We are very pleased with our fourth-quarter performance and book value of $7.63, which represents a 5.8% quarterly return on book value.
We have spent a significant amount of resources over the years building out our MSR acquisition and oversight platform, and we reaped some benefits this quarter as we added over $40 billion of unpaid principal balance of MSR through both our flow sale channel and bulk purchases.
Finally, as a reflection of all of these trends and with the confidence in our forward outlook, we also raised the common stock dividend this quarter by 21% to $0.17 per share.
Subsequent to quarter end, we issued $287 million of a new convertible note maturing in 2026 and whose proceeds were primarily used to refinance the existing convertible note that is maturing in January 2022.
As a consequence of the events of the first quarter, our ratio of preferred stock to total equity had increased from 20% to about 32%.
After the call was completed on March 15, our new ratio of preferred stock to total equity will be about 26%, which we think is appropriate for our Agency plus MSR portfolio.
Purchases in our MSR flow program grew by over 136% year over year, reflecting the strength of the platform and relationships we've built to source and manage the asset.
Results for 2020 as a whole were disappointing to be sure as book value declined to $7.63 from $14.54, a result of the market volatility and dislocation induced by the pandemic.
In many ways, we think of our newly internalized company as Two Harbors 2.0, and we are really excited for 2021 and the years ahead.
We generated comprehensive income of $113.5 million or $0.41 per common share, representing an annualized return on average common equity of 22.1%.
As Bill mentioned, our book value rose to $7.63 from $7.37 per share on September 30, resulting in a total economic return of 5.8%.
Core earnings increased to $0.30 per share from $0.28 in Q3.
Interest income decreased this quarter from $89.7 million to $72.5 million due to lower average balances and coupons as well as higher Agency amortization due to prepayments.
This decrease was partially offset by lower interest expense of $22.6 million, reflecting lower borrowing rates and average balances.
Gain on other derivatives increased from $32.9 million to $43.5 million due to higher TBA dollar roll income on higher average balances and continued roll specialness.
Roll specialness contributed $0.06 to core earnings versus $0.04 in Q3.
Expenses declined by $6.2 million, primarily due to transition to self-management and lower servicing costs.
Our portfolio yield in the quarter was 2.26%, and our net spread decreased two basis points to 1.76%.
Portfolio yield decreased by 16 basis points from 2.42% to 2.26%, primarily due to higher Agency RMBS prepayments.
Our cost of funds decreased 14 basis points from 0.64% to 0.50%, driven primarily by favorable repo rolls.
Inclusive of this impact, the annualized net spread for the aggregate portfolio was 1.96% with the benefit of 36 basis points in cost of funds.
Slide 7 highlights our strong liquidity and capital position with ample liquidity with $1.4 billion in unrestricted cash as well as $215 million in unused committed capacity on our MSR asset financing facilities.
Late in the third quarter, we also added a $200 million servicing advanced facility to provide committed capacity in the event of increased forbearances or defaults.
Our economic debt to equity at quarter end declined to 6.8 times from 7.7 times at September 30, as we decreased risk late in the quarter.
And our quarterly average economic debt to equity was 7.5 times in Q4 compared to 7.6 times in the third quarter.
With that certainty in hand and our plans to optimize the financing of our MSR asset over the coming year, we elected to redeem $275 million of preferred stock, effectively reducing our cost of capital as well as our preferred ratio to 26%.
Taken together, these actions are expected to deliver an annual net benefit to earnings of approximately $0.04 per share beginning in 2022, from the reduction in preferred dividends, offset by costs associated with the convertible debt and incremental MSR financing.
As previously noted, the fourth-quarter economic performance was primarily driven by a general spread tightening in MBS as the Federal Reserve continued its balance sheet expansion, having purchased almost 1.5 trillion MBS during Q4 so far.
As Mary noted, we did decrease risk somewhat during the quarter, reflected by lower economic debt to equity of 6.8 times.
In addition, after having increased our position size in TBA 2s to $7 billion, a significant spread tightening and resulting valuations in the quarter led us to reduce that exposure.
On net, we took our overall notional TBA exposure down by $1 billion to end the quarter at $5.2 billion.
The result has been that roll specialness in the 2% coupon has decreased significantly between mid-December and the end of January.
Additionally, we opportunistically added almost $200 million market value of interest-only securities, or IO, during the quarter.
In the lower left-hand chart, you can see that specified pool performance was mixed with a 3%, 3.5% and 4% coupon specified outperforming TBA, but flat or underperforming in both lower and higher coupons.
While we don't own any specified pools in the 2% coupon, as I mentioned earlier, we do own TBA, which outperformed by more than one point during the quarter, supported by strong Fed demand and attractive roll dynamics.
You can see that our MSR portfolio was valued at $1.6 billion as of December 31, based on $186 billion of UPB and with a gross coupon of 3.7%.
That translates into a price of about $0.86 or right around a 3.2 multiple on our existing portfolio.
The balances from the end of 2019 are also shown here, and I would highlight two things: first, our UPB is up modestly in a fast prepay environment, which is a testament to our ability to source new MSR investment; second, the weighted average coupon fell from 4.1% to 3.7%, consistent again with what you would expect in a refi environment.
We settled $23 billion UPB of new MSR through our flow program during the quarter, which represents record volume for us as we experienced our biggest three months ever.
We had some success in the bulk market and settled on $20.4 billion UPB in four separate transactions.
Primary mortgage rates have continued to grind lower with 30-year rates generally below 3% in national surveys, even with the spread between primary and secondary rates at wide levels.
The main change in our effective positioning was a decrease in the 2.5% and 4% coupons, a result of the specified pool activity I mentioned earlier.
The lower left-hand chart shows our common book value exposure to 25 basis point spread widening or tightening, and it indicates that book value would decrease by only 2.7% in an instantaneous 25 basis point spread winding.
In aggregate, this 2.7% exposure is lower than in recent quarters due to the reduction in specified pools and TBA positioning.
What we have here is 10 years of daily option adjusted spread data on the JPMorgan mortgage index with the x-axis being the OAS.
As of January 4, the OAS was 16 basis points and as highlighted by the vertical blue line.
This data shows that it's quite common for spreads to widen 20 or 30 basis points in the year that follows.
In fact, in the past 10 years, there are exactly 0 instances when spreads were unchanged, let alone tighter one year later.
You can see that at the OAS level of 16 basis points, historically, we've observed spreads move around 20 basis points wider over the next year.
And in that case, the one-year return would be expected to be negative around down 1% in the Agency-Only example.

Summary:
We are very pleased with our fourth-quarter performance and book value of $7.63, which represents a 5.8% quarterly return on book value.
Results for 2020 as a whole were disappointing to be sure as book value declined to $7.63 from $14.54, a result of the market volatility and dislocation induced by the pandemic.
As Bill mentioned, our book value rose to $7.63 from $7.37 per share on September 30, resulting in a total economic return of 5.8%.
Core earnings increased to $0.30 per share from $0.28 in Q3.