July Hugen - Director, Investor Relations Thomas Siering - President and CEO Brad Farrell - Treasurer and CFO William Roth - CIO.

Sam Cho - Credit Suisse Mark DeVries - Barclays Capital Trevor Cranston - JMP Securities Eric Beardsley - Goldman Sachs Kenneth Bruce - Bank of America.

Good day, ladies and gentlemen, and welcome to the Two Harbors Investment Corp First Quarter 2015 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions].

As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference call July Hugen, Director of Investor Relations. Ma’am, you may now begin..

Thank you and good morning. Welcome to our first quarter 2015 financial results conference call. With me this morning are Tom Siering, President and Chief Executive Officer; Brad Farrell, Chief Financial Officer; and Bill Roth, Chief Investment Officer.

After my introductory comments, Tom will provide a recap of our first quarter 2015 results, Brad will highlight some key items from our financials, and Bill will review our portfolio performance. The press release and financial tables associated with today’s conference call were filed yesterday with the SEC.

If you do not have a copy, you may find them on our website and the SEC’s website. This call is being broadcast live over the Internet and maybe accessed on our website in the Investor Relations section under the Events and Presentations link.

We encourage you to reference the accompanying presentation to this call, which can also be found on our website. Reconciliation of non-GAAP financial measures to GAAP can also be found in the presentation.

We wish to remind you that remarks made by management during this conference call and the supporting slide presentation may include forward-looking statements.

Forward-looking statements reflect our views regarding future events and are typically associated with the use of words such as anticipate, target, expect, estimate, believe, assume, project, and should, or other similar words. We caution investors not to rely unduly on forward-looking statements.

They imply risks and uncertainties and actual results may differ materially from expectations. We urge you to carefully consider the risks described in our filings with the SEC, which may be obtained on the SEC’s website at www.sec.gov.

We do not undertake any obligation to update or correct any forward-looking statements if later events prove them to be inaccurate. I will now turn the call over to Tom..

Thank you, July. Good morning and thank you to everyone for joining the call today. Beginning on slide 3, I will briefly review our financial results. Our book value at March 31st was $11.08 per share representing a total quarterly return on book value of 2.2% on a combined with the first quarter dividend of $0.26 per share.

During the quarter we delivered comprehensive income of $88.9 million or $0.24 per weighted average share and core and GAAP earnings of $0.26 per weighted average share respectively.

This performance exemplifies our long-term commitment to book value, preservation, and growth especially with regard to diversification, asset selection, and risk management. The highlight of the first quarter was the success of our conduit business which is an important and developing franchise value for our stockholders over the long-term.

We close two transactions totaling approximately 575 million UPB and our pipeline remains robust. We continue to target long-term flow MSR partners particularly where we can leverage our conduit relationships. Our goal is to work in tandem with our seller partners to develop a full suite of products that addresses voids within the market.

While relatively immaterial to our portfolio we made an initial investment in commercial real estate during the first quarter. As previously mentioned we intend to allocated $500 million in equity capital to this initiative and we expected to deploy the remainder of this in the latter half of 2015 and into 2016.

We have also been developing the infrastructure and team to support this strategy. We view commercial real estate as an attractive opportunity for our stockholders. My last comment on the portfolio is that our agency and non-agency assets continue to perform within our expectations during the quarter. Please turn to slide 4.

On the economic front, the March jobs report disappointment in the market and the Fed continue to make dervish commentary about when and if they will raise rates. However, the market generally expects that our modest increase in rates is likely sometime in 2015.

According to the CME Group, there is roughly a 60% probability that the Fed will raise rates by at least 25 basis points by December with an expected value of 35 basis points. While over the past few years macroeconomic conditions in the U.S.

appear to be improving, the global back drop has been less certain leaning to elevated interest rate volatility. This has been particularly true during the second quarter. National home prices increased 5.9% on a rolling 12 month basis in March according to CoreLogic.

We expect housing price depreciation to continue in 2015 albeit at a softer pace than the last few years. Unemployment have improved year-over-year following a 5.5% in March 2015 from 6.6% in March 2014 despite recent disappointments.

From a policy perspective, we continue to engage with parties in Washington on regulatory and policy related topics that directly impact our business, including the private label securities market, servicing standards, GSE risk sharing, and housing finance reform.

