates are higher than asset yields. This happens cleanly in this example because both the funding rate on the asset and the floating leg of the swap are tied to the same short-term index, SOFR, but it is also generally true for any short-term index to the extent that most of those rates are highly correlated. In particular, the same math works if we use treasuries to hedge instead of swaps where the treasury repo rate enters instead. Now, let's return to this example and imagine that SOFR rises unexpectedly by a 100 basis points and mortgage yields are unchanged. In this case, the expected static return of the hedged and levered REIT changes from 20.5% to 21.5%, a very modest increase of a 100 basis points compared to the unhedged REIT, which changed by 900 basis points. A REIT or portfolio, which is hedged, is largely immune to changes in funding. That's what it means to be hedged with the caveat that changes in short-term rates or risk-free rates affects the levered expected static return, one for one. This fact is exemplified by looking at the duration gap of the portfolio with swap hedges as shown at the bottom of the right hand side, and which shows that with hedges the duration gap is zero. I want to stress that our hedging strategies does not change depending on whether the yield curve is upward sloping or downward sloping. In all cases, the main effect contributing to the static return of the hypothetical REIT is the same, the spread between the asset yield and the fixed rate on the hedge, no matter the shape of the yield curve or whether borrowing rates are higher or lower than the asset yield. While I have tried to give a flavor of how we hedge in an inverted yield curve environment, we have simplified the assumptions in our hypothetical example because the format of this earnings call limits the amount of time we can spend. To that end, I'm excited to share that we are starting a series of short videos called Two Harbors Conversations, where we can delve a little deeper into special topics of interest to investors. We plan to release a conversations video that goes into further detail on this topic. Each quarter, we plan to release videos on special topics in the REIT industry or specific to Two Harbors. We hope that you will find these helpful and interesting. Looking ahead, we are excited about the investing environment in both Agency's and MSR. High rates will continue to keep prepayment speed slow, which is beneficial to our MSR assets. Many of the unknown variables in the first half of this year have been resolved, leading to lower volatility while spreads in RMBS remain at historically attractive levels. We believe that the overall environment is excellent for our unique Agency + MSR strategy. Furthermore, we continue to make progress on transitioning our MSR to RoundPoint, having transferred 63% of our portfolio from our sub-servicing network through the end of June. We continue to expect to realize additional cost efficiencies and opportunities to capitalize more broadly in the mortgage finance space in the future. The combination of these factors make it a terrific time for investing in our strategy. Now, I'll hand over the call to Mary to discuss our financial results.

Thank you, Bill, and good morning. Please turn to Slide 6. The company generated comprehensive income of $31.5 million or $0.31 per weighted average share in the second quarter. Our book value was $16.39 per share at June 30th compared to $16.48 at March 31st, including the $0.45 common dividend results in a quarterly economic return of 2.2%. Both components of our strategy contributed positive returns this quarter, which reflected the high carry of the portfolio partially offset by a small widening in higher coupon spreads. As Bill highlighted, we repurchased 514,000 shares of preferred stock at an average price of $19.39 per share and 593,000 shares of common stock at an average price of $11.89 per share, both of which were accretive to book value. Please turn to Slide 7. IXM for the second quarter was $0.60 per share, representing an annualized return of 14.8%. IXM was driven by increased income on RMBS and MSR as well as lower operating expenses. This was partially offset by increased RMBS and MSR prepays, increased funding expenses and TBA dollar roll losses. Slide 15, our return outlook slide is the forward-looking version of IXM. Please turn to Slide 8. Earnings available for distribution was negative $0.04 per share compared to positive $0.09 in the first quarter. The decline in EAD this quarter was driven by higher interest expense and losses on TBA dollar rolls, offset by higher net servicing revenue and U.S. Treasury futures income. Though we continue to report EAD as a metric, EAD currently does not reflect our portfolio's earning potential nor does it drive our dividend decisions. Turning to Slide 9. The portfolio yield increased 15 basis points to 5.24% due to purchases of higher coupon available-for-sale securities with lower unamortized premium and a higher proportion of the total portfolio invested in higher yielding assets. This was offset by a slightly higher experienced CPR on our available-for-sale securities. Our net realized spread in the quarter narrowed by 36 basis points to 0.16% from 0.52%, primarily due to higher rates and higher borrowing balances on both RMBS and MSR. As a reminder, the portfolio yields in this table are based on amortized cost as opposed to market value and expected returns. Please turn to Slide 10. In the beginning of the second quarter with the debt ceiling looming, we focused on rolling our repo to avoid any potential disruptions. Spreads and repurchase agreements remain stable and liquid throughout with financing for RMBS between SOFR plus 16 basis points to 22 basis points with no signs of balance sheet stress. At quarter end, our weighted average days to maturity for our agency repo was 67 days, which helps us maintain stability in our financing. We financed our MSR across four lenders with $1.7 billion of outstanding borrowings under bilateral facilities and $400 million of outstanding five-year term notes. We ended the quarter with a total of $428 million unused MSR finance capacity and $157 million unused capacity for servicing advances. I'll now turn the call over to Nick.

