Two Harbors Investment Corp. (TWO) CEO Bill Greenberg on Q1 2022 Results - Earnings Call Transcript

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Two Harbors Investment Corp. (NYSE:TWO) Q1 2022 Results Conference Call May 5, 2022 9:00 AM ET

Company Participants

Paulina Sims - Head, IR

Bill Greenberg - President, Chief Executive Officer and Chief Investment Officer

Mary Riskey - Chief Financial Officer

Conference Call Participants

Rick Shane - JPMorgan

Kenneth Lee - RBC Capital Markets

Trevor Cranston - JMP Securities

Eric Hagen - BTIG

Bose George - KBW

Doug Harter - Credit Suisse

Arren Cyganovich - Citi

Operator

Greetings, and welcome to the Two Harbors Investment Corp., First Quarter 2022 Financial Results Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this call is being recorded.

I would now like to turn the conference over to your host, Paulina Sims, Head of Investor Relations for Two Harbors Investment Corp. Thank you. You may begin.

Paulina Sims

Good morning, everyone, and welcome to our call to discuss Two Harbors First Quarter 2022 Financial Results. With me on the call this morning are Bill Greenberg, our President, Chief Executive Officer and Chief Investment Officer; and Mary Riskey, our Chief Financial Officer.

The earnings press release and presentation associated with today's call have been filed with the SEC and are available on the SEC's website as well as the Investor Relations page of our website at harbors investment.com. In our earnings release and presentation, we have provided a reconciliation of GAAP to non-GAAP financial measures, and we urge you to review this information in conjunction with today's call.

As a reminder, our comments today will include forward-looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These are described on Page 2 of the presentation and in our Form 10-K and subsequent reports filed with the SEC. Except as may be required by law, Two Harbors does not update forward-looking statements and disclaims any obligation to do so.

I will now turn the call over to Bill.

Bill Greenberg

Thank you, Paulina. Good morning, everyone, and welcome to our first quarter earnings call. Please turn to Slide 3. At quarter end, book value was $5.53 per share, representing a negative 2.9% total economic quarterly return. The speed and magnitude with which the bond market repriced this quarter was historic by many measures as the market rapidly adjusted its expectations that the Federal Reserve will move aggressively to contain rising inflation.

The steps taken last quarter to meaningfully reduce leverage and the significant reallocation of capital from MBS to MSR helped to insulate our portfolio from the large widening in MBS spreads. Although the portfolio was not completely immunized from the move in spreads, this quarter's performance demonstrates the benefits of the paired agency plus MSR construction as well as active management of the portfolio.

Please turn to Slide 4. During the quarter, inflation continued to trend higher as the Warren Ukraine and Russian sanctions contributed to the upward pressure. With CPI rising by 8.5% year-over-year, its fastest acceleration since 1981, the Fed vowed to do whatever it takes to combat increasing prices and re-anchor inflation expectations. The market received this message clearly and swiftly incorporated 9 to 10 rate hikes through the end of 2022 after pricing in only three hikes for the same period at the beginning of the quarter.

With only five Fed meetings left in 2022 after yesterday's meeting, the market is pricing in at least several more 50 basis point increases, which hasn't been done in more than 20 years. Further, as seen in figure 1, the market is clearly expecting short-term rates to rise above the so-called neutral rates before coming back down, implying an interest rate cut as early as the end of 2023.

To put the magnitude of this quarter's rate movements into perspective, we showed the distribution by size of quarterly changes in rates since 1989 in figure 2. The repricing across the rates complex was historic with current coupon and two-year treasury rates rising by 142 and 160 basis points, respectively, which were the largest quarterly increases in over 30 years, and are shown by the outlined observation on the far right of the histograms.

The 10-year treasury rate rose a more modest 83 basis points, but which was still in the 96th percentile of changes over that period. In addition, and equally important, the spread between the 2-year and 10-year treasury rates decreased by a dramatic 77 basis points, causing the treasury curve to briefly inverse. Indeed, the forward treasury rate curve is showing Two's 10s inversion from six months to two years forward.

To the extent that an inverted curve has sometimes been a signal for recession, this is something we will continue to monitor. The sharp rise in the current coupon rate translated nearly one for one in primary mortgage rates as the Freddie Mac survey rate rose from 3.11% to 4.67% during the quarter, as shown in figure 3. Mortgage rates have continued to rise into the second quarter and are now above 5%. With mortgage rates at their highest levels in more than a decade, the percentage of mortgages with more than 50 basis points of refinance incentive is now essentially zero.

