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EX-32.2 - CFO CERT - TWO HARBORS INVESTMENT CORP.twoexh93016322.htm
EX-32.1 - CEO CERT - TWO HARBORS INVESTMENT CORP.twoexh93016321.htm
EX-31.2 - CFO CERTIFICATION - TWO HARBORS INVESTMENT CORP.twoexh93016312.htm
EX-31.1 - CEO CERTIFICATION - TWO HARBORS INVESTMENT CORP.twoexh93016311.htm
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________
FORM 10-Q
______________________________

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: September 30, 2016

Commission File Number 001-34506
______________________________
TWO HARBORS INVESTMENT CORP.
(Exact Name of Registrant as Specified in Its Charter)

Maryland
 
27-0312904
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)

590 Madison Avenue, 36th Floor
New York, New York
 
10022
(Address of Principal Executive Offices)
 
(Zip Code)
(612) 629-2500
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of November 2, 2016 there were 347,643,717 shares of outstanding common stock, par value $.01 per share, issued and outstanding.
 
 
 
 
 



TWO HARBORS INVESTMENT CORP.
INDEX

 
 
Page
 
PART I - FINANCIAL INFORMATION
 
 
 
 
 
 
 
PART II - OTHER INFORMATION
 


i


PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
September 30,
2016
 
December 31,
2015
ASSETS
(unaudited)
 
 
Available-for-sale securities, at fair value
$
14,284,625

 
$
7,825,320

Residential mortgage loans held-for-sale, at fair value
723,174

 
811,431

Residential mortgage loans held-for-investment in securitization trusts, at fair value
3,620,037

 
3,173,727

Commercial real estate assets
1,114,548

 
660,953

Mortgage servicing rights, at fair value
455,629

 
493,688

Cash and cash equivalents
688,418

 
737,831

Restricted cash
264,872

 
262,562

Accrued interest receivable
67,089

 
49,970

Due from counterparties
56,095

 
17,206

Derivative assets, at fair value
199,013

 
271,509

Other assets
326,396

 
271,575

Total Assets (1)
$
21,799,896

 
$
14,575,772

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities
 
 
 
Repurchase agreements
$
10,637,373

 
$
5,008,274

Collateralized borrowings in securitization trusts, at fair value
3,375,906

 
2,000,110

Federal Home Loan Bank advances
4,000,000

 
3,785,000

Revolving credit facilities
30,000

 

Derivative liabilities, at fair value
39,918

 
7,285

Due to counterparties
78,179

 
34,294

Dividends payable
79,956

 
92,016

Other liabilities
80,323

 
72,232

Total Liabilities (1)
18,321,655

 
10,999,211

Stockholders’ Equity
 
 
 
Preferred stock, par value $0.01 per share; 50,000,000 shares authorized; no shares issued and outstanding

 

Common stock, par value $0.01 per share; 900,000,000 shares authorized and 347,635,488 and 353,906,807 shares issued and outstanding, respectively
3,476

 
3,539

Additional paid-in capital
3,655,854

 
3,705,519

Accumulated other comprehensive income
538,443

 
359,061

Cumulative earnings
1,696,630

 
1,684,755

Cumulative distributions to stockholders
(2,416,162
)
 
(2,176,313
)
Total Stockholders’ Equity
3,478,241

 
3,576,561

Total Liabilities and Stockholders’ Equity
$
21,799,896

 
$
14,575,772

____________________
(1)
The condensed consolidated balance sheets include assets of consolidated variable interest entities, or VIEs, that can only be used to settle obligations of these VIEs, and liabilities of the consolidated VIEs for which creditors do not have recourse to Two Harbors Investment Corp. At September 30, 2016 and December 31, 2015, assets of the VIEs totaled $3,686,340 and $3,237,918, and liabilities of the VIEs totaled $3,398,215 and $2,017,677, respectively. See Note 3 - Variable Interest Entities for additional information.
The accompanying notes are an integral part of these condensed consolidated financial statements.

1


TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands, except share data)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Interest income:
(unaudited)
 
(unaudited)
Available-for-sale securities
$
111,393

 
$
116,318

 
$
292,333

 
$
369,972

Trading securities

 

 

 
8,676

Residential mortgage loans held-for-sale
7,627

 
9,479

 
19,789

 
21,268

Residential mortgage loans held-for-investment in securitization trusts
33,495

 
24,841

 
100,765

 
64,908

Commercial real estate assets
15,907

 
1,947

 
40,279

 
2,841

Cash and cash equivalents
440

 
249

 
1,235

 
667

Total interest income
168,862

 
152,834

 
454,401

 
468,332

Interest expense:
 
 
 
 
 
 
 
Repurchase agreements
27,056

 
18,235

 
65,782

 
58,198

Collateralized borrowings in securitization trusts
26,422

 
15,562

 
70,965

 
39,401

Federal Home Loan Bank advances
6,744

 
3,282

 
18,804

 
8,012

Revolving credit facilities
128

 

 
128

 

Total interest expense
60,350

 
37,079

 
155,679

 
105,611

Net interest income
108,512

 
115,755

 
298,722

 
362,721

Other-than-temporary impairments:
 
 
 
 

 

Total other-than-temporary impairment losses
(1,015
)
 
(238
)
 
(1,822
)
 
(535
)
Other income (loss):
 
 
 
 
 
 
 
Gain on investment securities
28,290

 
64,123

 
66,095

 
263,512

Gain (loss) on interest rate swap and swaption agreements
5,584

 
(171,656
)
 
(132,608
)
 
(253,147
)
Loss on other derivative instruments
(12,028
)
 
(455
)
 
(44,064
)
 
(2,972
)
(Loss) gain on residential mortgage loans held-for-sale
(889
)
 
16,040

 
17,648

 
18,300

Servicing income
38,708

 
32,010

 
108,657

 
94,613

Loss on servicing asset
(33,451
)
 
(61,549
)
 
(211,426
)
 
(96,317
)
Other income (loss)
5,757

 
2,201

 
(977
)
 
(16,265
)
Total other income (loss)
31,971

 
(119,286
)
 
(196,675
)
 
7,724

Expenses:
 
 
 
 
 
 
 
Management fees
11,387

 
12,617

 
35,268

 
38,024

Securitization deal costs
2,080

 
2,676

 
6,241

 
7,771

Servicing expenses
9,073

 
7,234

 
24,510

 
19,849

Other operating expenses
14,780

 
16,150

 
47,280

 
48,032

Restructuring charges
1,189

 

 
1,189

 

Total expenses
38,509

 
38,677

 
114,488

 
113,676

Income (loss) before income taxes
100,959

 
(42,446
)
 
(14,263
)
 
256,234

Benefit from income taxes
(16,827
)
 
(7,656
)
 
(26,138
)
 
(25,270
)
Net income (loss)
$
117,786

 
$
(34,790
)
 
$
11,875

 
$
281,504

Basic and diluted earnings (loss) per weighted average common share
$
0.34

 
$
(0.09
)
 
$
0.03

 
$
0.77

Dividends declared per common share
$
0.23

 
$
0.26

 
$
0.69

 
$
0.78

Basic and diluted weighted average number of shares of common stock outstanding
347,627,226

 
367,365,973

 
348,218,234

 
366,985,731

The accompanying notes are an integral part of these condensed consolidated financial statements.