Thank you, Mary. Please turn to Slide 11. Over the second quarter, on aggregate, RMBS performed well, finishing May and June with positive excess returns on the Bloomberg MBS index. Lower coupon outperformed as supply fears from FDIC sales [indiscernible] bank assets waned, met with strong money manager demand and ahead of schedule, approximately 60% of the $85 billion of supply from the FDIC had been sold. Nominal spreads for current coupon MBS net widened by 7 basis points of the treasury curve, finishing at 140 basis points, substantially recovering most of the spread widening that took them out as wide as 166 basis points in late May. Aided by low realized volatility in the month of June when hedged to the curve and including carry even production coupons like 5.5 that modestly widened on spread still generated a positive return for the quarter. As you can see in figure one, nominal current coupon spreads remain historically attractive, still above the 90th percentile of long-term history. As we discussed last quarter, organic supply for the second half of this year will likely continue to be a headwind for MBS spread tightening, though at current yield and spread levels, we anticipate that inflows into fixed income and MBS specifically will remain strong, providing good support for spreads. And as we experienced in Q2 with spreads this wide, there is no need for spreads to tighten for our assets to generate attractive returns. Looking at figure two in terms of the coupon stack, you can see that as coupon increases so do spreads on either a nominal or option adjusted basis. Though we own a wide range of coupons when we incorporate our reviews on fundamentals and technical factors, we continue to concentrate our exposure in 3.5 to 5. Now let's turn to Slide 12 and discuss our portfolio positioning and activity in the second quarter. At June 30th, our portfolio was $15.2 billion, including $12.3 billion of settled positions. On the top right of the slide, you can see a few bullet points about our risk positioning and leverage. Our quarter-end economic debt-to-equity was 6.4x. We maintained a neutral leverage position throughout the quarter, balancing the wide nominal spreads available in the market against still elevated rate volatility. We kept our book value exposure to changes in rates low and unbiased. You can see more detail on our risk positioning by looking at Slides 17, 18, 29 and 30 in the appendix. In terms of portfolio activity, we moved $1.2 billion higher coupon TBAs into lower coupons. We did this to capture the relative widening of low coupons triggered by FDIC liquidations. Subsequently, we rotated some lower coupon positions from TBA into semi season specified pools to improve carry. In our MSR portfolio, we settled $14 billion UPB through three bulk acquisitions and added $539 million UPB through recapture and flow-sale purchases. After quarter-end, we reduced the servicing fee on our MSR to 25.2 basis points by converting 1.2 basis points to IO securities, reducing the MSR market value by approximately 5%. Moving to Slide 13 and as you can see in figure two. TBA performance over the quarter was led by 2s and 2.5s. Outperforming swap hedges across the curve by about three quarters of a point, a testament to how well the market absorbed the supply from the FDIC. The rest of the stack followed with 3s to 3.5s outperforming by 12 ticks, 4s through 5s by 6 to 8 ticks, while production coupon 5.5s and 6s outperformed by 10 ticks. Specified pools followed a similar coupon pattern with lower coupons outperforming higher coupons. Production coupon specified pools underperformed the same coupon TBAs due to a lack of sponsorship by real money accounts like banks. Moving to figure three, specified pool prepayment speeds increased slightly to 6.5% CPR, which was expected given the increased turnover seasonality. Please turn to Slide 14. Our MSR portfolio was $3.3 billion in market value at June 30th. Dovetailing off the strong increase in supply in the first quarter, $145 billion UPB of conventional MSR was offered in the second quarter, bringing the total for the first half of 2023 to $370 billion. Bulk packages remain well bid with continued notable strong demand. Our price multiple increased slightly to 5.5x. Speeds on MSR increased in the quarter from 4.1% to 5.4% CPR, which once again was anticipated due to seasonal effects. Despite the increase, speeds remain historically slow, which reflects the MSR's low gross weighted average coupon of 3.43%. Prepayment speeds should decline in the third quarter, owing to weaker seasonal factors and higher primary mortgage rates providing a tailwind for this strategy. Please turn to Slide 15, our return potential and outlook slide. The top half of this table is meant to show what returns we believe are available in the market. We estimate that about 62% of our capital is allocated to hedged MSR with a market static return projection of 13% to 16%, the remaining capital is allocated to hedged or MBS with a market static return estimate of 11% to 13%. This capital allocation and return expectations are in line with last quarter. The lower section of the slide is specific to our portfolio with a focus on common equity and estimated returns per common share. With our portfolio allocation shown in the top half of the table and after expenses, the static return estimate for our portfolio is between 9.5% to 12%, before applying any capital structure leverage to the portfolio. After giving effect to our outstanding convertible notes and preferred stock, we believe that the potential static return on common equity falls in the range of 10.9% to 14.9% or a prospective quarterly static return per share of $0.45 to $0.61. I really believe in the cyclicality of markets and there are plenty of reasons to be optimistic about our strategy at this point in the cycle. Spreads are historically wide on mortgages and when either combined with MSR or just rate hedged, have ample return potential. Speeds in our MSR are slow and should remain so for the foreseeable future. And if the Fed is indeed close to the end of this hiking cycle, volatility should moderate and spreads could tighten meaningfully, we believe we are well positioned to drive attractive shareholder returns. Thank you very much for joining us today, and now we will be happy to take any questions you might have.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question is from Doug Harter with Credit Suisse. Please proceed.

