Redwood’s Perfect Score Shows Jumbo Bank Draw: Mortgages

Redwood Trust Inc. is having a spectacular run. Its shares have returned almost 85 percent in the past year and there have been zero defaults among the $4 billion of jumbo loans it packaged and sold as bonds since 2010.

Business for the real estate investment trust is poised to pick up in 2013 as the U.S. housing rebound lifts California and East Coast cities where Redwood finds its mortgages. Nationwide, jumbo loans, those too big for government backing, may climb 15 percent to $253 billion after jumping 29 percent in 2012, “the best year for jumbo volume since the mortgage crisis,” according to Guy Cecala, publisher of Inside Mortgage Finance.

“The jumbo market is along both coasts, and last we checked they aren’t making any more ocean,” Mike McMahon, managing director at Mill Valley, California-based Redwood, said in a telephone interview. “We expect 2013 to be another good year.”

Jumbos, typically made to the most creditworthy borrowers, and often held on the books of lenders, have been the only new residential loans without government backing to be securitized since the market revived in 2010. Redwood, the most-active issuer, sold $1.1 billion of jumbo-backed bonds last month after about $2 billion in 2012, according to data compiled by Bloomberg.

“The collateral in Redwood deals after the financial crisis is better than the collateral pre-crisis -- and it was good before the crisis,” Daniel Furtado, mortgage REIT analyst at Jefferies & Co. in San Francisco, said in an interview. “This is the best-quality paper they’ve ever securitized.”

Tight Supply

U.S. home prices rose 8.3 percent in December from a year earlier, the biggest gain since 2006, as tight supply and brisk demand combined with borrowing costs near record lows, CoreLogic Inc. reported Feb. 5. California cities, which have provided about half of the loans in Redwood’s last 11 securities, were among the best performers in the S&P/Case-Shiller home-price index in November. San Francisco led the 20-city measure with a 2.5 percent gain from October.

Jumbos, also called non-conforming loans because they exceed the limit for government-run Fannie Mae and Freddie Mac to guarantee, are loans of more than $417,000 in most U.S. housing markets and $625,500 in pricier areas. Originations peaked in 2006, when banks made $480 billion of jumbo loans that were sold to investors amid fast-eroding credit standards that soon led to disaster, Cecala said.

Lax Underwriting

Defaults by risky subprime borrowers, with credit scores below 620 out of 850, exposed the lax underwriting and financial markets froze, with defaults spreading to jumbo borrowers with ostensibly better credit, said Brad Blackwell, portfolio manager for residential mortgages at San Francisco-based Wells Fargo & Co., the nation’s largest mortgage lender. Jumbo volume plunged to $98 billion in 2008, data from Bethesda, Maryland-based Inside Mortgage Finance show.

“Back in the go-go years, jumbos were mostly securitized, but those days are gone,” Cecala said. “The real challenge for 2013 is whether growth can continue, given tighter underwriting and a market less dependent on refinances.”

While national values only bottomed last year as measured by the S&P-Case-Shiller index, the jumbo revival has provided liquidity and lifted prices in expensive markets in California, Texas, Florida and the Northeast, according to Thomas Wind, executive vice president at EverBank Financial Corp. Expansion is likely even amid post-crisis scrutiny, he said.

Property Recovery

The Jacksonville, Florida-based bank reported that its retail mortgage business soared 63 percent to $840 million in the fourth quarter from the previous three months, primarily on the strength of jumbos made to its best customers. EverBank is betting on the real estate recovery as it opens 50 mortgage offices around the U.S., Wind said.

Prices for single-family homes climbed in almost 88 percent of metropolitan areas in the fourth quarter, the National Association of Realtors reported today. The median for existing houses rose 10 percent from a year earlier to $178,900, the biggest gain since 2005, according to the Washington-based group.

