The private-label Jumbo securitization from Redwood Trust called Sequoia Mortgage Trust 2010-H1 came to market last month, and that in itself is an accomplishment for a troubled mortgage securitization market.
As the first transaction to be backed by recently originated non-agency mortgages since 2008, this deal demonstrates that an offering of this type can be done despite the securitization market's uncertainties around regulatory scrutiny, investor acceptance and pricing considerations.
The overall response to the Redwood Trust deal was positive."It was able to get done with six to eight times oversubscription, and an interest rate of 3.75%, which is fairly attractive for the issuer," said Mike Kagawa, a portfolio manager at Payden & Rygel. Will this restart the non-agency RMBS market? "Maybe or maybe not - it remains to be seen," he said. "But the good news is that it can be done."
Being the first non-agency deal since 2008, Kagawa said that the initial non-agency transaction had to be the type that Redwood Trust represented - backed by collateral of the highest quality and well underwritten.
Brendan Keane, senior vice president at CoreLogic, said that the emergence of the first non-agency deal in two years is "a positive step in the right direction."
However, whether the market would see a significant increase in non-agency-backed deals is another question. "We're hearing of transactions lining up and that's probably correct, but whether it is 'significant' depends on one's perspective," Keane said. "I think it's going to be a much more narrowly defined pipeline with just a handful of deals; we may have to get used to that for awhile."
Jesse Litvak, a mortgage trader at Jefferies, said that Redwood's deal provides a semblance of a new-issue market, although it is going to take a while to build up. "The size of the deal was small, but it was a step in the right direction and was well received," Litvak said.
"There is definitely investor interest in mortgage-backed deals from "insurance and money-manager type of money, but they are being very selective," he said. Litvak added that the current pipeline consists of mostly re-remics and "it comes and goes."
More Disclosure
Redwood's deal is a landmark transaction, according to market participants, in terms of the amount of disclosure given to investors.
CoreLogic's Keane said that the amount of disclosure that the market will require in the future will "play to what investors are demanding." He added that it will also be influenced by regulations, both for public and private transactions, and be in the context of "what has been and what will eventually be rolled out and put into law." Also, there is the fact that "more transparency will create more market liquidity."
According to Michael Youngblood, a principal at Five Bridges Advisors, the recent Redwood Trust transaction was clearly successful in that the underwriter priced the deal at a yield significantly lower than initially indicated.
"The preliminary term sheet also had some of the most extensive disclosures I've ever seen in non-agency RMBS," he said. "Issuers have traditionally resisted demands by analysts and investors for additional information."
He added that the deal "is a welcome event, and we commend Redwood Trust for its courage in bringing this securitization, which was well received, to market." The deal can also be used as a benchmark for future mortgage offerings. "This is an important step, as it provides pool enhancement, yield level and other data that others can use to construct future deals. Other issuers can emulate this transaction and improve the scope and detail of loan-level disclosure before issuance."
However, Youngblood stated that the information provided in the prospectus supplement is incomplete, as it does not contain loan-level disclosure.
"This deal is the first wave on the shore in terms of disclosure," Youngblood said. He is hoping that future deals will "surpass Redwood Trust in the scope and detail of disclosure and, as a result, the market will reach the high tide of disclosure."
For example, Youngblood said that he would have wanted a stratification of the transaction's metropolitan area distribution to assess the influence of local economic conditions on future performance.
Drilling down into the deal, there were a significant number of loans that were not fully documented: 75 loans totaling $65 million. "We would have wanted to pay close attention to these loans and to verify the information on the preliminary term sheet," he said. The data on the prospectus was not well described - were they using full Fannie Mae/Freddie Mac documentation or were they using simpler or reduced mortgage documentation on the transaction? For example, which Fannie forms were they using in terms of verification of deposit, borrower assets and liabilities, etc?
He added that the prospectus supplement had only four pages on the originator's underwriting policy and processes. "This is exactly the summary information that was provided previously on underwriting standards and processes and it is clearly inadequate," Youngblood said, adding that in this case he would have wanted to know more about CitiMortgage's underwriting processes. CitiMortgage is a wholly owned subsidiary of Citibank.
For instance, disclosure in the term sheet included borrower debt-to-income ratio, but the preliminary prospectus did not provide how the firm arrived at the DTI that it provided in the term sheet. "With respect to the term sheet, progress has clearly been made since the last non-agency securitization in 2008," Youngblood said. "One should understand that the underwriting criteria and processes are a part of the disclosure that's needed to evaluate credit risk."
