Two Harbors Investment Corp.
Q3 2014 Earnings Call Transcript

Published: 5 Feb 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the Two Harbors Investment Corp Fourth Quarter 2014 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 be given at that time. [Operator Instructions] As a reminder, today’s conference is being recorded. I’d now like to turn the conference over to your host for today, Ms. July Hugen, Director of Investor Relations. Ma’am, you may begin.

[July Hugen:]

Thank you, Ben, and good morning. Welcome to our fourth quarter 2014 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 fourth quarter of 2014 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 may be 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.

[Tom Siering:]

Thank you, July. Good morning, everyone, and thank you for joining us today. Turning to Slide 3 in our presentation, I’d like to review our full year and fourth quarter financial results. 2014 was an excellent year for us despite a volatile interest rate environment. We generated a return on book value of 15% for the year. This metric is a testament to Bill and the investment team’s excellent portfolio management and risk mitigation strategy. This is particularly impressive given our low levels of leverage. Our book value at December 31st was $11.10 per share, representing a quarterly return on book value of 1% when combined with the fourth quarter dividend of $0.26 per share. In 2014, we delivered comprehensive income of $578.2 million, representing a return on average equity of 14.4%. During the quarter, we had comprehensive income of $42.2 million or $0.12 per weighted average diluted share. For the quarter ending December 31st, we reported GAAP and core earnings of negative $0.10 and positive $0.23 per share respectively. Let’s flip to Slide 4. 2014 was a very successful year with regards to the development of our operational businesses. We meaningfully increased the number of sellers in our network. We completed three securitizations in the second half of 2014 and our pipeline volumes are strong. Our MSR business continues to expand as we aim to create long-lasting flow relationships with high quality sellers leveraging off of relationships from our conduit business. In the fourth quarter, we were pleased to announce our expansion into commercial real estate with the addition of a seasoned commercial real estate team. We intend to initially allocate $500 million in equity capital to this initiative, further diversifying our portfolio. The commercial real estate bond market is over $3 trillion in size and over $1.5 trillion loans are expected to mature in the next several years. This business certainly meets the criteria we desire in respect of opportunity, scale and investment runway. We will keep you informed as this develops. Please turn to Slide 5. Let’s briefly discuss the macroeconomic and political environment. As expected, the Fed made its final reduction in asset purchases in December 2014 but plans to continue to make significant reinvestments of MBS paydowns for the foreseeable future. In 2014, the 10-year interest rate fell from 3% to 2.2% near below [ph] to 2013 and the curve continued to flatten in the fourth quarter. Employment; consumer tailwinds and HPA are important indicators of a healthy housing market. Unemployment metrics improved throughout 2014 falling from 6.6% in January to 5.6% in December. Additionally, national home prices increased 5.5% on a rolling 12-month basis as of November 30th according to CoreLogic. In fall of 2014, the FHFA released a proposed rulemaking change regarding membership in the Federal Home Loan Bank system which, if adopted, could have an impact on our membership. We consider ourselves members in good standing with the Home Loan Des Moines and we believe our interests align directly with the mission of the home loan system. Additionally, our secured financings are consistent with their safety and soundness mantra. We submitted a comment letter to FHFA in response to the proposed rulemaking and a copy can be found under Executive Insights in the Investor Relations section of our website. We strive to be a thought leader within the industry and have increased our engagement on regulatory and policy-related topics that directly impact our business, including conforming loan limits, guarantee fees in the private label securities market. 2014 was a transformational year for Two Harbors with respect to our operational businesses. We continue to broaden our business model to include investments in attractive sectors of the mortgage market including our planned expansion into commercial mortgage loans. In 2014, we also celebrated our fifth year in operation and are pleased to have returned 125% to stockholders over that time period with respect to share price and dividends compared to the Pine River mortgage REIT index of 57% over the same period. With that, I will turn the call over to Brad for a discussion on our financial results.