A $398 million deal sold by Redwood in January consisted of mortgages from borrowers with average 760 credit scores and a weighted loan-to-value ratio of about 67 percent, Moody’s Investors Service said in a Jan. 8 report. More than 80 percent of those borrowers had at least two years of cash reserves, the rating service said. EverBank originated 37 percent of the loans in the deal.

Shockingly Good

Loans backing Redwood’s bond deals that ended the two-year drought in offerings were of “shockingly” good credit quality, Sharif Mahdavian, a New York-based analyst at Standard & Poor’s, said last month at a securitization conference. Quality has “only crept a small bit” lower since and loan-to-value ratios remain relatively low, he said.

Non-conforming loans increased $3.6 billion in the fourth quarter to $49 billion at San Francisco-based Wells Fargo, which keeps all jumbos on its books and considers the assets among its safest. Federal rules that limit the ratio of debt-to-income at 43 percent won’t chill the market for non-conforming loans, Chief Executive Officer John Stumpf said on a Jan. 11 earnings call.

“Let me just say this about the jumbo market,” Stumpf said. “We love that business. We’ve been in it for a long time. In many cases, these are our best customers and we do a lot of other things with them.”

Mark Brown, a San Francisco real estate broker, said a wealthy client obtained a $1.5 million loan last month from the lender to buy a three-bedroom home that needed renovating. At less than 3 percent, the interest rate on the 15-year jumbo was too good to pass up, he said, even though the buyer could have afforded a cash purchase.

Cheap Money

“The money was so cheap that he’ll be able to spend more on fixing the place up and potentially get a better return in a short amount of time,” Brown said in a telephone interview.

His client, an executive at a family-owned manufacturer, plans to make improvements to the Pacific Heights house and sell it in two years for $500,000 more than the $2.2 million he paid.

None of the loans in 11 Redwood deals since 2010 have become delinquent by 60 days, according to Moody’s. Even the 5 percent share of the January transaction that consists of fixed-rate, interest-only loans were made to borrowers “who could easily put more money down,” according to McMahon.

“We believe that, in general, an interest-only loan to a well-to-do borrower who has ample resources and liquidity is a good credit bet,” McMahon said in the interview.

Issuance Revival

The revival in jumbos has helped drive Redwood’s 85 percent return in the past year, which includes reinvested dividends, compared with 21 percent for a 32-member Bloomberg index of mortgage REITs. Redwood rose 1 percent today, to $19.86 at 4:15 p.m. in New York, the highest level since October 2008. It extended the gain to 18 percent this year, outpacing the 9.8 percent advance for the index.

About 67 percent of San Francisco home purchases of more than $1 million in the past two years used jumbo financing, the same share as statewide sales at that price, DataQuick said. In Santa Clara County, home to Silicon Valley, the share was about 75 percent, data from the San Diego-based research firm show.

California has four of the 10 most expensive U.S. housing markets, led by the San Jose metro area with a median home value of $685,000, up almost 25 percent in the fourth quarter from a year earlier, according to the Realtors group. San Francisco ranked as third-costliest, up 28 percent to $593,200; Anaheim-Santa Ana in Orange County was fourth, up 17 percent to $568,600; and San Diego was sixth, up 13 percent to $405,400.

Rivals Join

Redwood bonds will likely be joined this year by rival issues from firms such as New York-based Chimera Investment Corp. and Minneapolis-based Two Harbors Investment Corp., assuming the economy continues to mend and U.S. mortgage backing is reduced from 95 percent at the crisis peak to a level nearer the 60 percent historic average, Furtado said. Private investors stand ready to fill any void when the government exits and “opens a sizable part of the pond,” McMahon said.

Redwood has suffered cumulative losses of just 57 basis points in $38 billion of total deals since the company started, according to Jefferies. The REIT’s record of zero defaults in the volatile era since financial markets restarted compares with 14 percent of outstanding U.S. jumbos that were three months late or more as of Nov. 30, according to CoreLogic.

“You’d expect a high level of borrower quality at the restart of any lending market,” said Furtado. “Redwood’s deals reflect that.”

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