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EX-32.2 - CFO CERT - TWO HARBORS INVESTMENT CORP.twoexh63018322.htm
EX-32.1 - CEO CERT - TWO HARBORS INVESTMENT CORP.twoexh63018321.htm
EX-31.2 - CFO CERTIFICATION - TWO HARBORS INVESTMENT CORP.twoexh63018312.htm
EX-31.1 - CEO CERTIFICATION - TWO HARBORS INVESTMENT CORP.twoexh63018311.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: June 30, 2018

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.)
575 Lexington Avenue, Suite 2930
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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
 
 
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
 
 
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 August 7, 2018 there were 248,072,557 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 (unaudited)
(in thousands, except share data)
ASSETS
June 30,
2018
 
December 31,
2017
Available-for-sale securities, at fair value
$
19,293,354

 
$
21,220,819

Mortgage servicing rights, at fair value
1,450,261

 
1,086,717

Residential mortgage loans held-for-sale, at fair value
28,813

 
30,414

Cash and cash equivalents
417,515

 
419,159

Restricted cash
564,705

 
635,836

Accrued interest receivable
61,108

 
68,309

Due from counterparties
35,385

 
842,303

Derivative assets, at fair value
257,917

 
309,918

Other assets
166,930

 
175,838

Total Assets
$
22,275,988

 
$
24,789,313

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities
 
 
 
Repurchase agreements
$
17,205,823

 
$
19,451,207

Federal Home Loan Bank advances
865,024

 
1,215,024

Revolving credit facilities
170,000

 
20,000

Convertible senior notes
283,268

 
282,827

Derivative liabilities, at fair value
39,429

 
31,903

Due to counterparties
25,957

 
88,898

Dividends payable
96,219

 
12,552

Accrued interest payable
84,296

 
87,698

Other liabilities
25,727

 
27,780

Total Liabilities
18,795,743

 
21,217,889

Stockholders’ Equity
 
 
 
Preferred stock, par value $0.01 per share; 50,000,000 shares authorized:
 
 
 
8.125% Series A cumulative redeemable: 5,750,000 and 5,750,000 shares issued and outstanding, respectively ($143,750 liquidation preference)
138,872

 
138,872

7.625% Series B cumulative redeemable: 11,500,000 and 11,500,000 shares issued and outstanding, respectively ($287,500 liquidation preference)
278,094

 
278,094

7.25% Series C cumulative redeemable: 11,800,000 and 11,800,000 shares issued and outstanding, respectively ($295,000 liquidation preference)
285,584

 
285,571

Common stock, par value $0.01 per share; 450,000,000 shares authorized and 175,470,398 and 174,496,587 shares issued and outstanding, respectively
1,755

 
1,745

Additional paid-in capital
3,678,586

 
3,672,003

Accumulated other comprehensive (loss) income
(34,933
)
 
334,813

Cumulative earnings
2,850,985

 
2,386,604

Cumulative distributions to stockholders
(3,718,698
)
 
(3,526,278
)
Total Stockholders’ Equity
3,480,245

 
3,571,424

Total Liabilities and Stockholders’ Equity
$
22,275,988

 
$
24,789,313

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

1


TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)
(in thousands, except share data)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2018
 
2017
 
2018
 
2017
Interest income:
 
 
 
 
 
Available-for-sale securities
$
183,467

 
$
149,910

 
$
374,183

 
$
285,237

Residential mortgage loans held-for-investment in securitization trusts

 
30,826

 

 
62,454

Residential mortgage loans held-for-sale
349

 
503

 
656

 
901

Other
3,544

 
3,502

 
6,540

 
5,303

Total interest income
187,360

 
184,741

 
381,379

 
353,895

Interest expense:
 
 
 
 
 
 
 
Repurchase agreements
97,812

 
43,806

 
184,392

 
76,062

Collateralized borrowings in securitization trusts

 
24,843

 

 
50,229

Federal Home Loan Bank advances
4,896

 
11,444

 
9,354

 
20,237

Revolving credit facilities
999

 
597

 
1,803

 
1,026

Convertible senior notes
4,707

 
4,591

 
9,425

 
8,412

Total interest expense
108,414

 
85,281

 
204,974

 
155,966

Net interest income
78,946

 
99,460

 
176,405

 
197,929

Other-than-temporary impairments:
 
 
 
 

 

Total other-than-temporary impairment losses
(174
)
 
(429
)
 
(268
)
 
(429
)
Other income (loss):
 
 
 
 
 
 
 
(Loss) gain on investment securities
(31,882
)
 
31,249

 
(52,553
)
 
(21,103
)
Servicing income
77,665

 
51,308

 
148,855

 
91,081

Gain (loss) on servicing asset
9,853

 
(46,630
)
 
81,660

 
(61,195
)
Gain (loss) on interest rate swap and swaption agreements
29,133

 
(76,710
)
 
179,678

 
(66,783
)
Gain (loss) on other derivative instruments
7,675

 
(19,540
)
 
15,728

 
(47,404
)
Other income
730

 
3,126

 
1,788

 
12,622

Total other income (loss)
93,174

 
(57,197
)
 
