Two Harbors Investment Corp. (TWO) CEO Tom Siering on Q1 2020 Results - Earnings Call Transcript

Two Harbors Investment Corp. (NYSE:TWO) Q1 2020 Earnings Conference Call May 7, 2020 9:00 AM ET

Company Participants

Margaret Karr - IR

Tom Siering - President and CEO

Mary Riskey - CFO

Matt Koeppen - Co-CIO

Bill Greenberg - Co-CIO

Conference Call Participants

Doug Harter - Credit Suisse Securities

Mark DeVries - Barclays Capital

Bose George - KBW

Trevor Cranston - JMP Securities

Rick Shane - JPMorgan

Stephen Laws - Raymond James

Kenneth Lee - RBC Capital Markets

Matthew Howlett - Instinet

Operator

Good day and welcome to the Two Harbors Investment Corp First Quarter 2020 Financial Results Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Ms. Margaret Karr. Please go ahead.

Margaret Karr

Thank you and good morning everyone. Thank you for joining our call to discuss Two Harbors' first quarter 2020 financial results. With me on the call this morning are Tom Siering, our President and CEO; Mary Riskey, our CFO; and Matt Koeppen and Bill Greenberg, our Co-CIOs.

On our call today given potential conflicts of interest, any comments about internalization will be delivered by Mary, Bill and Matt. The press release and financial tables associated with today's call were filed yesterday with the SEC. If you do not have a copy, you may find them on our website or on the SEC's website at www.sec.gov.

In our earnings release and slides, we have provided a reconciliation of GAAP to non-GAAP financial measures. We urge you to review this information in conjunction with today's call. I would also like to mention that this call is being webcast and may be accessed in the Investor Relations section of our website.

I would like to remind you that remarks made by management during this conference call and the supporting slides may include forward-looking statements. Forward-looking statements are based on the current beliefs and expectations of management and actual results may be materially different because of a variety of risks and other factors. We caution investors not to rely unduly on forward-looking statements except as may be required by law Two Harbors does not update forward-looking statements and expressly disclaims any obligation to do so.

I will now turn the call over to Tom.

Tom Siering

Thank you, Maggie, and good morning everyone.

We hope that you had a chance to review our earnings press release and presentation that we issued last night. Coming of the yields of a very strong, the company, we could not have imagined the societal economic conditions, that would result from the global corona virus pandamic. This has been a challenging time for our nation in the world, our thoughts are with those most affected by COVID-19, especially those of lost loved ones.

Additionally, we want to express our gratitude and admiration for the Euros, we're on the front lines. We like everyone else are hoping for a return to normalcy. First and foremost, we have been concerned about our most valuable asset. Our people, we have implemented mandatory work from home measures across our three offices, that are utilizing technology to stay well connected.

We are all of the adapting to the new reality, and we were able to execute our data they best with very minimal disruption. The first quarter non-spared from the volatility of the markets. Unlike the 2018 financial crisis, the speed with which the market dislocation appeared in the large spread those sort of heard on a daily basis, were unprecedented. Every asset classes are impacted. Spreads especially on liquid assets widened dramatically margin calls were swept.

I'm proud of how our team the volatility by actively derisking risk in our portfolio. In order to establish and maintain a very strong defense of liquidity position, throughout this period satisfy all margin calls and do not enter into any forbearance arrangements with our lenders.

In the mix of the volatility. We also made the difficult decision just spend on our first quarter preferred stock dividends. In order to ensure we maintain sufficient excess liquidity and preserve stockholder value for the long term. Decisive actions allowed us to weather extreme volatility March and ended the quarter with $1.2 billion in unrestricted cash. Given the derisking of our portfolio and increased confidence in our liquidity position.

We announced an interim common stock dividend of $0.05 per share, as well as full payment of our first quarter preferred stock dividends. So we are not able to provide guidance on future dividends together with the Board. We will be evaluating our quarterly dividends going forward, based upon the composition of our portfolio in a decisions. Additionally, post quarter end, we announced to be independent from Board of Directors elected not to review the Company's management agreement with PRCM Advisers.

Mary, will comment on this more detail shortly. We believe that how we are regarded once this crisis passes will depend upon our actually now we strive to be best-in-class, and in this time of great uncertainty. We are committed to all of our stakeholders, our employees stockholders, business partners, communities we are weathering this time together.

While we can't predict how this global pandemic buyout and what last year the effects will be, we are making every effort to best position our company programs outside of our control. Despite all the uncertainty, we believe that we can withstand future volatility and ultimately on the other side of this crisis, once again, drive long-term stockholder value.

With that I will now turn the call over to Mary to review our financial results.

Mary Riskey

Thank you, Tom.

Turning to Slide 4, let's review our financial results for the first quarter. Our book value at March 31 was $6.96 per share, representing a decline of 52% from $14.54 at December 31. On the right-hand side of this slide, we have provided a more detailed attribution of our book value decline in the quarter. As expected sale of substantially all of our non-agency securities was the largest contributor, resulting in over 70% of the decline.

Our rate strategy also contributed to the decline driven by fair value markdowns and MSR, specified pool underperformance as well as specified pool sales as a result of delivering, our portfolio in March. Matt and Bill will detail this portfolio activity shortly.

Moving to Slide 5, let's discuss our core earnings results. Core earnings were $0.25 per share in the first quarter, consistent with the previous quarter. Core earnings was favorably driven by higher net interest income due to purchase of higher coupon agency RMBS early in the quarter and lower amortization. This was offset by increased interest spread cost and swap positions due to LIBOR reset and lower TV roll income.

Turning to Slide 6, our portfolio yield in the quarter was 3.52% and our net yield decreased to 1.13% from 1.19%. Besides improvement in repo costs, this was more than offset by higher swap cost as 3-month LIBOR rates declined in the quarter. Expanding rates have come down post-quarter-end, we expect to continue to see improvement in repo costs.

