Summary
The company’s book value is growing but the price to book ratio indicates a bit undervalued stock with trading just 7% below its book value at the moment.
The management plans to further deploy capital in RMBS and RMS as opportunities come.
Since the stock price drop in July, it has not recovered yet and because of that, the company has a mind-boggling 11.26% dividend yield.
designer491/iStock via Getty Images Investment thesis
Two Harbors Investment Corp. ( TWO ) is a typical mREIT with a relatively secure and stable investment portfolio. Their cost of capital has been rising for 9 months now but the management is more than capable of handling it with the current portfolio and the profit margin is not shrinking but widening. The 3 rd quarter results were good and the dividend coverage is acceptable at the moment. TWO is yielding over 11% which is an eye-catching number for income-seeking investors. Business Model
Two Harbors Investment Corp. operates as a real estate investment trust (REIT) that focuses on investing in, financing, and managing residential mortgage-backed securities (RMBS), non-agency securities, mortgage servicing rights, and other financial assets in the United States. The company is a mortgage REIT (mREIT) and it provides financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities (MBS). The lion’s share of TWO’s investment portfolio is in Agency RMBS and Mortgage Servicing Rights. The management is keen on maintaining the high percentage of RMBS and secured loans in the investment portfolio. Financials & Earnings
Q3 results
TWO reported book value of $6.40 per common share, representing a 2.3% quarterly return on book value. EPS estimate was $0.2 per share while the actual Q3 results reported was $0.24 per share representing a 20% growth compared to Q2 2021. The company generated a comprehensive income of $45.2 million, representing an annualized return on average common equity of 9.1%. The management continued to grow the mortgage servicing rights (MSR) portfolio. TWO settled on $14.0 billion unpaid principal balance (UPB) generated through the flow-sale program and closed on $15.3 billion UPB through bulk transactions. The management also expects to settle on outstanding commitments of $21 billion UPB of MSR through bulk transactions in upcoming quarters.
Two Harbors’ President, CEO, and CIO says they want to deploy more capital to Agency-backed RMBSs and MRSs: “There was robust activity in our MSR program where we settled on $29 billion UPB during the quarter and committed to purchase another $21 billion UPB. With our recent capital issuances, we continue to position the company to deploy capital in MSR, and in RMBS as attractive opportunities arise.” Federal Reserve has already started to reduce its monthly purchases of U.S. Treasury securities by purchasing only $10 billion of it and purchasing just $5 billion of Agency RMBS beginning in November and expects to complete the process by mid-2022. We can also see that the cost of capital is slowly rising and the combination of higher mortgage rates and fewer number of financeable mortgages point to lower prepayment speeds ahead. Although the cost of financing is higher than a year ago and likely to increase due to the interest rate hike in 2022 the profit margin of TWO grows with it. Valuation
TWO is trading 7% below its book value which makes the stock a bit undervalued. Let’s compare TWO to its peers. Ellington Financial Inc. ( EFC ) has more than half of its portfolio in RMBS, MFA Financial, Inc. ( MFA )’s portfolio is in RMBS while Starwood Property Trust, Inc. ( STWD ) has a more diverse portfolio but has a similar revenue to TWO. TWO has a forward Non-GAAP P/E ratio of 7.52 while its competitors have higher valuations. EFC has a forward P/E ratio of 9.37, MFA has a P/E ratio of 8.42 and STWD has a P/E ratio of 11.92 while the sector median is 11.23 but that includes all asset managers, BDC, and all types of REITs. Comparing the 4 companies’ prices to book value we can still see a bit undervalued stock but TWO has a quite similar ratio to EFC and a much higher valuation than MFA. Source: Seeking Alpha Company-specific Risks
TWO operates in a highly regulated environment and is subject to the rules, regulations, approvals, licensing, reporting, and examination requirements of various federal and state authorities. There are also several competitors sharing the same marketplace.
While financial markets and mortgage delinquency levels have largely recovered to pre-pandemic levels, the losses incurred […]
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