{"id":4595,"date":"2023-09-14T18:51:11","date_gmt":"2023-09-14T18:51:11","guid":{"rendered":"https:\/\/frankbuysphilly.com\/redwood-trust-ceo-christopher-abate-on-the-reits-appetite-for-jumbos-home-equity\/"},"modified":"2023-09-14T18:51:11","modified_gmt":"2023-09-14T18:51:11","slug":"redwood-trust-ceo-christopher-abate-on-the-reits-appetite-for-jumbos-home-equity","status":"publish","type":"post","link":"https:\/\/frankbuysphilly.com\/redwood-trust-ceo-christopher-abate-on-the-reits-appetite-for-jumbos-home-equity\/","title":{"rendered":"Redwood Trust CEO Christopher Abate on the REIT\u2019s appetite for jumbos, home equity"},"content":{"rendered":"
\n<\/p>\n
Real estate investment trust Redwood<\/strong><\/a> was founded in the early 1990s as the need for more private investors in the mortgage market<\/a> grew. Like its competitors, the company wanted to replicate what the government-sponsored enterprises (GSEs) Fannie Mae<\/strong><\/a> and Freddie Mac<\/strong><\/a> have done for decades by acquiring mortgages and providing liquidity to originators.\u00a0<\/p>\n “We were originally built to serve banks and others with the thought that there was no private sector [to invest in mortgage assets]<\/em>,” Christopher Abate, Redwood CEO since 2018, said in an interview. “We would partner with banks to buy their loans and securitize them so the banks could recycle their capital.” <\/p>\n After 30 years, Redwood still seeks to fill voids in the mortgage market.<\/p>\n For example, bank regulators<\/a> in July released a plan to increase capital requirements for residential mortgages, the Basel III Endgame rules. Redwood executives are positioning the company to acquire mortgage loans in the market, mainly jumbos<\/a>, with the expectation that banks will have a reduced appetite.\u00a0<\/p>\n Abate doesn’t think “banks are going to necessarily exit the mortgage market,” but they will “be heavily disincentivized from growing mortgage portfolios.” Ultimately, “the real shift is going to be all those jumbos<\/a> that were going to banks will come back out, hopefully to non-banks like us.”<\/p>\n Another opportunity is in the home equity space. Redwood launched in September its in-house home equity<\/a> investment (HEI) origination platform called Aspire. Through Aspire, Redwood plans to directly originate HEIs by leveraging the company’s nationwide correspondent network of loan officers and establishing direct-to-consumer origination channels, the company said. <\/p>\n “The interesting thing about HEIs is instead of a homeowner taking out equity in the form of cash and paying a mortgage on it, there is no monthly payment within HEI,” Abate said. “The way the investor gets paid is that you share in the upside of the home.” <\/p>\n Abate explained the impacts of the Basel III Endgame rules on the market, the rationale behind the home equity investment product, and more about Redwood strategies in an interview with HousingWire<\/strong> from a company’s office in New York last week. <\/p>\n This interview has been condensed and edited for clarity.<\/em><\/p>\n Fl\u00e1via Nunes: <\/strong>How has Redwood strategically positioned itself in the residential mortgage space amid all of these potential regulatory changes?<\/em><\/p>\n Christopher Abate:<\/strong> Redwood is almost a 30-year-old company. The company was originally built to serve banks and others with the thought that there was no private sector [to invest in mortgage assets]<\/em>, only Fannie Mae and Freddie Mac. We would partner with banks to buy their loans and securitize them so the banks could recycle their capital. We don’t originate residential mortgages. We don’t service them. We’re very similar to the GSEs. We modeled the business to serve that role in the private sector. The mortgage market has changed over the decades. We’ve seen a few cycles. We’ve got the Great Financial Crisis, the Covid-19 pandemic, and now we’ve had a lot of interest rate volatility. Along the way, there have been many regulatory changes that have impacted the market; the CFPB has been created, and there’s the Dodd-Frank Act. Then there are the Basel rules<\/a>, the regulatory capital rules for banks. And that’s what’s really in play today. <\/p>\n We’ve positioned the company, from a strategic perspective, with the thought that banks will be heavily disincentivized from growing mortgage portfolios as an earning asset class. The banks are not going to necessarily exit the mortgage market because the mortgage asset is the biggest that a client takes out, and you want to be there for all the cross-selling in all the other consumer products. Banks will always serve their best clients. But viewing the mortgage portfolio as an investment class, that’s where the posture will shift because the capital required to hold against it [residential mortgages]<\/em> is going to go up. And just based on the rapidly rising rate of deposits, just given where interest rates are at, the net interest income that they earn is getting squeezed. Banks move slowly. This will be an evolutionary shift, not an overnight shift. <\/p>\n Nunes:<\/strong> As you noted, bank regulators released a plan to increase capital requirements for mortgages through the Basel III Endgame rules. Can we expect changes to what was proposed?