On Slide 7, we have summarized our financing profile as of March 31st. As the turmoil in the market unfolded in March, our financing and investment teams worked closely together to preserve liquidity and deliver the portfolio.

As a result, we have made all of our margin calls, our liquidity position remains strong and we are confident in our ability to continue to meet margin calls and servicing advance requirements on our MSR.

Our economic debt to equity at quarter-end was 7.0 times compared to 7.5 times at December 31 and our quarterly average economic debt to equity was 7.4 times. It is important to note that we sold our lower levered non-agencies during the quarter. So while the change was nominal in our quarter-over the debt to equity leverage on agency RMBS and MSR decreased meaningfully.

We did not experience any issues with access in the agency repo market and we're active enrolling every repo positions. At March 31st, we had 22 active agency repo counterparties with the weighted average maturity of 52 days. In aggregate, we have been able to roll our agency RMBS positions without much change in haircut.

As was true in many markets, repo levels were stressed in March. However, as we have progressed past quarter-end we have seen more clarity and consistency in rates and term markets are developing again. Repo levels for one month to three-month terms are indicated today in the OAS plus 25 to 35 basis point range.

As of March 31, we had $252.1 million outstanding across our MSR bilateral facilities and $400 million outstanding MSR terminal. Our total committed capacity across our MSR financing alternatives is $450 million. Importantly, we are in advanced discussions with two major banks and servicing advance facilities. This will provide us with additional liquidity to continue to make servicing advances in the event of increased for parent or default. For more information on our financing profile, please see appendix Slide 28.

Please turn to Slide 8. In April 13th, we announced our election to not renew the management agreement with PRCM Advisers. As a result, the agreement will terminate on September 19th, 2020, and we will become a self-managed company. The decision was the result of a diligent thorough and extensive month-long process led by the independent directors of our board with the advice of independent legal and financial advisers. The board-driven process commenced long before the COVID-19 pandemic and timing of the announcement was predicated in part on the non-renewal provisions of the management agreement.

We believe that our stockholders will benefit from significant annual cost savings as well as from further alignment of interest of management and stockholders, enhanced returns, and any future capital growth, and the potential for attracting new institutional investors.

Under the terms of the agreement, we are required to pay a one-time cash termination fee, which we estimate will be approximately $144 million. We expect to realize an annual cost savings of approximately $42 million or $0.15 per share. Before giving effect, any additional cost savings from the elimination of the management fee on future capital growth.

Therefore, the payback period on the termination payment is relatively short at just over three years. And the return on investment is approximately 29% per annum without accounting for future capital growth. The manner in which the termination payment is calculated using a 24-month look back period, especially when the lower management fees paid in earlier quarters just taken into consideration, the payment of the estimated termination fee results in the most favorable economic benefit to stockholders.

In conclusion, we are confident that this is the right time to make this change given the maturity of our business model, our well-established infrastructure and the material economic benefits to stockholders and we believe strongly that the transition to being self-managed, is a very positive step for the future of our company.

With that, I will now turn the call over to Bill and Matt for our market overview and portfolio update.

Bill Greenberg

Thank you, Mary, and good morning everyone.

We'd like to start this morning by spending a few minutes discussing the effects of the Covid-19 pandemic on the residential mortgage market. Then we will discuss our portfolio activity for the quarter, finally, we will talk about our outlook for servicing advances in our portfolio liquidity.

Please turn to Slide 9. In March the COVID-19 pandemic had a swift and dramatic effect on valuations leading to extraordinary spreads widening across virtually all asset classes. Left-hand chart shows the 10-year swap rate and the S&P 500 in the first quarter. Although the tenure swap rate trended lower early in the quarter, we move sharply in March, finishing the quarter roughly 120 basis points lower.

The S&P 500 performance really emphasizes how quickly events unfolded and the all-time high on the index was realized at February 19th before falling 35% Just a month later. The right-hand chart shows spread widening impacts across various fixed income asset classes from pre-crisis levels in February indicated by the low to be sort of the line, through the crisis indicated by the high point of view vertical line and then ending mid-April indicated by the great circles.

No asset classes capes and this affected us and other mortgage REITs significantly. Most spreads remain significantly wider than they weren't February with the exception of agency RMBS, which have retraced all of their widening more due to the direct impact of QE for purchases by the Federal Reserve.

Moving to Slide 10, the left-hand chart compares RMBS Treasury spread index in 2008 versus March 2020. While the magnitude of the widening is notable and similar in both cases, the real difference was the speed at which it unfolded. The round-trip was completed in three weeks in March compared to six months in 2018. The right-hand chart shows the large introduced spread changes in the Fannie coupon during the most volatile week in March.

As you can see in this chart, each day is delineated by the vertical lines and starts at zero. It was not uncommon during that week to see 50 basis point moves both widening and tightening, sometimes even in the same day. This high level of volatility was further exacerbated by extremely low levels of liquidity in the MBS market. At times, the bid-offer spread in the most actively traded securities were as much as 100 times at normal levels. At the end of April, the agency market has substantially healed and bid-offer spreads were largely back to normal.

Please turn to Slide 11. As the stress on the RMBS market grew, the Federal reserve with a number of actions meant to stabilize the markets. At the outset, the Fed cut interest rates by 50 basis points on March 3rd in an attempt to offset increasing liquidity fears. The market was not suit and by March 15th, it was clear that the system needed additional action.

The Fed responded by cutting rates to zero and announcing its commitment to purchase $500 billion in treasuries and $200 billion in RMBS. The market was still underwhelmed and volatility in the treasury RMBS markets actually worsened. In response on March 23rd, the Fed committed to unlimited purchases of both and what has become known as QE4.

Following the recommendations of various market participants, the Fed also began to buy bonds on a short settle basis waiting until the regular mid-month settlements. Fed RMBS purchases were also expanded to include higher coupons and not just the lower dollar price production coupons. It was very helpful for many market participants through the mortgage reads, who generally had large holdings in the higher coupon bonds.

