Redwood Trust's recent $280 million RMBS is generally viewed as the Mill Valley, CA-headquartered firm's second attempt to jump-start the RMBS market, but doubts persist about whether it will be any more successful.
The REIT's $240 million public offering last April was heavily oversubscribed, and market participants had widely hoped that it would open the door to more securitizations of non-agency Jumbo mortgage loans outside the parameters of a government guarantee.
That didn't happen. In fact, there were no more significant non-agency RMBS offerings for the rest of the year.
The recent $280 million deal, which was priced Feb. 18 and set to close on March 1, was issued under the firm's Sequoia Mortgage Trust 2011-1. The offering was collateralized by 303 loans comprising 43% ARMs and the rest by fully amortizing fixed-rate mortgages. Borrowers averaged very high FICO scores of 775 and monthly incomes of just under $47,000.
A banker at one of the underwriters predicted similar transactions to come. He noted the intentions of major money managers such as BlackRock (see sidebar) to begin originating mortgage loans, as well as the big banks ramping up their Jumbo loan programs and requiring loan originations to be fully documented and carry high loan-to-value scores.
"Those deals are going to get securitized," he said. "Very similar to how a Redwood deal happens, they'll sell the 'AAA'-rated tranches and retain [the subordinated tranches]."
The banker added that mostly banks and insurance companies would invest in a Redwood-type deal, given its relatively low coupon of 4.125%. "The only reason hedge funds would buy these bonds is if they can incorporate leverage," he said.
Redwood's second deal was reportedly lapped up quickly. However, investors have been starved for non-agency paper that yields at least marginally more than government-guaranteed RMBS.
A Redwood spokesman declined to comment about the transaction, which was led by Credit Suisse and co-managed by JPMorgan Securities and Jefferies & Co.
Michael Sheridan, president of DebtMarket, an online marketplace to buy and sell consumer loan portfolios, said his discussions with large and midsize banks suggest many are implementing Jumbo loan programs. However, he pointed out, they also said that in 2010.
"What this tells me is those guys started to do this in 2010 and they're pushing ahead in 2011, but they really haven't made a major move into the market yet," Sheridan said. "The question remains whether we will see this result in more private label deals like Redwood Trust or if these banks will hold the loans in their portfolios, because they seem starved for loans."
Comparisons to CMOs
Jay Menozzi, chief investment officer at UCM Partners, a hedge fund manager with $1 billion of mortgage assets under management, compared the current non-agency RMBS market to the agency CMO market of the mid-1990s.
In that market, securitization practically halted for two years after hedge funds managed by David Askin collapsed after the principal-only and inverse interest-only strips they invested in plummeted in value when interest rates rose.
That froze the CMO market for nearly two years, recalled Menozzi, whose firm also runs a discretionary fund representing a portion of BlackRock's $2.7 billion Public-Private Investment Program or PPIP allocation, because the underlying mortgage loans were worth more than the securities - a negative arbitrage.
"What I think we have in the Jumbo market now is a similar situation," Menozzi said. "The loans have been originated at a price that's higher than where that stuff, if turned into a securitization, is trading in the secondary market. So only when we see the secondary market recover will we see more RMBS deals."
Michael Farrell, chairman and CEO of Annaly Capital Management, the largest REIT listed on the New York Stock Exchange, also noted the unfavorable economics for RMBS deals in his congressional testimony before the Insurance, Housing and Community Opportunity Subcommittee of the House's Committee on Financial Services.
"In order for the math to work, either primary mortgage rates have to rise, the rating agencies' senior/subordinate splits have to come down and/or return requirements by the secondary market have to decline," Farrell said.
Farrell also pointed to investors' lack of interest in securitizations of new mortgage loans in favor of offerings that re-securitize existing RMBS and provide higher returns.
In addition, he said, banks have grown more comfortable holding non-conforming loans on their balance sheets, after tightening their underwriting standards and requiring sizable downpayments.
"As long as underwriting standards are so stringent, I don't see a vibrant private-label market developing," Farrell said.
And finally, Farrell pointed to the uncertainty in the regulatory environment, including the variety of government-sponsored mortgage modification programs and delays in foreclosures that complicate investors' analysis of cash flows, and the uncertainty of capital rules related to the definition of "qualified residential mortgages."
Menozzi noted the Dodd-Frank Act provision requiring issuers to retain a certain percentage of an offering on their books.
Market participants submitted comments last fall on the regulatory proposal related to that provision, but a final rule has yet to be approved and may not arrive until the July deadline set by the new law.
He said that uncertainty, coupled with the ratings agencies "still fumbling for what constitutes a 'AAA'-rated security," which makes it tougher to quantify the arbitrage, has made it very difficult for especially regulated financial companies to consider securitization.
The banker said one of the biggest hurdles faced by new deals is timely ratings from the ratings agencies. "They rated a ton of bonds that have gone sour, and then they rated re-REMICS, and those have been downgraded. So they're not sure of themselves and very concerned about backlash," the banker said.
Indeed, a ratings agency fracas erupted before the deal priced. Fitch Ratings had blessed all but $10 million of the issue with a 'AAA' rating, and Moody's Investors Service and Standard & Poor's issued unsolicited and dissenting opinions.
S&P noted the damage that a default on any one of the 303 mortgages would do to the bonds, while Moody's noted that the properties were concentrated in earthquake-prone territory.
Although both Redwood deals were completed successfully and even oversubscribed, that's probably unsurprising given the quality of the loans, dearth of non-agency paper, and their relatively small sizes.
More offerings, however, may be hindered by the demand side of the equation.
Curtis Ishii, senior investment officer for global fixed-income at California Public Employees Retirement System (CalPERS) told Asset Securitization Report last May, following the first Redwood offering, that the giant pension fund had recently sold its remaining $3 billion or $4 billion in non-agency RMBS.
He said the federal government's loan modification programs failed to address how modifications would impact holders of second-lien debt, so by default first-lien debt holders - investors in RMBS - would take the first hit when modifications occurred.
CalPERS and other traditional institutional investors vowed to refrain from further investments in non-agency RMBS until the government clarified the issue. "As far as we're aware, we don't believe the government has clarified this issue," said Clark McKinley, a CalPERS spokesman. "We have not gone back into the non-agency RMBS market."