Redwood ready to pounce on dubious market

Can Redwood Trust's recent securitization success, along with some excess cash, capitalize on a fragile mortgage market? (Photo of an 1984 British mortgage courtesy Flickr.com)

As “mortgage-backed security” became a dirty word, batted about by pundits decrying lax lending standards and complex slice and dicing, security underwriters backed off the playing field.

But toward the end of April, California-based Redwood Trust Inc. became the first to tag back in, along with Citigroup Inc., issuing more than $230 million in “private label” securities – bonds without Fannie Mae or Freddie Mac backing that were left for dead as euphoria gushed out of the housing bubble.

Blighted ratings agency Moody’s gave the deal’s senior tranche – the lowest-risk section of the transaction – top marks, and RWT shot above $17 in early May, its highest price since September 2009.

“The deal demonstrates the strength of the Redwood brand,” reads an April 28 JPMorgan Chase & Co. research note.

But RWT shares promptly slumped below $15, posting a value of $14.38 Friday, down 16 percent from that May high of $17.17.

So what’s the future? Investment trusts like RWT – real estate’s answer to the stock mutual fund – sit precariously. After leaping off a cliff in September 2008, the Dow Jones Equity All REIT Index, which measures the performance of the real estate investment trust industry, has climbed steadily from a March 2009 low of 306.75. The index closed Friday at 709.25, down nearly 15 percent from an April 30 high of 829.97.

And RWT is somewhat unique among other post-crisis REITs: it’s alive.

“It survived the mortgage meltdown,” said Guy Cecala, CEO and publisher of Inside Mortgage Finance.

Today, the REIT equity index is up more than 130 percent from that nadir, but questions remain as to the valuation of an industry infused with unprecedented government support.

After a devastating net loss of more than $170 million in the first quarter of 2008, RWT announced a first quarter profit of $47 million, or 58 cents per diluted share.

Redwood’s first quarter per share earnings, 58 cents, beat JPMorgan’s estimate by 16 cents – a mark of promise. And management is making some smart decisions by sitting on some cash. With more than $1.2 billion in short-term investments, RWT is poised to capitalize on resurgence in the private securitization market.

“With effectively $1 billion of liquidity, we think this is going to carry us for awhile,” said Redwood CEO Martin Hughes this week, according to a Bloomberg LP transcript.

And a nice chunk of change means RWT needn’t scramble for funds.

“We have no near-term plans to raise common equity,” stated Hughes.

When mortgage underwriting migrates from near-total government sponsorship, RWT will have the means to jump on high quality loan securitization. But don’t expect full pallets of new securities ready to ship out of Redwood’s docks.

“It’s unclear whether that’s more of a one-off,” Cecala said of the April deal. For one, it took 11 months to complete. And while the market loved the effort, Cecala said, Redwood’s securities comprised the best of the best, leaving questions as to the potential of frequent underwriting.

“They cherry picked those loans,” Cecala said. “It’s certainly not a business model unless you can replicate it.”

Not to mention investor appetite.

“They’re skittish,” Cecala said of potential investors. “You need to bribe them at this point because many were burned by the subprime experience.”

And they aren’t likely to pine for mortgage-backed bonds while rates are subdued. When the Federal Reserve ended its more than $1 trillion in mortgage-backed securities purchases, a semblance of reality was supposed to return to the market, pulling up rates as private issuers limped back onto the field. But then Greece struck, and European debt fears fueled a rush to Treasurys.

The consequence: Lower Treasury yields have not pushed mortgage rates higher, diminishing the prospects for investor returns.

But all this is predicated on that big assumption that the U.S. housing market has witnessed the worst of the sub-prime-spurred meltdown.

Redwood may be poised to capitalize on some post-recession deal making, but with a tepid recovery and home delinquency rates inching upwards, RWT’s securitization baby may be swimming in some dirty bathwater.

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