7 Reasons to Sell Two Harbors Investment Corp.

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7 Reasons to Sell Two Harbors Investment Corp.

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7Plain-vanilla risk

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Two Harbors’ investment strategy relies on buying very unique assets. In particular, these assets help to keep prepayment rates low and cash flows consistent. However, if the company continues to grow its portfolio there may not be enough supply of these assets, forcing Two Harbors to make more “plain-vanilla” investments, and losing some of what differentiates the business.

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6Limited competitive advantage

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There is nothing proprietary about mortgage-backed securities, and little stopping competitors from targeting similar assets. Increases in competition would have a negative impact on prices and valuations. Ultimately, this would make returns less attractive.

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5Tighter spreads

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While Two Harbors has less exposure to interest rates than its peers, the company isn’t immune to changes in rates impacting its returns. Most importantly, since 2009, the difference between short and longer-term interest rates, or spreads, have tightened. If this trend continues it would have a negative impact on the company’s profitability.

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4Winding down GSEs

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Following the financial crisis, and the enormous bailout of Fannie Mae and Freddie Mac, several bills have been introduced to reform the mortgage market. If government sponsored entities, or GSEs, are reformed or eliminated it could have a significant impact on supply of guaranteed-against-default mortgage products, which would increase competition, and raise prices on Two Harbors target assets.

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3FHLB financing

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Two Harbors subsidiary, TH Insurance Holdings, was given membership to the Federal Home Loan Bank (FHLB) in December 2013. This comes with two big perks, stable and very low borrowing costs. However, in May, the Director of the Federal Housing Finance Agency, Mel Watt, suggested he has concerns about this type of borrowing. Two Harbors noted in June, “FHLB financing [will be] important over the long-term.” If Two Harbors is denied access in the future, it would increase the borrowing costs, and concentrate its funding options.

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2Holding risky assets

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As of last quarter Two Harbors was holding more than $2 billion in subprime mortgages. Despite these assets not having a guarantee against default, having a high rate of default, and being backed by low credit score borrowers, if they’re price correctly they aren’t necessarily more risky. However, if they’re priced wrong, as they were before the financial crisis, it would have a damaging impact on Two Harbors’ portfolio.

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1Lack of experience

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Recently, Two Harbors has been aggressively pursuing mortgage servicing rights, or MSRs. These assets have gained considerable attention due to their durability in a rising interest rate environment. However, MSRs aren’t without risks, and Two Harbors’ management has limited experience investing in these assets. While the company has added new and more experienced personnel, its far from certain they will be successful competing in this market.

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