[Brad Farrell:]

Thank you, Tom, and good morning. Please turn to Slide 7. Book value end of the year at $11.10 per share versus $11.25 as of September 30th and $10.56 at the beginning of 2014. Book value was driven by comprehensive income of $42.2 million or $0.12 per weighted share in the fourth quarter and $578.2 million or $1.58 per weighted share for the full fiscal year. Our full year valuation gains in both our rates and credit strategy were marginally reduced due to interest rate volatility and wider credit spreads in the quarter. The company declared dividends of $0.26 and $1.04 for the fourth quarter and full year respectively. Please turn to Slide 8 for a summary of our financial results. Core earnings of $0.23 per weighted share represented an annualized return on average equity of 8.1% and were in line with the prior quarter and our expectations. While this was a relatively consistent quarter for core earnings, I will comment on a few of its underlying drivers. First, our implied debt-to-equity ratio, including our TBA position, remain low at 3.0x but modestly increased in the last half of the quarter from 2.7x at September 30th. Swap expense was higher as a result of a hedge position we held for the majority of the fourth quarter. This should trend lower next quarter as we repositioned our overall hedges, which included a reduction in our notional swaps in early December. Our expense ratio which dipped 30 basis points last quarter to 1.2% returned to the 1.5% level that we ran in the first two quarters of 2014. This falls within our expectations due to the variability of costs associated with supporting the operational businesses. Next, I would like to discuss our taxable income, dividend distributions and the 1099 treatment of those distributions, all of which are highlighted on Slide 9. During 2014, the REIT generated tax earnings of $388 million which included taxable realized gains of approximately $73 million on the sale of certain RMBS securities. As a reminder, we continue to hold unrealized gains of nearly $900 million in the RMBS portfolio as of year-end. For tax planning and optimization purposes, we were able to utilize a capital loss carried forward from 2013 of $50 million which reduced 2014 REIT taxable income to $338 million. Since our 2014 dividend declarations of $379 million exceeded taxable income but did not exceed 2014 tax earnings, our dividends will be treated as taxable to stockholders rather than a return of capital on the Form 1099. Please reference the dividend information found in the Investor Relation section of our website for additional information regarding distributions and their tax treatment. Please turn to Slide 10 for an overview of our financing profile. Our repo capacity continues to function in a normal manner with no meaningful shifts in financing haircuts or rates. We maintain a diversified counterparty mix including 25 active counterparties at year end, the maturity profile of our repo contracts was an average of 64 days to maturity at December 31st, down from 100 days at September 30th as a sizeable portion of our maturities were previously rolled into January. As of December 31st, we have secured advances with the FHLB of $2.5 billion with a weighted average maturity of approximately 119 months. Our weight average maturity increased from 44 months at September 30th as we added 20-year borrowings at competitive floating rates. The FHLB facility remains just one of the many tools we use to diversify and optimize our funding mix. For more information on our repurchase agreements and FHLB financing, please see the appendix on Slide 26. Now let me turn the call over to Bill.

[Bill Roth:]