Good morning, Doug.

Good morning. How do you see the potential catalysts or risks to spread kind of in the coming months and kind of how would that – any changes impact your return potential?

Nick, you're on mute. Sorry, Doug, a little technical difficulty here.

Yes, no worries, Bill.

Okay. Can you just repeat your question a little bit there Doug, so I can take that one while Nick figures out.

Sure. Yes. As you look at the MBS market, how do you see the potential catalysts or risks to spread at this point? And if we were to see a spread tightening, how does that impact the return potential of the portfolio?

Yes. Sure. So I mean, as we said in our prepared remarks and I think there's lots of the risks that we've seen and worried about in the first half of the year have dissipated or been reduced somewhat. We mentioned a couple of them. The Fed seems to be on a good path here. Inflation seems to be coming down. The FDIC sales were well received by the market. Rate volatility continues to be high, though we expect it to moderate as some of the remaining uncertainties solidify and get taken out of the market. So we do think spreads could tighten. However, lots of market participants are still out of the market. The Fed is letting their mortgages run off. Banks are still not participating. So we see a fair number of reasons why mortgage spreads could stay as wide as they are, which as we've said before is just fine with us and our strategy and the returns that we show on Slide 15 don't particularly depend on spreads tightening. If they do, and they may, as you can see from Slide 15 and so forth, our book value will benefit. We do have around 40% of our capital allocated to mortgage spreads, and so we will certainly benefit from that, but we still think that we maybe in an environment where spreads stay wider than they have been historically for more of extended period of time. Nick, are you back? Can you – do you want to add anything to that?