2


TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS), continued
(in thousands, except share data)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
 
(unaudited)
 
(unaudited)
Comprehensive income (loss):
 
 
 
 
 
 
 
Net income (loss)
$
117,786

 
$
(34,790
)
 
$
11,875

 
$
281,504

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Unrealized gain (loss) on available-for-sale securities
18,746

 
(58,031
)
 
179,382

 
(282,788
)
Other comprehensive income (loss)
18,746

 
(58,031
)
 
179,382

 
(282,788
)
Comprehensive income (loss)
$
136,532

 
$
(92,821
)
 
$
191,257

 
$
(1,284
)
The accompanying notes are an integral part of these condensed consolidated financial statements.


3


TWO HARBORS INVESTMENT CORP. 
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except share data)
 
Common Stock
 
 
 
 
 
 
 
 
 
 
 
Shares
 
Amount
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income
 
Cumulative Earnings
 
Cumulative Distributions to Stockholders
 
Total Stockholders’ Equity
 
 
 
 
 
 
 
(unaudited)
 
 
 
 
 
 
Balance, December 31, 2014
366,395,920

 
$
3,664

 
$
3,811,027

 
$
855,789

 
$
1,195,536

 
$
(1,797,974
)
 
$
4,068,042

Cumulative effect of adoption of new accounting principle

 

 

 

 
(2,991
)
 

 
(2,991
)
Adjusted balance, January 1, 2015
366,395,920

 
3,664

 
3,811,027

 
855,789

 
1,192,545

 
(1,797,974
)
 
4,065,051

Net income

 

 

 

 
281,504

 

 
281,504

Other comprehensive loss before reclassifications, net of tax

 

 

 
(54,805
)
 

 

 
(54,805
)
Amounts reclassified from accumulated other comprehensive income, net of tax

 

 

 
(227,983
)
 

 

 
(227,983
)
Net other comprehensive loss, net of tax

 

 

 
(282,788
)
 

 

 
(282,788
)
Issuance of common stock, net of offering costs
54,088

 
1

 
403

 

 

 

 
404

Repurchase of common stock
(1,391,887
)
 
(14
)
 
(12,462
)
 

 

 

 
(12,476
)
Common dividends declared

 

 

 

 

 
(286,323
)
 
(286,323
)
Non-cash equity award compensation
1,098,638

 
11

 
7,355

 

 

 

 
7,366

Balance, September 30, 2015
366,156,759

 
$
3,662

 
$
3,806,323

 
$
573,001

 
$
1,474,049

 
$
(2,084,297
)
 
$
3,772,738

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2015
353,906,807

 
$
3,539

 
$
3,705,519

 
$
359,061

 
$
1,684,755

 
$
(2,176,313
)
 
$
3,576,561

Net income

 

 

 

 
11,875

 

 
11,875

Other comprehensive income before reclassifications, net of tax

 

 

 
232,212

 

 

 
232,212

Amounts reclassified from accumulated other comprehensive income, net of tax

 

 

 
(52,830
)
 

 

 
(52,830
)
Net other comprehensive income, net of tax

 

 

 
179,382

 

 

 
179,382

Issuance of common stock, net of offering costs
43,764

 

 
356

 

 

 

 
356

Repurchase of common stock
(8,020,000
)
 
(80
)
 
(61,227
)
 

 

 

 
(61,307
)
Common dividends declared

 

 

 

 

 
(239,849
)
 
(239,849
)
Non-cash equity award compensation
1,704,917

 
17

 
11,206

 

 

 

 
11,223

Balance, September 30, 2016
347,635,488

 
$
3,476

 
$
3,655,854

 
$
538,443

 
$
1,696,630

 
$
(2,416,162
)
 
$
3,478,241

The accompanying notes are an integral part of these condensed consolidated financial statements.


4


TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Cash Flows From Operating Activities:
(unaudited)
Net income
$
11,875

 
$
281,504

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Amortization of premiums and discounts on investment securities and commercial real estate assets, net
29,469

 
32,556

Other-than-temporary impairment losses
1,822

 
535

Realized and unrealized gains on investment securities, net
(66,095
)
 
(263,512
)
Gain on residential mortgage loans held-for-sale
(17,648
)
 
(18,300
)
Loss on residential mortgage loans held-for-investment and collateralized borrowings in securitization trusts
5,173

 
19,441

Loss on servicing asset
211,426

 
96,317

Loss on termination and option expiration of interest rate swaps and swaptions
119,548

 
124,984

Unrealized (gain) loss on interest rate swaps and swaptions
(5,080
)
 
55,079

Unrealized loss (gain) on other derivative instruments
2,025

 
(15,563
)
Equity based compensation
11,223

 
7,366

Depreciation of fixed assets
981

 
1,002

Purchases of residential mortgage loans held-for-sale
(1,159,782
)
 
(2,166,494
)
Proceeds from sales of residential mortgage loans held-for-sale
95,331

 
137,612

Proceeds from repayment of residential mortgage loans held-for-sale
117,092

 
80,152

Net change in assets and liabilities:


 
 
(Increase) decrease in accrued interest receivable
(17,119
)
 
9,279

Increase in deferred income taxes, net
(24,581
)
 
(19,592
)
Decrease (increase) in income taxes receivable
3,667

 
(6,854
)
Increase in prepaid and fixed assets
(62
)
 
(221
)
Decrease in other receivables
5,721

 
8,563

Increase in servicing advances
(8,965
)
 
(3,465
)
Increase (decrease) in accrued interest payable
11,084

 
(4,780
)
Decrease in income taxes payable
(70
)
 
(1,215
)
(Decrease) increase in accrued expenses and other liabilities
(2,923
)
 
6,324

Net cash used in operating activities
$
(675,888
)
 
$
(1,639,282
)
The accompanying notes are an integral part of these condensed consolidated financial statements.