Please turn to Slide 5. In figure 1, we've updated a chart that we have been showing since the beginning of last year, to make the point that the mortgage spreads prevailing in 2021 were too tight and were expected to widen. Almost as soon as the calendar turned to the new year, mortgage spreads came under pressure and began to rise significantly.

During the quarter, current coupon option-adjusted spreads widened out by 33 basis points ending right around long-term average at 27 basis points. Subsequent to quarter end, spreads widened even further to around 38 basis points, which is very near the bottom of the blue band, which indicates the 90th percentile of spread widening seen during the last period of quantitative tightening in 2018.

Although, spreads are now at or wider than historical norms, this market environment is far from normal, with the large increases in primary mortgage rates, the mortgage universe has evolved to an almost entirely discount environment and prepayment speeds will be dominated by housing turnover. Historically, turnover speeds have typically ranged from 5 CPR to 10 CPR, and we expect prepayment rates to decline to speeds within that range in a very short order.

Single-digit speeds will be especially beneficial to holders of interest-only securities, such as MSR who will enjoy significantly higher carry than that experienced in the last several quarters. With rates haven't risen so much and so fast, the duration of the mortgage universe is nearly fully extended while convexity risk is at all-time low levels as seen in figure too. For those market participants who are holding low coupon mortgages, the less negative convexity makes for easier hedging, but comes at a cost of long spread duration and high spread exposure.

As we will discuss later, we have actively managed our portfolio and our exposure is still mostly in the near current coupons. Low coupon mortgages the ones that the Fed was recently buying are still not very interesting investments, but we think that current coupon mortgages are starting to look attractive from a fundamental valuation perspective. However, the technical backdrop is not very friendly.

During the quarter, the Fed announced that it would stop buying RMBS and treasuries and that it would impose a $35 billion per month cap on declines in its RMBS portfolio. At the current mortgage rates, the projected prepayment speed on its RMBS holdings could drop below 10 CPR. In that event, the organic portfolio runoff will not be enough to hit the cap and so the Fed is not expected to be reinvesting at all.

Furthermore Chairman Powell and other Fed speakers have raised the possibility of asset sales to more quickly reduce the Fed's balance sheet and transform it back into a portfolio of treasury-only holdings.

Putting all this together, in figure 3, we see the potential balance sheet reduction that might need to be absorbed by the private market over the next three years. Light blue bars show the organic runoff of the Fed's existing portfolio, while the dark blue bars assume asset sales sufficient to bring the monthly balance sheet reduction to the $35 billion cap beginning in mid-2023.

It's worth noting that while some analysts think that portfolio sales could occur even sooner than that. Others don't think sales will occur at all. The gray line shows the cumulative amount that the private market might have to absorb through the end of 2024, which is almost an additional $1 trillion of RMBS, assuming this level of asset sales above and beyond the usual organic supply of mortgages that occurs during normal times.

Even if the Fed doesn't sell any RMBS, we still expect an additional $700 billion of supply just due to the runoff. We are at the very beginning of a transition in which the 30% of mortgages that had been bought by a price-agnostic Fed now needs to find a home with price-sensitive investors. While it is true that origination volumes are going to be lower than that in the past, someone is still going to have to buy all of those mortgages.

So while the fundamentals are starting to look attractive as a result of the significant widening seen in the quarter, we believe the Fed's quantitative tightening and continued near-term interest rate volatility warrants a cautious approach to increasing leverage. However, given the fast moves and titanic shifts in the market, we expect there will be ample opportunities in the near and intermediate term to actively allocate capital to take advantage of market dislocations and fundamentally attractive valuations.

Now, I will turn it over to Mary to discuss our financial results in more detail.

Mary Riskey

Thank you, Bill, and good morning, everyone. Please turn to Slide 6. For the first quarter, the Company reported a comprehensive loss of $60.3 million, representing an annualized return on average common equity of negative 12%. Our book value was $5.53 per share compared to $5.87 at December 31, including the $0.17 common dividend results in a quarterly economic return of negative 2.9%.

Results were mainly driven by the substantial spread widening in RMBS and higher hedging costs, which were largely offset by spread tightening in MSR. Furthermore, our decision to reduce our RMBS position in the fourth quarter, and keep leverage low through February, also muted the impact of the spread widening in the quarter.

Moving on to Slide 7, earnings available for distribution was $0.18 per share compared to $0.22 for the fourth quarter. Interest income, which grew by $12 million, benefited from lower amortization as prepayment speeds slowed as well as incremental investment in Agency RMBS. Interest expense rose by $2 million to $22 million due to a combination of rate increases and higher average RMBS and MSR borrowing balances.

