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DATE

Tuesday, July 29, 2025, at 9 a.m. ET

Call participants

  • Chief Executive Officer — Bill Greenberg
  • Chief Financial Officer — William Dellal
  • Chief Investment Officer — Nick Letica

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Risks

  • Chief Financial Officer Dellal stated, "We took a loss contingency accrual of $199.9 million or $1.92 per share related to the ongoing litigation from the termination of our management agreement with PRCM Advisors in 2020."
  • Including the litigation accrual, book value decreased to $12.14 per share, resulting in a negative 14.5% economic return for the quarter.
  • Excluding the accrual, total economic return would have been negative 1.4% for the quarter, indicating additional underlying portfolio losses even before litigation impact.
  • Unfavorable market movements in MSR, swaps, TBAs, and futures resulted in mark-to-market losses of $93.4 million for the quarter.

Takeaways

  • Total economic return: Negative 14.5% including the litigation accrual; negative 1.4% excluding the accrual.
  • Loss contingency accrual: $199.9 million, or $1.92 per share, recorded as a GAAP loss contingency accrual following a court ruling regarding PRCM Advisors litigation.
  • Book value: Ended at $12.14 per share.
  • Comprehensive loss: $221.8 million, or $2.13 per share, with a $21.9 million, or $0.21 per share, loss excluding the accrual.
  • Net interest and servicing income: Increased by $3.1 million quarter over quarter, benefiting from a larger Agency RMBS portfolio and higher MSR float income, partially offset by runoff and higher financing costs.
  • Leverage: Economic debt-to-equity rose to 7x, impacted by the litigation accrual; implied leverage, excluding the accrual, is about 6.3x.
  • First lien originations UPB: $48 million funded, up 68% quarter over quarter from $29 million; this increase outpaced the national trend of a 16% quarter-over-quarter increase.
  • Second lien activity: $44 million UPB brokered; began originating second liens in-house for potential retention, sale, or securitization.
  • MSR bulk purchases: $6.4 billion UPB acquired through three transactions.
  • Mark-to-market result: Comprehensive losses were worsened by unfavorable movements in MSR, swaps, TBAs, and futures, partially offset by positive Agency RMBS performance.
  • MSR delinquencies: Sixty-plus day delinquency rate remained below 1% at quarter end.
  • Mortgage rates: Thirty-year fixed mortgage rates ended the quarter in the 6.7%-6.8% range, peaking near 6.9% and bottoming at 6.6% during the period.
  • Portfolio prepayment speeds (CPR): MSR prepayment rates rose by 1.6 percentage points to 5.8%, attributed to seasonal factors.
  • Static return outlook: Projected static return on common equity is 9.4%-15.3% (forward-looking, as presented on Slide 15 of the earnings call), with a prospective quarterly static return per share estimate of $0.28-$0.46, after giving effect to unsecured notes and preferred stock.
  • Unsecured financing: Issued $115 million of 9.375% senior notes due 2030, with net proceeds of $110.8 million, intended to prefund or refinance the 2026 senior notes maturity.
  • Unused MSR financing capacity: $837 million in unused MSR asset financing capacity at quarter end, plus $1 million in available capacity for servicing advances.
  • AI and technology investment: Significant expenditures for automation and AI, mainly expensed rather than capitalized, focused on contact center and customer service processes.
  • Risk appetite and portfolio management: Management reaffirmed comfort with leverage at 7x and will adjust in response to market-driven opportunities, with current risk exposures largely unchanged quarter over quarter.
  • Agency RMBS market: Nominal spread widened by three basis points to 171; option-adjusted spread finished 12 basis points wider at 81 basis points, reflecting recent volatility drops.
  • MSR portfolio "in the money": Only 0.7% of the MSR portfolio was considered in the money, potentially rising to about 8% if mortgage rates fall to 5%.
  • Expense run rate: Combined servicing, compensation, and operating expenses totaled $45 million; management expects this as a baseline for subsequent quarters.
  • Recent economic return trend: Chief Investment Officer Letica reported, "Quarter to date through last Friday, we were up about one and a half percent in economic return on the new book value." Analyst Harter clarified, "That's on economic return just to be clear."