5


TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
(in thousands)
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Cash Flows From Investing Activities:
(unaudited)
Purchases of available-for-sale securities
$
(13,734,884
)
 
$
(1,732,979
)
Proceeds from sales of available-for-sale securities
6,567,992

 
3,666,974

Principal payments on available-for-sale securities
910,386

 
918,798

(Purchases) short sales of derivative instruments, net
(13,953
)
 
3,592

Proceeds from sales (payments for termination) of derivative instruments, net
3,209

 
(93,352
)
Proceeds from sales of trading securities

 
2,004,375

Proceeds from repayment of residential mortgage loans held-for-investment in securitization trusts
649,134

 
435,967

Originations and purchases of commercial real estate assets, net of deferred fees
(463,680
)
 
(290,683
)
Proceeds from repayment of commercial real estate assets
15,296

 

Purchases of mortgage servicing rights, net of purchase price adjustments
(208,474
)
 
(75,011
)
Proceeds from sales of mortgage servicing rights
41,844

 

Purchases of Federal Home Loan Bank stock
(11,206
)
 
(53,640
)
Increase (decrease) in due to counterparties, net
4,996

 
(57,265
)
Increase in restricted cash
(2,310
)
 
(47,258
)
Net cash (used in) provided by investing activities
(6,241,650
)
 
4,679,518

Cash Flows From Financing Activities:
 
 
 
Proceeds from repurchase agreements
70,805,165

 
37,275,034

Principal payments on repurchase agreements
(65,176,066
)
 
(42,224,569
)
Proceeds from issuance of collateralized borrowings in securitization trusts
1,875,371

 
1,104,093

Principal payments on collateralized borrowings in securitization trusts
(568,485
)
 
(309,341
)
Proceeds from Federal Home Loan Bank advances
215,000

 
1,415,000

Principal payments on Federal Home Loan Bank advances

 
(205,000
)
Proceeds from revolving credit facilities
30,000

 

Proceeds from issuance of common stock, net of offering costs
356

 
404

Repurchase of common stock
(61,307
)
 
(3,683
)
Dividends paid on common stock
(251,909
)
 
(286,127
)
Net cash provided by (used in) financing activities
6,868,125

 
(3,234,189
)
Net decrease in cash and cash equivalents
(49,413
)
 
(193,953
)
Cash and cash equivalents at beginning of period
737,831

 
1,005,792

Cash and cash equivalents at end of period
$
688,418

 
$
811,839

The accompanying notes are an integral part of these condensed consolidated financial statements.

6


TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
(in thousands)
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Supplemental Disclosure of Cash Flow Information:
(unaudited)
Cash paid for interest
$
77,142

 
$
73,187

Cash (received) paid for taxes
$
(5,154
)
 
$
2,389

Noncash Activities:
 
 
 
Transfers of residential mortgage loans held-for-sale to residential mortgage loans held-for-investment in securitization trusts
$
1,031,707

 
$
1,705,885

Transfers of residential mortgage loans held-for-sale to other receivables for foreclosed government-guaranteed loans
$
14,200

 
$
12,764

Transfer of fair value of mortgage servicing rights to fair value of Ginnie Mae residential mortgage loans held-for-sale upon buyout
$
5,973

 
$
15,077

Additions to mortgage servicing rights due to sale of residential mortgage loans held-for-sale
$
764

 
$
1,568

Cumulative-effect adjustment to equity for adoption of new accounting principle
$

 
$
(2,991
)
Shares repurchase payable at end of period
$

 
$
8,793

Dividends declared but not paid at end of period
$
79,956

 
$
95,459

Reconciliation of residential mortgage loans held-for-sale:
 
 
 
Residential mortgage loans held-for-sale at beginning of period
$
811,431

 
$
535,712

Purchases of residential mortgage loans held-for-sale
1,159,782

 
2,166,494

Transfers to residential mortgage loans held-for-investment in securitization trusts
(1,031,707
)
 
(1,705,885
)
Transfers to other receivables for foreclosed government-guaranteed loans
(14,200
)
 
(12,764
)
Transfer of fair value of mortgage servicing rights to fair value of Ginnie Mae residential mortgage loans held-for-sale upon buyout
(5,973
)
 
(15,077
)
Proceeds from sales of residential mortgage loans held-for-sale
(95,331
)
 
(137,612
)
Proceeds from repayment of residential mortgage loans held-for-sale
(117,092
)
 
(80,152
)
Realized and unrealized gains on residential mortgage loans held-for-sale
16,264

 
17,292

Residential mortgage loans held-for-sale at end of period
$
723,174

 
$
768,008

The accompanying notes are an integral part of these condensed consolidated financial statements.

7


TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

Note 1. Organization and Operations
Two Harbors Investment Corp., or the Company, is a Maryland corporation focused on investing in, financing and managing residential mortgage-backed securities, or RMBS, residential mortgage loans, mortgage servicing rights, or MSR, commercial real estate and other financial assets. The Company is externally managed and advised by PRCM Advisers LLC, or PRCM Advisers, which is a subsidiary of Pine River Capital Management L.P., or Pine River, a global multi-strategy asset management firm. The Company’s common stock is listed on the NYSE under the symbol “TWO”.
The Company was incorporated on May 21, 2009, and commenced operations as a publicly traded company on October 28, 2009, upon completion of a merger with Capitol Acquisition Corp., or Capitol, which became a wholly owned indirect subsidiary of the Company as a result of the merger.
The Company has elected to be treated as a real estate investment trust, or REIT, as defined under the Internal Revenue Code of 1986, as amended, or the Code, for U.S. federal income tax purposes. As long as the Company continues to comply with a number of requirements under federal tax law and maintains its qualification as a REIT, the Company generally will not be subject to U.S. federal income taxes to the extent that the Company distributes its taxable income to its stockholders on an annual basis and does not engage in prohibited transactions. However, certain activities that the Company may perform may cause it to earn income which will not be qualifying income for REIT purposes. The Company has designated certain of its subsidiaries as taxable REIT subsidiaries, or TRSs, as defined in the Code, to engage in such activities, and the Company may in the future form additional TRSs.