375,156

 
(92,782
)
Expenses:
 
 
 
 
 
 
 
Management fees
11,453

 
9,847

 
23,161

 
19,655

Servicing expenses
11,539

 
11,296

 
26,093

 
16,594

Other operating expenses
15,515

 
17,471

 
30,007

 
31,235

Total expenses
38,507

 
38,614

 
79,261

 
67,484

Income from continuing operations before income taxes
133,439

 
3,220

 
472,032

 
37,234

(Benefit from) provision for income taxes
(6,051
)
 
8,759

 
(2,267
)
 
(15,758
)
Net income (loss) from continuing operations
139,490

 
(5,539
)
 
474,299

 
52,992

Income from discontinued operations, net of tax

 
14,197

 

 
27,651

Net income
139,490

 
8,658

 
474,299

 
80,643

Income from discontinued operations attributable to noncontrolling interest

 
40

 

 
40

Net income attributable to Two Harbors Investment Corp.
139,490

 
8,618

 
474,299

 
80,603

Dividends on preferred stock
13,747

 
4,285

 
27,494

 
4,285

Net income attributable to common stockholders
$
125,743

 
$
4,333

 
$
446,805

 
$
76,318

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

2


TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited), continued
(in thousands, except share data)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2018
 
2017
 
2018
 
2017
Basic earnings per weighted average common share:
 
 
 
 
 
 
 
Continuing operations
$
0.72

 
$
(0.06
)
 
$
2.55

 
$
0.28

Discontinued operations

 
0.08

 

 
0.16

Net income
$
0.72

 
$
0.02

 
$
2.55

 
$
0.44

Diluted earnings per weighted average common share:
 
 
 
 
 
 
 
Continuing operations
$
0.68

 
$
(0.06
)
 
$
2.36

 
$
0.28

Discontinued operations

 
0.08

 

 
0.16

Net income
$
0.68

 
$
0.02

 
$
2.36

 
$
0.44

Dividends declared per common share
$
0.47

 
$
0.52

 
$
0.94

 
$
1.02

Weighted average number of shares of common stock:
 
 
 
 
 
 
 
Basic
175,451,989

 
174,473,168

 
175,299,822

 
174,378,095

Diluted
193,212,877

 
174,473,168

 
193,016,793

 
174,378,095

Comprehensive income:
 
 
 
 
 
 
 
Net income
$
139,490

 
$
8,658

 
$
474,299

 
$
80,643

Other comprehensive (loss) income, net of tax:
 
 
 
 
 
 
 
Unrealized (loss) gain on available-for-sale securities
(34,887
)
 
81,628

 
(379,664
)
 
155,390

Other comprehensive (loss) income
(34,887
)
 
81,628

 
(379,664
)
 
155,390

Comprehensive income
104,603

 
90,286

 
94,635

 
236,033

Comprehensive income attributable to noncontrolling interest

 
42

 

 
42

Comprehensive income attributable to Two Harbors Investment Corp.
104,603

 
90,244

 
94,635

 
235,991

Dividends on preferred stock
13,747

 
4,285

 
27,494

 
4,285

Comprehensive income attributable to common stockholders
$
90,856

 
$
85,959

 
$
67,141

 
$
231,706

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


3


TWO HARBORS INVESTMENT CORP. 
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (unaudited)
(in thousands, except share data)
 
Series A
Preferred Stock
 
Series B
Preferred Stock
 
Series C
Preferred Stock
 
Common Stock Par Value
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Cumulative Earnings
 
Cumulative Distributions to Stockholders
 
Total Stockholders’ Equity
 
Non-
controlling Interest
 
Total Equity
Balance, December 31, 2016
$

 
$

 
$

 
$
1,739

 
$
3,661,711

 
$
199,227

 
$
2,038,033

 
$
(2,499,599
)
 
$
3,401,111

 
$

 
$
3,401,111

Net income

 

 

 

 

 

 
80,603

 

 
80,603

 
40

 
80,643

Other comprehensive income before reclassifications, net of tax expense of $27,014

 

 

 

 

 
151,789

 

 

 
151,789

 
2

 
151,791

Amounts reclassified from accumulated other comprehensive income, net of tax benefit of $2,722

 

 

 

 

 
3,595

 

 

 
3,595

 

 
3,595

Other comprehensive income, net of tax expense of $24,292

 

 

 

 

 
155,384

 

 

 
155,384

 
2

 
155,386

Contribution of TH Commercial Holdings LLC to Granite Point

 

 

 

 
(13,777
)
 
6

 

 

 
(13,771
)
 
195,646

 
181,875

Issuance of preferred stock, net of offering costs
138,872

 

 

 

 

 

 

 

 
138,872

 

 
138,872

Issuance of common stock, net of offering costs

 

 

 

 
256

 

 

 

 
256

 

 
256

Preferred dividends declared

 

 

 

 

 

 

 
(4,285
)
 
(4,285
)
 

 
(4,285
)
Common dividends declared

 

 

 

 

 

 