Summary

Two Harbors Investment Corp.(TWO 1.07%) recorded a substantial litigation accrual related to the PRCM Advisors dispute, which significantly reduced both book value and reported economic return. Agency RMBS and MSR portfolio activity remained elevated, with increased origination volumes and large bulk MSR purchases, even as net losses were driven by non-recurring legal charges and challenging mark-to-market performance across several asset classes. The shift toward unsecured funding was evidenced by a new $115 million senior note issuance aimed at prefinancing maturing obligations, and ongoing investments in AI and automation primarily impacted current expense levels rather than capitalization. Management emphasized stability in leverage strategy, affirmed execution across technology and origination channels, and signaled confidence in future return prospects based on portfolio allocation and market outlook.

  • The volume of MSR supply in the bulk market declined by approximately 30% year over year, but management continues to find targeted opportunities for acquisition.
  • Specified pool prepayment speeds increased in aggregate from 7.4% to 8.6% CPR, with a larger acceleration observed in higher coupon TBAs due to reduced mortgage rates in early April and seasonal turnover.
  • Strategic expansion into second lien origination and the use of derivatives with increased inverse IO exposure broadened the risk-return toolkit, albeit as a minor portfolio component to date.
  • Adjustments to the portfolio remained responsive to shifting spread volatility, with risk and leverage levels managed within well-established internal parameters.
  • AI deployment ranges from customer-facing support to internal data processing, with most development sourced from third parties and reflected as operating expenses under strict accounting rules.

Industry glossary

  • UPB: Unpaid principal balance; the outstanding principal on mortgage loans or securities.
  • MSR: Mortgage servicing rights; the contractual right to service a pool of mortgage loans in exchange for a fee.
  • TBA: To-be-announced; a forward contract for mortgage-backed securities where specifics are set shortly before settlement.
  • Inverse IO: Inverse interest-only; a mortgage derivative that gains value when interest rates fall due to negative duration exposure.
  • OAS: Option-adjusted spread; a measure of spread that accounts for embedded option risk in a fixed income security.
  • CPR: Conditional prepayment rate; an annualized percentage measuring mortgage prepayments in a pool.
  • Baby bond: A subordinated, often unsecured, bond typically issued in small denominations and tradeable on an exchange.

Full Conference Call Transcript

Bill Greenberg: Thank you, Maggie. Good morning, everyone, and welcome to our second quarter earnings call. Please turn to slide three. Fixed income and equity markets proved resilient in the second quarter, rebounding from poor performance in early April as the uncertainty of fluctuating tariff and trade policies roiled markets, spiking the VIX index to a multiyear high. As the quarter progressed, the tariff tension eased and the macro environment recovered steadily, leading the S&P to a record high and a significant recovery in the performance of Agency RMBS spreads. We remain disciplined in our approach to risk, keeping our interest rate and spread exposures low across the curve.

We utilized leverage judiciously and preserved ample liquidity, which allowed us to navigate these periods of heightened market volatility not seen since last October. For the second quarter, including the loss contingency accrual of $1.92 per share, we experienced a total economic return of negative 14.5%, and minus 1.4% without the accrual. For the first half of the year, this results in a total economic return on book value of negative 10.32.9% excluding the accrual. Please turn to slide four. The ten-year US treasury rates ultimately settled near where it began the quarter, as you can see in Figure one, but not before moving through a wide range.

From a low of 3.85% in early April to a high of 4.62% in late May. The spread between ten-year and two-year US Treasuries widened to 51 basis points, creating a steeper curve that continues to support attractive opportunities for RMBS and MSR portfolios. In this environment, we believe returns are compelling, and we expect further strengthening of the supply-demand dynamic, potentially leading to spread tightening. Mortgage rates generally track the treasury rate environment, moving higher in April and May before stabilizing in June. The thirty-year fixed-rate mortgage rose from 6.6% at its low to a high near 6.9%, ending the quarter in the 6.7 to 6.8% range.

While still high by recent COVID-era standards, rates remained below their 2023 peak levels. This has helped housing activity remain reasonably well supported. The Federal Reserve maintained its cautious stance and left rates unchanged even in the face of increases in inflation and mounting political pressures. Several members of the FOMC have suggested one to two rate cuts likely occurring later this year, and the market similarly projects 50 to 75 basis points of cuts in 2025. As you can see in the blue line in Figure two, if the Fed does indeed cut rates in the latter half of this year, we expect RMBS and MSR portfolios to respond positively.