The left-hand chart shows deal Fed purchases of MBS, which have now exceeded $500 billion. The right-hand chart shows the pace of QE4 compared to QE1 in 2008 and QE3 in 2012 demonstrating again the speed and size in which events are unfolding today.

With that, I will hand it over to Matt.

Matt Koeppen

Thank you, Bill, and good morning everyone.

Please turn to Slide 12. With the foregoing discussion as a backdrop, let's now discuss the actions we took in March in response to the liquidity crisis caused by the pandemic. The volatility increased and spreads widened on agency RMBS, we reduced risk to raise excess cash. We liquidated around $18 billion specified pools and TBA representing about 50% of our agency portfolio. When liquidity was poor in March, we initially sold lower coupons where there were some sponsorship, but eventually reduced exposure to higher coupons, one, the Fed adjusted its programs focus on purchases in that part of the coupon stack.

Timing of most of these portfolio sales occurring as they did before unlimited QE was announced was such that we did not fully benefit from the spread tightening driven by outside spread purchases. With respect to our legacy non-agency portfolio, we have become increasingly concerned about levered portfolio liquidations occurring across the market, acceleration in size, and frequency of margin calls arising from widening spreads, increasing haircuts and the future ability to access ongoing funding in the repo market.

As a result, we decided to liquidate substantially all of our non-agency portfolios and to eliminate the aforementioned risks. The chart on the bottom of the slide shows our portfolio composition on December 31st where you can see the effect that the portfolio sales we just described.

Please turn to Slide 13. Another large driver of performance during the quarter was the collapse in specified pool pay-ups. The chart on the upper right-hand side of this slide shows 3.5 coupon higher loan balance specified pool pay up levels.

This chart is indicative of the price action that impacted all stuff-- as the month unfolded with the risk appetite and balance sheet capacity low specified pools pay-- the pay ups are indicated by the blue bars and measured on the left-axis, the gray line shows the ratio of the pay up to one measure of its theoretical value and is measured on the right axis. You can see the premiums fell from around 4.0 to around 1.0 at the end of the quarter.

There were even trades that took place in the market at negative pay-ups indicating that the specified pools traded below settlement date adjusted and cost of funds adjusted PPA levels. Specified pools have significantly been covered in April. The lower charts show our specified pool breakdown on December 31st and on March 31st.

You can see that we liquidated essentially all of our lower pay-up stories during March to minimize losses while delevering. Specifically, we sold a net of $13.4 billion pools during the quarter across 3% to 4.5% coupons, predominantly in high LTV pools. Today we are positioned largely in loan balance and geography stories.

Turn to Slide 14, the graph on the right-hand side of this slide shows coupon performance for the first quarter, despite the massive volatility agency RMBS ultimately performed well after the Fed stepped in with support. Coupons in the middle of the stack include 3, 3.5 and 4 all outperformed by a point or more. Our effective coupon positioning is shown in the bottom chart. Our implied short positioning from the MSR asset move to the 2% coupon in March from 2.5 and 3s at the end of December as a result of the interest rate falling. Our long holdings include 2.5 to 5.

Please turn to Slide 15. This slide shows our interest rate and mortgage spread exposure. Although we recognize that these representations of our exposures are too simple to have been accurate subscriptions of portfolio performance during the crisis as volatility sites and market movements return to normal these kinds of risk measures regain their usefulness. These exposures remain low consistent with our historical positioning. In the top-right chart you can see our exposure to instantaneous changes in mortgage spreads.

As of March 31, 25 basis points spread widening would decreased book value by 1.4%. The chart on the bottom of the page shows our book value exposure to instantaneous parallel changes in all interest rates, which you can see that as of March 31st an instantaneous parallel shift in interest rates upward of 50 basis points would negatively impact book value by only 1.3%.

Bill Greenberg

Please turn to Slide 16. We would like to dedicate time today is one of the biggest challenges we are currently facing, increasing mortgage loan forbearances and servicing advances. While the COVID-19 pandemic began as liquidity crisis, these things often go it has transformed into a credit crisis shutting down large parts of the United States has had far-reaching economic impacts.

Unemployment has skyrocketed and is expected to continue to climb. With so much of the economy shuttered and people out of work and staying home, the ability of all types of borrowers, renters, and [indiscernible] to pay their obligations, the call to questions.

At the end of March, Congress enacted the CARES Act, which besides including relief checks and other supporting measures has an important impact directly on our industry. One provision fee act provides for up to 180 days of forbearance relief from mortgage loan payments with the right to expand up to an additional 180 days for borrowers with really back mortgages who experienced financial hardship related to the pandemic. The act also prohibits foreclosures for 60 days.

Through one of our subsidiaries, we own the MSR for over 8 loans guaranteed by Fannie Mae and Freddie Mac and as a result, we are responsible for making advances for certain payments the events they are not made by a borrower. In normal times is not burdensome pre-COVID our 60-day delinquency grade was about 30 basis points and we were able to manage the liquidity needs related to this in the ordinary course of our business.

However, with the forbearance programs now in place, as a result of the Cures Act, the situation is different. During the forbearance period, we are responsible for remitting monthly scheduled principal and interest for loans backed by Fannie and monthly scheduled interest for loans backed by Freddie.

Additionally, we are responsible for making interim and tax and insurance payments to local authorities and insurance companies. On this slide, we show our MSR portfolio forbearance rates as we started collecting data on March 23. This data is shown by the blue bars at the bottom of the chart and references the left axis. After April 28, our experience is that at 5.7% of our loans by count have entered forbearance.

The grey line shows the daily percentage changes in the number of loans and forbearance and is measured by the right axis. This number has been steady in the low single digits for some time. Worth pointing out that both the Mortgage Bankers Association and Black Knight, a loan servicing technology company published data regularly regarding forbearance rates for GSE loans and our data has so far been very consistent with both of those sources.

