An ongoing legal battle between Two Harbors Investment Corp. (TWO) and the parent company of United Wholesale Mortgage (UWM) has escalated, with TWO countersuing the lender over alleged breach of contract, fraud and negligent misrepresentation.

The companies have been at odds since March, when Two Harbors terminated an all-stock merger agreement with UWM in favor of a competing all-cash offer from CrossCountry Mortgage (CCM). A protracted bidding war ensued, with CCM ultimately prevailing and acquiring the coveted mortgage servicing rights (MSRs) of TWO affiliate RoundPoint Mortgage Servicing.

TWO’s counterclaims follow a complaint filed by UWM in August, two weeks before the TWO-CCM merger closed. UWM claimed Two Harbors violated nonsolicitation terms of its prior merger agreement with UWM by allegedly encouraging CrossCountry to make a competing offer.

Two Harbors has denied the accusation and is suing for reimbursement of the $25.4 million fee it paid to UWM for terminating the initial agreement, plus damages and interest.

A lost bet

TWO’s argument hinges on the timing and disclosure of a failed derivatives trade put on by UWM.

Disclosed during UWM’s second-quarter earnings call in August, the highly leveraged trade — which UWM CEO Mat Ishbia claimed was a pre-hedging strategy against the MSRs the company planned to acquire through the TWO deal — resulted in a $603 million loss after interest rates rose.

TWO argues that UWM should have disclosed the existence of that derivatives trade months earlier, and that failure to do so violated a notification covenant in the merger agreement for transactions having a potentially material adverse effect.

“If TWO had known about UWM’s highly speculative and massive interest-rate trade in breach of the ordinary-course covenant, TWO would promptly have terminated the agreement without having to pay the termination fee,” the counterclaim states.

Two Harbors also questioned the veracity of the pre-hedging narrative in the court filing, characterizing the trade instead as a speculative bet to prop up declining company earnings.

“Even if this position were really a ‘pre-hedge’ for TWO’s MSR portfolio — which makes no sense because it was an order of magnitude too large — then UWM should have taken it off after termination because it no longer had any need to hedge, was facing mounting losses, and had to keep a substantial amount of cash as margin,” the filing states. “Instead, UWM continued to add to the position after the UWM Merger Agreement was terminated, kept the derivative trade on for months, and continued to maintain the appearance of seeking to merge with TWO.”

UWM’s stance

In its complaint filed in August in a Maryland-based U.S. district court, UWM contended that Two Harbors’ management team was “driven by pride, greed and self-interest” and sabotaged the deal in favor of CCM’s proposal once it realized that UWM didn’t plan to keep TWO’s existing operations or leadership team post-merger.

The wholesale lender characterized TWO’s business as being “on the ropes,” but saw “tremendous promise” in acquiring its MSR book and revamping its servicing operations.

UWM also alleged that Two Harbors leadership was motivated to accept the CCM offer due to “accelerated cash payment of lucrative ‘golden parachute’ benefits to TWO’s management upon closing.”

UWM seeks to recover more than $500 million in damages.

A company spokesperson did not immediately respond to a request for comment on the counterclaims.