 
(177,963
)
 
(177,963
)
 

 
(177,963
)
Non-cash equity award compensation

 

 

 
7

 
8,207

 

 

 

 
8,214

 

 
8,214

Balance, June 30, 2017
$
138,872

 
$

 
$

 
$
1,745

 
$
3,656,398

 
$
354,617

 
$
2,118,636

 
$
(2,681,847
)
 
$
3,588,421

 
$
195,688

 
$
3,784,109

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


 
 
 
 
Balance, December 31, 2017
$
138,872

 
$
278,094

 
$
285,571

 
$
1,745

 
$
3,672,003

 
$
334,813

 
$
2,386,604

 
$
(3,526,278
)
 
$
3,571,424

 
$

 
$
3,571,424

Cumulative effect of adoption of new accounting principle

 

 

 

 

 
9,918

 
(9,918
)
 

 

 

 

Adjusted balance, January 1, 2018
138,872

 
278,094

 
285,571

 
1,745

 
3,672,003

 
344,731

 
2,376,686

 
(3,526,278
)
 
3,571,424

 

 
3,571,424

Net income

 

 

 

 

 

 
474,299

 

 
474,299

 

 
474,299

Other comprehensive loss before reclassifications, net of tax benefit of $658

 

 

 

 

 
(402,218
)
 

 

 
(402,218
)
 

 
(402,218
)
Amounts reclassified from accumulated other comprehensive income, net of tax benefit of $0

 

 

 

 

 
22,554

 

 

 
22,554

 

 
22,554

Other comprehensive loss, net of tax benefit of $658

 

 

 

 

 
(379,664
)
 

 

 
(379,664
)
 

 
(379,664
)
Issuance of preferred stock, net of offering costs

 

 
13

 

 

 

 

 

 
13

 

 
13

Issuance of common stock, net of offering costs

 

 

 

 
195

 

 

 

 
195

 

 
195

Preferred dividends declared

 

 

 

 

 

 

 
(27,494
)
 
(27,494
)
 

 
(27,494
)
Common dividends declared

 

 

 

 

 

 

 
(164,926
)
 
(164,926
)
 

 
(164,926
)
Non-cash equity award compensation

 

 

 
10

 
6,388

 

 

 

 
6,398

 

 
6,398

Balance, June 30, 2018
$
138,872

 
$
278,094

 
$
285,584

 
$
1,755

 
$
3,678,586

 
$
(34,933
)
 
$
2,850,985

 
$
(3,718,698
)
 
$
3,480,245

 
$

 
$
3,480,245

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

4


TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(in thousands)
 
Six Months Ended
 
June 30,
 
2018
 
2017
Cash Flows From Operating Activities:
 
 
 
Net income from continuing operations
$
474,299

 
$
52,992

Adjustments to reconcile net income from continuing operations to net cash provided by operating activities:
 
 
 
Amortization of premiums and discounts on investment securities, net
44,891

 
23,293

Amortization of deferred debt issuance costs on convertible senior notes
441

 
176

Other-than-temporary impairment losses
268

 
429

Realized and unrealized losses on investment securities
53,846

 
21,103

(Gain) loss on servicing asset
(81,660
)
 
61,195

Gain on residential mortgage loans held-for-sale
(556
)
 
(1,794
)
Gain on residential mortgage loans held-for-investment and collateralized borrowings in securitization trusts

 
(8,077
)
Realized and unrealized (gain) loss on interest rate swaps and swaptions
(162,029
)
 
56,305

Unrealized loss on other derivative instruments
22,040

 
35,111

Equity based compensation
6,398

 
8,214

Depreciation of fixed assets
348

 
550

Purchases of residential mortgage loans held-for-sale

 
(567
)
Proceeds from sales of residential mortgage loans held-for-sale

 
3,708

Proceeds from repayment of residential mortgage loans held-for-sale
1,754

 
4,532

Net change in assets and liabilities:


 
 
Decrease (increase) in accrued interest receivable
7,201

 
(10,217
)
Increase in deferred income taxes, net
(1,954
)
 
(16,078
)
(Increase) decrease in income taxes receivable
(316
)
 
80

Increase in prepaid and fixed assets
(143
)
 
(253
)
(Increase) decrease in other receivables
(2,267
)
 
4,637

Decrease in servicing advances
2,332

 
5,031

(Decrease) increase in accrued interest payable
(3,402
)
 
25,797

Increase in income taxes payable

 
51

Decrease in accrued expenses and other liabilities
(2,053
)
 
(6,695
)
Net cash provided by operating activities of discontinued operations

 
16,838

Net cash provided by operating activities
$
359,438

 
$
276,361

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

5


TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited), continued
(in thousands)
 
Six Months Ended
 
June 30,
 
2018
 
2017
Cash Flows From Investing Activities:
 
 
 
Purchases of available-for-sale securities
$
(3,221,949
)
 
$
(8,883,595
)
Proceeds from sales of available-for-sale securities
3,719,959

 
5,092,318

Principal payments on available-for-sale securities
949,116

 
627,277

Purchases of mortgage servicing rights, net of purchase price adjustments
(282,283
)
 