Can you hear me?

Yes.

Yes. Okay, good. Sorry about that. No, I think Bill, I think you pretty much said it. As we profiled on the call, the supply dynamic in the mortgage market, while it remains a little bit challenging for production coupons. In our opinion, there are good – are reasons to believe that it will be met with a reasonable amount of demand if you look at the inflows into the money manager sector and also just some public comments from some larger money managers and just look at what happened in the first quarter – first half, excuse me. We think that the probable path is a fairly balanced spread profile and as far as our own portfolio is concerned, this past quarter was a really good demonstration of the power of carry. We really were able to earn our carry this past quarter, which really shows you the spreads that are available in the market, which really can be expressed particularly when volatility calms down a little bit, which it certainly did in the – towards the tail end of last quarter. And even now for this first month of the third quarter, rate volatility has been – actual rate volatility has been fairly low. So we think it's a very constructive environment for our strategy for the rest of the year.

Great. Thank you.

Thank you. Our next question is from Bose George with KBW. Please proceed.

Hey, everyone. Good morning.

Good morning, Bose.

The expected return on your portfolio declined, I guess it was about 150 basis points from 1Q to the second quarter. Just wanted to see what the drivers of that change was.

Hey, Bose, how are you? This is Nick. We snapshot everything at the end of each quarter. That's just a – I think a reflection of the way spreads have moved a little bit from quarter-to-quarter.

Okay. So spreads are a bit tighter from the end of the first or the end of the second, so that was really just that?

That's correct.

Okay. Great. Thanks. And then in terms of book value, can you just give us an update on book value quarter-to-date? Does anything meaningful happen?

Yes. As things have moved around a little bit, we're up slightly on the quarter. We estimate that book value is up around 1% so far through close of yesterday.

Okay. Great. Thanks.

Thank you.

Thank you. Our next question is from Trevor Cranston with JMP Securities. Please proceed.

Hey. Thanks. You guys characterized your leverage positioning as neutral throughout the quarter. I'm curious as we go forward, if your view was to shift particularly on the MBS market in terms of having a higher probability of spread tightening and maybe less risk of widening. Can you talk about what you – how you guys would think about leverage and what you would view as sort of a more aggressive leverage level, if you start to see a change in the probability of spread tightening going forward? Thanks.

Hey. Thank you for the question. So first of all, we really do like our leverage and where our risk is currently. Once again, as we demonstrate in this past quarter at current spread levels, the return – the actual return of the portfolio has been good and our return potential is as you can see from the presentation is also very supportive of our dividend or potentially could out earn our dividend, which could generate extra return and growth of book value over time. So at the moment, we don't have any particular plans for increasing leverage. As said, it really doesn't feel like we need to do that. Should we be at that point in the cycle where we do see the Fed truly being done with raising rates? That I still believe is the single most important element to having a materially tighter spread environment. The paths that we have experienced in terms of higher rates or unbounded higher rates on the Fed side, I think I've held back how spreads can do and how investors – how optimistic investors can be about spread movement. However, I think the single most important thing to drive spreads materially tighter would be the Fed really being done, and then we should see a decline in volatility along with that. And that would be a big driver of spread tightening and extra performance. But once again, I don't really think that's necessary for a portfolio. We've seen over the – as we described, we're trying to keep our ourselves balancing a high amount of leverage versus the still uncertain environment we're in. And rate volatility has kind of ebbed and flowed, it's spiked a couple times, in the last six to 12 months come back down and then come back up a little bit. And we've even seen it come back up a little bit in this quarter again, in terms of implied rate volatility. That's an important driver in all spread models out there, which a lot of investors look at. So we're trying to balance those things, but at the end of the day, we look at how our portfolio can generate returns, and if we're generating returns that are supportive of our dividend and our book value growth, that's really what we're after. If there's a clear sign that it makes absolute sense to increase our leverage, we'll do so.