With the majority of our MSR portfolio still more than 300 basis points away from the refinancing window, we do not expect a few cuts in the front end of the yield curve to materially alter mortgage rates or prepayments. We are strengthening our direct-to-consumer originations platform at Roundpoint consistent with the market opportunity in order to recapture loans in our portfolio that may refinance. Please turn to slide five. In the second quarter, we funded $48 million UPB in first liens, up from $29 million UPB in the first quarter. Although starting from a low base, this increase of 68% outpaced the overall trend in mortgage originations, which saw funded loans rising nationwide 16% quarter over quarter.

We are encouraged by the growth in our first lien originations despite the fact that most of our portfolio does not have an economic incentive to move or refinance. Additionally, we continue to actively market second liens to our servicing customers to help them extract home equity most efficiently. We brokered $44 million UPB in second liens in the quarter, and we have begun originating second liens in our own name, which we can ultimately choose to hold, sell, or securitize. This activity not only increases revenue and improves recapture rates, we have also noticed significantly slower prepayments for MSR borrowers who have second liens on top of their firsts. Please turn to slide six.

I'd like to mention some of the really interesting things we are doing in technology in order to increase efficiencies, reduce costs, and most importantly, create better homeowner experiences. We are not alone in seeing the large opportunity that AI technologies can bring to the servicing and origination businesses, and we are making significant investments in time and resources in order to achieve the benefits that these technologies promise. Our initial focus has been within our contact center, we are currently implementing AI in many areas across the platform. We use human emulation bots to move data across applications and to perform other repetitive tasks. Image recognition utilizes OCR technologies to help perform data validation.

Speech recognition applications allow us to perform comprehensive analysis and statistics on our customer service calls. And we are using generative AI technology to create automatic call summaries which saves significant time for our contact center employees while improving accuracy. Conversational AI, which we are just beginning to explore, includes allowing customers to interact more fully with customized AI interfaces for simple situations and calling in live people for more complex problems. As we look towards the future, we are also actively evaluating the application of AI on the origination side to automate the application and fulfillment process.

I like to say that AI is just the newest form of technology, and we know that this technology is integral to success in operating our business going forward. Looking ahead, we believe the combination of our investment portfolio and operating company allows us to be dynamic and responsive as opportunities emerge across the mortgage finance space. Given the strength of our platform and the depth of experience across our team, we are confident in our ability to navigate and lead through changing market cycles, creating long-term value for our stockholders, customers, and business partners. With that, I'd like to hand the call over to William to discuss our financial results.

William Dellal: Thank you, Bill. Please turn to Slide seven. As Bill mentioned, in the quarter, we took a loss contingency accrual of $199.9 million or $1.92 per share related to the ongoing litigation from the termination of our management agreement with PRCM Advisors in 2020. On May 23, the court ruled that Two Harbors Investment Corp. did not have grounds to terminate its management agreement for cause. And so we, in consultation with our independent accountants and legal advisers, determined that the loss was not probable and estimable under ASC 450, which is the accounting standard that governs loss contingencies.

The amount of the loss contingency accrual is the same $140 million that we initially reserved in 2020 related to the nonrenewal of the management agreement before reversing the accrual in connection with the subsequent termination for cause. The current accrual also includes an assumed statutory prejudgment interest at the simple rate of 9%. No other potential losses are probable or estimable at this time. We are waiting for a trial date to be set to resolve certain claims related to intellectual property, and on the issues of potential damages for the contract termination. The parties have also agreed to participate in voluntary mediation.

Including the accrual, the book value decreased to $12.14 per share, representing a negative 14.5% quarterly economic return. Excluding this accrual, our total quarterly economic return would have been negative 1.4%. Please turn to slide eight. Including the loss contingency accrual, the company incurred a comprehensive loss of $221.8 million or $2.13 per share. Excluding the accrual, we would have incurred a comprehensive loss of $21.9 million or 21¢ per share. Net interest and servicing income, which is the sum of GAAP net interest and net servicing income before operating costs, was higher in the second quarter by $3.1 million driven by an increase in our Agency RMBS portfolio and higher float income on MSR.