(266,003
)
Proceeds from sales of mortgage servicing rights
399

 
627

(Purchases) short sales of derivative instruments, net
(78,944
)
 
(33,562
)
Proceeds from sales and settlement (payments for termination and settlement) of derivative instruments, net
278,460

 
15,905

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

 
181,806

Redemptions of Federal Home Loan Bank stock
12,981

 
33,080

Increase (decrease) in due to counterparties, net
743,977

 
(54,152
)
Net cash used in investing activities of discontinued operations

 
(366,204
)
Net cash provided by (used in) investing activities
2,121,716

 
(3,652,503
)
Cash Flows From Financing Activities:
 
 
 
Proceeds from repurchase agreements
64,622,311

 
78,592,898

Principal payments on repurchase agreements
(66,867,695
)
 
(74,781,325
)
Principal payments on collateralized borrowings in securitization trusts

 
(179,717
)
Principal payments on Federal Home Loan Bank advances
(350,000
)
 
(761,238
)
Proceeds from revolving credit facilities
170,000

 
74,000

Principal payments on revolving credit facilities
(20,000
)
 
(104,000
)
Proceeds from convertible senior notes

 
282,469

Proceeds from issuance of preferred stock, net of offering costs
13

 
138,872

Proceeds from issuance of common stock, net of offering costs
195

 
256

Dividends paid on preferred stock
(25,696
)
 

Dividends paid on common stock
(83,057
)
 
(170,665
)
Net cash provided by financing activities of discontinued operations

 
370,832

Net cash (used in) provided by financing activities
(2,553,929
)
 
3,462,382

Net (decrease) increase in cash, cash equivalents and restricted cash
(72,775
)
 
86,240

Cash, cash equivalents and restricted cash of continuing operations at beginning of period
1,054,995

 
758,916

Cash, cash equivalents and restricted cash of discontinued operations at beginning of period

 
56,279

Cash, cash equivalents and restricted cash at beginning of period
1,054,995

 
815,195

Cash, cash equivalents and restricted cash at end of period
$
982,220

 
$
901,435

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

6


TWO HARBORS INVESTMENT CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited), continued
(in thousands)
 
Six Months Ended
 
June 30,
 
2018
 
2017
Supplemental Disclosure of Cash Flow Information:
 
Cash paid for interest
$
208,377

 
$
89,296

Cash paid for taxes
$
3

 
$
192

Noncash Activities:
 
 
 
Transfers of residential mortgage loans held-for-sale to other receivables for foreclosed government-guaranteed loans
$
403

 
$
2,292

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

 
$
9

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

 
$
20

Cumulative-effect adjustment for adoption of new accounting principle
$
9,918

 
$

Dividends declared but not paid at end of period
$
96,219

 
$
95,049

Reconciliation of residential mortgage loans held-for-sale:
 
 
 
Residential mortgage loans held-for-sale at beginning of period
$
30,414

 
$
40,146

Purchases of residential mortgage loans held-for-sale

 
567

Transfers to other receivables for foreclosed government-guaranteed loans
(403
)
 
(2,292
)
Transfer of fair value of mortgage servicing rights to fair value of Ginnie Mae residential mortgage loans held-for-sale upon buyout

 
(9
)
Proceeds from sales of residential mortgage loans held-for-sale

 
(3,708
)
Proceeds from repayment of residential mortgage loans held-for-sale
(1,754
)
 
(4,532
)
Realized and unrealized gains on residential mortgage loans held-for-sale
556

 
1,774

Residential mortgage loans held-for-sale at end of period
$
28,813

 
$
31,946

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 investing in, financing and managing Agency residential mortgage-backed securities, or Agency RMBS, non-Agency securities, mortgage servicing rights, or MSR, and other financial assets. 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. 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. 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.
On June 28, 2017, the Company completed the contribution of its portfolio of commercial real estate assets to Granite Point Mortgage Trust Inc., or Granite Point, a newly formed Maryland corporation intended to qualify as a REIT, externally managed and advised by Pine River, and focused on directly originating, investing in and managing senior commercial mortgage loans and other debt and debt-like commercial real estate investments. The Company contributed its equity interests in its wholly owned subsidiary, TH Commercial Holdings LLC, to Granite Point and, in exchange for its contribution, received approximately 33.1 million shares of common stock of Granite Point, which represented approximately 76.5% of the outstanding stock of Granite Point upon completion of the initial public offering, or IPO, of its common stock on June 28, 2017. On November 1, 2017, the Company distributed, on a pro rata basis, the 33.1 million shares of Granite Point common stock that it acquired in connection with the contribution to stockholders holding shares of Two Harbors common stock outstanding as of the close of business on October 20, 2017.
On April 26, 2018, the Company announced that it had entered into a definitive merger agreement pursuant to which the Company would acquire CYS Investments, Inc., or CYS, a Maryland corporation investing in primarily Agency RMBS and treated as a REIT for U.S. federal income tax purposes. The transaction was approved by the stockholders of both the Company and CYS on July 27, 2018, and the merger was completed on July 31, 2018, at which time CYS became a wholly owned subsidiary of the Company. In exchange for all of the shares of CYS common stock outstanding immediately prior to the effective time of the merger, the Company issued approximately 72.6 million new shares of common stock, as well as aggregate cash consideration of $15.0 million, to CYS common stockholders. In addition, the Company issued 3 million shares of newly classified Series D cumulative redeemable preferred stock and 8 million shares of newly classified Series E cumulative redeemable preferred stock in exchange for all shares of CYS’s Series A and Series B cumulative redeemable preferred stock outstanding prior to the effective time of the merger.

