TWO Q3 Deep Dive: Litigation Settlement Drives Portfolio Adjustments, Subservicing Business Expands

Mortgage REIT Two Harbors Investment (NYSE:TWO) missed Wall Street’s revenue expectations in Q3 CY2025, but sales rose 147% year on year to $96.47 million. Its non-GAAP profit of $0.36 per share was in line with analysts’ consensus estimates.

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StockStory’s Take

Two Harbors Investment’s third quarter was marked by a significant negative reaction from the market, driven by a miss on revenue expectations and heightened expenses from a major litigation settlement. Management attributed the underperformance to the $375 million settlement with its former external manager, which necessitated portfolio sales and increased leverage. CEO William Greenberg noted that resolving this legacy issue provides “clarity and certainty of purpose,” but acknowledged the impact on the company’s expense ratio and capital allocation.

Looking forward, management emphasized plans to streamline costs, grow the subservicing business, and capitalize on attractive mortgage servicing rights (MSR) and agency mortgage-backed securities (RMBS) opportunities. The company aims to redeem outstanding convertible notes and maintain investments in technology to support origination and servicing. Greenberg stated, “With the uncertainty created by the litigation behind us, we are optimistic about the attractive investment opportunities available in the market for our strategy,” highlighting a focus on scaling servicing and origination activities while navigating evolving market dynamics.

Key Insights from Management’s Remarks

Management attributed the quarter’s result to the one-time litigation settlement, portfolio realignment, and emerging growth in third-party subservicing.

• Litigation Settlement Impact: The $375 million settlement with the former external manager required asset sales, temporarily reduced the capital base, and increased structural leverage, but management believes it restored clarity for future operations.
• Portfolio Adjustments: To address the new capital structure, Two Harbors sold agency securities and $19.1 billion of mortgage servicing rights (MSR), with another $10 billion scheduled for sale, aiming to maintain liquidity and risk metrics in line with historical levels.
• Subservicing Business Expansion: The company secured a major new third-party subservicing client, growing its subservicing portfolio to roughly $40 billion in unpaid principal balance. Management views this as validation of its acquisition of RoundPoint and a foundation for further growth.
• Direct-to-Consumer (DTC) Originations Momentum: The DTC platform recorded its highest-ever loan locks and funded $49 million in first and second liens, with an additional $52 million in the pipeline. Management sees this as a key lever for recapturing portfolio loans in refinancing environments.
• Technology and Efficiency Initiatives: Investments in technology, particularly AI-driven enhancements at RoundPoint, are delivering economies of scale and improved customer experiences. Management is actively seeking further cost reductions following the settlement to improve expense ratios.

Drivers of Future Performance

Two Harbors’ outlook is shaped by ongoing expense management, MSR and RMBS allocation strategies, and scaling subservicing and origination.

• Expense Reduction Efforts: Management has started initiatives to reduce the elevated expense ratio following the settlement, with expectations for meaningful cost savings in the coming quarters. CFO William Dellal confirmed that current return estimates do not yet factor in these potential savings, signaling possible upside if targets are met.
• MSR and RMBS Portfolio Strategy: The company plans to maintain a balanced allocation between low-coupon MSRs and agency RMBS. Management believes this approach provides stability and attractive risk-adjusted returns, particularly with only 3% of the MSR portfolio currently "in the money" for refinancing, limiting prepayment risk.
• Subservicing and Origination Growth: Two Harbors aims to further expand its subservicing relationships and direct-to-consumer origination activities. Management highlighted the potential for higher recapture rates as interest rates decline, supported by continued investments in technology and relationship-building in a consolidating subservicing market.

Catalysts in Upcoming Quarters

Looking ahead, the StockStory team will be watching (1) progress on expense reduction and its impact on profitability, (2) continued growth and client acquisition in the third-party subservicing business, and (3) the effectiveness of portfolio allocation between MSR and RMBS, particularly as interest rates fluctuate. Successful execution on technology upgrades and origination scale will also be key markers of strategic progress.

Two Harbors Investment currently trades at $9.79, in line with $9.82 just before the earnings. Is there an opportunity in the stock?See for yourself in our full research report (it’s free for active Edge members).

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