Two Harbors Demonstrates the Benefits of Planning Ahead

Near the end of an earnings season that has seen many mortgage REITs suffer stunning book value deterioration, the second-quarter earnings report from Two Harbors Investment (NYSE: TWO  ) is like a breath of fresh air. While it's true that, with per-share earnings of $0.21, the hybrid mREIT took in $0.10 less per share than analysts has predicted, the trust also reported a book value dip of a mere 6.4% from last quarter -- which compared to several of its peers, can be considered more of a scratch than a dent.

Positioning itself against the tide of higher rates
Astutely, Two Harbors saw the storm on the horizon and took steps early in the second quarter to protect itself against a tide of rising interest rates, realigning its portfolio and putting additional hedges in place. Longer-term, the company has been steadily diversifying its base, recently purchasing a small mortgage servicing company that it plans to plump later this year with more mortgage servicing rights. Since the value of MSR portfolios rise along with interest rates, this model hedges against rising rates quite nicely.

The trust moved into the securitization business and took part in a $400 million transaction involving prime jumbo mortgages this past quarter. To make this process even more lucrative, Two Harbors has set up its own depositor and plans to securitize another $520 million in jumbos in the near future. Currently, management is working on finding an ongoing source for loans -- a role its sees expanding as the wind-down of Fannie Mae and Freddie Mac gathers steam.

A better strategy than most
Two Harbors' hedging strategies doubtless helped it preserve book value, particularly compared to its agency cousins. Less than a month ago, CYS Investments (NYSE: CYS  ) reported a book value decline of nearly 19% dragging down the entire sector -- including hybrid Two Harbors -- in its wake. A few days later, Hatteras Financial (NYSE: HTS  ) announced that its book value had dropped by more than 20% and promptly saw its share value tumble by 10%. CYS, for its part, admitted that its own hedging hadn't worked out as the company had envisioned.

As for American Capital Agency (NASDAQ: AGNC  ) , management also took steps to maintain book value and wound up with a loss of less than 12%. American Capital had suffered a ding in book value in the first quarter and shrewdly repositioned its portfolio to avoid a big wallop in the following quarter.

Diversification has been a superb method of maintaining value for Two Harbors, and after this exhausting earnings season is over, many of its peers may start thinking the same way.

Two Harbors may be able to preserve its dividend this year, but many other mREITs will likely see cuts to their juicy payouts. Does that mean they are no longer a sweet investment? If you're confused about the current dividend environment -- and an investor who prefers returns to rhetoric -- you'll want to read The Motley Fool's new free report "5 Dividend Myths... Busted!" In it, you'll learn which stocks provide premium growth and whether bigger dividends are better. Click here to keep reading.


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