This was partially offset by reduction from the January maturity of our 2022 convertible senior notes, which should result in annual savings of approximately $9 million. TBA dollar roll income decreased to $22 million on a lower average notional position during the quarter. U.S. Treasury futures income was also lower as we moved to a net short position.

Turning to MSR. Servicing income grew by more than $11 million to almost $137 million on higher UPB from the settlement of bulk purchases in the quarter, while servicing expense increased by $2.5 million. Lastly, operating expenses rose to $13.9 million, a level which is more in line with our expected run rate. The increase reflects the impact of favorable compensation accrual adjustments in the prior quarter.

Turning to the portfolio yield on Page 8. Our realized net spread in the quarter was 2.89% compared to 2.99% in the prior quarter. Portfolio yield increased 18 basis points to 3.90%. This was more than offset by the increase in the cost of funds from the addition of payer swaps and, to a lesser degree, higher rates. Net spread as of March 31 is estimated at 2.83%.

Please turn to Slide 9. Funding in the repo market remains liquid and well supported. Funding costs for Agency RMBS continued to rise on an absolute basis. However, as shown in the chart in the upper right, the spread to sulfur remains low, currently right around 10 to 12 basis points for both three-month and six-month maturities. We maintained access to diverse funding sources for MSR and our unfunded and committed MSR asset financing capacity stood at $179 million at quarter end with an additional $470 million in available uncommitted capacity.

Please turn to Slide 10. As I mentioned earlier, we significantly reduced our overall mortgage exposure in December in anticipation of more hawkish positioning by the Fed, which lowered our portfolio leverage to 4.7x. During the first quarter, our portfolio leverage rose modestly to 5.1x as we settled on $37 billion UPB of mortgage servicing rights and in March began to cautiously add mortgage exposure at wider spreads. Average economic debt to equity in the first quarter was 4.7x compared to the fourth quarter average of 5.1x.

I will now turn the call back to Bill for our portfolio update.

Bill Greenberg

Thank you, Mary. With origination no longer adding supply and lower coupons and much of the past production locked up in the Fed and bank balance sheets, lower coupon spreads stayed tight relative to higher coupons. To take advantage of the additional spread offered by higher coupon specified pools, we sold our 2.5% bank service collateral and added loan balance and geography stories in 3% through 3.5% coupons.

We also adjusted our TBA positions up in coupon as current coupon rates increased from around 2.5% to 4%. Besides improving the hedging correlation to our MSR, moving up in coupon in TBA also allowed us to take advantage of the very strong dollar rolls and higher coupons as roll specialists and lower coupons has largely disappeared. In particular, we added $4.7 billion of 3.5% and 4% TBA while selling $4.3 billion of 2% through 3% TBA.

Please turn to Slide 11. Our specified pool position, as seen in figure 1, remains mostly allocated to high-quality loan balance, geography and investor collateral in 3% and higher coupons. With the main story of the quarter is late in figure 2, was a massive underperformance of specified pools and TBA contracts all across the coupon stack.

Aside from 5% specified pools, mortgages underperformed their interest rate hedges by 1.25% to 2.5% and on an asset basis before applying any leverage. 3% and 3.5% specified pools underperformed TBA, as they have longer cash flows and longer spread duration by 4%, 4.5% and 5% specified outperformed TBA, as the TBA deliverable worsened on a relative basis in those coupons.

With the sharp selloff in rates and mortgage spreads, mortgage rates spiked higher and prepayment speeds dropped precipitously as shown in figure 3. Our specified pool speeds dropped 38% during the quarter, from 27.7 CPR to 17.3 CPR. We expect speeds to drop a similar amount or more in the second quarter on their way to their terminal turnover levels of between 5 CPR and 10 CPR, though slightly premium dollar price 4.5s and 5s might flow out somewhere between 15 CPR and 20 CPR.

Please turn to Slide 12. Activity in the MSR market continues to be very robust with approximately $200 billion of UPB or a typical year's worth of volume traded through April. Sellers have been the regular cast of originators and servicers and buyers have been the typical mix of large banks, investment funds and other originators and servicers and REITs like us.

In figure 1, we show some of the characteristics of our MSR portfolio. Our UPB grew to almost $233 billion. Our weighted average coupon continued to decline to 3.2%, and our 60-day delinquency rate continued to fall to its pre-COVID levels, ending the quarter at 1.1%. Our MSR price multiple has climbed to 5.1x in conjunction with the higher interest rates and mortgage spread widening observed in the quarter.