Good morning, everyone. We are proud to have delivered stockholders a 15% total return on book value in 2014, particularly given our posture of relatively low leverage and little interest rate exposure throughout the year. Our fourth quarter return of 1% was notable in a difficult environment. Our book value performance for the quarter was impacted by several factors including hedging losses due to heightened interest rate volatility particularly in October, underperformance specified tool and wider mortgage credit spreads. Please turn to Slide 11 to discuss our portfolio composition. As of December 31st, our portfolio was $16 billion in assets including $11.9 billion in rates representing 56% of capital and $4.1 billion or 44% of capital in credit. With respect to our rate strategy, capital allocation to agency RMBS and MSR remain flat quarter-over-quarter. However, we opportunistically added approximately $1 billion of lower loan balance pool increasing our leverage slightly. In general, we continue to keep our basis risk exposure and leverage relatively low. Our credit portfolio remains predominantly weighted towards legacy, non-agency RMBS, with a focus on lower price, subprime bond with upside to better performance and prepays. That being said, the capital allocation to these assets declined from 38% a year ago to 31% at yearend as opportunity to add in the legacy space were limited throughout the year and we continue to sell certain bonds that we believe were fully valued. While we decreased our capital allocation to legacy non-agencies, we increased our allocation to new issue mortgage credit through our conduit activities as well as by purchases in the market. Our capital allocation to conduit activity increased from virtually nil at December 31, 2013 to over 9% at year end. Also, during the quarter we added some DSC credit risk sharing bond as spreads on these bonds widened dramatically. And we view the risk return profile as favorable at these wider spreads. Please turn to Slide 12 as we review our portfolio performance and yield. Our rate strategy yield increased 10 basis points quarter-over-quarter to 3.7%. Within this strategy, agency yields increased 10 basis points to 3.4% and MSR yield increased 20 basis points to 9.1. Prepays on agency decreased modestly in the quarter. On the credit side, yields on legacy non-agency decreased slightly while yields on new issue non-agency increased by 30 basis points. Our net economic interest in securitization yield also increased 30 basis points as subs and IOs grew as a percentage of our retained interest upon the completion of Agate Bay 2014-3. Non-agency prepayments were stable quarter-over-quarter. As you can see on the bottom right of this slide, our annualized net interest rate spread was 2.9%, down modestly from the third quarter. For more on our rates and credit strategies, please refer to the appendix, Slides 21 through 25. Moving to Slide 13, there are a few items I would like to highlight with respect to hedging. During the quarter, we adjusted our hedges, reducing the net notional of our swaps by 6.9 billion and adding optional protection via swaption totaling 4.8 billion. We believe this change positions us better for the fed moving interest rates higher on a more measured basis, but also covers us for a dramatic selloff in rates such as we saw in 2013. Further, the optional nature of many of our hedges helps protect book value in the case of a continued drop in rates. Consistent with our typical posture and as you can see in the table on this slide, we still maintain a fairly low overall exposure to rising rates. See Slides 27 and 28 in the appendix for more information on our hedges. Please turn to Slide 14 where we will spend some time talking about the conduit. 2014 was a banner year for our mortgage loan conduit as we made great stride adding seller partners which helped drive loan volume. We completed three securitizations throughout the year representing approximately $1 billion of mortgage loans. Our total net economic interest in securitization trust, by market value, increased by approximately $45 million quarter-over-quarter to $535 million at December 31st. Our prime jumbo pipeline which includes loan and interest rate lock commitments was approximately $1 billion at year end. A recent origination run rate has been roughly $300 million per month putting as on track to have substantially more volume and complete more securitization this year than in 2014, obviously subject to market condition. We ended the year with 33 approved sellers and we anticipate adding an additional 15 to 20 this year. We believe this high quality network of sellers will provide a rich source of opportunity across a variety of products over time. From a financing perspective, the FHLB facility has been beneficial to our conduit program as we are able to offer attractive pricing on a consistent basis to our seller partners. This is obviously helpful for homeowners who fall outside government program as attractive rates allow them to afford a home. Please turn to Slide 15. As we noted on our third quarter earnings call, we launched high-LTV and non-prime programs during the quarter. Both of these programs are in their nascency, although, we have beyond the lock [ph] loans with LTVs between 80% and 90%. As a reminder, this program is focused on high credit quality borrowers who prefer or require a lower down payment. The non-prime program is geared towards borrowers of average credit quality who have the financial wealth to buy a home, but haven’t been able to get a mortgage due to exceptionally tight credit standard. As we noted on our last call, we expect it will take some time to drive volumes in these products and we look forward to growing these programs in 2015 and beyond. Let’s now discuss mortgage servicing. The regulatory landscape for mortgage servicing and servicers remain dynamic. And we expect that this could result in large volume transfers in the next few years. We believe we are well-positioned to add MSR over time in both bulk and slow transactions and aim to add more flow sellers throughout 2015. We remain committed to growing our MSR program over time as it provides multi-faceted benefits across our portfolio. We are also excited about the opportunity to further diversify our portfolio into commercial real estate debt. Given the large market size and attractive returns, we feel this opportunity will help drive stockholder value. We’ll have more to say about this as we go through the year. Turning to recent market events, in January, the 10-year treasury rallied about 50 basis points and mortgages widened on fears of faster prepayments due to lower rates. Given our overall hedged profile and substantial holdings of prepayment protected pool, we are pleased that our book value is up slightly through January. As always, with these types of remarks, I would caution that we are only one month into the quarter. In closing, 2014 was an excellent year for Two Harbors. We delivered a strong return for our stockholders, while at the same time carrying a conservative risk profile with respect to leverage and rate exposure. We solidified the operational aspect of our business through the growth of our conduit and MSR initiatives and also laid the foundation to invest in commercial mortgage loans. I will now turn the call back to Ben to take questions.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from the line of Douglas Harter of Credit Suisse. Your line is open. Please go ahead.