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.

8


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

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. All per share amounts, common shares outstanding and restricted shares for all prior periods presented have been adjusted on a retroactive basis to reflect the Company’s one-for-two reverse stock split effected on November 1, 2017 (refer to Note 17 - Stockholders’ Equity for additional information). 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, 2017. In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at June 30, 2018 and results of operations for all periods presented have been made. The results of operations for the three and six months ended June 30, 2018 should not be construed as indicative of the results to be expected for future periods or the full year.
Due to its controlling ownership interest in Granite Point through November 1, 2017, the Company consolidated Granite Point on its financial statements. Effective November 1, 2017 (the date the 33.1 million shares of Granite Point common stock were distributed to the Company’s common stockholders), the Company no longer has a controlling interest in Granite Point and, therefore, has deconsolidated Granite Point and its subsidiaries from its financial statements and reclassified all of Granite Point’s prior period assets, liabilities and results of operations to discontinued operations.
The Company retains debt securities and excess servicing rights purchased from securitization trusts sponsored by either third parties or the Company’s subsidiaries. The securitization trusts are considered variable interest entities, or VIEs, for financial reporting purposes and, thus, are 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 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 trust. During the majority of 2017, the Company retained the most subordinate security in each of the securitization trusts, which gave the Company the power to direct the activities of the trusts that most significantly impact the trusts’ performance and the obligation to absorb losses or the right to receive benefits of the securitization trusts that could be significant. As a result, the Company consolidated all of the securitization trusts on its condensed consolidated balance sheet. During the fourth quarter of 2017, the Company sold all of the retained subordinated securities thereby removing the Company’s power to direct the activities of the trusts and the obligation to absorb losses or the right to receive benefits of the securitization trusts. As a result, the securitization trusts are no longer consolidated on the Company’s condensed consolidated balance sheet and the remaining retained securities are included withing non-Agency available-for-sale, or AFS, securities.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make a number of significant estimates. These 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 as of the date of the 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.
Significant Accounting Policies
Included in Note 2 to the Consolidated Financial Statements of the Company’s 2017 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 six months ended June 30, 2018.
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 by 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. 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. Additionally, the Company’s centrally cleared interest rate swaps require that the Company posts an “initial margin” amount determined by the clearing exchange, which is generally intended to be set at a level sufficient to protect the exchange from the interest rate swap’s maximum estimated single-day price movement. The Company also exchanges “variation margin” based upon daily changes in fair value, as measured by the exchange.

9


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

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. As a result of amendments to rules governing certain central clearing activities, the exchange of variation margin is considered a settlement of the interest rate swap, as opposed to pledged collateral. Accordingly, beginning in the first quarter of 2018 and in subsequent periods, the Company accounts for the receipt or payment of variation margin as a direct reduction to the carrying value of the interest rate swap asset or liability. The receipt or payment of initial margin will continue to be accounted for separate from the interest rate swap asset or liability. As of December 31, 2017, variation margin pledged or received was netted on a counterparty basis and classified within restricted cash, due from counterparties, or due to counterparties on the Company’s condensed consolidated balance sheets.
The Company presents repurchase agreements subject to master netting arrangements or similar agreements on a gross basis and derivative assets and liabilities (other than centrally cleared interest rate swaps) 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 (other than variation margin on centrally cleared interest rate swaps) on a net basis, based on counterparty, in its condensed consolidated balance sheets. However, the Company does not offset repurchase agreements or derivative assets and liabilities (other than centrally cleared interest rate swaps) 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 June 30, 2018 and December 31, 2017:
 
June 30, 2018
 
 
 
 
 
 
 
Gross Amounts Not Offset with Financial Assets (Liabilities) in the Consolidated Balance Sheets (1)
 
 
(in thousands)
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
Net Amounts of Assets (Liabilities) Presented in the Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Net Amount
Assets
 
 
 
 
 
 
 
 
 
 
 
Derivative assets
$
520,557

 
$
(262,640
)
 
$
257,917

 
$
(39,429
)
 
$

 
$
218,488

Total Assets
$
520,557

 
$
(262,640
)
 
$
257,917

 
$
(39,429
)
 
$

 
$
218,488

Liabilities
 
 
 
 
 
 
 
 
 
 
 
Repurchase agreements
$
(17,205,823
)
 
$

 
$
(17,205,823
)
 
$
17,205,823

 
$

 
$

Derivative liabilities
(302,069
)
 