In figure 2, we show the trend of our settled UPB for our flow and bulk channels over the last five quarters. We are buying bulk MSR opportunistically and settled on over $37 billion UPB during the quarter. Flow and recapture volumes totaled almost $8 billion UPB and are expected to decline further as refinancing activity continues to slow.

In figure 3, we compare our servicing prepayment speeds versus TBA. Overall, prepay speeds on our MSR portfolio declined by 36% from 22.1% to 14.2 CPR. Similar or greater declines are expected in Q2.

Please turn to Slide 13. As we have discussed previously, the MSR asset acts in many ways like a short position in RMBS as shown by the gray bars on the top left chart. The blue bars represent RMBS that hedge MSR and the amount is chosen to be equal and offsetting by construction. As you can see, the selloff in the current coupon has moved the effective short RMBS position from 2.5s all the way to 4s, an unprecedented large change for a single quarter.

After allocating the RMBS positions necessary to hedge the MSR, we are left with additional RMBS that we hedge with rates as seen in the middle chart. With most of the 4% specified pools in TBA allocated to hedge the MSR that net position in that coupon is slightly negative, with small long positions elsewhere on the stack. This 4% and higher coupon pools have not been made for some time, and liquidity in the TBA needs time to catch up to production, our largest position at quarter end was in 3.5 even though that was below par.

In the second row, we show book value exposure to changes in current coupon mortgage spread. The bottom left graph shows the contributions to book value from changes from the MSR and its hedges separately. Together, they have almost zero mortgage spread exposure. The chart on the bottom right shows a total of minus 2.8% exposure or a 25 basis point widening in the current coupon mortgage spread.

Although leverage has not materially increased from last quarter, our sensitivity to a widening in MBS has increased by about 2.5%. This is mainly a result of two factors. First, since the weighted average note rate of our MSR portfolio is 3.2%, those borrowers have become somewhat more insensitive to changes in the mortgage rate. Higher rates won't make them prepay more slowly, and it would take more than a few basis points of lower rates to make them prepay more quickly.

And therefore, the MSR asset hedges fewer RMBS than it does at lower rates, even after the large additions that occurred this quarter. Indeed, at quarter end, the MSR portfolio had an effective risk position of short approximately $5.5 billion of mortgages as of the end of Q4 that number was roughly $6.6 billion. Secondly, higher rates also increased the spread duration of our unallocated RMBS even as we actively manage the portfolio by selling low coupons and buying higher coupons.

So while our active portfolio management reduced the spread exposure somewhat, the net result was still an increase in that part of the portfolio. We view this net exposure as still low. As we add more current coupon exposure in the MSR asset, the amount of effective short position can increase again. However, if mortgages beginning to look attractive, this exposure is more likely to go up rather than down as we increase leverage and allocate into RMBS.

Please turn to Slide 14, where we show our interest rate and curve exposures. Interest rate sensitivity of the portfolio components changed drastically from the prior quarter. With the MSR almost fully extended, it has very little duration. A 25 basis point parallel shock up has an effect of plus 2.9% on book value compared to plus 5.8% in the prior quarter. The MBS position, on the other hand, had its sensitivity increased to minus 6.6%, up from minus 4.5%. The net result is that our hedge position of swaps, futures and options moved from minus 1.9%, all the way to a positive 3.6%.

As always, we carefully monitor and hedge our exposure to the entire yield curve, and this has been especially important recently as the yield curve flattened 77 basis points from 2 to 10 in this quarter alone. In today's environment, the Fed expectations changing almost daily, we are particularly focused on the very front end of the curve.

Figure 2 we show that our sensitivity to changes in short-term rates is very low with only a minus 0.2% impact to book value and an up 25 basis point bare flattening shock. Taken together, these three charts demonstrate our commitment to hedging the full yield curve exposure and the active management required to maintain a duration neutral portfolio.

Finally, I'd like to discuss our outlook for Two Harbors and our return expectations for new investments on Slide 15. The spread widening during the quarter has moved static gross returns for our assets to attractive levels for both MBS hedge with rates and the paired strategy. Levered pools hedge with rates now return low to mid-teens up from mid- to high single digits during the prior quarter.

TBA is hedged with rates. And here, we are showing current coupon TBA continued to benefit from real specialists and have static returns in the mid-teens. The higher end of the range assumes rural specialists last forever while the lower end of the range assumes it dissipates in 12 months. However, it should be noted that it is a changing deliverable characteristics in the TBA that are causing roles to look optically rich are they pricing the worst collateral for the future.

