Redwood Trust, the dominant issuer of home-loan securities without government backing since the financial crisis, plans to jump into the market backed by taxpayer-supported Fannie Mae and Freddie Mac.
The real estate investment trust said last week it's seeking approval from the two companies to start using them as bond guarantors by year-end. Redwood, a specialist in so-called jumbo mortgages too big for those firms, has issued six of eight non-agency securitizations of new loans since that market revived in 2010. Government-supported programs account for about 90 percent of all new lending.
Redwood would join firms such as PennyMac Mortgage Investment Trust, a rival REIT run by former Countrywide Financial Corp. executives, which are capitalizing on a retreat by larger lenders. Bank of America Corp., MetLife Inc. and Ally Financial Inc.'s Residential Capital are among those that ended or scaled back their purchases of new mortgages to resell as government-backed bonds in the past year.
"Many small originators will now need to find new buyers, such as Redwood, to purchase their loans," Chief Executive Officer Martin S. Hughes and President Brett D. Nicholas said in a quarterly investor letter posted Aug. 2 on the Mill Valley, California-based company's website.
'Added Bonus'
Less competition, and potentially higher margins, are "an added bonus" as the REIT seeks to take advantage of its burgeoning relationships with lenders and operations built for its jumbo-loan business, Michael McMahon, a managing director at Redwood, said in a telephone interview.
"Why not try to be more full-service for your correspondent sellers?" said Steven Delaney, an analyst in Atlanta at JMP Securities LLC who has a "market outperform" rating on Redwood. The strategy will offer fee income and offset some of the costs from being in the jumbo market, he added.
Jumbo mortgages are larger than allowed in government- supported programs, currently as much as $729,750 for single- family properties in some areas. Fannie Mae and Freddie Mac loans have limits of $417,000 to $625,500, after an October decrease from up to $729,750 that bolstered Redwood's volumes.
The REIT, which was founded in 1994, buys jumbo loans from banks and mortgage lenders to package into bonds, creating junior-ranking, potentially higher-yielding slices it retains. It's also begun profiting by reselling some loans outright.
Redwood Returns
Redwood has returned 33.4 percent this year, including reinvested dividends, compared with an 18.4 percent advance in the 24-company KBW Bank Index.
Redwood last quarter added 17 approved loan sellers, bringing its total to 37, including First Republic Bank and PHH Mortgage Corp. It raised its year-end target by 10 to 50, according to the letter.
The firm has issued three securitizations this year, after two in 2011 and one in 2010, totaling $1.9 billion, according to data compiled by Bloomberg.
Credit Suisse Group AG has teamed with Chimera Investment Corp., another REIT, to create $1.2 billion of securities filled mainly with jumbo loans sold off in bulk by Metlife. The insurer said in January it would stop originating mortgages as it scales back in banking to avoid oversight from regulators who twice rejected its dividend plans.
Issuers sold about $1.2 trillion of non-agency bonds, including securities backed by subprime loans, in each of 2005 and 2006, helping to spark the worst financial crisis since the 1930s when property markets crashed.
Government-supported programs, which have fueled issuance of more than $900 billion of bonds this year, and demand from banks for loans are limiting the bond markets revival.
Stabilizing Market
Redwood, whose executives said in the letter they're "hopeful that the stabilizing housing market will reduce pressure on Congress to maintain the government's current dominant presence," also sold $86 million of adjustable-rate loans outside of its securitizations last quarter.
While banks are seeking jumbo loans for their portfolios, lenders such as Bank of America are shying away from purchasing and reselling new government-backed mortgages partly because the business revolves around adding contracts to service, or manage, outstanding debt.
Bank of America, which became the largest U.S. home lender after purchasing Countrywide in 2008, last August announced a plan to exit lending through correspondents, and dropped to the fourth-ranked originator this year, according to newsletter Inside Mortgage Finance.
Shying Away
Fortress Investment Group CEO Randy Nardone said on an Aug. 2 conference call that big banks are shying away from mortgage- servicing rights. That's because of "looming increases in capital requirements" for the contracts tied to the Basel III international accord, earnings volatility caused by swings in the asset's value and the "continual headline risk" created by being in the business, he said.
Fortress, through companies the investment firm manages including Nationstar Mortgage Holdings Inc., has mainly targeted purchases of outstanding contracts, such as those on about $370 billion of loans being sold by Ally's Residential Capital unit, which filed for bankruptcy protection in May.
Redwood would "most likely" retain servicing rights on the Fannie Mae and Freddie Mac loans it buys and hire a separate company to handle the actual work, McMahon said. It uses Cenlar FSB as the so-called sub-servicer for its jumbo loans.
Higher Profitability
Lessened competition is boosting the profitability of companies involved in making government-backed mortgages.
Wells Fargo & Co., the top-ranked lender, recorded gains of about 2.25 percent on mortgages it sold last quarter, up from 1.9 percent in 2011's fourth quarter, according to comments by Chief Financial Officer Timothy J. Sloan in conference calls in April and last month. In 2007, Countrywide reported a margin on prime loans of 0.8 percent. Margins on correspondent purchases are typically lower than averages including direct lending.
"We are certainly cognizant of the current profitability in the agency market, which is a function of the reduced capacity that's giving the remaining lenders more pricing power," Redwood's McMahon said. "We would expect margins to normalize over time, but normal margins will still provide us with good incremental returns."
PennyMac, a REIT headed by former Countrywide President Stanford Kurland that initially focused on troubled loans, is already benefiting. Its purchases from correspondents totaled $3.4 billion last quarter, up 88 percent from the prior period. Only $2.6 million were jumbo loans, with the rest being Fannie Mae, Freddie Mac or Federal Housing Administration mortgages.
Top Lender
The initiative, which was started in 2010, has been "very successful" and the firm believes it's positioned "to become a top 10 correspondent lender," Kurland said on an Aug. 2 conference call.
PennyMac reported a net gain of $18 million on the mortgages it acquired for sale last quarter, including $16.8 million from the value of retained servicing rights, while earning $3.2 million in interest income on the holdings, according to a statement.
Two Harbors Investment Corp., the REIT run by Pine River Capital Management LP that mainly buys home-loan securities, has considered adding servicing rights, including new ones, CEO Thomas Seiring said.
"We've done some work around it," he said in a telephone interview, noting the firm isn't ready to jump in. "If it wasn't complicated more people would be doing it now," he said.
While Two Harbors has moved slowly in acquiring jumbo loans for securitizations after starting to do so last year, that business is looking more attractive, co-Chief Investment Officer Bill Roth said. Among other strategies that Seiring described as "tools in our toolbox," the REIT has accelerated its purchases of homes to rent and later sell, buying $48 million in July to bring its total since starting this year to about $120 million.
While Redwood has also considered such investments, the firm sees them as "not within our core competency" and potentially only a short-term opportunity so "it's not something that we're attracted to at this time," McMahon said.