Got it. Okay. That’s helpful. Thank you.

Thank you. Our next question is from Kenneth Lee with RBC Capital Markets. Please proceed.

Hey. Good morning. Thanks for taking my question. Just about the book value per share, you talk about how repurchases help the book value increase in the quarter, but wondering if you could just talk a little bit more about how the underlying investment strategy, the rates and MSR pairing strategy also potentially contributed to the book value increase there? Thanks.

Yes. Thanks very much, Ken, and good morning. The amount of share repurchases that we did during the quarter was reasonably small. And so it had a correspondingly small impact to the book value return that we announced. We think that was roughly around $0.05. The bulk of the return was from the performance of the portfolio, which given what it was, there's pluses and minuses that offset one another, and it was largely the result of carry in the portfolio such as it is being as high as it is as we show on Slide 15 and relatively IXM, that was the bulk of the return.

Got it. Thanks for that color there. And then I guess in terms of the investment opportunities, where you look at right now, what are some of the more attractive investment opportunities that they see over the near-term here? Thanks.

Thanks again. So I think we can see it on Slide 15 here, which is the same thing we've been saying for a little bit. Spreads are wide in both RMBS and in MSR. We happen to like the hedged MSR a little bit better than the RMBS, although, the supports amongst RMBS as shown by the investor demand from the FDIC sales was clearly robust and encouraging. Although as Nick just said, rate volatility remains high, there's other uncertainties in the market. But we like our target assets here of RMBS and hedged MSR. We like our capital allocation between those asset classes. And so we're going to continue to participate and invest in those sectors.

Great. Very helpful there. Thanks again.

Thank you. Our next question is from Rick Shane with JPMorgan. Please proceed.

Thanks guys for taking my questions. I'm really interested in the interplay at this point between coupon and the hedging strategy. And in particular, I'm kind of looking at comparing the potential return outlook from the first quarter to the second quarter. One of the things, and again, it is modest, but there's a slight decrease in the static return estimates for the rates in RMBS strategy. Is that a function of with where we are in the market pay-ups are increasing? Is that what's sort of tweaking that a little bit?

Hey Rick. This is Nick. Thank you for the question. Many things go into the static return slide potential. One of them, as we noted in the commentaries, we did go down in coupon a little bit, which does have a lower amount of nominal spread than higher coupons do. So natively a portfolio of lower coupon MBS will be tighter and consequently on a levered and hedge basis, you will have a lower static return potential. And I think that's probably the biggest thing that has affected those numbers quarter-over-quarter. As we noted in the commentary as well, this past quarter there was a big divergence in performance over the quarter. Current coupons were a little bit wider, nominally, lower coupons were tighter. So to the extent that we shifted down in coupon, I think that probably that is the largest reason why we've seen a little bit of a lower return potential on that component of the return side.

Got it. Okay. That's helpful. And again, when we look at the premium in the portfolio, it's relatively modest. I'm assuming given where we are in the rate cycle and all of the uncertainty that that will continue to be the strategy to either buy par or slight discount securities?

I'm sorry, Rick. I don't understand your question. When you say premium, what do you mean?

If I look at the amortized cost of the portfolio versus the par value, you don't have a ton of premiums so that if at some point in the intermediate term, we see a big pickup in speeds, you won't have a ton of realized losses.

Oh, I see. Yes, no that is – I think that's accurate. The world right now is a little bit – is a little bit as Bill says, kind of upside down in the sense of we have a mix of securities across the portfolio to the extent and you're right, we don't have the amortized cost basis of the portfolio from that measure, which, we're always looking at things more on, since we mark our book every day, every month, we're looking at things more on a total rate of return basis, but on an amortized cost basis, you're correct. The average cost is pretty close to par so that it wouldn't have a big effect in terms of the nominal yield or some of these more I would say accounting measures of the book.