Note 2. Basis of Presentation and Significant Accounting Policies
Consolidation and Basis of Presentation
The interim unaudited condensed consolidated financial statements of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission, or SEC. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, have been condensed or omitted according to such SEC rules and regulations. However, management believes that the disclosures included in these interim condensed consolidated financial statements are adequate to make the information presented not misleading. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at September 30, 2016 and results of operations for all periods presented have been made. The results of operations for the three and nine months ended September 30, 2016 should not be construed as indicative of the results to be expected for future periods or the full year.
The condensed consolidated financial statements of the Company have been prepared on the accrual basis of accounting in accordance with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires us to make a number of significant estimates and assumptions. These estimates include estimates of fair value of certain assets and liabilities, amount and timing of credit losses, prepayment rates, the period of time during which the Company anticipates an increase in the fair values of real estate securities sufficient to recover unrealized losses in those securities, and other estimates that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities as of the date of the condensed consolidated financial statements and the reported amounts of certain revenues and expenses during the reported period. It is likely that changes in these estimates (e.g., valuation changes due to supply and demand, credit performance, prepayments, interest rates, or other reasons) will occur in the near term. The Company’s estimates are inherently subjective in nature and actual results could differ from its estimates and the differences may be material.
The condensed consolidated financial statements of the Company include the accounts of all subsidiaries; inter-company accounts and transactions have been eliminated. Certain prior period amounts have been reclassified to conform to the current period presentation. The Company’s Chief Investment Officer manages the investment portfolio as a whole and resources are allocated and financial performance is assessed on a consolidated basis.
All trust entities in which the Company holds investments that are considered VIEs for financial reporting purposes were reviewed for consolidation under the applicable consolidation guidance. Whenever the Company has both the power to direct the activities of a trust that most significantly impact the entity’s performance, and the obligation to absorb losses or the right to receive benefits of the entity that could be significant, the Company consolidates the trust.

8


TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

Significant Accounting Policies
Included in Note 2 to the Consolidated Financial Statements of the Company’s 2015 Annual Report on Form 10-K is a summary of the Company’s significant accounting policies. Provided below is a summary of additional accounting policies that are significant to the Company’s consolidated financial condition and results of operations for the nine months ended September 30, 2016.
Revolving Credit Facilities
To finance MSR, the Company enters into revolving credit facilities collateralized by pledged MSR. Borrowings under these revolving credit facilities are generally short-term debt, which expire within one year. The Company’s revolving credit facilities generally bear interest rates of a specified margin over one-month LIBOR and are uncommitted. Borrowings under revolving credit facilities are treated as collateralized financing transactions and are carried at contractual amounts, as specified in the respective agreements.
Offsetting Assets and Liabilities
Certain of the Company’s repurchase agreements are governed by underlying agreements that provide for a right of setoff in the event of default of either party to the agreement. The Company also has netting arrangements in place with all derivative counterparties pursuant to standard documentation developed by the International Swap and Derivatives Association, or ISDA, or central clearing exchange agreements, in the case of centrally cleared interest rate swaps. Additionally, the Company and the counterparty or clearing agency are required to post cash collateral based upon the net underlying market value of the Company’s open positions with the counterparty.
Under U.S. GAAP, if the Company has a valid right of setoff, it may offset the related asset and liability and report the net amount. The Company presents repurchase agreements subject to master netting arrangements or similar agreements on a gross basis, and derivative assets and liabilities subject to such arrangements on a net basis, based on derivative type and counterparty, in its condensed consolidated balance sheets. Separately, the Company presents cash collateral subject to such arrangements on a net basis, based on counterparty, in its condensed consolidated balance sheets. However, the Company does not offset financial assets and liabilities with the associated cash collateral on its condensed consolidated balance sheets.
The following tables present information about the Company’s assets and liabilities that are subject to master netting arrangements or similar agreements and can potentially be offset on the Company’s condensed consolidated balance sheets as of September 30, 2016 and December 31, 2015:
 
September 30, 2016
 
 
 
 
 
 
 
Gross Amounts Not Offset with Financial Assets (Liabilities) in the Condensed Consolidated Balance Sheets (1)
 
 
(in thousands)
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts of Assets (Liabilities) Presented in the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Net Amount
Assets
 
 
 
 
 
 
 
 
 
 
 
Derivative assets
$
298,389

 
$
(99,376
)
 
$
199,013

 
$
(39,918
)
 
$

 
$
159,095

Total Assets
$
298,389

 
$
(99,376
)
 
$
199,013

 
$
(39,918
)
 
$

 
$
159,095

Liabilities
 
 
 
 
 
 
 
 
 
 
 
Repurchase agreements
$
(10,637,373
)
 
$

 
$
(10,637,373
)
 
$
10,637,373

 
$

 
$

Derivative liabilities
(139,294
)
 
99,376

 
(39,918
)
 
39,918

 

 

Total Liabilities
$
(10,776,667
)
 
$
99,376

 
$
(10,677,291
)
 
$
10,677,291

 
$

 
$


9


TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

 
December 31, 2015
 
 
 
 
 
 
 
Gross Amounts Not Offset with Financial Assets (Liabilities) in the Condensed Consolidated Balance Sheets (1)
 
 
(in thousands)
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts of Assets (Liabilities) Presented in the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Net Amount
Assets
 
 
 
 
 
 
 
 
 
 
 
Derivative assets
$
325,755

 
$
(54,246
)
 
$
271,509

 
$
(7,285
)
 
$

 
$
264,224

Total Assets
$
325,755

 
$
(54,246
)
 
$
271,509

 
$
(7,285
)
 
$

 
$
264,224

Liabilities
 
 
 
 
 
 
 
 
 
 
 
Repurchase agreements
$
(5,008,274
)
 
$

 
$
(5,008,274
)
 
$
5,008,274

 
$

 
$

Derivative liabilities
(61,531
)
 
54,246

 
(7,285
)
 
7,285

 

 

Total Liabilities
$
(5,069,805
)
 
$
54,246

 
$
(5,015,559
)
 
$
5,015,559

 
$

 
$

____________________
(1)
Amounts presented are limited in total to the net amount of assets or liabilities presented in the condensed consolidated balance sheets by instrument. Excess cash collateral or financial assets that are pledged to counterparties may exceed the financial liabilities subject to a master netting arrangement or similar agreement, or counterparties may have pledged excess cash collateral to the Company that exceed the corresponding financial assets. These excess amounts are excluded from the table above, although separately reported within restricted cash, due from counterparties, or due to counterparties in the Company’s condensed consolidated balance sheets.