[Douglas Harter:]

Thanks. Good morning, Bill. You had mentioned the continued attractiveness of the MSRs. Have you guys been able to add any additional flow deals over and above the PHH deal that you have?

[Bill Roth:]

Hey, good morning, Doug, and thanks for joining us. Basically, we haven’t made any announcements in any additional flow sellers at this point. We are focused primarily on increasing our sellers on the prime jumbo side. But I will tell you that one of our goals for this year is to add flow sellers on the MSR side, many of which that could come from our current sellers that we have on the prime jumbo side which, as I mentioned, are 33 at year-end. So that’s something that we think will be beneficial over time for the MSR initiative.

[Douglas Harter:]

And then as you’re looking at kind of the flow versus bulk opportunity, I guess how do you kind of weigh the opportunities there and the attractiveness of those opportunities?

[Bill Roth:]

Well, I mean, bulk is something that kind of shows up when somebody decides to sell something. And so that’s not unlike in the securities market if there’s securities out for bid. So we’re always examining bulk offers, our opportunities that are presented to us. The flow situation is a little bit different because as you know, there are many originators that sell flow as part of their cash flow management. So it’s a little bit different dynamic. And being positioned on the flow side we think provides a more stable flow of MSR to us over time. So basically, we’re happy and willing to look at both and they’re just a little bit different from a dynamic standpoint.

[Douglas Harter:]

Got it. And then shifting to sort of more of the MBS side, you guys have been running with lower leverage for a while. We’ve sort of entered a more volatile time. Have the opportunities improved enough for this volatility to sort of make you want to increase leverage more meaningfully or we’re not quite there yet?

[Bill Roth:]

Yes, that’s a great question. Yes, I mean, we saw agency mortgages, anyway, widen in January quite a bit. And we’ve seen a little bit wide mortgage credit spread. Bottom line is the agency ROEs, while they’ve improved slightly, they’re still in the single-digits. We did see, as I mentioned, some opportunity on the credit risk sharing with the wider spread. But there’s not that - basically, the best dollar we can spend today, frankly, comes out of the conduit. Where AAAs are trading in the market today, that’s roughly 10% ROE hedged and subs and IOs are better than that. So that’s obviously something we’re very focused on. But we wouldn’t intend to take our leverage up on the agency side unless we saw a dramatically higher expected ROEs.

[Douglas Harter:]

Great. Thank you for that, Bill.

[Bill Roth:]

Thanks, Doug.

[Operator:]

Thank you. Our next question comes from the line of Trevor Cranston of JMP Securities. Your line is open. Please go ahead.

[Trevor Cranston:]

Hey, thanks and congratulations on a good year. I guess one more question on the MSR portfolio. Presumably as rates have dropped in the fourth quarter and again into the first quarter, the negative duration of that portfolio has increased and I guess it seems like it might make sense that that’s happening to continue [ph] on the swap book sum which obviously happened in the fourth quarter. Can you talk about any changes you might have made to the hedge book to date in the first quarter?

[Bill Roth:]

Hey, Trevor, good morning and thanks for the kind remarks. I think that - well, first let me just make a couple of comments on MSR, right. If you look at the whack [ph] on our portfolio, it’s in the high 3s. So clearly, it hasn’t been in the money most of last year and it’s close to at the money currently. So the duration of that obviously changes as rates change. We manage our hedge position for the whole, our entire book. And as you know, we mentioned [ph] it pretty actively. So I think it’s constructive if you look at Slide 27 and 28 and you’ll see most interestingly I think to note on Slide 28 that our swaptions, our payers are now at roughly $8 billion and we actually have about $5 billion of receivers. So what we’re doing is we’re - and we took our swaps down, right, so we increased our swaptions on both payer and receiver side and we took our pay fixed swaps down. So without getting too mathy on this call, I think the point is is that what we’re trying to do is create a profile where we’re protected from various movements in the curve and rates. The perfect example, as I mentioned on the call, our book value is up slightly in January even though we saw a big rally in the 10-year flatter curve and at the same time wider mortgage spreads. So I think the important point is just to know that we’re very active in moving our hedges around as the market changes based on what our exposures are.

