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Among mortgage REITs, hope to retain home loan bank access springs eternal

Borrowings by the captive insurance subsidiaries of mortgage real estate investment trusts from the Federal Home Loan Bank system continued to decline in 2017 as the prospective terminations of their memberships loom less than three years away.

But some in the industry remain optimistic that a regulatory or legislative solution might be found to perpetuate access to what has emerged as a readily available source of low-cost financing.

According to a review of disclosures in regulatory filings, the captive insurance affiliates of six publicly traded entities covered by S&P Global Market Intelligence as mortgage REITs maintained aggregate home loan bank borrowings of $10.27 billion as of Dec. 31, 2017, down from $10.95 billion at the end of the third quarter of 2017 and $12.90 billion a year earlier. Total borrowings by captive insurers, regardless of the nature of their parent companies, fell by $7 billion on a year-over-year basis to $24.1 billion as of Dec. 31, 2017, with a JPMorgan Chase & Co. subsidiary accountable for $11 billion of that amount.

Other mortgage REIT captive insurers maintained advances as of Dec. 31, 2016, but those borrowings were repaid soon after under the terms of a Federal Housing Finance Agency rule which prohibited their membership beyond February 2017.

The memberships of the six remaining mortgage REIT captive insurers are grandfathered under the same rule through February 2021, and they may retain borrowings beyond that date. The non-grandfathered companies were required to repay their advances in full upon the termination of their memberships.

Annaly Capital Management Inc.'s Truman Insurance Co. LLC ranked highest among the six mortgage REIT captives based on outstanding borrowings of $3.59 billion from the Federal Home Loan Bank of Des Moines. Redwood Trust Inc.'s RWT Financial LLC ranked a distant second with $2 billion in borrowings from the Federal Home Loan Bank of Chicago, followed by Invesco Mortgage Capital Inc.'s IAS Services LLC with $1.65 billion and Ladder Capital Corp's Tuebor Captive Insurance Co. LLC with $1.37 billion.

The TH Insurance Holdings Co. LLC unit of Two Harbors Investment Corp. had led the group with $4 billion of borrowings from the Des Moines home loan bank as of Dec. 31, 2016, but its advances fell to $1.22 billion at year-end 2017. The July 2017 acquisition of Chicago home loan bank member Prospect Mortgage Insurance LLC by Starwood Property Trust Inc. and subsequent borrowings made by the captive insurer, which totaled $445 million at year's end, helped partially offset Two Harbors' decline among the mortgage REIT group as a whole.

Two Harbors CFO Brad Farrell said during a February conference call that the mortgage REIT views home loan bank advances as "a valuable financing alternative for us," offering borrowing capacity to the extent the market for repurchase agreements becomes strained. He said that Two Harbors continues to "thoughtfully manage" its FHLB capacity.

Redwood Trust President Christopher Abate, during an investor day presentation, characterized his company's relationship with the Chicago home loan bank as being "incredibly important" and one that took Redwood Trust to "another level" from a capital structure perspective.

For Ladder Capital, where home loan bank borrowings declined 17.5% year over year, advance limits recently updated by the Federal Home Loan Bank of Indianapolis will gradually fall to $750 million at the start of 2021 from the lower of $2 billion, 40% of Tuebor's assets and 150% of the company's equity at present.

The mortgage REIT and several of its peers held out hope that certain scenarios, such as regulatory changes once the term of FHFA Director Melvin Watt ends in January 2019, the enactment of legislation or the filing of litigation challenging the validity of the FHFA's rule, could play out and permit them to retain home loan bank membership. Senate Bill 2361 as introduced in January would allow a captive insurer that maintained membership in the home loan bank system prior to January 2016 to continue or restore their status. The bill has been referred to the Senate Banking Committee. A similar bill was introduced in the House of Representatives in June 2017, where it too remains in committee.

"We believe our business objectives align well with the mission of the FHLB System," Annaly said in its most recent 10-K. "While there can be no assurances that such steps will be taken, we believe it would be appropriate for there to be legislative action to permit Truman and similar captive insurance subsidiaries to retain their membership status beyond the current sunset period."