<\/em><\/p>\n Abate: <\/strong>Yes, it will change. In particular, some of the sliding scale capital charges are based on things like LTV [loan-to-value]; <\/em>there’s a fair likelihood that that changes because of the way it disproportionately impacts first-time homebuyers and underserved communities. But the rule is not going away. Bank regulators are paid to keep things safe. And the idea that regulators are going to allow banks to continue to do what a First Republic<\/strong> <\/a>or Silicon Valley Bank<\/a><\/strong> did, I don’t see that in the cards. <\/p>\n We saw significant changes after the Great Financial Crisis, which was more of a credit crisis. We saw banks getting out of risky credit mortgages like option ARMs<\/a> and some subprime lending happening back then. There will be changes. Banks will not wait for the rule to be finalized to start implementing it. There will be some evolution to the rule itself. But the thrust of the rule is that it’s going to be more expensive for banks to hold mortgages.<\/p>\n Nunes:<\/strong> If banks won\u2019t wait for the Basel III Endgame to be finalized, how are they anticipating the rules?<\/em><\/p>\n Abate:<\/strong> A year ago, banks were very happy to hold mortgages, deposit rates were sticky, and the cost of deposits was still very low. Now, all of them are looking for a capital partner, at least an option to have liquidity. The tone has changed dramatically amongst bank executives. Some banks move more slowly than others.<\/p>\n I like to remind people that independent mortgage banks live and die by liquidity. They care about the basis point. Banks don’t operate that close to the ground. Things take longer to develop, but the relationships are also typically stickier. Once you forge a strong partnership with a bank partner, the likelihood of them shopping for that liquidity is much less than an independent mortgage bank that is trying to optimize every dollar.<\/p>\n Nunes: <\/em><\/strong>In your recent 2Q 2023 earnings report, you mentioned acquiring three bulk pools of loans from depositories, primarily with seasoned underlying loans at attractive discounts. How is the secondary market now for these trades in terms of volumes and prices?<\/em><\/p>\n Abate: <\/strong>I certainly expect RMBS <\/a>volumes to go up significantly over time. It’s not something that happens overnight. We’ve been active. We just completed a deal in August. I would expect us to continue using securitization. <\/p>\n Right now, we’re in this hybrid phase where loans that are getting securitized are partially seasoned loans, and some of the loans have gone down in value\u2013the lower coupon mortgages. The banks have been slowly selling some of those, and Wall Street dealers have quite a bit in inventory. We’re still seeing a lot of that aged collateral coming out through securitization. Issuers like Redwood have been combining current coupon mortgages. We saw this last year in the private sector securitization market, where we had all of this aged inventory. It was hard to get investors to focus on the collateral because there was so much sitting in inventory that they could price it wherever they wanted to. The pricing now is probably the best it’s been in a year, maybe two years. So, the market is finally starting to cross back into more current coupon on-the-run production, which is what we’re focused on.<\/p>\n We\u2019ve completed well over 100 residential securitizations, close to 140 If we factor CoreVest. There’s been years we’ve done 12-15 securitizations. There’s been years where we’ve done none or one. So, we very much want to get volume going again to the extent we could be in the market with certainly a deal a quarter, but if not two or three, that would feel the base to me.