We expect that once origination in these coupons catch up to demand that roll specialness will also begin to decline. Static returns on the paired strategy remain attractive. While MSR spreads tightened, the wider RMBS spread dominated and resulted in increasing returns of the parent strategies. We see paired returns in the low to mid-teens in the static scenario.

The longer-term outlook for Two Harbors has decidedly improved as a result of the market movements during the quarter. The rise in mortgage rates and the resulting decrease in prepayment speeds of actual unexpected should be an ideal environment for the MSR, while the widening of mortgage spreads has materially improved the return profile of MBS. Although near-term volatility in interest rates is expected and could weigh on short-term returns, both the MSR and MBS should benefit when volatility eventually subsides.

Thank you very much for joining us today. And we'll now be happy to take any questions you might have.

Question-and-Answer Session

Operator

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Rick Shane with JPMorgan. Please proceed with your question.

Rick Shane

Look, the MSR strategy is really being validated by what we've seen over the last quarter and, frankly, over the last several quarters. But I am curious when you think about the strategy long term, I think the one consideration is that you are hedging a highly liquid product with a much less liquid product, and as we sort of move through the cycle, can you talk about how you manage that balance?

Bill Greenberg

Sure, Rick. Thanks for the question. We consider the liquidity profile of the portfolio in the Company across various different scenarios and cycles. And when we think about how much excess liquidity we need to protect us in different rate movements and spread movements. That is built into our portfolio management, right, and our strategy and our expected returns and all of that. And I think if ever there was a test of such a thing this last quarter with its very large rate movements of 150 basis points or more shows that we manage that very well and incorporate into our strategy.

Rick Shane

Got it. And as -- and again, we're obviously very early in the tightening cycle. But as we think about again, way, way down the road, how things will evolve? Is the strategy that because you will have ultimately less liquidity on the MSR portfolio in a time when that will become a headwind. Is the strategy just ultimately to use the TBA market and the MBS market to lever up and basically use that as your flex and keep the MSR portfolio relatively static inside?

Bill Greenberg

Well, I mean you're right, there's no question RMBS and TBAs are more liquid than MSR, but MSRs are not completely illiquid, right? There are trades that take place, right, and people do move around portfolios, right? And so when we think about our liquidity needs in short time periods, yes, it is a liquid part of our portfolio that we're primarily relying on, right? But what you think about longer time scales and how portfolios evolve through time, right? I think it's fair to also consider that there can be movements in the MSR portfolio, if necessary or desired from a portfolio strategy perspective.

Operator

Thank you. Our next question comes from the line Kenneth Lee with RBC Capital Markets. Please proceed with your question.

Kenneth Lee

You talked about the spec pools underperforming relative to TBAs in the quarter. Just wondering if you could just share with us what's your expectations going forward? Do you expect that to reverse?

Bill Greenberg

Thanks, Ken, very much. I think it depends a little bit on the coupons and the stories. I mean, on Page 11 of our presentation, we showed this a little bit where the specified pools and 2.5 through 3.5 underperformed TBAs and 4s and above outperformed TBAs, and I tried to make a comment about that in my prepared remarks, but for the lower coupons, it was a longer spread duration, mostly that was mostly the cause of that or the catalyst for that and then the higher coupons, you have this effect of that's where the production is going to occur and the deliverables are going to be changing there, making the TBA worse than specified pools.

So it depends a little bit. We're starting to find attractive valuations in the -- what I used to call high coupons, but maybe now I'll call current coupons in terms of specified pools where the production is. And so while there is continued roll specialness in those coupons, 4.5s where we have some TBA exposure, we have been increasing our allocation to specified pools there. We think that is attractive. And as production catches up with the rate market and you start seeing those new bonds being created, the role special high coupons, I do expect to dissipate and diminish. And when that happens, I think as that happens, I think you can expect to see our allocation to specified pools probably increase relative to TBA over time.

Kenneth Lee

Got you. Very helpful there. And for my follow-up, I wonder if you could just share your thoughts on where spreads and now and how you think about the potential for any kind of further widening driven by the RMBS runoff as the Feds starts their actions?

Bill Greenberg

Thanks, Ken. Well, yes, that's the key question. As I said in my prepared remarks, I think -- and the chart that we showed on Slide 4 -- no, Slide 5 where OASs are back to long-term averages, maybe the cheap side of fair. But interest rate volatility has been high and so static spreads, these spreads are certainly in a quite attractive range. There is concern, both, as I said, from interest rate volatility as well as the runoff from the Fed as well as potential Fed sales that could make them widen somewhat.