Please turn the page to Slide 17. On this slide, we consider how our servicing obligations in respect with our liquidity position. We have taken a scenario analysis approach and created 50 scenarios and cases, a moderate stress case, and a severe stress case. Depending on the speed of the relaxation of social distancing measures and the reopening of the economy, we believe that a 15% rate is a reasonable estimate for a base case.

Of course, it is possible to predict the ultimate take-up rate with any certainty, but as you will see we believe our liquidity position is strong enough to withstand stresses to this outcome. Scenarios differ primarily by varying the maximum forbearance take-up rates, the base case assumes 15%, the moderate stress case assumes 20%, the severe stress case assumes 25%.

Additionally, in moving across these three scenarios, you vary pre-payments from 25 CPR in the base case to 20 CPR in the moderate stress case to 15 CPR in the severe stress case. The pre-payment rate is an important driver forecasting advancing obligations. Is their custodial accounts for principal and interest can be used to offset obligations, but of course, these funds must be paid back the next month.

Next variable is the existence of a servicing advance facility. We are in the process of negotiating documents on such facilities for large Wall Street banks. We expect that any facility would accommodate both Fannie and Freddie's advances. Most subject to customary closing conditions and GSE approvals, we have included the existence of such a facility in our scenarios. The last variable of valuation of our existing MSR portfolio. We have two outstanding facilities where we borrow against our MSR assets, our distinct of our facilities, which are meant to finance advances, and the borrowing base depends on the market value of MSR.

Therefore in each scenario, we stress [technical difficulty] in order to simulate potential market calls. This price distresses start from our 331 valuations and declines from a 3.0 multiple down to a 2.0 multiple in the severe stress scenario. Of three scenarios, explicitly include payments of the estimated non-renewal fee due in September.

Chart at the bottom left of this slide shows our projection for our advancing obligations. In all three scenarios, you can see that the servicing obligation peaks right around in December 2020. In all of this, the curves rise quickly due to the accumulation of P&I and P&I advances and then decline as we are able to recoup P&I advances from interim claims processing.

Even in the base case, the maximum advancing obligation is around $100 million, while in the moderate stress and some stress scenarios the obligation increases $250 million and $450 million respectively. To determine whether or not those are big numbers are small, we need to overlay those with our liquidity.

The chart on the bottom right of the slide lays out a path of our liquidity over the next 18 months. Start with a steady-state cash balance of around $1.2 billion. The reason we are holding such a large cash balance today is precisely in consideration of this advancing obligation. As you can see, we expect our excess cash balances to decline as we pass through the advanced state where and to return to a more normal level.

In all three cases, we maintain an excess liquidity buffer of between $400 million and $600 million. For a portfolio of our size and with their big tolerances we expect to be running, we believe full [technical difficulty] the best comfortable.

It's important to us, that you have full transparency about what we're seeing around servicing advances and how we are thinking about this in the context of our MSR portfolio. We hope this explanation helps. Summary based on the information we have been discussing today, we feel quite confident about our liquidity position.

Matt Koeppen

Please turn to Slide 18. The reality is that this pandemic has reordered everything and we have a lot of work to do before we are in a position to return to business as usual. The advancing obligation is significant and while we feel confident in our ability to manage it, it will take time for events to unfold before we anticipate returning to a steady-state business model there are multiple obstacles double certainly dragged down earnings in the near term.

These include higher than normal cash balances, increased servicing costs from our subsurface services that linked the loans, cost to set up, and maintain the servicing advance facilities and uncertainty in MSR pricing.

Having said that, we believe that the opportunity set in our target assets is very attractive. We discussed earlier, with such support agency TBAs recovered all of the March widenings and then some, so that returns in that part of the market are similar to what they were pre-crisis. Specified pool pay-ups have recovered much of what they lost in March but are still somewhat lower than they were when the crisis began. As a result, we are seeing returns on rate hedged agency RMBS in the low to mid-teens.

In the MSR asset that we're seeing the most interesting opportunities. While it's true that there is much to work through regarding forbearances, advances, and higher cost of service, we still estimate that the forward-looking returns on our existing book of MSR, when paired with MBS, is in the mid-teens based on our Q1 valuation.

Earlier we discuss some potential scenarios about the future path of MSR prices, should MSR multiples decline 2.5 times on our existing book from three times, we would estimate that the paired return would be in the very high-teens. The MSR bulk market remains shutdown, so it's not possible at the moment to acquire new assets there. The MSR flow market slowly comes back to life, and indeed we are buying a trickle of MSR assets in that channel. The multiples in the flow market are usually lower than in the bulk market. And while visibility remains somewhat unclear today, we think that flow product can be acquired below two multiples.

On a forward basis, we think that translates to yield north of 25% one paired with agency RMBS. We don't yet know the amount of assets that can be acquired at those levels, but it is clearly very interesting at those prices. The barriers to entry in the servicing business are many. Every asset is time-consuming and complex. Only market participants who already have the infrastructure, process, and relationships in place, will be able to access the kind of returns just mentioned.

We had Two Harbors, are uniquely positioned to take advantage of that attractive opportunity on an ongoing basis. With each day that passes, the outlook gets a little clearer. As Tom said at the outset, we aim to be as transparent as possible and we will continue to update you with new developments over time.

With that, I will turn it back to the operator.

Question-and-Answer Session

Operator

[Operator Instructions] We will take our first question today which comes from Doug Harter. Please go ahead.

Doug Harter

First, thanks for the additional disclosure around the liquidity just Matt then on your commentary about the attractiveness of new returns, can you just talk about kind of where you are in the flow program. Is that something that you guys are acquiring loans or MSR is through the follow today or what it would take from a liquidity position to feel comfortable acquiring loans through flow?

Bill Greenberg

Yes, this is Bill I'll take that. So as Matt said, we are acquiring, what we call a trickle during the depths of liquidity crisis. We like many of other competitors suspended our acquisitions there. As I said, that market is slowly coming back to life we are back in the market on a limited basis really in a way that does not increase our forbearance and advance risk there is different ways to view that by targeting certain types of collateral and so forth.