This was partially offset by lower servicing fee income from MSR portfolio runoff and slightly higher financing costs. Mark-to-market gains and losses were lower in the quarter by $93.4 million. As a reminder, this column represents the sum of investments in securities, net gains and losses, and change in OCI, net swap and other derivative gains and losses, and net servicing asset gains and losses. In the second quarter, mark-to-market gains and losses were impacted by unfavorable market movements on MSR, swaps, TBAs, and futures, partially offset by overall positive market movements on Agency RMBS. You can see the individual components of net interest and servicing income and mark-to-market gains and losses on appendix slide 22.

Please turn to slide nine. RMBS 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 our agency RMBS repo was sixty days. We issued a baby bond in the second quarter with the intention of using the proceeds in part for the refinancing or repayment of our 6.25% senior notes due in 2026. In total, we issued a $115 million aggregate principal amount of nine and three-eighths percent senior notes that are due in 2030 for net proceeds of $110.8 million. We finance our MSR, including the MSR asset, with $1.8 billion of outstanding borrowings under bilateral facilities.

We ended the quarter with a total of $837 million in unused MSR asset financing capacity. Our servicing advances are fully financed, and we have an additional $1 million in available capacity. I will now turn the call over to Nick.

Nick Letica: Thank you, William. Please turn to Slide 10. and $3 billion in TBAs. Our economic debt to equity increased to seven times, which includes the effect of the loss contingency accrual on our book value. We brought our debt to equity and mortgage spread risk down in early April in response to market volatility and spread widening. As volatility subsided, we brought our leverage and spread risk back up and we feel comfortable with today's level given the attractive opportunities in both Agency RMBS and MSR spaces. As you can see in figures two and three, we continue to manage our exposure to rates across the curve very closely.

You can see more detail on our risk exposures on appendix slide 19. Please turn to slide 11. Agency RMBS spreads to interest rate swaps widened meaningfully in April, tracking overall market volatility, before retracing over the following two months. As shown in figure one, our preferred volatility gauge, two-year options on ten-year swap rates, peaked at 104 basis points in mid-April and declined to end the quarter at 94 basis points, four basis points lower than the end of the first quarter. Hedged Agency RMBS performance varied across the coupon stack, with higher coupons outperforming lower, longer duration coupons.

Current coupon nominal spreads widened by three basis points to 171 while option-adjusted spreads finished 12 basis points wider at 81 basis points, reflecting the drop in implied volatility. As you can see in figure two, spreads across the curve both nominally and on an option-adjusted basis, shifted up with larger pickups in OAS. At quarter end, considering the drop in implied rate volatility, and that mortgage spread volatility had fallen to its lowest level in the post-COVID period, spreads versus swaps looked and continue to look very attractive on a historical and return potential basis. Please turn to slide 12 to review our Agency RMBS portfolio.

Figure one shows the hedge performance of TBAs and specified pools we own throughout this quarter. Higher coupons generally outperformed lower coupons, and specified pools outperformed TBAs in the lower coupons we owned, while 6.5% TBAs outperformed specified pools. We have seen some strength in higher coupon dollar rolls, particularly in 6.5s, fueled by historically strong demand for CMO floaters, with CMO issuance accounting for over 85% of the net issuance in and 6.5. On the margin, we shifted our exposure up in coupon in the quarter, which you can see in appendix slide 18. We also increased our exposure to mortgage derivatives, which positively contributed to outperformance.

Figure two on the bottom right shows our specified pool prepayment speeds by coupon, which in aggregate increased from 7.4 to 8.6% CPR. Most of the coupons in the stack experienced a mild absolute increase in speeds, resulting from a pickup in turnover rates from seasonal factors. Higher coupons, particularly TBAs, displayed larger speed increases due to lower mortgage rates in March into early April. We observed fast processing speeds for agency collateral reducing the lag time from application to closing. 6.5% TBAs in particular showed a large pickup in speed, similar to the prepayment response we observed last fall when they briefly went in the money. Please turn to slide 13.

The MSR market remains very well supported, with bank and nonbank servicers aggressively bidding for a declining amount of supply. As you can see in figure one, the volume of MSR available in the bulk market has continued to trend lower from the peak years of 2022 and 2023, with supply about 30% lower year over year. That said, we have still been able to find pockets of opportunity in the bulk market. Figure two is a chart that we periodically update for our earnings deck, which shows that with mortgage rates at their current level of around 6.75%, only 0.7% of our MSR portfolio is considered in the money.

