Two Harbors Investment Corp (TWO): This mREIT Will Fly High on MSR Approval Despite Target Price Reduction

Competition

Two Harbors Investment Corp (NYSE:TWO) competes with other mortgage REITs, including American Capital Agency Corp. (NASDAQ:AGNC) and Annaly Capital Management, Inc. (NYSE:NLY). Both American Capital Agency and Annaly Capital Management, Inc. (NYSE:NLY) are exclusively invested in fixed rate residential mortgage backed securities for which interest and principal payments are guaranteed by any of the government Agencies. However, the investment portfolios of both vary. American Capital Agency Corp. (NASDAQ:AGNC) possesses a portfolio that has high prepayment protection attributes. Its portfolio is low coupon, HARP eligible, and has low loan-to-value securities. These attributes have led American Capital Agency Corp. (NASDAQ:AGNC) to report one of the lowest CPRs during times of accelerated refinancing.

On the other hand, Annaly Capital’s bottom line was hurt significantly during the past two quarters due to accelerated refinancing. The refinancing accelerated prepayments on Annaly’s securities. Annaly Capital Management, Inc. (NYSE:NLY) has a portfolio composed of high coupon and high loan-to-value securities. This is why its portfolio is more exposed to prepayments. It reported 19% CPR at the end of the fourth quarter of the prior year, which is one of the highest among pure-play mREITs.

Conclusion

Despite the fact the Two Harbors Investment Corp (NYSE:TWO)’ price target has been downgraded by Credit Suisse, I believe the stock offers growth potential. Therefore, I recommend it as a buy. The MSR approvals will bring attractive returns during the prevailing environment where interest rates are increasing. Besides, MSRs will act as a hedge against a drop in book value. Therefore, the target price reduction should not be a concern.

Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.