262,640

 
(39,429
)
 
39,429

 

 

Total Liabilities
$
(17,507,892
)
 
$
262,640

 
$
(17,245,252
)
 
$
17,245,252

 
$

 
$


10


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

 
December 31, 2017
 
 
 
 
 
 
 
Gross Amounts Not Offset with Financial Assets (Liabilities) in the Consolidated Balance Sheets (1)
 
 
(in thousands)
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
Net Amounts of Assets (Liabilities) Presented in the Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Net Amount
Assets
 
 
 
 
 
 
 
 
 
 
 
Derivative assets
$
340,576

 
$
(30,658
)
 
$
309,918

 
$
(31,903
)
 
$

 
$
278,015

Total Assets
$
340,576

 
$
(30,658
)
 
$
309,918

 
$
(31,903
)
 
$

 
$
278,015

Liabilities
 
 
 
 
 
 
 
 
 
 
 
Repurchase agreements
$
(19,451,207
)
 
$

 
$
(19,451,207
)
 
$
19,451,207

 
$

 
$

Derivative liabilities
(62,561
)
 
30,658

 
(31,903
)
 
31,903

 

 

Total Liabilities
$
(19,513,768
)
 
$
30,658

 
$
(19,483,110
)
 
$
19,483,110

 
$

 
$

____________________
(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 evaluated the new guidance and determined that interest income, gains and losses on financial instruments and income from servicing residential mortgage loans are outside the scope of ASC 606, Revenues from Contracts with Customers, or ASC 606. For income from servicing residential mortgage loans, the Company considered that the FASB Transition Resource Group members generally agreed that an entity should look to ASC 860, Transfers and Servicing, to determine the appropriate accounting for these fees and ASC 606 contains a scope exception for contracts that fall under ASC 860. As a result, the adoption of this ASU did not have a material impact on the Company’s financial condition, results of operations or financial statement disclosures.
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, results of operations or financial statement disclosures.

11


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

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. Valuation allowances for credit losses on AFS debt securities will be recognized, rather than direct reductions in the amortized cost of the investments, regardless of whether the impairment is considered to be other-than-temporary. 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 to determine the impact it may have on its condensed consolidated financial statements, which at the date of adoption, is expected to increase the allowance for credit losses with a resulting negative adjustment to retained earnings, with offsetting impacts to accumulated other comprehensive income.
Clarifying the Definition of a Business
In January 2017, the FASB issued ASU No. 2017-01, which changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. The ASU requires an entity to evaluate if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set of transferred assets and activities is not a business. The guidance also requires a business to include at least one substantive process and narrows the definition of outputs by more closely aligning it with how outputs are described in ASC 606. 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’s adoption of this ASU did not have a material impact on the Company’s financial condition, results of operations or financial statement disclosures, but will impact how the Company accounts for any future transfers of sets of assets and activities.
Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income
In February 2018, the FASB issued ASU No. 2018-02, which permits entities to reclassify tax effects stranded in accumulated other comprehensive income as a result of the Tax Cuts and Jobs Act, or TCJA, to retained earnings and requires entities to disclose whether or not they elected to reclassify the tax effects related to the TCJA as well as their policy for releasing income tax effects from accumulated other comprehensive income. 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. Early adoption of this ASU was elected and applied by recording a cumulative-effect adjustment of $9.9 million to retained earnings, with the offsetting impact to accumulated other comprehensive income as of January 1, 2018.
Accounting for Share-Based Payments to Nonemployees
In June 2018, the FASB issued ASU No. 2018-07 to simplify the accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees, with certain exceptions. Under the guidance, equity-classified nonemployee awards will be measured on and fixed at the grant date, rather than measured at fair value at each reporting date until the date at which the nonemployee’s performance is complete. 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. Early adoption of this ASU was elected subsequent to quarter-end on July 1, 2018 and applied by recording a cumulative-effect adjustment to retained earnings as of January 1, 2018, which did not have a material impact on the Company’s financial condition, results of operations or financial statement disclosures.


12


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

Note 3. Discontinued Operations
On June 28, 2017, the Company contributed its equity interests in its wholly owned subsidiary, TH Commercial Holdings LLC, to Granite Point and, in exchange for its contribution, received approximately 33.1 million shares of common stock of Granite Point, representing approximately 76.5% of the outstanding stock of Granite Point upon completion of the IPO of its common stock on June 28, 2017. On November 1, 2017, the Company distributed, on a pro rata basis, the 33.1 million shares of Granite Point common stock that it acquired in connection with the contribution to stockholders holding shares of Two Harbors common stock outstanding as of the close of business on October 20, 2017. Due to the Company’s controlling ownership interest in Granite Point through November 1, 2017, its results of operations and financial condition through such date reflect Granite Point’s commercial strategy, which includes as target assets first mortgages, mezzanine loans, B-notes and preferred equity. As of November 1, 2017, the Company no longer has a controlling interest in Granite Point and, therefore, has deconsolidated Granite Point and its subsidiaries from its financial statements and reclassified all of Granite Point’s prior period assets, liabilities and results of operations to discontinued operations. In accordance with ASC 845, Nonmonetary Transactions, the pro rata distribution of a consolidated subsidiary is recognized at carrying amount within stockholders’ equity. As a result, no gain or loss was recognized on the distribution.
Summarized financial information for the discontinued operations are presented below.
(in thousands)
November 1,
2017
Assets:
 