If rates were to drop to around 5%, the portion of our portfolio in the money would rise to only about 8%. Importantly, prepays have remained below our projections for the majority of our portfolio. Please turn to Slide 14 where we will discuss our MSR portfolio. Figure one is an overview of our portfolio at quarter end, further details of which can be found on appendix Slide 25. In the second quarter, we purchased $6.4 billion UPB of MSR through three bulk purchases. The price multiple of MSR was unchanged quarter over quarter at 5.9 times, and sixty-plus day delinquencies remained low at under 1%.

Figure two compares CPRs across implied security coupons in our portfolio of MSR versus TBAs. Quarter over quarter, our MSR experienced a 1.6 percentage point pickup in prepayment rates to 5.8%. The increase was anticipated owing to stronger seasonal factors, though the speed was slower than model expectations. Overall, prepayment rates on our low coupon MSR are expected to remain very slow on a historical basis, which will remain a tailwind for our portfolio. Finally, please turn to slide 15, our return potential and outlook slide. This is a forward-looking projection of our expected portfolio return, which contemplates the effect of the loss contingency accrual on our portfolio.

As you can see on this slide, the top half of this table is meant to show what returns we believe are available on the asset in our portfolio. We estimate that about 72% of our capital would be allocated to servicing with a static return projection of 11% to 14%. The remaining capital would be allocated to securities with a static return estimate of 12% to 17%. 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 8.8% to 12.1% 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 9.4% to 15.3% or a prospective quarterly static return per share of 28 to 46¢. Looking ahead, ongoing tariff threats and trade negotiations, as well as geopolitical tensions, will continue to weigh on the market. The resilience that markets demonstrated in the second quarter is a reminder of the global demand for investment, like mortgage-backed securities. Spreads for agency RMBS, particularly when hedged with interest rate swaps, remain historically wide and offer good relative value to other high-quality spread assets like corporate bonds.

Supply and demand is balanced with demand diversified between money managers, banks, REITs, and overseas buyers. Demand from depository institutions should increase if regulatory reform proceeds as anticipated. Our core strategy of low coupon MSR paired with agency RMBS is well positioned to benefit from both stable prepayments and wide agency spreads. Additionally, Roundpoint's direct-to-consumer franchise enhances MSR returns through efficient recapture should we enter a faster prepay environment. Taken together, we are confident that our portfolio construction should drive attractive risk-adjusted returns across a range of market conditions. Thank you very much for joining us today. And now we will be happy to take any questions you might have.

Operator: Thank you. If you are dialed in via the telephone and would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute phone is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question. We'll pause for just a moment to allow everyone an opportunity to ask a question. We'll go first to Doug Harter with UBS.

Doug Harter: Thanks, and good morning. So your leverage increased this quarter, I guess, as a result of the litigation reserve. Can you just talk about is that kind of the new level of leverage that we should be thinking about? Or are there still more portfolio actions to come to kind of bring it back to the prior level leverage range?

Nick Letica: Doug, this is Nick, and thank you for the question. So we ended the quarter at a leverage of 7x. And, you know, the range that we have discussed in these calls in the past is there's really been a, you know, a range that we quote a range of about five to eight as a leverage target. If you look at our leverage historically, even in that chart that's on that page, you will see that we've been at seven times in the not too distant past. Right? So it really is it's very much within the range of the leverage that we operate in.

By quarter end and through the quarter, you know, we really did like the risk in the market. We believe the mortgages versus swaps look quite attractive. And so we felt it was right from a portfolio management standpoint to increase our leverage. Through the quarter, and that seven times is as you say, is inclusive of the $200 million loss reserve that affects our book value. If you were to add that back into our capital, our leverage would drop to about 6.3. But in any case, the leverage, you know, we feel very comfortable where the leverage is at seven times and you know, we'll govern, you know, portfolios we always do.

It will depend upon where spreads are in the market, what the opportunities where the opportunities are, and we will move the leverage around accordingly based upon market opportunities and our capital base.

Doug Harter: Great. Appreciate that. And is there any way you could give us an update on, you know, economic return performance so far in July?

Nick Letica: Yeah. Good morning, Doug. Quarter to date through last Friday, we were up about one and a half percent.

Doug Harter: That's on economic return just to be clear. Right?

Nick Letica: Yes. Economic return on the new book value.

Doug Harter: Perfect. Thank you, guys.

Nick Letica: Thanks, Doug.

Operator: We'll go next to Bose George with KBW.

