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Jumbo-Mortgage Market Gets Backing From a Big Player

NEW YORK (TheStreet) -- Redwood Trust (RWT) will continue to buy and securitize prime jumbo loans in 2013, despite new mortgage rules that would make it riskier to do so.

The mortgage REIT (real estate investment trust), which reported fourth-quarter results Thursday, said it plans to acquire and package into securities $7 billion in residential mortgages in 2013, up from $2.3 billion in 2012.

The acquisitions are expected to be predominantly prime jumbo loans that are too large to be sold to government-sponsored enterprises Fannie Mae (FNMA) and Freddie Mac (FMCC). Currently, the agencies buy mortgages up to a limit of $ 417,000 in most areas and over $625,500 in high-cost regions.

Redwood and Credit Suisse (CS) have been the two active players in the jumbo-mortgage market at a time when few others will touch them.

Bond investors have largely been unwilling to buy mortgage-backed securities that don't have a government guarantee, and since the agencies don't back loans greater than $625,500, new originations of jumbo loans have consequently shrunk from $480 billion in 2006 to $148 billion in 2012, according to data from Royal Bank of Scotland and Inside Mortgage Finance.

While there are signs that the private U.S. mortgage market is rising from the dead, the future for jumbo loans remains under a cloud.

The Consumer Financial Protection Bureau recently issued a rule that provides lenders and investors greater legal protection for making "qualified mortgages" -- loans that do not have excess upfront points and fees, have no toxic features such as interest-only loans, negative amortization and balloon payments, and where the borrower does not spend more than 43% of his income to pay down debt.

According to analysts from Deutsche Bank, the rule, which goes into effect in January 2014, is expected to "significantly curtail the demand for jumbo loans," because at least 13% of these loans are either interest-only or above the debt-to-income limit of 43%.

Still, Redwood says it remains comfortable buying prime, interest-only jumbo loans, many of which have favorable credit profiles. "Interest-onlys (IO) have traditionally been sought after by prime jumbo loan borrowers who prefer the IO feature to a standard amortizing loan. In the hands of these borrowers, IO loans have been historically safer (based on Redwood's experience in investing in prime jumbo IO loans between 1997 and 2007) than some of the so-called "toxic loans" they now, as a regulatory matter, appear to be lumped in with (e.g., IO loans that were extended to subprime borrowers as a way to increase purchasing power during the housing bubble)," the management said in its quarterly review.

"We remain comfortable with this type of loan product and we are working to keep ourselves positioned to continue to acquire, securitize and invest in IO loans even after the qualified-mortgage rule goes into effect in January 2014."

Redwood said it will expand its market share of interest-only loans should competitors become less comfortable with these type of loans once the rules go into effect.

However, Redwood said one caveat would be how the risks related to these non-QM loans are regarded by credit rating agencies who establish the credit ratings for the firm's securitizations.

If rating agencies take a harsh view of the risks, Redwood would find few takers for the loans.

Other lenders -- notably First Republic Bank (FRC) -- have also said they would continue to participate in the interest-only residential mortgage market, which has been a source of extraordinary growth for the bank.

JPMorgan Chase (JPM) is seeking to sell private mortgages for the first time since the crisis, according to Bloomberg News.

-- Written by Shanthi Bharatwaj in New York



>To contact the writer of this article, click here: Shanthi Bharatwaj.

>To follow the writer on Twitter, go to http://twitter.com/shavenk.

>To submit a news tip, send an email to: tips@thestreet.com.

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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