And we'll have to see how those dynamics unfold a little bit. I would say the risk to wider spreads is probably greater than the risk to tier spreads. But they are looking attractive on a fundamental basis. And we -- as we said during the prepared remarks, we've increased our leverage somewhat from quarter end, and we've done a little bit more since quarter end. Our current leverage is probably now in the 5-4 area, right, to express our interest in these attractive valuations. But we want to be cautious given the supply/demand dynamics that you just said. And so we're trying to balance those two effects.

Operator

Thank you. Our next question comes from the line of Trevor Cranston with JMP Securities. Please proceed with your question.

Trevor Cranston

Bill, you mentioned the sort of marginal increase in net spread exposure because of the low coupon of the MSR relative to kind of where current mortgage rates are. Can you talk about sort of how quickly the hedge effectiveness of the MSR would be expected to change if rates continue to move up? And if there's a level of rates at which you'd actually expect the duration of the MSR asset to turn positive and sort of how you'd manage the overall hedging of the portfolio through that?

Bill Greenberg

Yes, sure. Thanks, Trevor. Yes. So as you know, in April alone or since quarter end, rates are another especially the long end run are 65 basis points higher. And with the gross coupon of our servicing remaining fixed at 3.2%, the hedging effectiveness or the duration of the MSR asset has become even less negative, right?

Rates have to go up an awful lot for them to be positive probably another couple of hundred, but the duration of the MSR asset is pretty low here. And in order to get that back up, some amount of new mortgage servicing that the money needs to be created and the portfolio need to be recycled a little bit in order for that to happen. So, that's something that's going to happen organically over time and it's just part of the life cycle of a servicing portfolio.

Trevor Cranston

Okay. Sure. That makes sense. And in terms of supply of MSR, you guys bought some bulk this quarter. Can you talk about what you expect to see on the bulk side of the market going forward? And if the bulk stuff coming out tends towards the lower coupon, how much appetite you guys would have to add more of that to the portfolio?

Bill Greenberg

Yes. So, as we said in the prepared remarks, the MSR market has been very active, very robust. We've seen more than a full year of typical bulk activity already in 2022. This rate movement has been so fast that there hasn't really been time to adjust. So, all of the portfolios that we saw and that we are continuing to see in the market are generally of the lower WACC variety, right. And as you pointed out, our appetite for that stuff is probably less than it was given that we're probably more on the lookout for things that are going to hedge our portfolio more. And so, we're going to be focused more on trying to find the new anti-money stuff rather than focused on the lower coupon high multiple, high priced stuff.

Trevor Cranston

Okay. Got it. And then last thing, do you guys have an estimate as to how much book values changed since the end of the quarter?

Bill Greenberg

Yes. As I said, it's been a very, very volatile April into May. Rates are up another 65 basis points. Since then, mortgage spreads have continued to widen especially down in the low coupon. But with that said and the way that we've been able to position our portfolio. And we've been relentless in keeping our mortgage exposure with print coupons. We've been able to maintain a positive 0.5% book value change since the end of the quarter.

Operator

Thank you. Our next question comes from the line of Eric Hagen with BTIG. Please proceed with your question.

Eric Hagen

I think I have three questions. First is just how do you see the prepayment profile for spec pools developing here? Like how sensitive do you think some of the low balance borrowers are to home price appreciation and cash out refi. I'm not sure I've heard anyone ask you guys your perspective on how much value is left for upside in the MSR. I think it would be good to get your thoughts there. And maybe just an approximate DV01 in dollar terms for the MSR, if you have that. And then in the past, the Company has been short some TBAs within the coupon stack. I'm curious how what the value is, if any, in running that strategy now?

Bill Greenberg

Sure. So your first question was on what, I think, prepay speeds or how I think HPA or think that will affect a little on balance? So that's -- is that right?

Eric Hagen

Right.

Bill Greenberg

The conventional wisdom, I think, of low loan balance pools is that not only do they provide refi protection, but they also generally have higher turnover speeds, discount speeds from lower lock-in. I think that's probably borne out in the data. We are, to a very large degree, in unchartered waters here. I don't think that we've ever had an environment where we've had so many mortgages so deep out of the money to be able to see how these things will behave. And of course, discount environments in general, let alone on a sort of deep as this one are few and far between. And so -- and every one of economic environment is different and so forth.

HPA has obviously been very high. That has been the cause behind some pretty fast cash out refinance activity in the last year and two years, but we have a significant number of mortgages today that are 200 basis points out of the money right? And to be -- if people want to take cash out, at that stage, that's if you about taking 10% of your mortgage balance 20% of your mortgage balance out, the implied rate on that marginal amount is very, very high. And if the market starts to start producing some HELOCs or some second liens that would almost surely be a more attractive option for borrowers to do.

