During an interview with CNBC on Thursday, Steven Mnuchin, the newly minted Secretary of the Department of the Treasury, reiterated the Trump administration’s pledge to pursue reform of Fannie Mae and Freddie Mac.
“I’m committed that under this administration we’re going to have housing reform so that we don’t just leave these entities the way they are,” Mnuchin said. “They’ve been sitting there for too long of a period of time and we need a solution.”
If Fannie and Freddie reform does take place, one of the beneficiaries could be private capital, which has been largely absent from the mortgage market since the crisis.
And if that happens, Marty Hughes, the CEO of Redwood Trust, says that the real estate investment trust will be ready and willing to step further into the market.
Hughes proclaimed Redwood Trust’s readiness to capitalize on the return of private money to the mortgage market in a letter to the REIT’s investors, released as part of the company’s fourth-quarter earnings.
“Like many of you, we have a strong interest in making sense of all the changes underway in Washington and to develop a better understanding of how the new Administration’s policies will impact the mortgage market,” Hughes and Redwood Trust President and Chief Financial Officer Christopher Abate said in the letter.
“While no one really knows for sure how policies will play out, our view is that federal regulation will trend in a direction that favors private capital and away from government dominance in the mortgage market,” the letter continues.
“Indications in Washington give us hope that the highly contentious approach to financial services regulation since Dodd-Frank was passed will give way to more balanced and sensible government policies,” Hughes and Abate continue.
The Redwood Trust execs note that there are several efforts underway to eliminate the Consumer Financial Protection Bureau, or at least provide “much needed clarity on the application and meaning of the agency’s many regulations and pronouncements.”
And if those things happen, then private capital could be on its way back, Hughes and Abate write.
“We believe the change in regulatory focus will remove barriers that have kept large segments of private capital from reentering the mortgage market, and will actively begin to shrink the government’s role in the mortgage market,” they write.
The Redwood Trust execs caution that changes of this type do not happen overnight, but say that the REIT will be ready when they do.
“While the trend looks positive, we are realistic about the speed of change. The Administration has issued Executive Orders intended to begin the process of regulatory reform, however those Orders do not apply to the many independent regulators that are responsible for implementing the Dodd-Frank Act,” the letter continues.
“Therefore, substantial reform may not be completed until the Administration has its officials in place at those regulatory agencies, or Congress has passed a law amending Dodd-Frank. Both of those steps appear to be underway,” Hughes and Abate write.
“In addition, the new Treasury Secretary has expressed a strong desire to finally get GSE reform legislation enacted, which will likely result in private capital taking the leading role as the investor in mortgage credit risk,” they continue. “We welcome all those policy developments and we will aggressively position Redwood to take advantage of the opportunities that open up.”
In the short-term, the executives note that Redwood Trust is off to a strong start in 2017 with its jumbo mortgage business, thanks to increasing investor demand for yield.
Hughes and Abate write that Redwood Trust executed three jumbo residential mortgage-backed securities in all of 2016, but state that the REIT has almost equaled that total in just two months of 2017.
According to the letter, Redwood Trust issued two jumbo RMBS deals so far in 2017, and plans to issue more.
As they note, all of the REIT’s recent securitizations were backed primarily by 30-year, fixed-rate loans purchased through the companies traditional prime jumbo program, Redwood Select, and are not subject to the risk retention rules set forth under the Dodd-Frank Act.
But the REIT plans to expand its alternative programs.
“We continue to believe that our expanded-prime Redwood Choice loan program will represent the most significant area of growth for our conduit going forward,” Hughes and Abate write.
“Currently, over 70% of our sellers have rolled out the Choice program and over 90% of these sellers have begun locking Choice loans,” they continue. “As compared to our traditional prime Select program, the expanded-prime loans we have purchased, on average, have loan-to-value ratios about six points higher, credit scores about 30 points lower and fewer liquid reserves. Additionally, yields on expanded-prime loans average about 125 basis points higher than on our traditional prime loans.”
As the executives state, so far, the REIT’s distribution strategy for the expanded-prime program has been to sell the loans to whole loan investors, in order to “continue refining and validating our product set and pricing parameters.”
Eventually, Hughes and Abate write that they believe it will “make sense” to hold Choice loans for long-term investment, or to securitize the loans, enabling the company to add “attractive” securities to its portfolio.
Overall, the REIT’s executives state that they are very optimistic about the future.
“Starting off with the big picture, we are and remain patient, long-term credit investors. We think in terms of years, not quarters. Using that lens, we are bullish on our business model and our future growth prospects,” they write.
“We see private capital investors continuing to advance and becoming the leading holders of credit risk in the mortgage markets. Additionally, in a low-yield investment world, having a loan conduit that serves to both create investments and generate fees is a key competitive advantage,” they continue.
“Aside from our primary investment objectives, we expect our residential mortgage banking business to meaningfully contribute to earnings in 2017,” they conclude. “We continue to feel very positive about our ability to capitalize on opportunities that arise in the market, as well as those we can create ourselves in order to generate additional net interest income that translates into compelling, long-term shareholder value.”