Recently Issued and/or Adopted Accounting Standards
Revenue from Contracts with Customers
In May 2014, the Financial Accounting Standards Board, or FASB, issued ASU No. 2014-09, which is a comprehensive revenue recognition standard that supersedes virtually all existing revenue guidance under U.S. GAAP. The standard’s core principle is that an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. As a result of the issuance of ASU No. 2015-14 in August 2015 deferring the effective date of ASU No. 2014-09 by one year, the ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2017, with early adoption prohibited. The Company has determined this ASU will not have a material impact on the Company’s financial condition or results of operations.
Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
In August 2014, the FASB issued ASU No. 2014-15, which requires management to evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern for both annual and interim reporting periods. The update requires certain disclosures if management concludes that substantial doubt exists and plans to alleviate that doubt. The ASU is effective for annual periods ending after December 15, 2016, and for both annual and interim periods thereafter, with early adoption permitted.
Recognition and Measurement of Financial Assets and Financial Liabilities
In January 2016, the FASB issued ASU No. 2016-01, which changes how entities measure certain equity investments and present changes in the fair value of financial liabilities measured under the fair value option that are attributable to their own credit. The ASU requires certain recurring disclosures and is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2017, with early adoption permitted. The Company has determined this ASU will not have a material impact on the Company’s financial condition or results of operations.

10


TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

Lease Classification and Accounting
In February 2016, the FASB issued ASU No. 2016-02, which requires lessees to recognize on their balance sheets both a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term. The ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2018, with early adoption permitted. The Company has determined this ASU will not have a material impact on the Company’s financial condition or results of operations.
Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued ASU No. 2016-13, which changes the impairment model for most financial assets and certain other instruments. Allowances for credit losses on AFS debt securities will be recognized, rather than direct reductions in the amortized cost of the investments. The new model also requires the estimation of lifetime expected credit losses and corresponding recognition of allowance for losses on trade and other receivables, held-to-maturity debt securities, loans, and other instruments held at amortized cost. The ASU requires certain recurring disclosures and is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2019, with early adoption permitted for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2018. The Company is evaluating the adoption of this ASU.
Classification of Certain Cash Receipts and Cash Payments
In August 2016, the FASB issued ASU No. 2016-15, which clarifies how entities should classify certain cash receipts and cash payments and how the predominance principle should be applied on the statement of cash flows. The ASU is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2017, with early adoption permitted. The Company has determined this ASU will not have an impact on the Company’s financial condition or results of operations but may impact the presentation of the condensed consolidated statements of cash flows.

Note 3. Variable Interest Entities
The Company purchases subordinated debt and excess servicing rights from securitization trusts sponsored by either third parties or the Company’s subsidiaries. Additionally, the Company is the sole certificate holder of a trust entity that holds a commercial real estate loan. All of these trusts are considered VIEs for financial reporting purposes and, thus, were reviewed for consolidation under the applicable consolidation guidance. Because the Company has both the power to direct the activities of the trusts that most significantly impact the entities’ performance, and the obligation to absorb losses or the right to receive benefits of the entities that could be significant, the Company consolidates the trusts. As the Company is required to reassess VIE consolidation guidance each quarter, new facts and circumstances may change the Company’s determination. A change in the Company’s determination could result in a material impact to the Company’s condensed consolidated financial statements during subsequent reporting periods.
The following table presents a summary of the assets and liabilities of all consolidated trusts as reported on the condensed consolidated balance sheets as of September 30, 2016 and December 31, 2015:
(in thousands)
September 30,
2016
 
December 31,
2015
Residential mortgage loans held-for-investment in securitization trusts
$
3,620,037

 
$
3,173,727

Commercial real estate assets
45,837

 
45,698

Accrued interest receivable
20,466

 
18,493

Total Assets
$
3,686,340

 
$
3,237,918

Collateralized borrowings in securitization trusts
$
3,375,906

 
$
2,000,110

Accrued interest payable
9,457

 
5,943

Other liabilities
12,852

 
11,624

Total Liabilities
$
3,398,215

 
$
2,017,677



11


TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

The Company is not required to consolidate VIEs for which it has concluded it does not have both the power to direct the activities of the VIEs that most significantly impact the entities’ performance, and the obligation to absorb losses or the right to receive benefits of the entities that could be significant. The Company’s investments in these unconsolidated VIEs include non-Agency RMBS, which are classified within available-for-sale securities, at fair value on the condensed consolidated balance sheets. As of September 30, 2016 and December 31, 2015, the carrying value, which also represents the maximum exposure to loss, of all non-Agency RMBS in unconsolidated VIEs was $1.8 billion and $1.9 billion, respectively.

Note 4. Available-for-Sale Securities, at Fair Value
The Company holds AFS investment securities which are carried at fair value on the condensed consolidated balance sheets. AFS securities exclude the retained interests from the Company’s on-balance sheet securitizations, as they are eliminated in consolidation in accordance with U.S. GAAP. The following table presents the Company’s AFS investment securities by collateral type as of September 30, 2016 and December 31, 2015:
(in thousands)
September 30,
2016
 
December 31,
2015
Agency
 
 
 
Federal Home Loan Mortgage Corporation
$
1,808,122

 
$
1,678,814

Federal National Mortgage Association
10,393,094

 
3,602,348

Government National Mortgage Association
235,600

 
691,728

Non-Agency
1,847,809

 
1,852,430

Total available-for-sale securities
$
14,284,625

 
$
7,825,320


At September 30, 2016 and December 31, 2015, the Company pledged AFS securities with a carrying value of $14.3 billion and $7.8 billion, respectively, as collateral for repurchase agreements and advances from the Federal Home Loan Bank of Des Moines, or the FHLB. See Note 15 - Repurchase Agreements and Note 17 - Federal Home Loan Bank of Des Moines Advances.
At September 30, 2016 and December 31, 2015, the Company did not have any securities purchased from and financed with the same counterparty that did not meet the conditions of ASC 860, Transfers and Servicing, or ASC 860, to be considered linked transactions and, therefore, classified as derivatives.
The following tables present the amortized cost and carrying value (which approximates fair value) of AFS securities by collateral type as of September 30, 2016 and December 31, 2015:
 
