Redwood Trust's recent RMBS deal has been lauded by Fitch Ratings as implementing several important structural features that further reduced credit risk exposure for its senior bond investors. These are an improvement over 2005-2007 vintage prime deals.

According to Fitch, the transaction utilizes a traditional senior subordinate structure, shifting the interest for the distributions of principal and interest and allocation of losses. 

The latest deal from Redwood, Sequoia Mortgage Passthrough Certificates Series 2011-1 (SEMT 2011-1), does not allow for the timing of increased payments to subordinate classes to be accelerated if mortgage prepayments exceeded expectations. "The absence of this 'early step-down' feature will help retain subordinated credit protection for senior classes," Fitch analysts said.

SEMT 2011-1 also contains a subordination floor, which provides for a minimum amount of credit support throughout the life of the deal for the benefit of the senior tranche. Fitch believes the subordination floor will help mitigate tail risk for the senior class as the number of loans in the mortgage pool decline and mortgage pool performance becomes increasingly volatile.

In traditional shifting-interest structures, payments to subordinate classes increase after a number of years if performance measures are met. This results in reduced credit protection for more senior classes as the deal seasons. However, unlike most prior prime transactions, subordination in SEMT 2011-1 cannot be reduced below 1.25% of the original mortgage pool balance. This, Fitch said, mitigates the impact of performance volatility arising from a few loans becoming delinquent towards the end of the deal.

Another aspect that the rating agency said highlights structural improvement is SEMT 2011-1 arbitration for breaches of representation and warranties. Under the deal structure, a review by the master servicer of any and all loans that become 120 or more days delinquent will be conducted to determine if there are any breaches of representations and warranties.

If there is a breach that the seller cannot cure, the seller is obligated to repurchase the loan no later than 120 days following discovery of the breach. If a resolution to a breach is not satisfactory to both the seller and the originator, either party may enter into arbitration. The finding of the arbitrator shall be final and binding upon the parties. The enhanced clarity of the process for any such breaches is viewed by Fitch to benefit the trust's performance.

However, Redwood Trust's handling of representations and warranties does not address the regulatory changes highlighted under Dodd-Frank's new regulatory approach to handling and reporting repurchases. Redwood has no disclosure regarding its repurchase history — just textual descriptions of the repurchase obligations and provisions.

"The item that is mentioned by Fitch as a positive in the repurchase area is a glass half full or half empty, depending on who is looking at the glass," said Kenneth Kohler, senior of counsel at Morrison & Foerster.  "Fitch applauds the repurchase procedure for its clarity in setting forth who has the right and obligation to review defaulted mortgage loans for rep and warranty breaches, what the time frames are, and what the procedure is for resolving disagreements — mandatory arbitration. "

He said that, on the one hand, this procedure is tighter and more specific than the standard provisions in past deals, and therefore gives the issuer less wiggle room for negotiation (or in the eyes of many investors, evasion) than the traditional procedures.

"The Redwood approach is less favorable to investors than the process specified under the proposed Reg AB II for deals done off shelf registration statements (as the Redwood deals are), in which an issuer must repurchase a loan unless an independent, third-party reviewer actually issues an opinion that there was no breach of a rep and warranty," he said. 

He added that given the likely difficulty in obtaining such opinions, and the fact that the Reg AB II procedure does not seem to leave room for a settlement or compromise that one might achieve in arbitration, the proposed Reg AB II procedure seems heavily weighted in favor of investors.

Many commenters, he said, opposed the proposed Reg AB II formulation and an arbitration procedure like Redwood's is the principal alternative advanced by the industry as being more workable and fair.

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