Mortgage REIT Two Harbors Investment (NYSE: TWO) fell short of the market’s revenue expectations in Q2 CY2025, with sales falling 111% year on year to -$12.28 million. Its non-GAAP profit of $0.28 per share was 21.2% below analysts’ consensus estimates.

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StockStory’s Take

Two Harbors Investment’s second quarter was marked by a significant miss on both revenue and non-GAAP profit expectations, triggering a negative market reaction. Management attributed the underperformance primarily to a litigation-related loss contingency, which resulted in a pronounced impact on book value and economic return. CEO William Ross Greenberg described the period as one of “heightened market volatility not seen since last October,” compounded by unfavorable mark-to-market movements on mortgage servicing rights (MSR), swaps, and derivatives. The company also highlighted that increased market volatility and a one-time litigation accrual were the main factors behind the challenging quarter.

Looking ahead, Two Harbors Investment’s outlook is shaped by expectations for continued volatility in the mortgage and fixed income markets, as well as the potential for Federal Reserve rate cuts later this year. Management is focused on leveraging technology and artificial intelligence to improve efficiency and customer service, while maintaining a disciplined approach to portfolio risk. Greenberg emphasized that “the combination of our investment portfolio and operating company allows us to be dynamic and responsive,” and the company aims to capitalize on opportunities as spreads in agency mortgage-backed securities (RMBS) and MSRs remain historically wide.

Key Insights from Management’s Remarks

Management identified the litigation charge and adverse market movements as the main contributors to the negative quarter, while emphasizing ongoing investments in technology and portfolio diversification.

• Litigation expense drives loss: The company booked a $199.9 million loss contingency related to the termination of its management agreement with PRCM Advisers, which was the largest single factor impacting quarterly results and book value. Management is awaiting further legal proceedings and indicated that no timetable for resolution has been set.

• Market volatility impacts portfolio: Heightened volatility in rates and spreads, especially in April, led to unfavorable mark-to-market results in MSRs, swaps, and agency RMBS. While spreads eventually recovered as the quarter progressed, these movements weighed on performance.

• Increased leverage and portfolio repositioning: Two Harbors increased its economic debt-to-equity ratio to 7x by quarter end to capitalize on perceived attractive opportunities in agency RMBS and MSRs. Management clarified that this leverage level is within their historical operating range and will be adjusted based on market conditions.

• Growth in mortgage originations and second liens: The company’s RoundPoint platform saw a 68% increase in first lien originations and began originating second liens in its own name. Management noted that while volumes remain small, these new products are intended to provide flexibility and revenue opportunities as market conditions shift.

• AI and technology investments: Significant investments were made in artificial intelligence to automate servicing and origination processes, including the deployment of conversational AI and process automation. The company expects these efforts to yield long-term efficiency gains and improved borrower experience, with most expenses recognized immediately rather than capitalized.

Drivers of Future Performance

Two Harbors’ guidance is driven by expectations for ongoing market volatility, the outcome of the litigation process, and strategic investments in technology and product diversification.

• Interest rate and spread dynamics: Management stressed that future performance will hinge on the behavior of agency RMBS spreads and mortgage rates, with potential Federal Reserve rate cuts seen as a catalyst for improved portfolio returns. However, there remains sensitivity to prepayment speeds and funding costs, which can shift quickly in volatile markets.

• Litigation resolution uncertainty: The unresolved litigation with PRCM Advisers represents a major overhang, with the timing and financial impact of a final settlement still unknown. Management indicated that further accruals or outflows could affect leverage and capital allocation strategies.

• Technology-led operational changes: Ongoing implementation of AI and automation is expected to reduce servicing costs and enhance efficiency, but management cautioned that most costs will be expensed in the near term. The success of these initiatives could support profitability if the company can scale originations or unlock new revenue streams through product expansion.

Catalysts in Upcoming Quarters

In future quarters, the StockStory team will be monitoring (1) developments and potential resolution in the PRCM Advisers litigation, (2) the impact of Federal Reserve policy decisions on mortgage rates and RMBS spreads, and (3) measurable efficiency gains and revenue growth from ongoing AI and technology investments. Additionally, we will track the company’s ability to scale new origination products as market conditions evolve.

Two Harbors Investment currently trades at $10.01, down from $10.35 just before the earnings. In the wake of this quarter, is it a buy or sell? See for yourself in our full research report (it’s free).

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