Then we can talk about later if you'd like, but what we're doing it in a way that minimizes that liquidity burden and we're using the opportunity to see how much assets can be acquired at those levels and how much and obviously at those levels its very interesting. And if we're able to do that we will figure out a way how to make that work.

Doug Harter

Great, Tom and then if you could just talk about the capital structure after the book value decline in the quarter the mix of preferred is obviously much higher now and kind of how you think about that mix and kind of what would be the plan to kind of get that back in line with goals you had previously or targets you had previously mentioned?

Tom Siering

Well thank you, good morning. Obviously, it's something that we're acutely aware of them and are reviewing. So yes, you're right that it had that effect on the capital structure. And so it's something that we have under review. So people might be curious as to whether or not we would raise common equity and obviously that would be there dependent upon the opportunity. So, but it's something that we're obviously where we have a review and we will attempt to fuel with that the best we can.

Doug Harter

Okay. Thank you, Tom.

Tom Siering

Thank you.

Operator

Our next question today comes from Mark DeVries. Please go ahead. Your line is open.

Mark DeVries

Yes, thanks. I had a question about the liquidity projection on Slide 17. Is that liquidity number, is that assume is that just based on the - current we have on hand now or does it also assume draw as on these facilities, and during the process of negotiating?

Bill Greenberg

This is Bill. I'll take that. It's a combination of all of that, it's a pretty comprehensive set of assumptions and models that incorporate to the best of our knowledge, all of the potential drags and sources that we will have at our disposal. I mean, we think, where we can, we tried to be fair, but conservative and try to stress the models, as you see like 3 scenarios, so it includes all of those things.

Mark DeVries

Okay, got it. And just given the high quality nature of the servicing events and all risk around it, are you generally sensing somewhat unlimited capacity to finance that. So God forbid, you had a scenario is even more stressful than your severe stress you would just be able to expand the financing available to you?

Matt Koeppen

Yes I mean we are certainly, and I think you can see this in liquidity projections. We are certainly sizing our needs based on stresses to the base case to this to the severe stress and even a little bit more than that. You can see that in the liquidity projection because we only went to this stress. But it would still be true it would hold up for so much bigger than that. Now, it is true if we see forbearance rates increasing a lot higher than 25% which right I mean I don't see.

I think we're already starting to see as staggeringly big as the unemployment statistics are that we're seeing in the market. We are starting to see them leveling off a bit. And so, we feel pretty good about the projections. They won't rise above 20% or 25%, but I am obviously if that does where the negotiations that we have with the banks could allow potentially to be re-negotiated upsize but we're sizing it to be something larger than 25% at the moment.

Mark DeVries

Okay, great. And could you give us a sense of how your blended returns might be impacted under the different scenarios is kind of forced to reallocate capital got the funding advances and other business scenario?

Matt Koeppen

Well it might be a little bit more. I don't know if I have those numbers at my fingertips. I do know what we said was, including the higher forbearance and increased cost of service and reduced cash flow from loans in forbearance on the servicing asset that in our base case the paired levered return is still in the mid teens. I'd have to check about the other scenario. I don't have them here you can get back.

Mark DeVries

Okay yes fair it’s helpful. Thank you.

Operator

Our next question today comes from Bose George. Please go ahead. Your line is now open.

Bose George

Good morning, hope everyone staying safe. Actually first can you give us an update on book value since quarter-end?

Tom Siering

Good morning, Bose guys this is - I’ll take that - first and then head off to Bill and Matt for further comments. So firstly, I always have to compromise the caveat that five weeks to model quarter make but as Bill and Matt alluded to in their script in April and May, we experienced a notable and favorable repricing of spec pools, which generated a significant amount of P&L.

However, there is a couple of things to note, as Bill and Matt discussed. There is some uncertainty with respect to the effects that forbearance and extended servicing advances will have on future MSR remarks and then additionally we plan to record the internalization fees to Pine River in Q2. So there is a couple of the big variable obviously is the forbearance effect. Bill and Matt, please.

Bill Greenberg

Yes, I'll take that one. Thanks, Tom, and good morning, Bose. So to put a little more color around those moving parts. The specified performance has been strong in April and followed on in May. We've seen a multiple point recovery after the big fell-off in March basically things back to closer in line with where we saw them in February.

So that component for Q2 is driving an attribution of around up 14%. Tom also mentioned servicing. So we like always are getting our servicing valuations, they are valued by three independent brokers. However, as time passes, right. And we had this in some of our liquidity projections as you can imagine, as forbearance flows through and prepayment fees possibly pick up, we might see some pressure on multiples and so if that sort of pricing were to come through, we could see that sort of in the base case with the 2.5 more leading to a book value change of about that could be $150 million or $175 million.

So that could be around an 8% or 9% impact. And the third thing Matt said, Tom noted internalization payment, although it is due to be paid in September. We’re going to record it in Q2, so that's about another 8% offset. So I'd like to give you a more straightforward answer. But there is a lot of moving parts here, and it will depend on how those things play out.

Bose George

Okay. Actually, thanks. That is very helpful. So actually just leaving aside, that the charge for the management fee, the spec pool up 14, the MSR maybe down 8 or 9. So like a 5% up for the quarter-to-date is probably a reasonable ballpark?

Tom Siering

So for a second, so the MSR mark that we're guessing about that, that we don't, we don't know. We have end of circle marks which don't reflect that kind of kind of movement at the moment, given what we think is happening with forbearance rates increasing and how we think the world will think about that, that is a possibility of how we think the world might unfold. All right, but that depends on the path of how the MSR asset performs and what the future remarks end-up being. We highlighted and we flag it just to put it out there that, that is a possibility and could happen, but we don't know, we'll have to wait and see.

