Redwood Trust CEO Christopher Abate laid out a bold vision of growth for the real estate investment trust at an investor conference in New York City last month. Part of that vision included finding ways to tap into the nation’s multitrillion-dollar pool of home equity.
To that end, Redwood Trust has partnered with Point, a fintech firm that provides homeowners who may not otherwise qualify for a home-equity loan with a path to tapping the equity in their homes. That is done via what is called a home-equity investment contract, or an HEI.
This week, Redwood and Point, the latter founded in 2014, announced that they have completed a first-of-its-kind securitization supported by those HEI contracts.
The private-placement transaction, which closed in late September, involved issuing $146 million in securities through a conduit dubbed Point Securitization Trust 2021-1. The offering, backed by HEI contracts, was structured in two tiers — with $120 million of unrated senior class A-1 notes and about $26 million of unrated class A-2 securities.
Bo Stern, head of portfolio strategy and risk for Mill Valley, California-based Redwood, said security holders will get paid a monthly coupon from the cash flow generated by HEI contract pay-offs.
“The primary source is the money collected when consumers [homeowners] pay off their HEI contracts,” he explained. “The pricing assumption is that 20% of homeowners will repay on an annualized basis, which provides plenty of coverage to make the required interest payments on the securities. Any money greater than the required interest payment is used to pay back principal on the securities.”
The HEI contracts — which have 10- or 30-year maturities, the latter the standard since early 2020 — address many variables in a complicated, nuanced housing market. The general premise, however, is that Point provides the homeowner with cash upfront in exchange for a contract providing the Palo Alto, California-based company with a slice of the homeowner’s equity. That share is typically around 10 percent or so.
Plus, Point gets a cut — up to a preset cap — of the home’s future appreciation after making a 15% to 20% downward adjustment to the home’s market value at the time the HEI contract is signed to account for its risk. Point also shares some of the downside risk with the homeowner in the event the home price drops.
In exchange, homeowners get to cash out a slice of their home equity with no payments due until the contract matures. There are no prepayment penalties, and the payoff is achieved via a home sale, refinancing or after the HEI contract is otherwise bought out by the homeowner.
“The way the [securitization] deal is structured is that interest payments on the securities can be covered by approximately 5% of homeowners repaying on an annualized basis, so we think there is plenty of coverage,” Stern adds. “A six-month interest reserve account was set up to pay interest, if interest payments cannot be met from the underlying HEI pay-offs. The reserve account is topped-off if, and when, [HEI contract] repayments are greater than the amount needed to pay interest on the securities.”
Point co-founder and CEO Eddie Lim sees the HEI-backed securitization as a path to unlocking some of the trillions of dollars in “illiquid wealth” now tied up in homes nationwide. “This first-of-its-kind securitization is a testament to the investments we’ve made in Point’s technology platform, homeowner education, and seamless execution,” he said in a prepared statement.
Homeowners with mortgages gained $2.9 trillion in equity in the second quarter of 2021, a 29.3% year-over-year increase, according to a CoreLogic report released last week. The average homeowner posted a gain of $51,500 since the second quarter of 2020, CoreLogic found. In California, equity leapt $116,000 per borrower year-over-year.
Point’s business strategy appears to dovetail with Redwood’s vision of its own future. Abate stressed at the recent investor conference that there is some $9 trillion in household equity nationwide, plus another $14 trillion of homes owned in cash, for a total available equity pool of some $23 trillion. He then pointed to a slide in his presentation that states Redwood plans to “target traditional mortgage borrowers and ‘under-banked’ borrowers of all profiles.” Point’s customer base clearly fits into the latter category.
“We see this [the HEI contracts] as a new asset class that allows both consumers and investors to access one of the biggest markets in the world — specifically, the $23 trillion homeowners’ equity market,” Stern said.
Still, this HEI-backed securitization is not without risk to investors, given it is novel and untested over time. That’s one reason the securities are not rated by a rating agency. Stern said, however, that is expected to change with future offerings “as the performance history can be tracked by investors and rating agencies.”
That’s right, there are more HEI-backed securitizations in the works.
“We expect to be back in the market sometime next year,” Stern said. “Since this deal was the first of its kind, we are still determining the next deal size and frequency of future securitizations. The decision will be contingent on many factors, including market conditions, origination outlook, etc.”