Commercial real estate assets
$
2,233,080

Available-for-sale securities, at fair value
12,814

Cash and cash equivalents
84,183

Restricted cash
2,838

Accrued interest receivable
6,588

Other assets
22,774

Total Assets
$
2,362,277

Liabilities:
 
Repurchase agreements
$
1,516,294

Dividends payable
48

Other liabilities
10,337

Total Liabilities
$
1,526,679


13


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

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Interest income:
 
 
 
 
 
Commercial real estate assets
$

 
$
25,840

 
$

 
$
49,410

Available-for-sale securities

 
256

 

 
502

Other

 
4

 

 
6

Total interest income

 
26,100

 

 
49,918

Interest expense

 
7,773

 

 
13,879

Net interest income

 
18,327

 

 
36,039

Expenses:
 
 
 
 
 
 
 
Management fees

 
1,925

 

 
3,587

Servicing expenses

 
307

 

 
629

Other operating expenses

 
1,900

 

 
4,173

Total expenses

 
4,132

 

 
8,389

Income from discontinued operations before income taxes

 
14,195

 

 
27,650

Benefit from income taxes

 
(2
)
 

 
(1
)
Income from discontinued operations

 
14,197

 

 
27,651

Income from discontinued operations attributable to noncontrolling interest

 
40

 

 
40

Income from discontinued operations attributable to common stockholders
$

 
$
14,157

 
$

 
$
27,611


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. The following table presents the Company’s AFS investment securities by collateral type as of June 30, 2018 and December 31, 2017:
(in thousands)
June 30,
2018
 
December 31,
2017
Agency
 
 
 
Federal National Mortgage Association
$
12,102,934

 
$
13,920,721

Federal Home Loan Mortgage Corporation
3,017,056

 
3,616,967

Government National Mortgage Association
669,001

 
701,037

Non-Agency
3,504,363

 
2,982,094

Total available-for-sale securities
$
19,293,354

 
$
21,220,819


At June 30, 2018 and December 31, 2017, the Company pledged AFS securities with a carrying value of $19.0 billion and $21.0 billion, respectively, as collateral for repurchase agreements and advances from the Federal Home Loan Bank of Des Moines, or the FHLB. See Note 13 - Repurchase Agreements and Note 14 - Federal Home Loan Bank of Des Moines Advances.
At June 30, 2018 and December 31, 2017, the Company did not have any securities purchased from and financed with the same counterparty that did not meet the conditions of ASC 860, to be considered linked transactions and, therefore, classified as derivatives.

14


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 all non-Agency securities, which are classified within available-for-sale securities, at fair value on the condensed consolidated balance sheets. As of June 30, 2018 and December 31, 2017, the carrying value, which also represents the maximum exposure to loss, of all non-Agency securities in unconsolidated VIEs was $3.5 billion and $3.0 billion, respectively.
The following tables present the amortized cost and carrying value (which approximates fair value) of AFS securities by collateral type as of June 30, 2018 and December 31, 2017:
 
June 30, 2018
(in thousands)
Principal/ Current Face
 
Un-amortized Premium
 
Accretable Purchase Discount
 
Credit Reserve Purchase Discount
 
Amortized Cost
 
Unrealized Gain
 
Unrealized Loss
 
Carrying Value
Agency
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal and interest
$
15,178,924

 
$
960,177

 
$
(24,315
)
 
$

 
$
16,114,786

 
$
9,494

 
$
(532,602
)
 
$
15,591,678

Interest-only
3,377,698

 
229,293

 

 

 
229,293

 
15,728

 
(47,708
)
 
197,313

Total Agency
18,556,622

 
1,189,470

 
(24,315
)
 

 
16,344,079

 
25,222

 
(580,310
)
 
15,788,991

Non-Agency
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal and interest
4,470,380

 
6,425

 
(664,948
)
 
(923,834
)
 
2,888,023

 
549,072

 
(7,707
)
 
3,429,388

Interest-only
5,349,634

 
73,708

 

 

 
73,708

 
3,843

 
(2,576
)
 
74,975

Total Non-Agency
9,820,014

 
80,133

 
(664,948
)
 
(923,834
)
 
2,961,731

 
552,915

 
(10,283
)
 
3,504,363

Total
$
28,376,636

 
$
1,269,603

 
$
(689,263
)
 
$
(923,834
)
 
$
19,305,810

 
$
578,137

 
$
(590,593
)
 
$
19,293,354

 
December 31, 2017
(in thousands)
Principal/ Current Face
 
Un-amortized Premium
 
Accretable Purchase Discount
 
Credit Reserve Purchase Discount
 
Amortized Cost
 
Unrealized Gain
 
Unrealized Loss
 
Carrying Value
Agency
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal and interest
$
17,081,849