[Tom Siering:]

Yes, Trevor, it’s Tom. I think the investment team did a marvelous job in respect to their timing switching to more optional protection because obviously we’ve had a heck of a rate move in relative terms in the interest rates. Our timing I think was very good and I think we’re very well positioned for shifts up or down in interest rates right now.

[Trevor Cranston:]

Got it. That makes sense. And then on the commercial real estate side, can you maybe give a little bit of color kind of on what you’re thinking in terms of the initial focus in terms of what kind of property types you might want to focus on or avoid and kind of what sort of geographies you might be looking to exploit or stay away from?

[Bill Roth:]

Yes, sure. Let me just take a minute and give sort of a very high level overview. First, as of the end of the year, we hadn’t made any investments yet. I think the deployment will probably largely be back-ended in 2015. As was mentioned on the call, obviously, a very large market with a lot of volumes expected over the next several years. So we’re going to be focused on loans in the U.S. and property types that we consider could be office, multifamily, retail, industrial, hospitality or self-storage. We said that we’re going to initially allocate $500 million in equity capital. And our target assets on the loan side could be senior loans, mezzanine loans with the typical size or B notes and preferred equity, pretty much any part of the capital stack, specifically debt-oriented. You can probably expect typical loan size to range in the $10 million to $100 million size. Most loan terms are sort of in the 3- to 10-year range and typically float off a LIBOR.

[Tom Siering:]

And just like our other credit allocations, it will be very MSA-focused, too, Trevor. Obviously, market conditions are quite different depending upon what city or state you’re talking about.

[Trevor Cranston:]

Got it.

[Bill Roth:]

Yes, and the last comment that was made is we see expected ROEs in the low double-digits which certainly we think is attractive especially given that most of the assets are floating and would be levered to higher rates.

[Trevor Cranston:]

Got it.

[Bill Roth:]

So we’re really excited about it. We don’t really have much more to say than that at this point because it’s really early. But in the next several quarters, we obviously hope to have a lot more to talk about.

[Trevor Cranston:]

Yes, fair enough. That’s helpful. Would you anticipate using FHLB financing for these loans?

[Brad Farrell:]

Yes, great question. We’re working with them quite a bit looking at their collateral requirements. Some of these senior products might fit really nicely in their, quote, guidelines. So, yes, we’re definitely looking at them. I think it might be a nice fit for a portion of the production.

[Trevor Cranston:]

Okay, great. Appreciate the comments. Thank you.

[Tom Siering:]

Thanks for the kind words, Trevor.

[Operator:]

Thank you. Our next question comes from the line of Rick Shane at JP Morgan. Your line is open. Please go ahead.

[Rick Shane:]

Hey, guys. Thanks for taking my questions. I will say I’m not big on complements on earnings calls. But I really do appreciate the disclosure. I think you guys do a very good job helping investors understand what’s going on here. I love to explore Slide 13 just a little bit more. I know you went through this a little bit with Trevor. But there’s an interesting and sort of element of heads I win, tails you lose to the swaps strategy right now. And I think what’s happening here is that you guys are trying to, in a longer lower rate environment, maximize spread which seems like a good strategy. But I would be curious if you extended this book value exposure to change in rates table out to plus 200, plus 300, would we see because of the swaptions that starts to flatten out but you basically have a lot of sort of tail risk insurance in place and that you sort of lose that normal as rates continue to rise, further deterioration of book value.