<\/p>\n Nunes:<\/strong> In terms of products, what the current landscape brings in terms of opportunities? <\/em><\/p>\n Abate: <\/strong>Right now, the biggest opportunity, ironically, is in the regular prime jumbo market<\/a> because that was the product banks were most focused on. And they weren’t wrong to focus on it from a credit standpoint because when the banks got through the Great Financial Crisis, all the big regulatory shifts were to get them out of taking risky mortgages on the balance sheet. Then, they started taking less risky mortgages, which are jumbos. The real shift is going to be all those jumbos that were going to banks will come back out, hopefully to non-banks like us<\/a>. <\/p>\n Nunes:<\/strong> Redwood also launched a home equity platform. What is the strategy here? <\/em><\/p>\n Abate: <\/strong>When you look at prime rates in the high single digits and add a credit spread to that, even for the most well-qualified borrowers, you are looking at a 10% to 12% interest rate on a second mortgage. For a well-qualified borrower, 750 FICO or above, and a low-LTV first mortgage, you might be comfortable paying 10% to 12%. But that\u2019s the best-case scenario. For everybody else, unlocking that equity is even more expensive. We’re seeing that for the traditional second mortgage products, there’s way more investor demand than consumer demand.<\/p>\n We’ve rolled out the traditional products and a newer product called home equity investment [HEI]<\/em> options. The interesting thing about HEIs is instead of a homeowner taking out equity in the form of cash and paying a mortgage on it, there is no monthly payment within HEI. The way the investor gets paid is that you share in the upside of the home, so the home price appreciation. There are a lot of use cases for HEI over traditional products. If you think about somebody with a lot of student debt or lower FICO, they’re going to qualify for a very expensive second mortgage. So, this is a good option. It doesn’t add to their monthly payment obligation. You can do what you want with the cash, just like with a home equity line of credit, but not having the payment. It’s a bridge until the second mortgage is cheaper.<\/p>\n Nunes:<\/strong> To invest in this product, investors must believe home prices will keep rising, right?<\/em><\/p>\n Abate: <\/strong>There are a couple of things investors care about. You have <\/strong>to believe in a HPA [home price appreciation]<\/em> story. But one way we mitigate that is we strike the price of the home at a discount to its current appraised value<\/a>. So that, even if the home is sold next week, the investor will make money. If you believe that interest rates are nearing the top, as far as the Fed’s rate hike cycle, HPA should start to realign. If rates are going down, HPAs are going up. Investors are starting to get comfortable with this huge move in rates, hopefully, this fall is gonna pause. <\/p>\n Then, ultimately, the investors want to understand if we give you $100,000 with this HEI, when do they get their money back? Because it’s a 30-year product. And that’s where we’ve designed the product, which is unique to Redwood, that creates strong incentives for the homeowner to refi.<\/p>\n Nunes:<\/em><\/strong> How did you get the property at a discount? <\/em><\/p>\n Abate:<\/strong> The product is for people in their homes that are not moving out. There isn’t an actual transaction on the property. It’s somebody that wants to stay in their home. And if it’s a $1 million home, and we offer you $150,000 HEI, we might strike that HEI at $900,000. Let’s say it’s a $1 million home, and for purposes of coming up with the investor return, we’re going to call it a home at $850,000. Even if they sold the home at a $50,000 loss, the investor would still generate a return, and that’s what gets investor capital into the asset class. But what the homeowner gets is all of the proceeds, the cash and no monthly payments<\/p>\n The investors are institutional investors, well-known institutions, firms, pension funds, and life companies; they’re all just to varying degrees focused on HEI now. And the big reason is that nobody’s been able to tap this massive home equity opportunity. We are going to give it a try. <\/p>\n Nunes:<\/em><\/strong> Residential mortgages are just one facet of the business. What are your plans for commercial real estate, which has had a challenging year?<\/em><\/p>\n Abate:<\/strong> <\/em>What we do here in New York is our business-purpose lending platform. We realized a number of years ago that investors are becoming a much bigger participant in the real estate markets. Serving them and providing bridge loans to investors who want to flip homes or provide turned-out financing for investors who want to rent homes, that\u2019s an entire other residential business that we run under the flag of CoreVest. In residential, we’ve more or less stuck to our knitting of non-agency. We’ve had opportunities to enter the agency space in the past and participated in certain instances, but mostly, what we do is non-agency. <\/p>\n