Credit Enhancement
In terms of future credit enhancement levels on deals, Keane said that this would be applied on a case-by-case basis and would depend on at least three factors: the nature of the collateral backing the deals, the perspective of the investor, and the transactions' structure. If investor risk appetite increases, "we would hope different transactions will result and RMBS deals move down in weighted average FICO," he said.
Youngblood said that the credit support percentage of 6.5% on Redwood's deal is "very comparable to the subordination of Alt-A top tier issuers in 2008 and before or during the battle days." He added, "It remains to be seen whether this credit support is adequate to protect certificate holders against the loss of principal and interest."
Payden & Rygel's Kagawa added that investors were talking with the issuer prior to the deal getting done and were expecting the deal to have higher credit enhancement than 6.5%.
However, Moody's Investors Service, which rated the deal, came up with its own calculation.
Moody's explained in a release last week that the loans backing Redwood's transaction were all originated by CitiMortgage. The mortgages were originated in 2009, have never been delinquent and are current as of the cut-off date, the rating agency said.
The rating agency also reported that these loans were underwritten using a high level of documentation. For roughly 72% of the loans, the originator received two years of documented income, and for 95% of the loans at least one year of documented income. For a small portion of high net worth borrowers, CitiMortgage underwrote the loans using asset verification as well as income verification of less than a year.
Moody's Mortgage Metrics (MMM) model simulates a range of 10,000 economic paths to estimate a distribution of losses. This distribution is used to get loss estimates under different rating stresses. MMM estimates losses under a 'Aaa' stress on the Redwood pool to be around 6.41%. The MMM also takes into account the hybrid-rate feature of loans in the pool and simulates the stresses those mortgages will experience through different macro economic scenarios accounting for future interest rate exposure. After five years, the simulated rate on the mortgages becomes floating which influences the default behavior of the mortgages. The rating agency adjusted the MMM results to reflect the deal's structural features, such as the shifting interest cash flows, and the strong third party assessment to arrive at 6.5% 'Aaa' credit support, the rating agency explained.
Moody's Managing Director Linda Stesney and Senior Vice President Navneet Agarwal said that the reliance on a third party to go through a deal's loan file is critical in this transaction, and future ones as well.
However, particular to this deal is the strength of every single loan as 100% of the loans were re-underwritten for this deal.
"We have criteria that clearly lay out that depending on the transaction, the re-underwriting does not have to be 100% and could be based a sample to meet our criteria," Agarwal said. "This deal exceeded our criteria."
In terms of structure, although the shifting interest structure has been typically used in past Jumbo or prime transactions, Redwood's offering is different because it had only four principal tranches, according to Stesney and Agarwal. "There would have been a least six classes of certificates in a typical deal," Agarwal said. Traditionally Jumbo transactions "were issued with many sub tranches of senior notes, sometimes adding up to scores of them including many exchangeables" he said.
"The structure was definitely a lot simpler," Stesney said. "In our analysis, we quantified the credit impact of the shifting interest structure, instead of a purely sequential one. The overall credit enhancement reflects our view of the collateral's credit quality and structural features."
Agarwal said that certain aspects of this transaction could guide future transactions, for example: reps and warranties of exceptionally high quality, the credit quality of the provider of the representation and warranties and the binding arbitration mechanism. He added that even if Redwood sells its holdings in the transaction, the rights related to a breach will transfer to the trustee.
Third-Party Assessments
Similar to Redwood Trust's transaction, the market might see more third-party assessment on the collateral backing mortgage transactions.
Mark Hughes, a vice president at CoreLogic, said that rating agencies are now more actively involved in a securitization's due diligence process. These agencies are also increasing their efforts to understand and make more transparent the underwriting processes used on the loans backing deals.
CoreLogic works closely with issuers and rating agencies by providing independent third party assessment of loan- level results based on an agreed scope of review and sample of loans. "It's a validation and a confirmation that there was robust due diligence used, which would vary around portfolio characteristics, including seasoning, credit and payment history," he said.
The rating agencies in late 2008 came out with revised loan level diligence criteria. Third-party assessment providers such as CoreLogic get involved in the compliance review processes to make sure the due-diligence process is consistently applied to deals.
"Rating agencies specify what they expect to be included," he said. "It's really the third party reviewer who assigns grades and confirms that those grades are independently and consistently applied on the deals that rely on those grades."
