Redwood testing the market for “expanded prime” RMBS
Redwood Trust, long known for targeting only the most pristine borrowers, is preparing its first securitization of residential mortgages with slightly wider credit parameters.
Choice mortgages, introduced in April 2016, have loan-to-value ratios about six points higher, credit scores about 30 points lower, and fewer liquid reserves than Redwood’s traditional Select mortgages. To compensate for the additional risk, Choice mortgages also pay interest roughly 100 to 125 basis points higher than Select mortgages.
They are currently offered by roughly 90% of Redwood’s correspondent lenders, and accounted for 20% of total volume in the second quarter, according to a transcript of an Aug. 3 conference call published by Seeking Alpha. Initially, Redwood sold these loans to whole loan investors, but in recent months it has been holding on to them in anticipation of tapping the securitization market, company executives stated during the call.
Choice mortgages account for a "significant portion" of the collateral for Sequoia Mortgage Trust 2017-CH1, a $316.5 million offering of mortgage bonds launched Wednesday, according to Kroll Bond Rating Agency.
By most measures, Choice mortgages are still firmly in prime territory; credit scores are no lower than 660, though debt-to-income ratios no can exceed 50, and loan-to-value ratios can exceed 85%. However, some of them have features that preclude them from being considered Qualified Mortgages. That means Redwood must hold on to 5% of the economic risk of the deal in order to satisfy risk retention requirement.
Redwood is not required to retain a stake in securitizations of its Select mortgages, because it can rely on an exemption for loans that meet the criteria for qualified residential mortgages.
Kroll expects Redwood to retain at least 5% of the aggregate fair value of the issued certificates as a first-loss “eligible horizontal residual interest.”
Kroll expects to assign an AAA rating to both the “super senior” tranche of notes to be issued, which benefits from 15% credit enhancement, as well as to the “senior support” tranche, which benefits from just 10% credit enhancement.
Wells Fargo Securities is the initial purchaser.
Investors have demonstrated a strong appetite this year for all kinds of residential mortgages bonds, including bonds backed by mortgages to borrowers with much weaker credit than Redwood’s Choice mortgages. Of course, subprime mortgages pay higher interest rates than expanded prime mortgages, offsetting the added risk. By the same token, investors demand higher credit enhancement on subprime mortgage bonds.
Redwood is hoping that that the risk-return tradeoff for securitizing expanded is attractive, compared with selling the whole loans. “It's hard to give specifics at this point until we complete a deal, and see where spreads fall out, but we certainly think the return profile will be quite a bit better than our Select program,” chief executive Marty Hughes said on the conference call.
Here’s how the overall pool of loans backing 20170-CH1 stacks up to Redwood’s previous deals this year, which were backed entirely by Select mortgages: The weighted average original credit score of the entire portfolio is 744, compared with an average of 770 for the six previous deals; the weighted average cumulative loan-to-value ratio is 74.8%, versus 68.2%; and the weighted average debt-to-income ratio is 36.3%, versus 32.25%.
The deal employs a structural feature, used in all Redwood RMBS issued since 2015, in which servicer will not provide advances of interest and principal on loans that are 120 days or more delinquent. To date, this feature has not been used in any transaction, but Kroll noted there is a far greater likelihood of being employed in this transaction SEMT 2017-CH1 than prior SEMT-shelf transactions that have not included expanded prime collateral.