Fitch Ratings laud of Redwood misses ‘fatal’ RMBS flaw

Fitch Ratings famously stepped up to the plate to rate the only private-label residential mortgage securitization platform in 2011. The issuer, Redwood Trust, dropped a previous ratings agency, Moody’s Investors Service, over a high concentration risk in the collateral. Namely, Moody’s worried an earthquake may destroy many of the properties involved in the RMBS. Today, Fitch and Redwood continue to benefit from the new found partnership. Fitch released a report: “Improved Structural Features in New U.S. RMBS a Credit Positive.” While Fitch admires the representations and warranties structure of the Redwood deal, a leading attorney says other RMBS deals may have a “fatal flaw.” I found the headline of the Fitch report ambiguous at first, to be fair. With the market moving to finally produce new RMBS from sources other than Redwood, the Fitch report is, in fact, referring specifically to the Sequoia Mortgage Trust 2011 platform. To be clear, Redwood’s success is being looked to market-wide as a potential model maker. Once a successful model is made, more can be similarly crafted. And once the process streamlines and gets smoother, even more deals follow. This is how the private-market RMBS industry will regain its foothold in mortgage finance. And so it feels like Fitch believes the Redwood deal can serve as a benchmark for issuers going forward. “These structural changes are an improvement from the 2005-2007 vintage prime deals and serve to further reduce credit risk and exposure to senior bond investors,” said managing director at Fitch, Roelof Slump. Of the touted changes, the ratings agency said the arbitration of representation and warranties under the new Redwood deals invokes an “enhanced clarity of process for any such breaches.” This is one of many credit positives Fitch finds, but, to be sure, investors place reps and warrants settlement at the top of their list of must-haves. Under the Redwood deal, the alleged violations of representations and warranties are diminished. Under the deal, the master servicer (in this case Wells Fargo) must review any and all loans past 120 days delinquent. Wells needs to do its best to “cure” these bad mortgages, Fitch states. “If there is a breach which the seller can not cure the seller is obligated to repurchase the loans,” the report states. To be clear, First Republic Bank originated 65% of the aggregate pool and PHH Mortgage Corp. originated the remainder of the mortgages. But, this strength is not common in cases of RMBS where the originator and servicer are not at arms length. And, in its lauding of Redwood, Fitch fails to take this into account. “The one question that will continue is whether or not the mortgage servicer is affiliated with the originator,” said leading investor-rights attorney Talcott Franklin. “If so, then it is a fatal flaw in the enforcement mechanism.” Fitch states that Redwood allows for third-party reps and warrants arbitration. The arbitration ruling is final and binding. But Franklin, who was asked to review the report for this HousingWire column, remains unconvinced of a much more robust reps and warrants system. And he should know, he continues to get investors on board with his idea of a clearinghouse for failed mortgage bonds. He is nearly up to half, meaning his clients are reaching a voting majority that could swing the reps and warrants outcome into his favor. Franklin said the new deals should be responsibly structured so that bad loans are noticeable by investors. Speaking of the Fitch release, he comments: “As with previous deals, the mortgage servicer can simply ignore the breaches that they are discovering all of the time, to the benefit of the servicer’s affiliate and the detriment of investors,” Franklin adds. Reps and warrants conflicts for investors are Franklin’s bread and butter. So he should be worried that new RMBS structures would eventually and potentially erode his client base. But he isn’t. Not with this as a solution. Write to Jacob Gaffney. Follow him on Twitter @JacobGaffney.