Bose George

Okay. Now, that's really helpful. Obviously, that makes sense for in terms of conservatism on that estimates. So yes, thanks very much, and then just going back to that stress scenario slide, you know that you assume the reimbursement on that, the P&I is after the 15 months. There's been some discussion and some chatted with the GSEs might come out with something to reimburse servicer sooner than that. Do you have any thoughts on how that might play out?

Bill Greenberg

I don't unfortunately. I'm hearing the same thing as you’re. There's lots of proposals and possibilities in flux. These projections are made with the best information and assumptions that we have at the time, we update them every day as we learn new things and incorporate new information. So as of the moment, that's what these things include and should we be able to reimburse it differently or hopefully better then we'll include those and we can update you guys on those when they happen.

Bose George

Okay, great, thanks very much.

Bill Greenberg

Thanks Bose.

Operator

Our next question comes from Trevor Cranston. Please go ahead.

Trevor Cranston

Hey, thanks. One more question on the liquidity projections in the forbearance scenarios. First, I just wanted to clarify that, that does include the buyout of the management contract and then two, I was curious if there's any assumption in that projection around the dividend level changing from what was paid for the first quarter? Thanks.

Tom Siering

Hi Trevor, thanks for the question. So the answers to those first question is, yes it explicitly includes that payment. Also point out by the way, what's not included in here is any liquidity or cash raising from any portfolio adjustments that we could make if necessary. All right, this is all keeping the portfolio casting of what it is, it does not include any dividend payments, but it doesn't, it doesn't in a way, but the idea here is that, that the portfolio is going to earn what It's going to earn right.

And that's going to be paid out right. So we're not building into these liquidity projections, a growth in the liquidity from not paying the dividend. All right. It assumes all be paid out, so that included or not included. I'm not sure. But we're not taking that money and hoarding it to make the liquidity look better, it's assumed to be paid out to the dividend.

Trevor Cranston

Okay. Got you.

Tom Siering

It sounds good, Trevor.

Trevor Cranston

Yes, thank you for that. And then in areas you were discussing for MSR valuations. I was curious if there's any way for you to sort of provide some context around kind of what you think the rough approximate sort of multiple on the MSR book would be in the scenario with if your stress case in terms of forbearance combined with like a significant compression in the primary, secondary, mortgage credit spread?

Tom Siering

Look, it's very. Thanks for the question. That's a very hard question. It's very hard to know, you're asking about what I think the future prices of something might be as the world unfolds. All right. That said and we've talked about this a little bit earlier in the quarter. The MSR market is hard to value especially today because there is not very many trades taking place. All right.

And so the brokers are in a situation where they say, well, how do I put numbers on something when I don't see any observable trades in an illiquid and stressed markets without willing buyers among sellers.

All right. And so in the absence of that, the brokers have taken the approach that let's keep for the moments risk premiums constant to what they were, don't know whether that's true or not, the speed with which the markets have been evolving and moving has been astonishing as Matt just told you, specified pool pay-ups and you saw on the chart in the presentation.

They went from four points down to one point or below, right in some cases back up to four points. They're all back to where they were all right now, there will be increased costs from servicing delinquent assets from the forbearances, there will be reduced cash flows as the non-paying borrowers pay their service fees. So there is what I would call a technical cash flow effect, right from the servicing cash flows, but depending on the curing scenario that you think might exist in the world, whether it's a deferral option or something. How long that persists for…

you think might exist in the world, whether it's a deferral option or something. How long that persists for is unknown, maybe it's even short maybe after one year people start paying the mortgages again if some of these deferral options come to fruition, and there's not that much of an interruption.

So it's hard to know right. I think we do you think generally - that the low 2 multiple is very hard to achieve on any long-term basis for these assets with willing buyers and willing sellers just the nature of the cash flows in the timing and what they're worth and the interest rate and convexity characteristics and so forth. As I said in the previous comment, I think it could go to 2.5 million depending on some of these things depending on lots of factors.

I don't see it going much below that below 2, I guess if we had some very high-stress scenario 25% that no one is expecting including us. I guess, it's very hard to know - as things normalize as trade start to occur. The market started to heal we'll get more visibility and we'll be able to speak with –more clarity on what we think those scenarios are.

Matt Koeppen

Trevor I would add in our liquidity projections, we did and have like Bill said there's all kinds of uncertainty, but we did and do include scenarios that do take us down to 2 multiple even though we think that maybe that's severe, we'll have to see what happen, but we do include those numbers - in our projection.

Trevor Cranston

Okay got you, that's helpful. And then on the advanced facilities, you guys are working on I know they are not closed yet. But are you able to say anything about kind of –what the cost of those facilities are likely to be when they're utilized and assuming that you closed?

Tom Siering

Not really I'd say, we're still working on. I mean they're not closed. And we're seeing still negotiating I mean they're very market tops I would say - yes with the FERC prepared to discuss that today.

Trevor Cranston

Thank you, guys.

Tom Siering

Thanks Trevor.

Operator

Our next question today comes from Rick Shane. Please go ahead.

Rick Shane

Hey guys, thanks for taking my questions this morning and I hope everybody is doing well. I wanted to touch on servicing advance facilities briefly historically and I think Mark pointed this out, servicing advances our AAA type assets and get very favorable financing. I am curious in this environment if pricing remains as attractive as it has historically and does access to servicing advance borrowing represent another barrier to entry in terms of that business?

Bill Greenberg

Sure, thanks for the question. So servicing advancing as an asset class does typically enjoy the financing you could sponsor and so forth. That would be an asset though that I think what you're thinking of is, if we were to create the advancing securities and then sell them to the marketplace. What it would look like AA, AAA securities for the investor that would buy those notes right. That's on the end user side to what we're making here right. So we may to do that.

Rick Shane

No actually I misspoke and you’re over complicating my question, I apologize. I just meant from a collateral perspective the servicing advance is considered to be AAA collateral. Then it gets - that it gets that it is because of where it stands in the waterfall you typically get very favorable borrowing cost and very high advance rates?