September 30, 2016
(in thousands)
Agency
 
Non-Agency
 
Total
Face Value
$
14,254,562

 
$
2,634,994

 
$
16,889,556

Unamortized premium
625,519

 

 
625,519

Unamortized discount
 
 
 
 
 
Designated credit reserve

 
(352,489
)
 
(352,489
)
Net, unamortized
(2,620,684
)
 
(789,425
)
 
(3,410,109
)
Amortized Cost
12,259,397

 
1,493,080

 
13,752,477

Gross unrealized gains
208,319

 
359,748

 
568,067

Gross unrealized losses
(30,900
)
 
(5,019
)
 
(35,919
)
Carrying Value
$
12,436,816

 
$
1,847,809

 
$
14,284,625


12


TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

 
December 31, 2015
(in thousands)
Agency
 
Non-Agency
 
Total
Face Value
$
8,257,030


$
2,655,381

 
$
10,912,411

Unamortized premium
394,787



 
394,787

Unamortized discount
 
 
 
 
 
Designated credit reserve


(409,077
)
 
(409,077
)
Net, unamortized
(2,721,979
)

(707,021
)
 
(3,429,000
)
Amortized Cost
5,929,838


1,539,283

 
7,469,121

Gross unrealized gains
98,389


329,206

 
427,595

Gross unrealized losses
(55,337
)

(16,059
)
 
(71,396
)
Carrying Value
$
5,972,890

 
$
1,852,430

 
$
7,825,320


The following tables present the carrying value of the Company’s AFS securities by rate type as of September 30, 2016 and December 31, 2015:
 
September 30, 2016
(in thousands)
 Agency
 
 Non-Agency
 
 Total
Adjustable Rate
$
32,588

 
$
1,545,843

 
$
1,578,431

Fixed Rate
12,404,228

 
301,966

 
12,706,194

Total
$
12,436,816

 
$
1,847,809

 
$
14,284,625

 
December 31, 2015
(in thousands)
Agency
 
Non-Agency
 
Total
Adjustable Rate
$
108,596

 
$
1,673,038

 
$
1,781,634

Fixed Rate
5,864,294

 
179,392

 
6,043,686

Total
$
5,972,890

 
$
1,852,430

 
$
7,825,320


The following table presents the Company’s AFS securities according to their estimated weighted average life classifications as of September 30, 2016:
 
September 30, 2016
(in thousands)
 Agency
 
 Non-Agency
 
 Total
≤ 1 year
$
2,186

 
$
67,171

 
$
69,357

> 1 and ≤ 3 years
102,324

 
241,346

 
343,670

> 3 and ≤ 5 years
5,407,166

 
214,452

 
5,621,618

> 5 and ≤ 10 years
6,923,818

 
957,723

 
7,881,541

> 10 years
1,322

 
367,117

 
368,439

Total
$
12,436,816

 
$
1,847,809

 
$
14,284,625


When the Company purchases a credit-sensitive AFS security at a significant discount to its face value, the Company often does not amortize into income a significant portion of this discount that the Company is entitled to earn because the Company does not expect to collect the entire discount due to the inherent credit risk of the security. The Company may also record an other-than-temporary impairment, or OTTI, for a portion of its investment in the security to the extent the Company believes that the amortized cost will exceed the present value of expected future cash flows. The amount of principal that the Company does not amortize into income is designated as a credit reserve on the security, with unamortized net discounts or premiums amortized into income over time to the extent realizable.

13


TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

The following table presents the changes for the nine months ended September 30, 2016 and 2015, of the unamortized net discount and designated credit reserves on non-Agency AFS securities.
 
Nine Months Ended September 30,
 
2016
 
2015
(in thousands)
Designated Credit Reserve
 
Unamortized Net Discount
 
Total
 
Designated Credit Reserve
 
Unamortized Net Discount
 
Total
Beginning balance at January 1
$
(409,077
)
 
$
(707,021
)
 
$
(1,116,098
)
 
$
(927,605
)
 
$
(967,368
)
 
$
(1,894,973
)
Acquisitions
(45,398
)
 
(140,318
)
 
(185,716
)
 
(274
)
 
(4,293
)
 
(4,567
)
Accretion of net discount

 
50,596

 
50,596

 

 
76,861

 
76,861

Realized credit losses
279

 

 
279

 
13,376

 

 
13,376

Reclassification adjustment for other-than-temporary impairments
(1,226
)
 

 
(1,226
)
 
1,742

 

 
1,742

Transfers from (to)
70,371

 
(70,371
)
 

 
85,767

 
(85,767
)
 

Sales, calls, other
32,562

 
77,689

 
110,251

 
282,821

 
227,078

 
509,899

Ending balance at September 30
$
(352,489
)
 
$
(789,425
)
 
$
(1,141,914
)
 
$
(544,173
)
 
$
(753,489
)
 
$
(1,297,662
)

The following table presents the components comprising the carrying value of AFS securities not deemed to be other than temporarily impaired by length of time that the securities had an unrealized loss position as of September 30, 2016 and December 31, 2015. At September 30, 2016, the Company held 1,220 AFS securities, of which 80 were in an unrealized loss position for less than twelve consecutive months and 124 were in an unrealized loss position for more than twelve consecutive months. At December 31, 2015, the Company held 1,181 AFS securities, of which 121 were in an unrealized loss position for less than twelve consecutive months and 182 were in an unrealized loss position for more than twelve consecutive months.
 
Unrealized Loss Position for
 
Less than 12 Months
 
12 Months or More
 
Total
(in thousands)
Estimated Fair Value
 
Gross Unrealized Losses
 
Estimated Fair Value
 
Gross Unrealized Losses
 
Estimated Fair Value
 
Gross Unrealized Losses
September 30, 2016
$
2,122,527

 
$
(12,318
)
 
$
551,086

 
$
(23,601
)
 
$
2,673,613

 
$
(35,919
)
December 31, 2015
$
1,503,939

 
$
(26,984
)
 
$
1,141,839

 
$
(44,412
)
 
$
2,645,778

 
$
(71,396
)

Evaluating AFS Securities for Other-Than-Temporary Impairments
In evaluating AFS securities for OTTI, the Company determines whether there has been a significant adverse quarterly change in the cash flow expectations for a security. The Company compares the amortized cost of each security in an unrealized loss position against the present value of expected future cash flows of the security. The Company also considers whether there has been a significant adverse change in the regulatory and/or economic environment as part of this analysis. If the amortized cost of the security is greater than the present value of expected future cash flows using the original yield as the discount rate, an other-than-temporary credit impairment has occurred. If the Company does not intend to sell and will not be more likely than not required to sell the security, the credit loss is recognized in earnings and the balance of the unrealized loss is recognized in either other comprehensive income (loss), net of tax, or gain on investment securities, depending on the accounting treatment. If the Company intends to sell the security or will be more likely than not required to sell the security, the full unrealized loss is recognized in earnings.

