By Al Yoon Of DOW JONES NEWSWIRES NEW YORK -(Dow Jones)- Two Harbors Investment Corp. (TWO) on Thursday said it wasn't backing away from the cautious outlook even as others may now be more comfortable with the risks of a revised U.S. home loan refinancing program. The real estate investment trust, with a $6.6 billion portfolio, last quarter joined others in selling mortgage bonds backed by high-interest-rate loans as it became clear the Obama administration would make it easier for borrowers without home equity to refinance under a 2009 program. Two Harbors said late Wednesday that it sold $681 million in mortgage bonds seen as most vulnerable to refinancing. Some investors have started to veer from that strategy since the Federal Housing Finance Agency on Oct. 24 outlined changes, however, as most analysts doubted the new features would significantly boost refinancings. Buying has surged in higher-rate bonds, but potential pitfalls for those MBS persists, warned Bill Roth, co-chief investment officer of Two Harbors in New York. "It's a huge focus in Washington, they really want to try and make this work," Roth said of the Home Affordable Refinance Program. "I think there's a huge amount of pressure to do something that works" during a presidential election season. Potential for faster refinancing has unnerved investors in the $5 trillion market for mortgage-backed securities of Fannie Mae and Freddie Mac this year as more government involvement distorts predictability. MBS are also hovering at record high prices, setting them up for steep falls as refinancings lead to "prepayments" of principal at face value, or 100 cents on the dollar. Roth's concern is reflected in the portfolio's prepayment rate of 5% over the past two quarters, the lowest among similar REITs, according to Keefe, Bruyette & Woods. Agency MBS prepayment rates last quarter at mortgage REITs Invesco Mortgage Capital and Annaly Capital Management rose, though those firms this week also said their portfolios were protected from a refinancing pick-up. Under the new plan, the Federal Housing Finance Agency, which regulates government-owned mortgage-securities issuers Fannie Mae and Freddie Mac, will allow refinancing of loans guaranteed by those agencies no matter the home's value. The FHFA also will extend the term of HARP though 2013 and will waive some liabilities to banks, giving the lenders more incentive to close loans with risky characteristics. Since 2009, only 894,000 borrowers have used the HARP, of which just 70,000 were significantly underwater. The FHFA said the changes "may roughly double or more" the number of homeowners who enroll, while analysts at Barclays Capital estimated up to 3.1 million loans are eligible for the program. The FHFA is due to give more details at midmonth, including how it plans to relieve banks of liability of their "representations and warranties" if a refinancing reveals faults in the initial loan. "That's the $64,000 question," Roth said on a conference call with analysts. Representations and warranties are the "big wildcard" for whether the plan reaches more or less borrowers than expected, he said. Bets that many underwater loans will not meet new HARP rules, or that banks will be too busy refinancing more preferable loans, have sparked renewed interest in the high-coupon MBS, however. Fannie Mae MBS paying 6% interest have recovered their losses since the FHFA announcement, trading up 2/32 to 109-23/32 on Thursday. Lower-coupon MBS fell, according to Credit Suisse. Roth said that the high-coupon 30-year MBS Two Harbors sold at price above 110 last quarter were still lower today. In their place, the firm bought 4%-4.5% MBS with low principal balances that require a bigger drop in interest rates to make the cost of a refinancing worthwhile. Two Harbors has also increased its allocation to nonguaranteed residential mortgage bonds to take advantage of price drops in recent months. -By Al Yoon, Dow Jones Newswires; 212-416-3216; albert.yoon@dowjones.com