[Bill Roth:]

Yes. Hey, Rick, that’s a good observation. The interesting thing about this table on Slide 13, it’s a standard disclosure of an immediate parallel shift, right, which I don’t think any of us on this call have ever seen an immediate parallel shift at exactly 60 or 150 basis points. And it’s obviously driven out of the model. But the bigger point of the table, first of all, is just to give a rough idea of we’ve taken a lot of interest rate exposure or not so much. And if you look at the table on the left, you can see that generally, we don’t take very much in our results over time of obviously showing that in different rate environments we’ve done pretty well. I think in terms of your up 200, up 300, obviously it’s a little challenging to see that happening today. But markets will always find a way to surprise us. If you look at our assets, they’re really very stable. So obviously the HECMS don’t really move much, they’re fairly short. We generally at higher coupon, prepaid protective pools on the agency side. And those, the cash flow variability is much less because there’s less volatility in prepayments. So one of the things we’re thinking about is those cash flows are generally fairly stable. You don’t get a massive amount of extension. And then if you look at our payer swaptions, we have about $8 billion of payer swaption, which is, like I said, I refer you back to Slide 28. Typically, those are - you can see they’re 56 months to expiration. So basically, five years of protection into, on average, about 7.5-year swap. So the whole point there is if you look at what’s going on in the world today, right, central banks all around the world are easing. European rates are extremely low. And it’s hard for us to see long rates going massively higher. The point is what we want is we want tail protection against something unforeseen that would drive rates massively higher. And that’s the whole point of those swaptions. So while we haven’t put out any numbers for up 200 or 300, we’re pretty comfortable - and immediate, we’re pretty comfortable with those payer swaptions are both long-dated and plentiful enough to protect us. I hope that gets to what your point.

[Rick Shane:]

It does. Exactly. Okay. Thank you, guys.

[Tom Siering:]

Thanks, Rick.

[Bill Roth:]

Thanks, Rick.

[Operator:]

Thank you. Our next question from the line of Dan Altscher of FBR. Your line is open. Please go ahead.

[Dan Altscher:]

Hey, thanks. Good morning, everyone. I appreciate you taking the question today. I just want to follow up maybe in a little bit more detail from Trevor’s question related to what your stand in the commercial loan side. I appreciate the color there, but are you looking to maybe buy loan packages as opposed to actually building out an origination team and doing it directly? Is that kind of the idea?

[Bill Roth:]

Yes. Hey, Dan, good morning. Thanks a lot. Yes, I mean as you know, we announced that - I mean Two Harbors is obviously externally managed by Pine River. And on the Pine River side, we brought in this very senior and well-accomplished seasoned team to basically build out a commercial real estate debt platform. And this is really focused more on loans and origination as opposed to buying CUSIPs in the market. So I think you should expect to see that our holdings will pretty much substantially be all loan-oriented. I’m not ruling CUSIPS out at all. But that’s the focus.

[Dan Altscher:]

I guess my question was more so in terms of we’re going - are we as Pine River or Two Harbor is going to have a team that’s actually going to be actively going out in trying to source product as opposed to there might be a large insurance company for instance that’s riding a senior and we want to partner with them to take the mezz or take a B note. What’s the game plan related to that, I guess, specifically?

[Bill Roth:]

Yes. I mean the team that’s going to - the focus that they’re building this team out clearly are going to be looking to originate loans, okay? And that doesn’t mean that they’re not going to buy parts of loan that someone else originated or team up with anybody. But they’re going to be originators who are working directly with either loan brokers or borrowers.

[Dan Altscher:]

Okay. I think that I got it. I think that’s helpful. Just following up maybe on Rick’s question at least related to the parallel shift in the curve, what we’ve seen from a couple of other folks is some sensitivity analysis around spread widening or bases. Do you have any kind of sensitivity around incremental 10 basis points widening, hit the book value or change the book value 25 basis points, something similar like that? That might be a little bit more applicable on kind of where we are at this point.

[Bill Roth:]

Sure. Yes, that’s not something we typically poured out. What we’ve generally done is refer people to the appendix where you can see what our assets are. We’ve got close to a couple billion HECMs which are very short. Our exposure in 30 years is typically in the higher coupon. And so most of the stuff that we have is fairly short duration. Second of all, obviously we’ve got a substantial credit bulk. Almost of which is a pretty significant discount. And so if you look at what happened in January mortgage spreads widened out quite a bit and yet, we ended up making money anyway. And I think that talks to the fact that we are typically keeping leverage low and basis exposure low because if you look at historically where spread are, they’re not particularly exciting in terms of jacking up leverage and taking more risk. The other thing is that our MSR book obviously is a great basis risk catch. And so while we don’t really calculate and put that out there, I think you could probably spend some time looking at what we have and determine what you think our exposure is.

