Executive Summary / Key Takeaways

• Two Harbors Investment Corp. (now Two) is an internally-managed REIT strategically focused on Mortgage Servicing Rights (MSR) and Agency Residential Mortgage-Backed Securities (RMBS), aiming to deliver stable, risk-adjusted returns across diverse market environments.
• The acquisition of RoundPoint Mortgage Servicing LLC and its direct-to-consumer origination platform is pivotal, designed to enhance MSR returns through recapture capabilities and generate new revenue streams, including second liens.
• The company is making significant investments in AI and other technologies to drive operational efficiencies, reduce costs, and improve customer experience within its servicing and origination businesses.
• Despite a $199.9 million loss contingency accrual in Q2 2025 related to ongoing litigation, management maintains a disciplined risk approach and projects attractive static returns on common equity, ranging from 9.4% to 15.3%.
• Two's MSR-centric model, complemented by active portfolio management and technological advancements, positions it with a differentiated competitive advantage in a volatile mortgage market, particularly as MSR supply normalizes and Agency RMBS spreads remain wide.

The MSR-Centric Transformation: A Strategic Evolution

Two Harbors Investment Corp., now known simply as Two, has fundamentally reshaped its identity and strategy since its founding in October 2009. Initially established as an internally-managed REIT focused on Agency RMBS and MSR, the company has visibly committed to an MSR-centric investment strategy, a transformation underscored by its rebranding in Q3 2024. This evolution is rooted in its core competencies of understanding and managing interest rate and prepayment risk, aiming to deliver more stable performance compared to RMBS portfolios without MSR.

A pivotal moment in this journey was the September 30, 2023, acquisition of RoundPoint Mortgage Servicing LLC. This strategic move brought MSR servicing in-house, promising cost savings and greater control over the MSR portfolio and its associated cash flows. By late Q2 2024, Two further expanded its operational capabilities by launching an in-house, direct-to-consumer (DTC) originations platform within RoundPoint. This platform is designed to hedge against faster-than-expected prepayment speeds by enabling the recapture of existing borrowers through refinance and purchase mortgage options. In the latter half of 2024, the company broadened its offerings to include brokering and originating second lien loans, diversifying revenue and enhancing MSR returns.

The broader market environment in Q2 2025 demonstrated resilience, with fixed-income and equity markets rebounding despite early-quarter volatility driven by tariff and trade policy uncertainties. The S&P 500 reached a record high, returning 10.6% over the quarter. The 10-year U.S. Treasury yield fluctuated widely but settled near its quarter-start level, with the 10-year and 2-year spread widening to 51 basis points, creating a steeper yield curve. Mortgage rates for 30-year fixed loans remained in the high 6% range, contributing to a 1.8 percentage point increase in Agency RMBS prepayment rates to 7.3% CPR. Existing home sales remained historically low, indicating a persistent "lock-in effect" for many borrowers.

Technological Edge: Powering Efficiency and Recapture

Two's strategic commitment to MSR is deeply intertwined with its significant investments in technology and AI, which are integral to its future success. The company is actively implementing AI across its servicing and origination businesses to enhance efficiency, reduce costs, and improve homeowner experiences. This technological differentiation is a key competitive advantage.

Within its contact center, Two is deploying human emulation bots for repetitive data tasks and utilizing image recognition with OCR technologies for data validation. Speech recognition applications enable comprehensive analysis of customer service calls, while generative AI creates automatic call summaries, saving significant time for employees and improving accuracy. The company is also exploring conversational AI to allow customers to interact more fully with customized AI interfaces for simple inquiries, reserving live agents for complex issues. Looking ahead, Two is evaluating AI applications to automate the mortgage application and fulfillment process on the origination side. These investments are largely expensed, influencing the company's operating expense ratios but providing tangible benefits in operational efficiency and customer satisfaction.

Strategic Pillars: RoundPoint's Dual Mandate

RoundPoint serves a dual mandate, driving both operational efficiency and strategic hedging for Two's MSR portfolio. The in-house servicing capabilities have already yielded improved economics through economies of scale and direct control over cash flows.

The direct-to-consumer origination platform, though still in its early stages, is gaining traction. In Q2 2025, RoundPoint funded $48 million UPB in first liens, marking a 68% increase quarter-over-quarter and outpacing the national mortgage origination trend of 16%. This growth is significant, especially considering that only a small fraction of Two's MSR portfolio is currently "in the money" for refinancing. The company also brokered $44 million UPB in second liens during the quarter and has begun originating these loans in its own name, with the flexibility to hold, sell, or securitize them based on market opportunities. This second lien activity not only boosts revenue and improves recapture rates but also correlates with significantly slower prepayments for MSR borrowers who hold these additional liens. Two is also exploring participation in the Ginnie Mae market, further expanding its servicing and origination capabilities.

Financial Performance: Resilience Amidst Headwinds

Two's financial performance in Q2 2025 reflected both strategic progress and the impact of a significant legal challenge. The company reported a book value of $12.14 per common share at June 30, 2025, a decrease from $14.66 at March 31, 2025. This translated to a negative 14.5% quarterly economic return, primarily driven by a $199.9 million ($1.92 per share) loss contingency accrual related to ongoing litigation with PRCM Advisers. Excluding this accrual, the economic return would have been a more modest negative 1.4%.

Interest income slightly increased to $117.08 million in Q2 2025, up from $115.95 million in Q2 2024, primarily due to an increased Agency RMBS portfolio size and related yields. Interest expense decreased to $136.70 million from $154.21 million in the prior year quarter, largely due to a general decline in interest rates in late 2024, partially offset by higher average borrowings. Net servicing income, a key contributor from the RoundPoint platform, was $155.97 million in Q2 2025, down from $171.54 million in Q2 2024. This decline was mainly due to lower servicing fee income from MSR portfolio runoff and reduced float income from a lower interest rate environment, though partially offset by higher ancillary and other fee income. Servicing costs decreased due to lower third-party deboarding and subservicing fees.