I might add just a couple other points to that, Rick, if I can, which is number one, there's not very many above par dollar price securities in the world these days, right? I mean, [Fannie 6s] today are par dollar price handle and so forth. Looking at the amortized cost is also of a – it sort of suffers for a little bit from the EAD problem, which is asynchronous, it refers to what the prices of the things when we bought them, right. It doesn't refer to current market prices of things too. So that is potentially a little bit misleading about what the actual prepayment risk is of the securities, right. In terms of prepayment risk, as Nick said that, I always say, we're in an upside down world, we're in a discounted environment. Slow prepays are bad, fast prepays are good in RMBS. Of course in MSR, the exact opposite is true and slow prepayments are always good. But you're right, the average dollar price of our current holdings does not have a lot of premium in it.

Yes. Look, I think at the end of the day you guys are managing a portfolio when tail risks are a lot closer than they normally would be.

These are uncertain times. I agree.

Okay. Thank you guys very much.

Thank you, Rick.

Thank you. Our next question is from Eric Hagen with BTIG. Please proceed.

Hey. Good morning. How are we doing? I think just a couple of questions here on RoundPoint. I mean, how much operating leverage do you feel like you have there? How scalable do you feel like the platform is in maybe both a scenario where you're scaling up the MSR or even if there's a prepay wave and how would it look, in light of that, maybe stepping back even more philosophically, like talking about the onboarding of RoundPoint and how you think about your appetite to grow the servicing portfolio. Would you say that you have even more appetite for like bulk servicing because you've brought that platform on? Thank you, guys.

Yes. Sure. Good morning, Eric. Thanks for the question. So we haven't closed on RoundPoint yet. We know we're still waiting on a few remaining states. As we said in our prepared remarks, we've transferred around 63% of our portfolio to RoundPoint already. And RoundPoint has been able to absorb that capacity well and easily and the reports that we've gotten post transfers have been very good. And that's all happened smoothly, which gives us confidence that we can continue to scale up that platform even more. And while we don't own the platform yet, we have been able to appear inside a little bit and we're still confident that the operating leverage and the earnings that we said when we announced the deal are still in the context of what we expect to achieve once we do close. The platform itself does – as we have moved our loans over there and as we see what RoundPoint can do and what it's capable of doing. We do imagine that the cost of service for loans on the RoundPoint platform will be lower than what we are currently paying in sub-servicing, right? And so as a marginal cost exercise that will make servicing that we acquire more attractive to our investors on that platform. So all else equal adding to our MSR portfolio will be advantageous. It will look even better than just the numbers that you see on Slide 15. But we're balancing that with some amount of diversity and ability to have liquidity in the RMBS sector. And as Nick said, markets are cyclical and there is – we believe in mean reversion, so we think there are still good opportunities there. So our capital allocation is something close to what we want it to be, and we like that. RoundPoint will give us the opportunity to participate in other parts of the mortgage finance sector. Can we –we're looking to be able to increase our presence in the third-party sub-servicing space. RoundPoint has a little bit of that already. We see opportunities there to grow that, which we'll be able to benefit from that low cost of service and the operating platform, the scalability from that perspective. And there is other opportunities that we'll be able to have too. You mentioned what will happen in a refinancing wave. RoundPoint right now does not have capabilities to do that. But we're working with other partners in order to be able to provide portfolio protection in various ways. And so we think that's another opportunity that we'll be able to have to participate in that space as the markets evolve and as time unfolds.

Thank you so much.

Thank you, Eric.

Thank you. As there are no further questions at this time, I would like to turn the floor over to Bill Greenberg for closing comments.

I just want to thank everyone for joining us today and thank you as always for your interest in Two Harbors.