[Dan Altscher:]

Okay. And then just kind of a geeky question maybe probably for Brad. Just related to the dividend and taxable income for end of 2014. Do you kind of have a rough guesstimate as to what the actual kind of cash taxable income was versus maybe the non-cash taxable income that is generated in the year?

[Brad Farrell:]

We haven’t put that out. And that’s something we typically don’t. But if really think about the drivers of our $388 million that we disclosed and obviously the realized gains, our cash, and if you think about the majority of our yield or our run rate or carry whatever you want to refer to it, a majority of that is cash flowing. We always do have a bit of what’s referenced as kind of phantom income on non-agency securities.

[Dan Altscher:]

Sure, sure.

[Brad Farrell:]

But if you look at the scheme of the number relative in our legacy portfolio, the size of it, it’s a pretty small amount. So I guess the higher level answer is the majority of that is cash flowing return. And that’s kind of how we think about our dividend. It’s not a surprise as you would expect to us that the 379 comes in nicely with a 388. And that’s kind of how we think about it.

[Dan Altscher:]

Okay. So I guess if I look back to the Qs and the Ks and just look at the discount accretion on the non-agency, that’s probably a decent enough ballpark to kind of get me there?

[Tom Siering:]

Yes. Hey, Dan, it’s Tom. How are you? I guess this is what they call on the radio, a teaser. So it’s our expectation on our Analyst Day to have more disclosure around our mortgage spread exposure, so hopefully you can join us then.

[Daniel Altscher:]

Okay. Well, now you know I’m definitely coming, so thank you.

[Operator:]

Thank you. Our next question comes from Chris Gamaitoni of Autonomous Research. Your line is open. Please go ahead.

[Chris Gamaitoni:]

Good morning, guys. Thanks for taking my call.

[Tom Siering:]

Sure.

[Chris Gamaitoni:]

Can you give us an updated outlook on the goal mix for the conduit business, how much AAAs versus how much subs, IOs?

[Bill Roth:]

Hey, Chris, good morning. This is Bill. Yes, so on the conduit side, as I mentioned, our run rate’s been going about $300 million a month roughly for the last several months. So for you math experts out there, I think you can figure out what an annual rate would be. Clearly, that would be a big pick-up versus last year and the year before. In terms of subs and IOs versus AAAs, basically on the AAAs, the way we think about that is is that our general intention is to do a securitization, sell off the AAA, potentially other pieces that we - like AAs or As and keep the credit risk because we’re doing all the underwriting and we understand the credit there. Now that being said, one of the things that we have said before is that it’s important for us to be consistent providers of attractive rates as we build our program. And the FHLB allows us to do that because to the extent the market gets disruptive and AAAs widen out and are worth retaining, we’re happy to do that and fund them at the FHLB until the market settles down and we can either sell them out at tighter spreads or continue to do securitizations in a natural manner. So, Chris, the bottom line is I can’t predict what the mix would be but our general intent is to retain subs and IOs. But from time to time, we’re happy to retain AAAs if it’s warranted by where they’re pricing.

[Tom Siering:]

Chris, it’s Tom. It’s difficult for us to answer that because we love all our children equally, right? And so it’ll just depend upon what the return profile is of this or any other thing going forward.

[Chris Gamaitoni:]

That makes sense. That intent is really was my question, obviously, is market dependent.

[Tom Siering:]

Sure.

[Chris Gamaitoni:]

And the other part of that is, in your conduit business, most of the servicing appears to be done by SanMar. Who’s actually holding - is typically a subservicer. Who’s holding the MSR in that transaction? I’m just trying to get a sense of kind of the outlook of maybe being able to buy additional flow from these counterparties and understanding who’s doing the asset, who’s doing the servicing in, generally, these transactions.

[Bill Roth:]

Chris, it’s Bill. Yes, so on any of the loans that we aggregate and then securitize, we’re holding the servicing. And then we contract that out to a subservicer.

[Chris Gamaitoni:]

Okay, perfect. And for the high-LTV subprime, the same process would occur I’m assuming?

[Bill Roth:]

Yes, that’s correct.

[Chris Gamaitoni:]

That’s perfect. Thank you so much.

[Bill Roth:]

Thanks a lot.

