The FHLB of Indianapolis, Indiana, is accepting REIT insurance units as members and granting them loans under criteria that are “well-established for all member classes,” which have included insurers since Congress created the system, Jeff Sanders, a spokesman, said in an e-mail. “In addition to carefully underwriting every member, the bank controls and closely values and monitors each member’s collateral position.”

The FHLB in Des Moines, Iowa, requires collateral on every loan, so the borrowing is “fully secured,” Dan Clute, its chief business officer, said in a March telephone interview. The Two Harbors subsidiary, its first REIT-related member, was put through “the same exact process” any other prospective member would face, he said.

The lending network was set up in 1932 after a string of bank failures caused by runs on deposits. In return for buying stock in the institutions and pledging collateral such as mortgages, highly rated bonds or other assets, the members receive access to low-cost, wholesale funding.

Bond Sales

The cooperatives’ lending is fueled by joint sales of bonds, now totaling $786 billion. Because of the perception the government would step in to prevent a default, they sell the debt at yields similar to Treasuries, with the notes carrying a top rating from Moody’s Investors Service and the second-best from Standard & Poor’s, the same as its U.S. ranking.

The FHFA, which Watt took over in January, monitors member activity at each bank.

“Captive insurance borrowing and membership in the FHLBank system raises a number of possible issues related to safety and soundness and access to the system,” Watt said in a speech at a conference for FHLB directors in May. “You will certainly be hearing more about this as we move forward.”

While mortgage REITs’ insurance units are overseen by state regulators, the financial health of their parent companies aren’t the responsibility of any U.S. agencies.

Two Harbors, which is managed by hedge fund Pine River Capital Management LP, linked up with the Des Moines FHLB last year. The Minnetonka, Minnesota-based REIT plans to use its membership to finance assets including mortgages that don’t qualify for government-backed guarantees before packaging those loans into bonds, according to Two Harbors Chief Investment Officer Bill Roth. The loans could also serve as a substitute for securitizations or help Two Harbors retain AAA classes if investor demand isn’t strong enough, he said.

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