Bill Greenberg

Yes that's true because the counterparty risk is generally considered to be, do you see risk instead of the servicer risk. Yes the advance rates are typically, but I think how you rate market advance rates on advanced facilities depending on P&Is and P&Is corporate advances typically range in the 85% to 95% range right. Those are just market terms for those kinds of things.

Rick Shane

Yes.

Bill Greenberg

And you’re reflective of what you just said.

Rick Shane

Yes and are you seeing any change in pricing given the current market conditions related to those facilities?

Bill Greenberg

Yes I'd say it's probably a little bit wider than what it was and what it would have been in February but it's still, it’s very low I consider still very low compared to other things in the world at the moment.

Rick Shane

Got it, okay. Yes you made the classic mistake of assuming my question with smarter than it really was. I wanted to on a very simple level make sure I understood that. Second thing look you’ve exited the non-agency business we understand given market conditions, why you did that. I am curious if you think that that is a permanent exit or that will be a business that you will and an opportunity that you'll revisit when markets normalize?

Tom Siering

Well, obviously,

Bill Greenberg

I will take.

Tom Siering

Good morning, Rick it's Tom. Obviously it’s something that we have deep expertise and but we'll just have to see how things unfold.

Rick Shane

Great thanks, Tom.

Tom Siering

You bet.

Operator

Our next question today comes from Stephen Laws.

Stephen Laws

Hi, good morning. Effectively no credit risk now, so I want to focus one question on prepayments into our servicing if I can. First on repayments and refinance activity really more at the higher level, how do you see the recent environment impacting processing times and repayment speeds? A lot of informing applications borrowers that would have maybe done a clean rate driven refi will now have an employment gap, unemployment possibly other things that I would have to take slow that approval pipeline.

But how do you guys see that impacting refinance activity. I know the Mortgage Bankers is pretty optimistic that the mortgage treasury spread tightens pretty quickly back to pre-COVID levels, but would love to get your thoughts. And then how to think about that from a lag on the refi index is it going to extend where that sort of 6 weeks it’s more of 8 or 10 or 12 or more so comments around that would be great?

Matt Koeppen

Sure, I'll start with that one. Stephen that’s a great and interesting question these days there is definitely a lot of uncertainty and speculation going on out there. I think one interesting thing that we've observed very recently just yesterday actually speeds were released for the April period. And broadly I think they surprise, most of the market on the high side. So the April closings would have reflected the very high - NBA refi rate and the rate environment sort of back in the end of February and early March before we really came under any stress.

And I think most market participants would have thought that there would have been a very big impact on the ability of people to sort of go through closings just about social distancing right and the country being shutdown as it was I think the speeds that came through in April showed that there probably was a pretty high pull through rates. They actually increased by about 25% which I think is what people might have thought they would have increased in typical times in normal times given the prevailing interest rates and conditions.

So I think that was, it's only one month and it was a bit surprising and we’ll have to see. This is unlike anything anyone's ever really observed. So we're monitoring that and we're obviously going to watch the data as it comes in and see where that goes.

Bill Greenberg

Yes, I'll also add a few words to that. I think there are forces on both side obviously rates are at low levels right. So that in ordinary should be creating very high refinance volumes. 47 states now permit some sort of remote modernization right. By our counter I think that we read some two-thirds of recording offices allow electronic filings today. Verification employment requirements have been relaxed across the country and so forth.

So but the world has made these adjustments to allow for the refinancing machines to continue and I think this month speed has been or collection of that said, which was a surprise to many people. That said, I think I think various Wall Street analysts are projecting speeds to slowdown as much as, as much as 15% or maybe more next month. This, we are seeing some signs and the refi index and so forth, but I think it's slowing down from a high level and from.

And so I think the speeds will probably remain more elevated than people might think given a more naïve thought about what the pandemic is doing and the social distancing measures.

Stephen Laws

Great appreciate the comments. And I guess before asking to predict the future again, I'll ask about the servicing portfolio. And just how the advance obligations are structured, but can you provide any kind of mix of your obligations. How much of it is scheduled versus actual for both interests from principal. I know it's different across Fannie and Freddie and certainly Ginnie I believe is scheduled, but I don't think you guys have any exposure there. Can you give us any breakdown there and maybe will quantify the difference. I mean how much of an average payment is principal and so if its actual principal advances instead of scheduled. How much is that a savings on the total advance obligation to you guys its 5% or 15% or what is that number on the delinquent payments?

Bill Greenberg

Okay. So the short answer to your last question is, I don't know, I don't have those numbers handy. On the breakdown of the portfolio 20% of our portfolio is Fannie Mae actual/actual I want to say around 30% is Freddie Mac and therefore scheduled actual, right. And the balance is Fannie Mae schedule/schedule. Even the actual/actual though, which has no principal and interest advancing obligation does have D&I advancing obligation.

Matt Koeppen

Yes.

Bill Greenberg

And in most yes and most ways the way the model works and I think the modeling the way the world works, is that the bigger part of your obligation anyway.

Stephen Laws

Okay. But still, I mean if I heard correctly 20% is schedule excuse me is actual/actual which means you're not advancing any schedule and unreceived interest for principal in that 20%?

Bill Greenberg

That's correct.

Stephen Laws

Great, I appreciate you clarifying that - I was looking for that information. Back to predicting the future [WF recovery or WF] event outlook is certainly concerned. People are talking about and one aspect of the 120 day rule is if you get one good payment, they go into forbearance, again the clock reset. So I don't want to ask you to run a scenario for every possible situation, but in that event where you're may be forced to cover, seven of the next 10 mortgage payments, how does that look from a liquidity standpoint.

I would imagine the government would have to step in and that type of situation with some facility because it's certainly not Two Harbors specific problem, it would be everyone. But do you have any thoughts around that with the clock resetting if you get one payment in?

