Pine River’s Two Harbors Now Targets Non-Prime Mortgages

Count Two Harbors Investment Corp. among investors looking for profits in riskier home loans -- and expecting a market for bonds backed by them to re-emerge even with safer issuance showing limited signs of life.

The real-estate investment trust, whose 74 percent total return over the past three years is almost double that of peers, recently told the lenders that have been selling it big, high-quality mortgages that it’s now also seeking to purchase non-prime loans and those with low down payments, Chief Investment Officer Bill Roth said today during a conference call for analysts and investors.

“Our expectation and certainly hope would be as this market opens up and becomes fairly meaningful that a securitization market would develop,” he said. Of course, he sees the timeline as “probably measured in years, not months.”

After firms such as Two Harbors and its manager Pine River Capital Management LP made a killing gobbling up at distressed values the bonds backed by subprime and other risky mortgages that fueled the 2008 financial crisis, higher prices for those so-called legacy non-agency securities are reducing potential returns on additional purchases, pushing the companies to look this year for ways to put money to work in riskier new loans.

‘Extra Care’

Others targeting the debt include Lone Star Funds, Western Asset Management Co. and Macquarie Group Ltd., which are each partnering with one or more originators. Another option is to wait for the loans to get made and bid on packages offered for sale by lenders, which a mortgage REIT managed by Apollo Global Management LLC said yesterday has started in small sizes.

Like the others, Two Harbors sees potential untapped demand among borrowers who represent acceptable risks and just “need extra care” in underwriting amid the “tight credit standards that exist today,” Roth said.

“We obviously want to make loans where the borrowers can afford the house and can make the payment,” he said. “If that is accomplished we’re going to have happy borrowers and good loans.”

Packaging such mortgages into bonds would expand the amount of capital available and create leverage that amplifies returns for those taking the most risk. Still, issuance of non-agency bonds tied to new loans totals only about $7 billion this year, down from $1.2 trillion in each of 2005 and 2006, according to data compiled by Bloomberg.

Bank Competition

Hefty demand from banks for the so-called jumbo prime mortgages used to create the recent bonds has pushed sales down from $13.4 billion last year. Two Harbors’s own growing issuance of bonds backed by jumbo mortgages too big for the government-backed programs that dominate the mortgage market shows that investor appetite also remains a hurdle.

The REIT, which would prefer to retain just the higher-yielding junior portions of the deals, was holding about $390 million of the top-rated slices as of Sept. 30, up from about $180 million, according to its disclosures. Its two deals completed last quarter were backed by $642 million of loans, Bloomberg data show.

The membership that the REIT gained last year in the government-chartered Federal Home Loan Bank system gives it flexibility, Chief Executive Officer Thomas Siering said on the call. While the FHLBs’ regulator has proposed changes that could end up kicking out REITs such as Two Harbors, the company said it expanded its borrowing capacity by $1 billion to $2.5 billion last quarter.

Being able to finance the securities with an FHLB “gives us the ability to wait for what we consider to be a sunnier day for the AAA space,” said Siering. He added that he believes “our mission aligns well’ with the system’s and poses no risk to it.

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