[Operator:]

Thank you. Our next question comes from the line of Joel Houck of Wells Fargo Securities. Your line is open. Please go ahead.

[Joel Houck:]

Hi, good morning, guys. My question has to do with bulk MSR purchases. Obviously, there’s a distressed company out there who just disclosed this morning they were going to sell between 5 and 20 bane [ph] of agency MSRs on a monthly basis. Without commenting specifically on price, there is some I guess confusion around whether or not a regulatory monitor would come with any asset sale. Can you guys comment or shed some light on what your understanding is with respect to asset sales? Just in general, not necessarily that particular instance. In general and potential, if a regulatory monitor would come with it, is that something you would shy away from?

[Tom Siering:]

Yes, thanks, Joel. It’s Tom. This is obviously kind of an evolving situation and we really can’t comment on things that we may or may not do in the market going forward. Obviously, the MSR market is something that we monitor very closely. But what we may or may not do in the future I really couldn’t comment on.

[Joel Houck:]

But I mean, is the regulatory monitor a deal breaker or you don’t even want to comment on that?

[Tom Siering:]

Yes. As I said, it’s a developing situation. So I think it would probably not appropriate for me to make a strong comment one way or the other.

[Joel Houck:]

Okay, that’s fair enough. Let me ask you a different question then. So obviously the legacy non-agency exposure came down last year and you guys mentioned on your prepared remarks. How much today is a function of you kind of allude to that you didn’t necessarily the prices or the HPA kind of outlook going forward. Is it a combination of both or just simply HPA still okay, but we need to have better pricing in order to take on, make new purchases?

[Bill Roth:]

Yes. Hey, Joel, it’s Bill. Thanks for joining us today. Yes, I mean the HPA situation obviously is we saw a nine run up and then generally we’ve seen that taper down to a smaller growth in prices, not only this past year but going forward. Frankly, the legacy portfolio is just really more a question of price. We have bonds that we bought at very attractive prices and I think we talked about one - and I’m trying to remember when it was that we bought $60 plus or minus that you know at one point, was trading almost at par. And bonds get to levels where their yield aren’t attractive and there’s no more upside. So the decline in our holdings is a combination of pay down as well as fail. But we certainly wouldn’t like anything more to be able to buy some more at attractive yields with upside. It has nothing to do with HPA really, it has to do with price.

[Joel Houck:]

Okay. That’s helpful. And then I think the last thing I have is, can you maybe comment on the incremental returns on CRT bands versus the legacy and non-agency portfolio. I mean maybe we’ll compare and contrast.

[Bill Roth:]

Well, in terms of - I think I mentioned a little bit in an earlier one legacy, non-agencies today. ROEs are in the mid - to high single digits. And in case I might find something that standout from that, which has some good upside and et cetera. And we have been able to do that from time to time. But it’s not a systemic occurrence. The GSE credit risk bonds are really interesting. They were really interesting when they first come out and then the dramatically. And the risk, reward there didn’t look that interesting. But recently, in the fourth quarter, particularly wind out dramatically. And we saw returns there, depending on the tranche [ph]. But without going into lots of detail, they were double digit expected returns. So that’s why we went and bought some more recently. So I would say, if you want to compare and contrast - once again, it depends on price. But more recently, the credit risk sharing bonds have been more attracted and offered better returns and where the legacy have been trading. But that’s not true all the time.

[Joel Houck:]

All right. Okay. No, that’s good color. Thank you very much.

[Bill Roth:]

Thanks for joining us.

[Operator:]

Thank you. And that does conclude our Q&A session. I’d like to turn the conference back over to Tom Searing for any closing remarks.

[Tom Siering:]

Thank you, Ben. I’d like to thank everyone for joining our fourth quarter conference call today. 2014 was a fantastic year for Two Harbors and we are quite proud of the growth of our operational businesses. We were excited about opportunities in 2015 and look forward to keeping you updated on our new initiatives. We will be hosting our annual analyst and investor day on March 19th at the New York Stock Exchange with Billy Beane of the Oakland A’s as our keynote speaker. Additionally, we will be attending the current Swiss Financial Services forum on February 11. We would welcome the opportunity to speak with you at these events. Have a wonderful day.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect.