Real estate investment trust Two Harbors (TWO) will continue buying subprime mortgage bonds as yields climbed and delinquencies improved over the past year.

Two Harbors has a large stake in subprime. It holds a $9.4 billion residential mortgage-backed securities portfolio. Roughly 84% of its $1.9 billion in non-agency mortgage bonds is backed by subprime loans.

“We like the subprime story because the segment is not only attractive from a valuation standpoint, but also from a performance perspective,” said Bill Roth, co-chief investment officer of Two Harbors, during a webinar Monday.

Yields on these bonds averaged 10% over the past 12 months, compared to smaller 1% or 2% yields on 5-year Treasurys and investment grade bonds, according to his presentation.

The credit crisis in 2007 began with subprime. The 60-plus day delinquency rate rose to 52% in January 2010, but declined to 42% as of May 2012, according to Lender Processing Services (LPS) data.

Subprime delinquency rates actually dipped below option adjustable-rate mortgages last year, according to a chart Roth provided (click below to expand).

Many large banks began reducing exposure to the subprime market, but some buyers may be coming back. Recent Maiden Lane sales of American International Group (AIG) subprime assets attracted much participation.

The Federal Reserve decision last week to keep interest rates low for the foreseeable future has made these subprime bonds a more attractive place for investors, analysts at Bank of America Merrill Lynch (BAC) said in a research note Monday.

“Supply continues to be limited as many view the high yielding assets, amid an improving housing picture, to be a better place to put money to work relative to ten-year treasurys which currently yield 1.67%,” analysts said.

Roth suggested there may finally be some demand returning to the sector at last.

“High volatility remains characteristic of the sector, however there seems to be a better balance of buyers and sellers today,” Roth said.


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