We have not heard anything further from the FHFA after submitting our response letter with respect to the proposed rule making regarding federal home loan bank membership. We understand that many letters were submitted, so the process could take some time.

As most of you are aware, the FHLB admission window has reopened and several mortgage REITs have recently been approved for membership. Importantly, we believe our interest aligns directly with the mission of the home loan bank system and our secured financings are consistent with their safety and soundness merger.

For illustration, this financing enables us to provide stable and consistent pricing to the mortgage market which is helpful to home owners. We are members in good standing with the Home Loan Des Moines as underscored by the recent increase in our facility to $4 billion up from $2.5 billion.

With that I will hand it to Brad to comment on our financial results..

Thank you, Tom and good morning everyone. Please turn to slide 5. Book value is $11.08 per share at March 31st versus $11.10 as of December 31st. Comprehensive income was $88.9 million or $0.24 per weighted share in the first quarter.

Comprehensive income was primarily driven by the net carry on our available for sales securities, house for sale loans, and retain interest on our securitizations. I would note that during the quarter we realized gains of $117.5 million on the sale of primarily non-agency RMBS.

The company declared dividends of $95.3 million or $0.26 per share in the first quarter. Please turn to slide 6 for a summary of our financial results. Core earnings of $0.26 per weighted share were in-line with our expectations and represented an annualized return on average equity of 9.2%.

Core earnings increased quarter-over-quarter and I would like to detail few of those larger drivers of the variance. The most significant driver was lower swap expense as a result of the repositioning of our overall hedges which included a reduction in our swap notion in December.

Following modestly increased leverage on our agency and non-agency portfolios resulting in higher interest income, our implied debt-to-equity ratio actually decreased quarter-over-quarter due to increased short TBA position. Offsetting these tailwinds was a slight uptick in our operating expense ratio to 1.6%.

Looking forward I would note that we increased our notional swap position in March to protect against higher rates which will drive higher interest spread cost in future periods. We also continue to expect an increase in our other operating expense ratio as we deploy capital into the commercial real estate strategy.

I would like to spend a brief moment on an accounting topic. As discussed, the accounting treatment of our commercial real estate investments, for the majority of our assets we use fair value accounting, as we believe this is the truest reflection of our portfolio of performance and dividend power.

That being said we anticipate commercial real estate debt would deviate from this as they are bespoke structures do not lend themselves to fair value measurement. These investments will be accounted for at amortized costs and tested for impairment on a quarterly basis. Please turn to slide 7 for an overview of our financing profile.

I would like to highlight a couple of things on this page which includes our typical financing disclosure. Our FHLB capacity was extended to $4 billion in late February and we drew down a $125 million of the added capacity in the quarter. Subsequent to quarter end, we drew down another $125 million leaving $1.25 billion of available capacity.

The FHLB facility is a valuable financing tool that among other things affords our corner of business a stable and dynamic funding source at attractive rates and a variety of maturities. And provides us greater flexibility when responding to repo market shifts.

While disruptions in the repo market have been reported in the media lately due to the storage of quality collateral in the market specifically U.S. Treasuries and balance sheet constraints at the banks, our repo continues to function normally with no meaningful shifts and financing haircuts or rates.

For more information on our repurchase agreements and FHLB financing, please see the appendix slide 22. With that I will turn the call over to Bill..

Thank you Brad and good morning everyone. The markets in the first quarter were quite volatile. After a sharp rally in January, rates retraced dramatically before moving lower again in March. These lower first quarter rates were due to a number of factors including somewhat dervish commentary from the Fed on the timing and pace of future rate hikes.

That said we believe we could be added in inflection point with the potential for more volatility and higher rates and are positioned accordingly. From a performance perspective, we essentially earned our carry this quarter with the slight drop in book value due to a modest under performance of in pay ups for specified pool.

As we have discussed before we continue to maintain a generally conservative risk profile and are focusing much of our time on our operational businesses which I will talk about in more detail shortly. Please turn to slide 8 for a portfolio update.

As of March 31st, the portfolio was 16.3 billion in assets including 12.2 billion in the rate strategy representing 55% of capital and 4.1 billion or 45% of capital in the credit strategy. Additionally we closed on a $46 million commercial real estate loan for our first investment into the sector.

With respect to the rate strategy we added some specified pools increasing our leverage slightly while improving our convexity profile. In general, our basis risk exposure and leverage remain relatively low. In the credit strategy we continued to sell certain legacy non-agency bonds that we believe were fully valued.

More importantly we added assets that we created from two Agate Bay securitizations including subordinate [indiscernible] bonds as well as some AAA's. Finally we added modestly to our GSE risk sharing holdings.

As we have discussed before, capital allocation in our portfolio has been shifting towards our operational businesses with over 20% dedicated to retained interest from securitizations, the loan pipeline, and MSR at quarter-end. Capital to the conduit at 11% has increased greatly from virtually zero at December 31, 2013 and 9% at year end.

Please turn to slide 9, for a review of our portfolio performance and yields. As you can see on the bottom right, our annualized net interest spread for the quarter was 3.07% up 16 basis points quarter-over-quarter. This was due largely to lower swap expense as Brad mentioned as well as a 70 basis point increase in MSR yield.

As usual I would note that future MSR yields will be driven by prepayment activity. For more details on our rate and credit strategies please refer to the appendix, slide 17 through 21.

With respect to risk management our hedging profile has not changed dramatically from what was detailed on our fourth quarter earnings call and at our Analyst and Investor Day in March. You may recall that we had eliminated several billion swaps in December so our average swap position was lower during the first quarter.

But we added swaps in March taking our total notional payers up by 1.1 billion from year-end. We are positioned for the Fed to move interest rates higher on measured basis while maintaining optional protection should a dramatic change in rates occur. Please see slides 23 and 24 in the appendix for more information on our hedges.

Please turn to slide 10, where I would like to spend some time talking about the conduit. We completed two securitizations during the quarter. These generated approximately 45 million in subordinate and IO bonds for our portfolio and ROEs in the low double-digits.

While marketing Agate Bay 2015-1 interest rates fell and spreads on AAAs widened dramatically. While we did sell some AAAs from this deal we retained the majority of them as the expected ROE was attractive using FHLB financing.

As noted in the past we have the flexibility to finance the AAA bonds with the FHLB if marketing conditions prove difficult which was the case for this deal. On the other hand Agate Bay 2015-2 came to market at a time when AAA spreads had tightened back to more normal levels and we sold all of the senior bonds.

Importantly as we bring more deals to market we have seen broader investor interest which is evidenced by the increasing number of investors purchasing bonds. We believe this results from becoming a consistent issuer and having developed some brand recognition.

Our total net economic interest in securitization trust by market value increased to 770 million at March 31. Subsequent to quarter-end we completed Agate Bay 2015-3 selling all of the AAA bonds and retaining the credit and IO bonds. Once again, we saw broad investor participation.

Our prime jumbo pipeline which includes loans and interest rate lock commitments remains robust and was approximately $1.2 billion at March 31st. The strength of our pipeline supports our goal to be a regular and consistent issuer.

We are committed to growing our conduit business by expanding our high quality network of sellers for both prime jumbo loans as well as a variety of products over time. We remain on track to have 45 to 50 sellers in place by year-end.

We continue to work on an expanded credit program that would reach additional borrowers, particularly those ineligible for our standard prime jumbo program and those unable to get a mortgage due to the tight credit standards that exist in the market today.

We believe this expansion of credit can benefit the housing market and while we continued to project slow volume growth in the near-term, we believe this program could become meaningful to Two Harbors overtime. Please turn to slide 11.

With respect to MSR, current market dynamics have changed over the last several months and both flow and bulk MSR opportunities have become more attractive. Given this, it remains a top priority for us to add flow sellers during the course of this year. We also continue to evaluate bulk MSR deals as they become available.

MSR remains an excellent asset for Two Harbors and we are focused on growing it as a core holding in our rate strategy. Another significant accomplishment was our initial investment in commercial real estate late in the quarter. Specifically this is a $46 million senior floating rate mezzanine loan on a diversified portfolio of hotel assets.

We expect the ROE to be in our targeted range of low to mid double digits using a small amount of leverage. More importantly, the personnel and infrastructure requirements necessary to fully ramp the program are close to being built out and we are excited about the potential long-term opportunities commercial real estate offers our stockholders.

In closing, we are pleased with the continued growth of our operational businesses, as they have the potential to drive stockholder returns and the creation of franchise value over the long-term. I will now turn the call back to Marcus to assist us in taking any questions..

[Operator Instructions]. Our first question comes from the line of Doug Harter from Credit Suisse. Please proceed with your question..

Hi, this is actually Sam Cho filling in for Dough Harter. I was wondering if you could expand on the attractiveness of the MSR opportunity and how you see that persisting during the year..

Yeah, hey good morning. This is Bill. Thanks for joining us today. Yeah, so on the MSR side couple of things are worth noting. First of all the potential supply this year appears to be higher. There has been some increased selling activity and comments about selling throughout the year.

So the supply side looks fairly full and at the same time the competitive landscape that we see on the buy side has reduced somewhat. So basically we’ve seen MSR cheapen out a little bit, and making it more attractive and at the same time there is less competition in certain situations.

So when you put those two together we think it’s definitely a good time to focus on adding some flow sale partners as well as taking a closer look at bulk deals when those come to market. .

Got it.

My second question was, I mean the shares are treading below book and I was wondering if you had any thoughts on maybe implementing a share repurchase plan during the year?.

Sure, this is Tom. Obviously with respect to share buyback, we view it as we would any investment opportunity. We view it versus other alternatives. Obviously we bought back stock in the past. We did not during this quarter but it’s something that we constantly review..

Got it. Thank you so much..

Thank you..

And our next question comes from the line of Mark DeVries from Barclays, please proceed with your question..

Yeah, thanks.

Just a follow up on the MSR opportunity, Bill what kind of ROEs do you think you can get in the current environment kind of inclusive of the savings you get from reduced hedging cost?.

Hey Mark, good morning and thanks for joining us. Yes, so MSR, prime new issue MSR we see on its own sort of in the high single digits which is out 100 to 200 basis points and so additionally on a hedged basis it takes it into the low double-digits.

But you know in addition to that instead of using swaps or other hedging activity that we would use, the MSR combination is a much lower basis risk position. So we view that as a higher quality ROE as we have talked about before. .

Yes and especially in the current interest rate environment where we have a lot of volatility, it’s particularly beneficial in the overall risk mitigation strategy. .

Okay, and I think you eluded to the fact that you are kind of raising for greater volatility, are you referring to mainly volatility of the rates market or you also kind of concerned about the basis as we kind of head towards what should be the eventual Fed typing cycle and the additional withdraw the reinvestment of principal by the Fed?.

Yes, sure. So, the thing is -- to answer the first part of your question, yes the rate we think that as we get into this unchartered territory at least that hasn’t raised rates in 10 years. We haven’t seen that for a long time and so if you look back historically typically you get increased rate volatility and you can get increased spread volatility.

So it’s our view and I probably -- we were probably a little bit early on this last year by keeping a conservative position. But we definitely think that you could see both dynamics take place and which is why we kept our rate exposure and our basis exposure in a conservative position. .

Do you think that spread volatility can get exacerbated by the tapering that goes along as well?.

Yes, well mortgages are if you look at them on a spread or in OAS basis over a long period of time like many other asset classes they are at the tighter end. So it’s certainly possible.

It kind of depends on whether what the Fed does in their reinvestment or how much delta hedging you need to see now given that the Fed is not delta hedging that obviously reduces the need for re-hedging. But last time we saw, during the taper tantrum [ph] a few years ago there was a lot of spread volatility. So I mean it certainly could happen again. .

Yes, Mark I mean without a doubt, right there is correlation between interest rate volatility and spread volatility historically and that’s why if you look at our overall risk profile our spread duration is very well, our leverage is very well.

We are very fully hedged on interest rates and so we think we are well off positioned for a variety of Fed scenarios. .

Okay, great. Thank you. .

Thank you Mark. .

Thank you. .

Our next question comes from the line of Trevor Cranston from JMP Securities. Please proceed with your question. .

Hey, thanks.

Just first question, now that you guys have done several securitizations off your own shelf can you maybe just give us some color and talk about any changes you’ve seen and trends in the execution on your deals in terms of subordination and kind of how that’s improved overtime, has it become a more regular issue?.

Hey, good morning Trevor. .

Good morning. .