So I don't know how big that effect will be. My intuition is that with the Fed raising rates and the overall intent to cool things down a little bit that the cash at activity will generally slow and I think that turnover speed, as I said in my prepared remarks, which have historically ranged between 5 CPR and 10 CPR. I think many people are thinking that they're probably at the higher end of the range now because of the cash out activity that we said. I actually think have a possibility to surprise to the slow side, but we'll see how that unfolds, of course. Your second question was about -- remind me, I'm sorry.

Eric Hagen

Yes, sure. It was about the value upside left in the MSR.

Bill Greenberg

In MSR, sure. So again, you can look back at historical periods to see how high servicing prices have been. The floating-rate components are one value that sort of increase quickly when rates rise, especially short-term rates rise and in the steep curve, especially, if you look back to other periods of higher rates, it's easy to see periods where the floating rate components alone can add a full multiple or more to the value of servicing.

The highest I've seen servicing malts be in the world, and I've been doing this since the late '90s is probably mid-6s is about as high as I've ever seen them go depending on that the curve level of short-term rates, amount of float, servicing costs all of those things. And those days, people didn't even build in -- never mind about that. I was going to say people didn't even build and recapture, but in the discount environment with high multiple, that's not going to be a very big effect.

And your last comment is, what is our duration of our servicing at the moment? It's pretty low. I would say that for the entire servicing portfolio right now for a 100 basis point move, right. On a model basis, of course, it depends on all market environments and shape of curve and all of those things, right, is probably around $50 million for parallel shift up 100 basis points -- and just the MSR assets to be clear.

Eric Hagen

Yes, that's very helpful. And then in the past, you guys have done the coupon swap strategy a little bit with on the coupon stack. Can you talk about the attractiveness there?

Kenneth Lee

Yes. Right now, we have -- I don't know what we had at the end of the quarter, but certainly had no net short positions as you see from the chart on Page 13, I think, right? There was no net positions. We've been diligent and quick in moving our exposure up in coupon. So, we don't have -- as you see on the Page 13, we have very little exposure below 3.5% at all, right? And we have no exposure in short positions in any TBAs in low coupons in particular.

Obviously, the market changes all the time, should the valuations warrant such a thing, we could consider that. But we're not particularly taking a strong view about the price or the valuations of low coupons at the moment relative to the turnover speeds that are priced into the market there. So, we're happy being flat down there at the moment. And our exposure is up in the current coupons.

Operator

Thank you. Our next question comes from the line of Bose George with KBW. Please proceed with your question.

Bose George

Actually, first, in that Slide 10, where you give the return expectations, is that based on your current leverage?

Bill Greenberg

Slide 15, you mean?

Bose George

Sorry 15, sorry, yes.

Bill Greenberg

No, those would be based on more market standard leverage numbers.

Rick Shane

And so your -- you said you were at 5-4, what would be sort of a market at more normal leverage or a couple of times higher or...?

Bill Greenberg

Yes. I think that -- we've said in the past that we can operate with leverages in the 8 to 9x. That depends, of course, on the amount of servicing that we have in the portfolio. We have more servicing today than we did when we said that number in the past. So a natural resting place for us is probably in the seven handle, eight handle areas.

Bose George

Okay. Great. That's helpful. And then can you just talk about your expectation for specialists into the back half of the year?

Bill Greenberg

Sure. So as I said in the prepared remarks, rule specialists on the formerly Fed coupons is all but disappeared, right? We're seeing reasonable rule specialist babies call it, 50 basis points in the production coupon here. In the higher coupons, 4.5s and 5s, it's even more pronounced, more than 100 basis points of specialists. But that is, as I've said sometimes, is optical, by that, I mean that the role mechanics back into an implied financing spread by looking at the difference between the price in the front month and the price in the back month.

And today, again, because the rate market has moved so far so fast and the production mortgage market hasn't really had time to catch up. The collateral characteristics of bonds in the front month are pretty different than the collateral characteristics for bonds in the back months, right? And so there's really two different bonds and so it's a little bit unfair to imply a financing spread from those two different bonds.

Nevertheless, you can do that, and that's in there, and those are big numbers here. But as the market catches up as the production in the current coupons and the slight premiums begins to normalize in the back half of this year. I also expect that to diminish. I would expect by the end of the year, things should be pretty normal.

Operator

Thank you. [Operator Instructions] Our next question comes from the line of Doug Harter with Credit Suisse. Please proceed with your question.