Tom Siering

Not very deep ones. I would say that the advanced facilities are built to cover that, right. So I think these things that there would be scalable in order to accommodate that. But the size is large enough. As you know, especially with the P&I advancing, the principal and interest custodial accounts can be used to offset that and so look while low rates and fast prepayments for premium mortgage portfolio are generally not great. In this instance, it would go a long way towards covering those sorts of obligations. As I said the P&I part of the advancing is generally, we look at it as being the easier to accommodate because of that. And so I think all of those thoughts would be true, if that were to take place.

Bill Greenberg

I would add too, like we said earlier if scenario like that worse to happen. We of course will then have time right there. We do have, I have an unlimited amount of time, but as time passes. That allows us to sort of be reactive and work on either additional facilities for upsizing of facilities, which I think we would be able to do if we needed to in that scenario.

Stephen Laws

That's a great point because it's not a margin call one-day issue, it's something you'll see playing out over months and you'll see that as you call your delinquency numbers. So I appreciate the comments today. And thank you very much.

Bill Greenberg

Thank you.

Tom Siering

Thanks Stephen.

Operator

Our next question comes from Kenneth Lee. Please go ahead.

Kenneth Lee

Hi, thanks for taking my question. Just wondering on a broader level, how would you characterize your current appetite for making investments in over the near-term, just given the potentially attractive opportunities you see weighed against the uncertainty that's not environment? Thanks.

Tom Siering

I’m sorry, could you repeat that question, I don't think I caught it.

Kenneth Lee

Yes, certainly. Just on a broader level. Just wondering, how would you characterize your current appetite for making investments in the near-term given the potentially attractive investment opportunities you're seeing weighed against the uncertainty you're seeing around environments and relatedly how leverage and the portfolio further could evolve over the near-term?

Matt Koeppen

Yes, I'll start. This is Matt. I mean in one word, we’re quite cautious here. I think we have to get a little bit of time passage and a little bit more visibility into what our advancing obligations are going to be and see how forbearance unfolds and sort of look at its impact on all mortgage assets and we're looking forward to doing that, I think we're not quite there. We do need some passage of time.

But like I said earlier, there is indications that there is interesting opportunity out there. Once we feel like we're in a comfortable position to take advantage of things but we're still pretty cautious today.

Tom Siering

And I would add one thing that I think is sort of self-evident in the way like one signal for that would be when the forbearance upgrades start turning over like seen in other context, once you see that, then you can sort of project really what the future is going to look like and so forth and so I think that's one of the main things that we're looking for.

Kenneth Lee

Okay, very helpful. Thanks again and hope everyone stays safe.

Tom Siering

Likewise, thank you very much.

Bill Greenberg

Likewise, yes.

Operator

Our final question comes from Matthew Howlett. Please go ahead.

Matthew Howlett

Hey guys, thanks for taking my questions. Just a few quick ones. First, how are you monitoring sort of counterparty risk with the non-bank sub-servicers or the guys you buy from them. Just curious on what's it like out there?

Tom Siering

I'm sorry, from people who we’re buying from or?

Matthew Howlett

Well, kind of both, I mean mainly sub-servicers or some of the capital rules coming out, what could come out of liquidity also issues. How does that sort of not being monitored. I guess the question is, if you are there could be a need to servicing at some point?

Tom Siering

Right. So the answer is, no I mean we have three sub-servicers, as you know, all right and we've been public about who they are, it's Flagstar Bank to the Bank. All right, there is bill renewal, which is a pure subset for sure they don't own any servicing, they don’t have particularly any capital stress here and then we have Mr. Cooper. And we have ongoing diligence reviews with them and we're checking with them about these sorts of things regularly and periodically. So we don't have concerns at the moment about that.

Matthew Howlett

Okay. And so there's no need to go back up servicing or anything of that nature runs into any one of them into liquidity issues?

Tom Siering

I’m sorry, can you say it one more time, I'm sorry.

Matthew Howlett

I'm just saying back up servicing, things like that and there is no, is there anything in place to move servicing if you have to?

Tom Siering

We do not have like a hot back up in place. No, we don't have that. I mean one of the advantages, I think of our model is it's diversified nature of the thing that we have, it's spread out among different sub-servicers. So as you know, our portfolio is roughly split 40:30:30 all right to the extent that we would be able to potentially see through our regular reviews, any stress or maybe on a forward-looking basis, try to anticipate such things we can of course entrance the process to move servicing from one to the other, that we do that not regularly. But we do it. We're very experienced in that, that could be accommodated in some number of some amount of time, obviously requires coordination and approval from the GSEs. So we could do that but we do not have a hot backup in place.

Matthew Howlett

Yes, okay. Thanks and then on just from a modeling question that sort of net interest spread, did you guys get that 113. I mean there's been a lot of moving parts obviously with the sale of the Non-Agency book, repo costs coming down, how do we think about trending, how that is going to trend. How should we think about modeling that going forward?

Mary Riskey

So I can take that question, this is Mary. So I think we expect on the asset side, the yields to be in the low to mid-threes in the near-term. I would note that as we de-lever the portfolio, we correspondingly needed to reduce our net swap book at a time when three-month LIBOR was extremely elevated and stressed and long-term rates were low.

So we do expect that this will impact build in Q2. But as swap and repos reset, we expect the net yield to return to more recently observed levels.

Matthew Howlett

Got it and then there will be an impact from lower yields because the non-agency, higher yearly non-agency book is out?

Mary Riskey

Yes, that will have a slight impact.

Matthew Howlett

Got it. Great, thank you.

Operator

Ladies and gentlemen, that concludes today's question-and-answer session. I would like to turn the call back over to Margaret Karr for any additional or closing remarks.

Margaret Karr

Thank you, Claire. And thank you all for joining our conference call today. We look forward to speaking with you again soon. Have a wonderful day.

Operator

Ladies and gentlemen, that will conclude today's conference call. Thank you for your participation.