Two Harbors Investment’s (TWO) recent second-quarter earnings depicted just how far the mortgage real estate investment trust has fallen in profit.

But it's not all bad news, the company still retains a positive outlook from FBR Capital Markets, with an outperform rating.

The mREIT reported a net income of $39.68 million in the second quarter of 2014, down nearly 90% from the $388.64 million the real estate investment trust earned in the second quarter of 2013.

However, this fell right in line with FBR’s estimate of $0.24 and only modestly below the Street at $0.25. 

While FBR has spent some time discussing Two Harbor's initiative to purchase mortgage-servicing rights, this quarter, FBR said, “The main takeaway for us was substantial progress on one of its other key initiatives, building up its mortgage loan conduit business.”

“Specifically, at the end of the quarter, Two Harbors had $377 million in prime jumbo loans awaiting securitization. Recently, the company completed its second securitization, Agate Bay 2014-1, a $268 million deal backed by 334 prime jumbo loans,” FBR said.

 “It is in our opinion that successful execution across all of its initiatives will help to further differentiate Two Harbors from the rest of the mREIT pack,” the FBR stated. “We think this should lead to the stock having the best chance to start trading back above book value as the market starts recognizing that Two Harbors is becoming a diversified mortgage finance company with franchise value across the platform, rather than a simple mortgage REIT,” it continued.  

Here are the two areas that remain key for the mREIT:

1. The success of FHLB

In the first quarter of 2014, the company drew down $465 million at a rate of ~40 basis points and a 2.8-year maturity on its advance line with the Des Moines FHLB. During the quarter, the company further drew down in its line up to the $1.5 billion committed maximum. The weighted average borrowing rate is 0.4% with a weighted average maturity of 47 months. The company has $1.65 billion of pledged collateral against the lines, of which nearly all are highly rated securities ($1.355 billion).

Although the line is fully advanced at this point, we think the pledged collateral is fungible, and inasmuch, we would expect to see Two Harbors look to swap collateral more toward residential prime whole loans as a means of utilizing the facility as attractively priced warehouse financing.

2. MSRs on MSRs

In the second quarter, Two Harbors added $5.3 billion in unpaid principal balance to its MSR portfolio. Specifically, the company completed a $4.8 billion UPB purchase from Flagstar Bank. Two Harbors paid $50 million for the underlying pool of Fannie Mae loans, nearly all of which are new production

Two Harbors also purchased $545 million in UPB from its flow agreement with PHH Mortgage Corporation. In April, the company also completed a $5 billion UPB bulk purchase, paying around $50 million, primarily of new Fannie Mae production. At the end of the quarter, the total UPB here was $45.6 billion, and the MSR stood at $500.5 million on a fair value basis. We estimate that Two Harbors earned a gross 22% ROE on servicing income from the MSR and a 10.9% ROE net of amortization expense.