14


TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

The Company recorded $1.0 million and $1.8 million in other-than-temporary credit impairments during the three and nine months ended September 30, 2016 on one and four non-Agency RMBS, respectively, where the future expected cash flows for each security were less than its amortized cost. As of September 30, 2016, impaired securities with a carrying value of $124.0 million had actual weighted average cumulative losses of 12.0%, weighted average three-month prepayment speed of 6.8%, weighted average 60+ day delinquency of 22.9% of the pool balance, and weighted average FICO score of 666. At September 30, 2016, the Company did not intend to sell the securities and determined that it was not more likely than not that the Company will be required to sell the securities; therefore, only the projected credit loss was recognized in earnings. During the three and nine months ended September 30, 2015, the Company recorded $0.2 million and $0.5 million in other-than-temporary credit impairments on two non-Agency RMBS where the future expected cash flows for the security were less than its amortized cost.
The following table presents the changes in OTTI included in earnings for the three and nine months ended September 30, 2016 and 2015:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Cumulative credit loss at beginning of period
$
(6,710
)
 
$
(6,622
)
 
$
(6,499
)
 
$
(8,241
)
Additions:
 
 
 
 
 
 
 
Other-than-temporary impairments not previously recognized
(1,015
)
 
(238
)
 
(1,307
)
 
(238
)
Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments

 

 
(515
)
 
(297
)
Reductions:
 
 
 
 
 
 
 
Decreases related to other-than-temporary impairments on securities paid down

 

 

 

Decreases related to other-than-temporary impairments on securities sold

 
361

 
596

 
2,277

Cumulative credit loss at end of period
$
(7,725
)
 
$
(6,499
)
 
$
(7,725
)
 
$
(6,499
)

Cumulative credit losses related to OTTI may be reduced for securities sold as well as for securities that mature, are paid down, or are prepaid such that the outstanding principal balance is reduced to zero. Additionally, increases in cash flows expected to be collected over the remaining life of the security cause a reduction in the cumulative credit loss.
Gross Realized Gains and Losses
Gains and losses from the sale of AFS securities are recorded as realized gains (losses) within gain on investment securities in the Company’s condensed consolidated statements of comprehensive income (loss). For the three and nine months ended September 30, 2016, the Company sold AFS securities for $2.8 billion and $6.6 billion with an amortized cost of $2.8 billion and $6.5 billion for net realized gains of $31.8 million and $63.3 million, respectively. For the three and nine months ended September 30, 2015, the Company sold AFS securities for $1.1 billion and $3.7 billion with an amortized cost of $1.0 billion and $3.4 billion for net realized gains of $66.5 million and $259.8 million, respectively.
The following table presents the gross realized gains and losses on sales of AFS securities for the three and nine months ended September 30, 2016 and 2015:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Gross realized gains
$
31,942

 
$
75,427

 
$
77,836

 
$
269,314

Gross realized losses
(164
)
 
(8,955
)
 
(14,487
)
 
(9,511
)
Total realized gains on sales, net
$
31,778

 
$
66,472

 
$
63,349

 
$
259,803



15


TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

Note 5. Residential Mortgage Loans Held-for-Sale, at Fair Value
Residential mortgage loans held-for-sale consists of residential mortgage loans carried at fair value as a result of a fair value option election. The following table presents the carrying value of the Company’s residential mortgage loans held-for-sale as of September 30, 2016 and December 31, 2015:
(in thousands)
September 30,
2016
 
December 31,
2015
Unpaid principal balance
$
720,609

 
$
812,661

Fair value adjustment
2,565

 
(1,230
)
Carrying value
$
723,174

 
$
811,431


At September 30, 2016 and December 31, 2015, the Company pledged residential mortgage loans with a carrying value of $632.7 million and $745.5 million, respectively, as collateral for repurchase agreements and FHLB advances. See Note 15 - Repurchase Agreements and Note 17 - Federal Home Loan Bank of Des Moines Advances.

Note 6. Residential Mortgage Loans Held-for-Investment in Securitization Trusts, at Fair Value
The Company purchases subordinated debt and excess servicing rights from securitization trusts sponsored by either third parties or the Company’s subsidiaries. The underlying residential mortgage loans held by the trusts, which are consolidated on the Company’s condensed consolidated balance sheets, are classified as residential mortgage loans held-for-investment in securitization trusts and carried at fair value as a result of a fair value option election. See Note 3 - Variable Interest Entities for additional information regarding consolidation of the securitization trusts. The following table presents the carrying value of the Company’s residential mortgage loans held-for-investment in securitization trusts as of September 30, 2016 and December 31, 2015:
(in thousands)
September 30,
2016
 
December 31,
2015
Unpaid principal balance
$
3,499,285

 
$
3,143,515

Fair value adjustment
120,752

 
30,212

Carrying value
$
3,620,037

 
$
3,173,727


Note 7. Commercial Real Estate Assets
The Company originates and purchases commercial real estate debt and related instruments generally to be held as long-term investments. These assets are classified as commercial real estate assets on the condensed consolidated balance sheets. Additionally, the Company is the sole certificate holder of a trust entity that holds a commercial real estate loan. The underlying loan held by the trust is consolidated on the Company’s condensed consolidated balance sheet and classified as commercial real estate assets. See Note 3 - Variable Interest Entities for additional information regarding consolidation of the trust. Commercial real estate assets are reported at cost, net of any unamortized acquisition premiums or discounts, loan fees and origination costs as applicable, unless the assets are deemed impaired.