 
$
1,079,246

 
$
(24,638
)
 
$

 
$
18,136,457

 
$
42,149

 
$
(134,969
)
 
$
18,043,637

Interest-only
2,941,772

 
223,289

 

 

 
223,289

 
10,955

 
(39,156
)
 
195,088

Total Agency
20,023,621

 
1,302,535

 
(24,638
)
 

 
18,359,746

 
53,104

 
(174,125
)
 
18,238,725

Non-Agency
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal and interest
3,758,134

 
2,757

 
(676,033
)
 
(653,613
)
 
2,431,245

 
488,931

 
(3,166
)
 
2,917,010

Interest-only
5,614,925

 
65,667

 

 

 
65,667

 
2,163

 
(2,746
)
 
65,084

Total Non-Agency
9,373,059

 
68,424

 
(676,033
)
 
(653,613
)
 
2,496,912

 
491,094

 
(5,912
)
 
2,982,094

Total
$
29,396,680

 
$
1,370,959

 
$
(700,671
)
 
$
(653,613
)
 
$
20,856,658

 
$
544,198

 
$
(180,037
)
 
$
21,220,819



15


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

The following tables present the carrying value of the Company’s AFS securities by rate type as of June 30, 2018 and December 31, 2017:
 
June 30, 2018
(in thousands)
 Agency
 
 Non-Agency
 
 Total
Adjustable Rate
$
20,611

 
$
3,175,732

 
$
3,196,343

Fixed Rate
15,768,380

 
328,631

 
16,097,011

Total
$
15,788,991

 
$
3,504,363

 
$
19,293,354

 
December 31, 2017
(in thousands)
Agency
 
Non-Agency
 
Total
Adjustable Rate
$
23,220

 
$
2,622,710

 
$
2,645,930

Fixed Rate
18,215,505

 
359,384

 
18,574,889

Total
$
18,238,725

 
$
2,982,094

 
$
21,220,819


The following table presents the Company’s AFS securities according to their estimated weighted average life classifications as of June 30, 2018:
 
June 30, 2018
(in thousands)
 Agency
 
 Non-Agency
 
 Total
≤ 1 year
$
7,054

 
$
82,833

 
$
89,887

> 1 and ≤ 3 years
39,666

 
109,416

 
149,082

> 3 and ≤ 5 years
275,305

 
410,861

 
686,166

> 5 and ≤ 10 years
12,156,899

 
2,151,623

 
14,308,522

> 10 years
3,310,067

 
749,630

 
4,059,697

Total
$
15,788,991

 
$
3,504,363

 
$
19,293,354


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.

16


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

The following table presents the changes for the three and six months ended June 30, 2018 and 2017 of the net unamortized discount/premium and designated credit reserves on non-Agency AFS securities.
 
Six Months Ended June 30,
 
2018
 
2017
(in thousands)
Designated Credit Reserve
 
Net Unamortized Discount/Premium
 
Total
 
Designated Credit Reserve
 
Net Unamortized Discount/Premium
 
Total
Beginning balance at January 1
$
(653,613
)
 
$
(607,609
)
 
$
(1,261,222
)
 
$
(367,437
)
 
$
(623,440
)
 
$
(990,877
)
Acquisitions
(310,985
)
 
(14,025
)
 
(325,010
)
 
(100,558
)
 
(78,796
)
 
(179,354
)
Accretion of net discount

 
44,611

 
44,611

 

 
44,301

 
44,301

Realized credit losses
14,810

 

 
14,810

 
8,424

 

 
8,424

Reclassification adjustment for other-than-temporary impairments
(268
)
 

 
(268
)
 
(429
)
 

 
(429
)
Transfers from (to)
26,222

 
(26,222
)
 

 
22,676

 
(22,676
)
 

Sales, calls, other

 
18,430

 
18,430

 
3,588

 
52,063

 
55,651

Ending balance at June 30
$
(923,834
)
 
$
(584,815
)
 
$
(1,508,649
)
 
$
(433,736
)
 
$
(628,548
)
 
$
(1,062,284
)

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 June 30, 2018 and December 31, 2017. At June 30, 2018, the Company held 1,464 AFS securities, of which 525 were in an unrealized loss position for less than twelve consecutive months and 228 were in an unrealized loss position for more than twelve consecutive months. At December 31, 2017, the Company held 1,435 AFS securities, of which 253 were in an unrealized loss position for less than twelve consecutive months and 234 were in an unrealized loss position for more than twelve consecutive months. Of the $13.5 billion and $12.2 billion of AFS securities in an unrealized loss position for less than twelve consecutive months as of June 30, 2018 and December 31, 2017, $13.1 billion, or 97.0%, and $12.0 billion, or 98.5%, respectively, were Agency AFS securities, whose principal and interest are guaranteed by the GSEs.
 
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
June 30, 2018
$
13,496,177

 
$
(404,135
)
 
$
2,291,284

 
$
(186,458
)
 
$
15,787,461

 
$
(590,593
)
December 31, 2017
$
12,198,870

 
$
(65,313
)