Redwood Trust Inc., which proved last month that it is once again possible to securitize mortgages without government backing, has made a more serious commitment to reviving the secondary market.
The Mill Valley, Calif., company said Monday evening that it is now buying jumbo mortgages on a "flow" basis — that is, one at a time, as soon as they are originated, at a price locked in before the loan closes. This arrangement gives the originator a degree of certainty that it can sell its loans at a profit.
Such confidence has been sorely lacking since the financial crisis began in 2008. Without a reliable outlet for jumbo loans — those too large to receive federal guarantees — lenders have been hesitant to write these mortgages on high-priced homes.
"There is a great deal of consternation out there with originators that they don't know what will happen with the price of the loan," said Rob Kessel, the managing partner of Compass Analytics LLC, a provider of mortgage valuation and risk management analytics in San Rafael, Calif.
The flow arrangement "gives the lender a lot more comfort when they know they don't have to worry about Redwood Trust changing the price during that pipeline period," Kessel said.
Redwood, a real estate investment trust founded in 1994 to invest in mortgage securities, with a focus on jumbo loans, has taken it upon itself to restart this dormant sector of the industry.
"If you were a fisherman and there were no boats, probably the best thing you could do is to go out and build a boat that met your specifications and then get out fishing," said Martin Hughes, Redwood's president and co-chief operating officer, during an investor presentation Tuesday.
Last month's $238 million securitization by Redwood showed there is strong investor demand for bonds secured by jumbo loans with low-risk characteristics, such as high FICO scores and low loan-to-value ratios.
"They deserve kudos for getting the deal done because there are still obstacles to getting a free-flowing jumbo market opening up again," said David Spector, the president and chief operating officer of PennyMac Mortgage Investment Trust. "Whenever you have a jumbo securitization, you're closer to the real market opening."
But Redwood bought the mortgages in bulk from Citigroup Inc., which had to be prepared to hold the loans on balance sheet for a long time if there were no buyers.
The new flow arrangements mean Redwood, not the originator, is now taking the risk that ultimately the loans won't be salable in the bond market.
The price a loan can command at the time the borrower's interest rate is locked in can be very different from the price at closing, Kessel said.
A loan's pipeline period can last as long as 45 days, he said, during which inspections, appraisals and approvals take place. What transpires during that period can alter the credit risk of the loan and thus change the price a buyer is willing to pay for the loan.
Flow contracts also have benefits for the buyers.
"Redwood has more control over the loan they're buying," said Merrill Ross, an analyst at BGB Securities in Arlington, Va., who does not follow Redwood but covers the REIT industry broadly.
Redwood, in essence, takes on the role that the government-sponsored enterprises Fannie Mae and Freddie Mac have been playing, she said, by setting underwriting standards for the loans it is willing to buy. What Redwood is doing "is a necessary part of the housing recovery," she said — providing a template for what is acceptable and getting capital flowing.
Ultimately, Redwood's flow program should encourage more originators to make jumbo loans.
"We think one of the advantages is to give [originators] a commitment on a loan-by-loan basis, something that really hasn't been prevalent in the jumbo space, so that they can feel free to accumulate [the loans] on their books," Hughes said.
"They don't have any problem warehousing them now, but the risk … at that time has passed from them over to Redwood," he said.
Originators might also be more inclined to expand their product menus to include loans they would not otherwise originate, Hughes said, because they know that Redwood could buy them.
Redwood said it is buying loans under flow arrangements with a handful of national mortgage originators, which it did not name, and is developing relationships with additional lenders.
Brett Nicholas, Redwood's chief investment officer and co-chief operating officer, admitted that loan volume may be "muted" for some time, until lenders are confident that the private mortgage market is returning to more normal conditions.
Other REITs have begun to show a willingness to participate in the secondary market.
PennyMac last week said it had bought newly originated prime loans from community banks and nonbank lenders with the intent of securitizing them.
Though the Calabasas, Calif., REIT is for now focusing on loans guaranteed by Fannie, Freddie and the Government National Mortgage Association, it plans eventually to start buying and securitizing nonagency jumbo loans.
Lenders will be watching such efforts closely. "Originators have demand and interest for these kinds of products," Kessel said. "There's a great deal of interest in how well this plays out."