Thanks for joining us. Well, I would say there is couple of parts to that and so there is probably a few different points to address. So the first thing is we’ve done in the last couple of years we did three Agate Bay deals last year. We had one in the prior year and we done three so far this year in just the first four months.

So I think there is a couple, so first I think we are seeing some good, we have developed somewhat of a brand. Our investor base has expanded greatly. We’ve obviously been out kind of telling the story or meeting with folks and that helps as people gain better understanding of what we are doing.

Additionally you are a buyer of security, if you want to feel like there is some liquidity and so to the extent that your regular issue people feel that there is better liquidity. So we have seen our spreads very consistent with where the better names in the AAA space trade.

And so from that standpoint we feel like our execution on the AAA is as good as is in the market.

In terms of credit enhancement, a few years ago credit enhancement on some of these deals was like 8% or so and we started to see that come down not only across the sector but on our most recent deal, Agate Bay 2015-3, our credit enhancement to AAA was 5.35% The earlier deals in the year were 6.65 and then 6.05, so clearly the trend is good and I think that reflects the quality of the collateral that we’re putting out there and the recognition of that.

And so despite the lower credit enhancement we still have had very broad investor participation and interest. So we are very pleased that the CE has come down. Obviously there is a limit to that but at least it feels like it’s much more in the range that’s appropriate as opposed to what it was a few years ago..

Got it, that’s helpful color. And then on slide 9, I noticed that there was a new bucket there in the rates category for Ginnie Mae buy outs, I assume that’s pretty small but can you maybe talk a little bit about what the strategy is there. .

Yes, thank you for the question. So over the -- as we own Ginnie Mae MSR pools, I know that economic responsibility. We have an obligation to buyout loans when they are in the process or about to be modified.

So typically the process you buy the loans from pool, they undergo some form of modification, and then based on their performance can be redelivered on to new Ginnie Mae pools. So it’s large in operational process that we undergo as owners of the MSR.

And those loans come on our balance sheet, we work with them, and then the ultimate goal is to have them be re-performing and be redelivered to pools.

The amounts are really small but they’ve grown enough that we want to make sure that they were distinct against credit sensitive loans or re-performing loans which was the strategy we obviously were doing in the past couple of years. And so that’s why the separate breakout and that’s why they are included in the rate strategy. .

Okay, got it. Thanks guys. .

Our next question comes from the line of Eric Beardsley from Goldman Sachs. Please proceed. .

Hi, thank you and good morning. Just a quick question on your non-prime plans.

When will we expect to see something out there in the market?.

Hey, good morning Eric. Let me just clarify your question when you are saying in the market you are talking about the securitization or... .

I guess just in terms of the product and when you think you might have some loans on your book?.

Well we’ve already been taking as we said in the past we have been taking in some higher LTV loans. Now that is relatively a light volume given the nature of the borrower and our hope would be that we would start to see something on the lower credit quality, sometime later this year but it’s too hard to predict exact timing on that. .

Got it and just on the commercial real estate, you mentioned that you put modest leverage on the mezz loan that you did, just curious in terms of I guess where you had the financing cost today and what the optimal leverage on that might be?.

Sure on the commercial real estate, so basically use one turn of leverage on that and the financing -- if the financing was sort of sub 200 over LIBOR without getting to granular on that but we think that’s appropriate for a conservative mezzanine loan. And so as I mentioned in my comments we see that as sort of low to mid double digits ROE.

We’re floating rate asset, floating rate financing. .

Got it and then just lastly if you could just remind us where you see your spread duration today, you mentioned that you are keeping a low profile from certainly a lower profile with the MSR book?.

Yes, I think -- I have seen some folks publish an actual duration number. With regard to rates we’re pretty fully hedged. If you look at our sensitivities to rate changes they are extremely low. I mean they have always been low but today they are really extremely low.

And then on spread duration not much is changed from on the asset side from our Analyst Investor Day in March where we talked about having mostly high coupons which were short duration, HECMs which are short duration, etc.

So if you look in the Appendix at our holdings you’ll see that between the low leverage and effectively the shorter average life bonds spreads widened. Obviously that’s going to impact the valuations but not as much as if you had more current coupons. .

Got it, great. Thank you. .

Thank you. .

Our next question comes from the line of Ken Bruce from Bank of America. Please proceed with your question. .