16


TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

The following tables summarize the Company’s commercial real estate assets by asset type, property type and geographic location as of September 30, 2016 and December 31, 2015:
 
September 30,
2016
 
December 31,
2015
(in thousands)
Mezzanine Loans
 
First Mortgages
 
Total
 
Mezzanine Loans
 
First Mortgages
 
Total
Unpaid principal balance
$
139,334

 
$
983,463

 
$
1,122,797

 
$
153,913

 
$
513,433

 
$
667,346

Unamortized (discount) premium
(42
)
 
(190
)
 
(232
)
 
(237
)
 

 
(237
)
Unamortized net deferred origination fees
(380
)
 
(7,637
)
 
(8,017
)
 
(830
)
 
(5,326
)
 
(6,156
)
Carrying value
$
138,912

 
$
975,636

 
$
1,114,548

 
$
152,846

 
$
508,107

 
$
660,953

Unfunded commitments
$
1,580

 
$
93,761

 
$
95,341

 
$
1,900

 
$
50,334

 
$
52,234

Number of loans
6

 
22

 
28

 
6

 
12

 
18

Weighted average coupon
8.4
%
 
4.9
%
 
5.3
%
 
8.1
%
 
4.5
%
 
5.4
%
Weighted average years to maturity (1)
1.8

 
3.1

 
2.9

 
2.6

 
3.3

 
3.1

____________________
(1)
Based on contractual maturity date. Certain loans are subject to contractual extension options which may be subject to conditions as stipulated in the loan agreement. Actual maturities may differ from contractual maturities stated herein as certain borrowers may have the right to prepay with or without paying a prepayment penalty. The Company may also extend contractual maturities in connection with loan modifications.

(in thousands)
September 30,
2016
 
December 31,
2015
Property Type
Carrying Value
 
% of Commercial Portfolio
 
Carrying Value
 
% of Commercial Portfolio
Retail
$
237,007

 
21.3
%
 
$
185,883

 
28.1
%
Hotel
85,520

 
7.7
%
 
80,843

 
12.2
%
Industrial
104,929

 
9.4
%
 

 
%
Multifamily
208,265

 
18.7
%
 
139,011

 
21.1
%
Office
478,827

 
42.9
%
 
255,216

 
38.6
%
Total
$
1,114,548

 
100.0
%
 
$
660,953

 
100.0
%
(in thousands)
September 30,
2016
 
December 31,
2015
Geographic Location
Carrying Value
 
% of Commercial Portfolio
 
Carrying Value
 
% of Commercial Portfolio
West
$
180,943

 
16.2
%
 
$
131,488

 
19.9
%
Southeast
104,688

 
9.4
%
 
79,118

 
12.0
%
Southwest
266,238

 
23.9
%
 
161,721

 
24.4
%
Northeast
491,503

 
44.1
%
 
238,913

 
36.2
%
Midwest
71,176

 
6.4
%
 
49,713

 
7.5
%
Total
$
1,114,548

 
100.0
%
 
$
660,953

 
100.0
%
 

17


TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

At September 30, 2016 and December 31, 2015, the Company pledged commercial real estate assets with a carrying value of $997.2 million and $361.1 million, respectively, as collateral for repurchase agreements and FHLB advances. See Note 15 - Repurchase Agreements and Note 17 - Federal Home Loan Bank of Des Moines Advances.
The following table summarizes activity related to commercial real estate assets for the three and nine months ended September 30, 2016 and 2015.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Balance at beginning of period
$
926,377

 
$
45,605

 
$
660,953

 
$

Originations and purchases
190,100

 
246,644

 
470,547

 
292,200

Repayments
(908
)
 

 
(15,295
)
 

Net discount accretion (premium amortization)
64

 
49

 
204

 
98

(Increase) decrease in net deferred origination fees
(2,858
)
 
(1,517
)
 
(6,867
)
 
(1,517
)
Amortization of net deferred origination fees
1,773

 
129

 
5,006

 
129

Allowance for loan losses

 

 

 

Balance at end of period
$
1,114,548

 
$
290,910

 
$
1,114,548

 
$
290,910


The Company evaluates each loan for impairment at least quarterly by assessing the risk factors of each loan and assigning a risk rating based on a variety of factors. Risk factors include property type, geographic and local market dynamics, physical condition, leasing and tenant profile, projected cash flow, loan structure and exit plan, loan-to-value ratio, project sponsorship, and other factors deemed necessary. Risk ratings are defined as follows:

1 –
Lower Risk
2 –
Average Risk
3 –
Acceptable Risk
4 –
Higher Risk: A loan that has exhibited material deterioration in cash flows and/or other credit factors, which, if negative trends continue, could be indicative of future loss.
5 –
Impaired/Loss Likely: A loan that has a significantly increased probability of default or principal loss.

The following table presents the number of loans, unpaid principal balance and carrying value (amortized cost) by risk rating for commercial real estate assets as of September 30, 2016 and December 31, 2015:
(dollars in thousands)
September 30,
2016
 
December 31,
2015
Risk Rating
Number of Loans
 
Unpaid Principal Balance
 
Carrying Value
 
Number of Loans
 
Unpaid Principal Balance
 
Carrying Value
1 – 3
28

 
$
1,122,797

 
$
1,114,548

 
18

 
$
667,346

 
$
660,953

4 – 5

 

 

 

 

 

Total
28

 
$
1,122,797

 
$
1,114,548

 
18

 
$
667,346

 
$
660,953


The Company has not recorded any allowances for losses as no loans are past-due and it is not deemed probable that the Company will not be able to collect all amounts due pursuant to the contractual terms of the loans.


18


TWO HARBORS INVESTMENT CORP.
Notes to the Condensed Consolidated Financial Statements (unaudited)

Note 8. Servicing Activities
Mortgage Servicing Rights, at Fair Value
One of the Company’s wholly owned subsidiaries has approvals from Fannie Mae, Freddie Mac, and Ginnie Mae to own and manage MSR, which represent the right to control the servicing of mortgage loans. The Company and its subsidiaries do not originate or directly service mortgage loans, and instead contract with fully licensed subservicers to handle substantially all servicing functions for the loans underlying the Company’s MSR. The following table summarizes activity related to MSR for the three and nine months ended September 30, 2016 and 2015.
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(in thousands)
2016
 
2015
 
2016
 
2015
Balance at beginning of period
$
427,813

 
$
437,576

 
$
493,688

 
$
452,006

Additions from purchases of servicing rights
98,224

 
67,175

 
204,435

 
75,709

Additions from sales of residential mortgage loans
242

 
752

 
764

 
1,568

Subtractions from sales of servicing rights
(60,910
)
 

 
(60,910
)
 

Changes in fair value due to:
 
 
 
 
 
 
 
Changes in valuation inputs or assumptions used in the valuation model
3,846

 
(49,449
)
 
(139,587
)
 
(63,573
)
Other changes in fair value (1)
(18,231
)
 
(12,100
)