Doug Harter

Just another question on leverage. Can you just talk about how you think about -- or remind us how you think about leverage on agency paired with MSR versus agent paired with rates?

Bill Greenberg

Sure. Yes. Thanks for bringing that up, Doug. So in a portfolio without MSR, there's really a very direct and straight line correspondence between leverage and risk and drawdown risk, how much money can you lose, right, for spread widening. With the portfolio with MSR, as current coupon mortgage spreads widen, the MSR will benefit from that, will have a natural increase in price from that. And so, we always look at leverage through the lens of what that drawdown risk number is, right? I mean we obviously want to be respectful of nominal leverage numbers.

But another important number for us is what you see on the bottom right side of Page 13, which is, what is the portfolio exposure for a 25 basis point widening in mortgage spreads? And that number, which is -- which currently at the end of the quarter was minus 2.8%, right, is a lower number than you would get for a portfolio without MSR for the same leverage, right? And so, we look at both of those things, obviously, and account for both those things when we say when we determine how much risk we're comfortable with and what we think the appropriate amount of our portfolio is.

Operator

Thank you. Our next question comes from the line of Arren Cyganovich with Citi. Please proced with your question.

Arren Cyganovich

I was interested in kind of your return profile Obviously, your Slide 15 shows a much better environment for investing, but you talked about being still a little bit cautious with the potential Fed sales coming on board. When do you think you might feel comfortable really kind of expanding your leverage? Is it just kind of seeing how the initial roll-off does? Or are you waiting until they actually start to sell their portfolio?

Bill Greenberg

It's good question. Look, that's a hard one, right? It's obviously very market dependent and will depend exactly on how things unfold. As I said before, the things that are giving us pause here are potential Fed sales potential appetite of the private market in general of who's going to buy all the bonds that are going to be running off and interest rate volatility, right?

I think we need to see some progress some clarity on at least some of that before we start to meaningfully be adding. But as I said, from a valuation perspective, fundamentally, they actually look pretty good. I think Chairman Powell's comments yesterday took some of the tail risks off the table a little bit, right?

Pre-affirm commitment to not go 75 to not keep hiking until something breaks to be looking at the trends of the economy and watching it as the hiking process is underway. So I think those were pretty friendly comments, which have been interpreted as such by the market in general. So that was helpful. But I think I'd like to see just a little bit more progress in at least some of those three dimensions.

Arren Cyganovich

Okay. And it did look like you took up the portfolio a little bit. Do you expect that your ROE might expand a little bit from here just from the portfolio changes that you've made thus far?

Bill Greenberg

Well, I mean, given the static expected returns on Page 15, right, increasing leverage will increase the carry of the portfolio and can increase expected returns, right? But of course, red movements do and will always dominate those sorts of things. So it's, of course, impossible to predict what the returns will be. But certainly on a static basis, increasing leverage, we'll do that.

Arren Cyganovich

Okay. And then just lastly, I think Mary had referenced that repo prices were rising a little bit, but I'm assuming that takes that into account in Slide 15. So, there is the financing readily available to create the types of returns that you're highlighting?

Mary Riskey

Yes. So one thing I'll say is, rising financing costs in and of themselves don't particularly change returns, right? Because on the fixed rate mortgage side, we are hedging our interest rate risk, which some people like to explicitly say that, that hedge has the funding, right? You pay fixed on swaps, you pay fixed up right at some fixed rate and you receive some floating rate, some SOFR rate or OS rate that generally offsets the increase in funding that you would have right, from rising Fed rates rising, repo rates and so forth. In you said exactly.

On the MSR side, the floating rate components that we generally receive, right, the float on taxes, insurance on principal interest. This is a little less intuitive to understand, but nevertheless, it's true also offsets the increase in funding on the structure rates from our MSR facilities. And so in and of themselves rising short-term rates, rising funding rates don't change the economics of our portfolio very much. In fact, they increase it, right, because there's the equity piece and all these things that matters.

The thing that matters most is the spread to a risk-free rate that you would get on a fixed rate swap or something like that of SOFR or OS or something like that relative to repo rates and relative swaps. And so far, we have seen repo rates being very stable as a spread to say, SOFR. That's a chart that we have in our portfolio on Page 9, right? And we've seen that spread in both three-month and six-month tenors to be stable at right around 10 basis points for quite a long time.

Operator

Thank you. Ladies And gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Greenberg for any final comments.

Bill Greenberg

I just want to thank you, everyone, for joining us very much today. And as always, thank you for your interest in Two Harbors.

Operator

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.

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