Bose George: Hey, everyone. Good morning.

Nick Letica: Good morning, Bose.

Bose George: Can you remind us on Slide 15, you guys have the breakout of the expected returns. Actually, are the main drivers the differences between that and the EAD metric?

Nick Letica: So the EAD is based on historical purchase yields of the assets. Right? And as a result, I always like to say that the EED calculations are asynchronous among assets in the portfolio. Right, because it depends on the yield on which it was on the day that it was purchased. Whereas the return outlook slide is all meant to reflect the forward-looking mark-to-market yields at current prices. We show a range of returns on slide 15 to reflect things like potential fluctuations in prepayment speeds, potential fluctuations in funding spreads, as well as potential fluctuations in leverage of the securities. Right?

But the main difference is the timing and the market prices at which the assets are utilized in the calculation of the yields.

Bose George: Okay. That makes sense. And just given where the EAD has been trending sort of the back half of the year, does it make sense that it probably continues to trend sort of below the economic return?

William Dellal: Excuse me. Hi, Bose. Yes. I think that's the case because spreads have widened recently, and so the JD of old securities that were purchased previously would not reflect that change in market value.

Bose George: Okay. Yep. That makes sense. Thanks. And then just one follow-up on Doug's question on the leverage. You know, does your view on leverage change once that capital that's reserved sort of goes out the door? I mean, is there you know, because right now, as you noted, your sort of optical leverage is different from, you know, kind of your real leverage because you still have that cash. So just curious how that whether there's any change once some or part of that is paid out.

Nick Letica: No. I mean, on a general rule, no. It doesn't really change our view on leverage. It just we will manage the portfolio according to the amount of capital that we have. But as far as a general view about leverage, no. It doesn't change the way we look at the market.

Bose George: Yep.

Nick Letica: It may change manage the portfolio. Right. It will, you know, it could potentially change. It's another factor in how we manage the composition of our assets. But as an overall rule, no, I do not think it will govern how we do leverage in total.

Bose George: Okay. Great. Thanks.

Nick Letica: Thanks, Bose.

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

Trevor Cranston: Morning, Trevor. Thanks. Good morning.

Bill Greenberg: Bill, in your prepared comments, you mentioned the small amount of originations you guys have done in second liens. And I think you said that's a product you guys could hold or sell in the future. Obviously, it's a small number right now, but I was curious if you could comment on, you know, is that a product you guys are actually interested in building into the investment portfolio or in the near term or that something that's more likely to just be sold off to third parties? Thanks.

Bill Greenberg: Yeah. Thanks for the question. You know, I think it's a question about risk and reward. Right? So if the yields available on the securities are attractive, we will hold them as we create them. And if we feel that we can extract more value by selling them, either in bulk or on flow or in a securitized form, then we'll do that. Really, it's just another set of tools in our tool belt to be able to use. And if it's an attractive asset class, we will take advantage of that. But to be able to have multiple outlets for the product is important to us. And so we'll look at all the opportunities on a real-time basis.

Trevor Cranston: Got it. Okay. That makes sense. Then you guys also made a comment about some increased exposure to mortgage derivatives contributing to performance this quarter. Can you just elaborate a little bit on kind of where you guys have been active in the mortgage derivative space? Thanks.

Nick Letica: Sure, Trevor. This is Nick. Thank you for that question. At the beginning of the year, we did add another team member to focus on derivatives, which to date has mostly taken the form of growing our inverse IO exposure on the book. But, you know, over the quarter, I think we may have allocated about $50 million invested in that sector. But it's still, you know, under 5% of the securities capital. So it's still a small component of the book. It's just another sector of the market as, you know, given the level of expertise we have in prepayments and managing risk across the mortgage the agency mortgage sector was it's sector which we felt does have opportunity.

And, you know, we have a very skilled of people here to manage that part of the book. So it's something that, you know, we do believe we're going to continue to have a lot of focus on in the upcoming quarters. But as a total of amount of our risk, it's still a fairly small amount.

Trevor Cranston: Yep. Okay. Appreciate the comments. Thank you, guys.

Nick Letica: Thanks.

Operator: We'll go next to Harsh Hemnani with Green Street.

Harsh Hemnani: Morning, Harsh. Thank you.

Harsh Hemnani: Hey. Good morning. Can we talk about financing strategy and maybe the thought process behind moving part of the financing from repo to unsecured this quarter?