Great job, thank you, good morning gentlemen. The allocation of capital into the rates in credit strategy has been relatively consistent nevertheless, several quarters I am just wondering if you see that changing as volatility in rates increases here going forward or how we should be thinking about that overall capital allocation going forward.

It’s obviously 55%, the rate strategy is still high by itself and given the leverage there it has a pretty big balance sheet impact so, do you see that changing at all?.

Hey Ken, thanks for joining us, this is Bill. I would say, first a couple of things, first of all within the rate strategy keep in mind an MSR say most of 2013 and into early part of last year was zero. And that’s now about 10%. So of the 55%, the agency pools, etc have actually gone down quite a bit from up in the high 50s into the mid 40s.

So additionally as I mentioned on the conduit assets created by the conduit have gone from zero to 11%. So those are retained interests as well as loans in pipeline. So if you think about, I mentioned it between MSR and assets we create and our conduit has gone from effectively zero to 20% are actually over 20% into the low 20s.

And we think that trend is going to continue. So as we do more securitizations you are going to see that increase on the credit side and as we add more MSR you are going to see that increase as a percentage of the rate strategy.

And then finally commercial real estate we’ve committed 500 million of equity capital which is about 12.5% and that’s currently -- it’s not zero but is pretty darn close to zero because we just have one loan and that can obviously go up a lot.

So I think if you look forward to say in the next year or two you are going to see the securitization interest go up, you are going to see MSR go up, you are going to see commercial real estate go up, and you’re going to see agency pools and legacy credit bonds go down. .

Good, that’s actually very helpful. Is it maybe -- have you given any consideration to maybe refining the way that you basically present that information to me.

When you look at Two Harbors it gets lumped in with a lot of different types of mortgage REITs and yours is quite different and unique in a lot of different ways and frankly should comp against those that are trading at much higher multiples and a team to kind of get thrown into the basket with some more agency oriented ones and anything that would help to maybe separate you from the pack might actually be helpful from that perspective, I guess as a comment?.

Yes, this is Tom. Thanks for the question, it is a very good. Well obviously we always want to do anything that is beneficial to our shareholders. So, if you have thoughts on presentation we will be delighted to talk about those.

But we do appreciate your comments that our business is quite different from other business models within the mortgage REIT space. But we are always eager for input from our valued analyst. .

And then maybe my last question is just you had a lot of success in the operational businesses and we have talked in the past about that is very different investment, you can't move in and out of it as quickly, you have got dedicated property plan equipment resources and the like that are part of that.

Do you really envision this really turning into almost an operational company or do you always feel like it is going to have a heavy emphasis on the investment aspects and operational manufacturing for the end investments that you are looking to retain?.

Yes, it is a great question. Obviously we have a few guiding factors, right. The whole pool is a guiding factor for us which historically is needed to be fulfilled within the agency space.

But I would think this that we want to be able to do a number of things within the mortgage space and our messaging today is very consistent with our messaging in the past which are that our new initiatives of securitization, MSR, and commercial real estate are the most attractive use for dollars today.

And obviously that is where we are dedicating money and resources and thought. And so, as we have said in the past, we want to operate within whatever space we feel delivers the highest quality ROE to our shareholders. .

I would offer one thing, as specific as you address the operational and kind of the size of the infrastructure, we don’t touch the bar so we do not -- we obviously use sub-servicers and we use obviously originators facing the bar for origination.

So really where we have grown our operational capability is really an oversight and credit quality and control. So, where -- if you think about our overhead I will quote middle office operations is really to kind of add value to the investment, to understand the investments, and to kind of help generate that ROE that we project.

So it is a different form of operational, but it adds value and how we are approaching the capital, the capital piece of the investment. .

Okay, well thank you for your comments and congratulations on a very successful quarter. .

Thank you..

Thanks Kenny. .

This concludes our question-and-answer session. I would now like to turn the conference over to Mr. Siering for closing comments. .

Thank you Marcus and thank you for joining our earnings call today. We will be attending the KBW Mortgage Finance Conference on June 2nd in New York. We welcome the opportunity to speak with you at this event. Have a wonderful day. Thank you. .

Ladies and gentlemen thank you for attending today's conference. This does conclude today's program. You may now disconnect, have a wonderful day..