Bloomberg News

Pine River’s REIT Bought Subprime-Mortgage Bonds After Slump

November 04, 2011

(Adds comment from Travelers in eighth paragraph.)

Nov. 3 (Bloomberg) -- Two Harbors Investment Corp., the mortgage investor that raised about $1 billion in stock sales this year, snapped up subprime bonds last quarter after a slump in prices across the market for so-called non-agency securities.

The real estate investment trust, which is run by Minnetonka, Minnesota-based hedge fund Pine River Capital Management LP, “particularly” targeted subprime debt as it added $500 million of home-loan securities without government guarantees, said Bill Roth, its co-chief investment officer.

Debt tied to the most troubled class of homeowners was attractive because “we don’t have to count on these guys paying us back,” Roth said yesterday in a telephone interview. The securities will yield about 10 percent in scenarios including more than 80 percent defaults, he said.

Two Harbors, which reported the increase in its holdings with earnings late yesterday, joined insurer Travelers Cos. in buying bonds tied to the most-delinquent loans after a renewed rout in the $1.1 trillion non-agency market. This year’s slump began as the Federal Reserve auctioned securities in May from its bailout of American International Group Inc. and deepened as Europe’s sovereign debt crisis intensified.

Almost 40 percent of subprime loans are at least 30 days late, in foreclosure or now seized properties, even with record loan modifications, according to data compiled by Bloomberg.

‘Market Bias’

“A market bias against subprime” has created a greater opportunity as many investors are reluctant to buy securities that three years ago sparked the worst financial crisis since the Great Depression, Two Harbors Chief Executive Officer Thomas Siering said in the interview.

Travelers increased its bets on subprime and alternative- documentation mortgages last quarter by the most since 2007, adding $62 million of the bonds, according to company filings.

“Relative to the $2.7 billion of securities we purchased in the quarter and our portfolio of more than $73 billion, this is insignificant and consistent with our strategy of seeking investments with an appropriate risk-reward balance,” New York- based Travelers said in an e-mailed statement last month.

One type of subprime securities rated AAA when issued in 2007 fell to estimated prices of 31 cents on the dollar last quarter, a drop of about 7 cents this year, JPMorgan Chase & Co. data show. Similar bonds backed by adjustable-rate Alt-A mortgages, often tied to low-documentation loans, fell to approximately 47 cents, down 5 cents.

Aviva Avoids

Aviva Investors is avoiding such securities partly because they became tougher to trade and value earlier this year, said Bill Bemis, a senior fixed-income money manager at the firm, which oversees $60 billion of assets in the U.S. from Des Moines, Iowa. Data on the “still fragile” housing market is also likely to be weak for at least several months because of seasonal issues, he said.

“For us, it’s waiting for a time where we’re more comfortable there’s fundamental improvement on the horizon and where we’re comfortable with where the market is from a pricing standpoint,” Bemis said in an Oct. 27 interview.

Non-agency bonds other than subprime securities have more “downside” because “maybe the borrower’s better but they might strategically default” and unexpectedly boost foreclosures, Two Harbors’ Roth said, referring to consumers walking away from homes when they owe more than their values.

Non-agency debt climbed to 19.1 percent of the REIT’s $6.6 billion portfolio on Sept. 30, from 16.3 percent three months earlier, according to company statements. The firm also buys agency-mortgage securities.

‘Liquidity Considerations‘

Subprime bonds rose to 75 percent of non-agency holdings, from 55 percent on June 30, according to a slide prepared for a conference call with analysts today. The REIT reported yesterday third-quarter core earnings of $51.8 million, or 40 cents a share, from 35 cents a share a year earlier.

Returns on Two Harbors’ new subprime investments offering 10 percent loss-adjusted yields can be increased by borrowing against them at rates of about 2 percent and “haircuts” of from 30 percent to 50 percent, Roth said. Repurchase-agreement financing for Fannie Mae, Freddie Mac or Ginnie Mae bonds typically requires haircuts, or down payments, of less than 5 percent and with rates of less than 0.3 percent.

Yields on government-backed mortgage securities averaged 3.10 percent last quarter, Barclays Capital index data show.

American Capital Mortgage Investment Corp., the Bethesda, Maryland-based REIT that raised $160 million in an initial public offering in August, bought manly agency securities, even though it can also invest in non-agency debt.

“While the assets do present attractive cash flows, we are cognizant of the liquidity considerations and the impact on our book value as our positions get marked to market,” President Gary Kain said on an Oct. 27 conference call.

Subprime bonds have been little changed since September, losing about 0.3 percent on average, according to Bank of America Merrill Lynch index data.

--Editors: Pierre Paulden, Dan Kraut

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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