William Dellal: Good morning, Harsh. It's William Dellal. The reason we did the unsecured baby bond was to start to pre-finance the maturity of the convertible. And some of the warehouse lines that we used to use are now kind of warehouse repos, so that's why there's some change there. But, basically, the big change is the issuance of the baby bond, which is to prefund part of the convert maturity.

Harsh Hemnani: Got it. Thank you. That's all for me.

William Dellal: Thank you, Harsh.

Operator: We'll go next to Kenneth Lee with RBC Capital Markets.

Kenneth Lee: Good morning, Ken. Hey, good morning. Thanks for taking my question.

Nick Letica: Morning.

Kenneth Lee: Just wondering if you could just talk about thoughts around potential impact of a steepening yield curve on the portfolio and then in particular, just further expand upon the potential benefits there to the MSRs? Thanks.

Nick Letica: Hey, Ken. This is Nick. Thanks for the question. In general, as we have said, you know, we do hedge across the yield curve in general. So we don't have a particularly strong view about particularly strong view across the curve. And if you look at small. So as a broad measure to our performance, we are hedged across the curve. That being said, steeper yield curves are usually good things for mortgage spreads because it does incent depository institutions frequently to go out on the curve and invest and particularly in one of their prime assets are mortgage-backed securities.

And in history, we'll tell you that when the Fed cuts and the yield curve steepens, that you tend to see more participation by banks in our sector, and that drives spreads tighter. So there's a secondary effect of that. The actual implications on MSR are, you know, again, built into our risks. You know, MSR is an asset that is like an IO and that it's prepayment sensitive. I think everybody knows that. But, also, a component of the value of MSR is also the float income, right, which is tied to the front end of the curve.

So to the extent that the curve steepens, if front end rates go down, that will take that will drive the price of MSR down. And in fact, that's one of the reasons why MSR these days, our low gross WACC still has as much, you know doesn't have much negative duration, but it does have negative duration. A big component of that is that is that is the front rates and the effect on float income. So the effect is that if you do get into a steep real curve environment, on MSR, there really are two counterbalancing effects. The first is that forward rates for longer forward rates typically go higher, which means that prepayment assumptions go lower.

So there's a little bit of a balancing, but those two things will govern how the price action of MSR performs over time.

Kenneth Lee: Just wondering if you could talk a little bit more about your risk appetite. I you said that in the quarter, took on you like the risks in the markets. And looking at the risk exposures, it looked as if there's some quarter over quarter slight increase in rate exposure maybe unchanged on spread. Just want to get a little bit more color around your appetite for risk in the current market. Thanks.

Nick Letica: Our rate exposure quarter over quarter is virtually unchanged. The and our spread risk from quarter end to quarter end is also pretty close, if you measured by our spread risk on the appendix slide and on the main portion. Overall, I would say, you know, risk right now, we like the market. We like where mortgage spreads are. You know, if you look at mortgages hedge with swap spreads, they are generous historically. And even on an OAS basis, they look pretty cheap relative to the amount of spread volatility that we've seen. As I said in my prepared remarks, you know, spread volatility has declined.

We had a bit of a spike in April when the market was quite volatile and the VIX hit that bit of a multiyear high. But the market settled right back down to where it was before that, and we're in a good place. I mean, I realized rate volatility right now has been fairly low. The second quarter and, you know, for the third quarter so far, you know, we've been in a pretty tight range of rates. You know, we like where spreads are. And, you know, the MSR continues to perform quite well, and the market is extremely well supported right now in terms of demand.

Kenneth Lee: Great. Helpful there. Thanks again.

Nick Letica: Thanks, Ed.

Operator: We'll go next to Jason Weaver with Jones Trading.

Jason Weaver: Hi. Good morning. Thanks for taking my question. In your prepared remarks, you mentioned something about your outlook for the mortgage origination market, how that might affect the sort of MSR appetite, the opportunity set there in the competitive landscape going forward?

Bill Greenberg: Yeah. Well, you know, we've been saying for a little bit now that our mortgage origination effort is still small. And as we said in the prepared remarks, you know, only 0.7% of our portfolio is eligible for refinance from a rate and term. And so, you know, we're trying to be mindful of the cost attached to growing that effort too large, too fast. Because that would create a drag on our earnings. But, you know, we're trying to do things within the business in order to be able to scale more quickly. Originating at second liens is part of that, and we can utilize having more loan officers making loans and making second liens and brokering second liens.