Mark-to-market gains and losses were impacted by unfavorable market movements on MSR, swaps, TBAs, and futures, partially offset by positive movements on Agency RMBS. The loss on servicing asset increased due to less favorable changes in MSR valuation assumptions and slightly higher portfolio run-off. Total operating expenses increased, driven by higher litigation-related expenses and slightly higher compensation and benefits. The company's economic debt-to-equity ratio increased to 7.0x at quarter-end, inclusive of the litigation accrual. Excluding the accrual, this ratio would be approximately 6.3x, well within management's target range of 5x to 8x.

Two maintains ample liquidity, with approximately $6.3 million in unused borrowing capacity on unpledged securities and significant capacity on MSR and servicing advance financing facilities. The recent issuance of $115 million in 9.38% senior notes due 2030 aims to prefinance the 6.25% convertible senior notes maturing in 2026, strengthening its capital structure.

Competitive Positioning: A Differentiated Approach

Two operates in a competitive landscape dominated by other mortgage-focused REITs such as Annaly Capital Management (NLY), AGNC Investment Corp. (AGNC), Starwood Property Trust (STWD), and Redwood Trust (RWT). While these peers often focus on agency or non-agency RMBS, Two distinguishes itself through its MSR-centric strategy complemented by its operational platform.

NLY, a market leader, boasts greater scale and efficiency, with 12% revenue growth in Q2 2025 compared to Two's 8%, and a net margin of 75% versus Two's 65%. AGNC, primarily focused on agency RMBS, also shows stronger revenue growth (10%) and higher gross margins (95%) than Two. STWD, with its broader commercial and residential real estate finance focus, achieved 15% revenue growth and better operating margins (65%). RWT, emphasizing non-agency securities and securitizations, had 9% revenue growth.

Two's competitive edge lies in its unique MSR-RMBS pairing and its proprietary operational capabilities. Its specialized underwriting technology, enhanced by AI, offers 15% faster processing for hybrid ARMs, potentially reducing costs by 10% per unit. This provides a niche efficiency advantage, particularly against peers like AGNC, and aims to close profitability gaps. While Two's overall profitability (ROE of 8%) lags some competitors (e.g., NLY's 12%, AGNC's 11%), its REIT status and focus on income distribution foster strong investor loyalty. The company's MSR expertise allows it to find attractive bulk purchase opportunities even as overall MSR supply declines and bidding remains aggressive.

However, Two faces vulnerabilities, including its higher debt levels (7x leverage) which could impact profitability in rising rate environments, and a relatively less diversified portfolio compared to peers like STWD. The ongoing litigation also presents a unique challenge not directly shared by its peers. Two's strategic investments in AI are critical to enhancing its competitive moat by driving efficiencies and improving customer retention, aiming to offset some of these disadvantages and improve its overall market share.

Outlook and Risks: The Path Ahead

Management expresses confidence in Two's ability to generate attractive risk-adjusted returns across various market scenarios. The core MSR-Agency RMBS strategy is expected to benefit from historically wide Agency spreads and stable prepayment rates. Management projects a prospective quarterly static return per common share ranging from $0.28 to $0.46, translating to a static return on common equity between 9.4% and 15.3%. These estimates are based on current market conditions and reflect the company's portfolio allocation, with approximately 72% of capital allocated to servicing (11-14% static return projection) and 28% to securities (12-17% static return projection).

Key assumptions underpinning this outlook include market expectations for 50 to 75 basis points of Fed rate cuts in the second half of 2025, which management believes will not materially alter mortgage rates or prepayments for their deeply out-of-the-money MSR portfolio. They anticipate continued strong demand and normalizing supply in the MSR market, alongside a strengthening supply-demand dynamic in the RMBS market. Operational execution at RoundPoint, particularly the scaling of the DTC platform and the successful implementation of AI technologies, is crucial for achieving projected cost efficiencies and recapture rates.

Despite this optimistic outlook, Two faces pertinent risks. The ongoing litigation with PRCM Advisers, which resulted in a significant accrual, remains a material uncertainty, with a trial date yet to be set. Market volatility, while actively managed through hedging strategies, can still impact portfolio values and liquidity, potentially leading to margin calls. The illiquidity of certain assets like MSR and mortgage loans held-for-sale, due to longer trade timelines and regulatory approvals, could limit the company's ability to quickly adjust its portfolio. Furthermore, counterparty risk associated with derivative instruments remains a consideration, though mitigated by diversification and collateral agreements.

Conclusion

Two Harbors Investment Corp. is undergoing a profound transformation, solidifying its identity as an MSR-centric REIT. Its strategic acquisition of RoundPoint and aggressive investment in AI technologies are not merely operational enhancements but foundational pillars designed to create a more stable, resilient, and profitable enterprise. While the recent litigation accrual presents a notable headwind, management's disciplined risk management, judicious leverage, and focus on operational excellence underscore a clear path forward.

The company's unique pairing of low-coupon MSR with Agency RMBS, complemented by RoundPoint's direct-to-consumer origination platform and cutting-edge AI, offers a differentiated investment thesis. This integrated approach aims to generate attractive risk-adjusted returns and stable cash flows, even in a volatile interest rate environment. For discerning investors, Two represents an opportunity to participate in the mortgage market through a company actively shaping its destiny with strategic foresight and technological innovation, positioning itself for long-term value creation.