While there's not a lot of first lien activity, right? So we can share some of that, and then, you know, should rates fall later, we can transfer some of those things back to first liens right from seconds where the loan sizes are bigger and there will be more opportunity, should rates fall. And we get into an environment where more loans are eligible for refinance. So, you know, we're trying to balance those factors of costs and opportunity. And I think, you know, we'll watch the market going forward, and we'll be ready to react as rates move.

Jason Weaver: Got it. And I was wondering, can you provide maybe some more clarity or some bracketing around what you expect on timeline for resolution of the PRCM litigation as well as if you have a ballpark for what the claims are for you against IP?

Bill Greenberg: Well, look. Unfortunately, I appreciate the question. I really do. Unfortunately, I can't really say a lot more than what William said in his prepared remarks. You know, a trial date has not been set yet. And so, you know, we are waiting for the next stages to occur when there is something to update you and the rest of the market on, we will, of course.

Jason Weaver: Alright. Thank you. Appreciate the time.

Nick Letica: Yep. Thank you.

Operator: We'll go next to Rick Shane with JPMorgan.

Rick Shane: You know, just servicing costs down sequentially, down year over year. Comp and OpEx down sequentially. I assume that there's in the first quarter on the comp side, some sort of annual stuff that comes through and that's what drives it. But particularly as you are expanding your investment in AI, can you help us understand what will be expense, what will be capitalized, and how you see that driving your expense lines going forward.

William Dellal: Good morning, Rick. A lot of what we're doing is going to be expense. Rather than capitalize the rules for capitalizing are quite strict this the material we're doing now is likely to be expensed, which is why our expense ratio is tended to stay constant or even creep up a little bit.

Rick Shane: So when we think about it, so when we think about expenses for the second half, the combined expense between servicing costs and comps benefits and OpEx, was $45 million in the second quarter. Is that a decent run rate to build off of into third, fourth and into 2026?

William Dellal: I think we're going to be in that ballpark. Yes.

Rick Shane: Challenge for companies of your size balancing off the shelf versus you know, Help us understand how that works in your business, please.

Bill Greenberg: Look. I think it works the same way. It works really almost everywhere. There's going to be know, there's lots of activity and lots of development and lots of products being brought to market in real time and changing rapidly in this space. That can help us do all kinds of efficiencies and cost savings and improve our experience. So it's changing very, very rapidly. I'd say it's more likely that we will be accessing some of those resources from other companies rather than building ourselves. But some simple things that we could do ourselves that are particularly bespoke for our needs, we are likely to do.

But I'd say the bulk of it is probably going to be from third parties.

Rick Shane: Got it. Okay. Thank you very much.

William Dellal: Part of the stuff that we take, some of it requires a little bit of customization and to our particular needs, but the main bulk of it will be third party.

Rick Shane: Thank you.

Operator: We'll go next to Jason Stewart with Janney.

Jason Stewart: Hey. Thanks. Following up on Trevor's question on second liens in the balance sheet. You know, as production ramps on the core business, is there any possibility or intent to retain POS? Or is the goal to continue to sell that?

Bill Greenberg: I think there is a possibility for that, and I think that's one of the things that we're looking at as we grow the origination effort and the products that we offer. And the outlets that we will access. To do those things, whether it's selling it, and some of it could involve retaining some of that stuff. So, yeah, I think that's one of the things that we're looking at.

Jason Stewart: Okay. And I assume that you look at the same way as you described seconds, meaning it's got to hit certain economic return hurdles, etcetera. Is there any other strategic thought behind shifting the balance sheet from primarily agency to private label credit?

Bill Greenberg: Well, I think it would still be primarily I don't think we would talk about expanding our non-agency exposure to a level that it would be primarily that. So, you know, as a minority interest in the portfolio of other kinds of asset class with predominantly similar risks but some slightly different ones. I think it has a benefit in the portfolio. And so that's the way we're gonna look at it.

Jason Stewart: Okay. Thank you.

Operator: At this time, there are no further questions. I'll turn the call back to Bill for any additional or closing remarks.

Bill Greenberg: I thank you, everyone, for joining us today. And as always, thanks for your interest in Two Harbors Investment Corp.

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