Here is the next title that I will buy
Last week, government sponsored entities Fannie Mae and Freddie mac made an announcement that rocked mortgage originators. The companies announced that they had obtained a ceiling of 7% on investment properties and second homes by the Federal Housing Finance Agency (FHFA). This directive was issued in the last days of the Trump administration and was intended to limit the risk that the American taxpayer bears in the housing market.
I recently wrote about New Residential Investment Corp. and how would this change benefit him. There is another mortgage REIT that could also benefit: Redwood Trust (NYSE: RWT). I plan to buy stocks as soon as the Motley Fool trading rules allow. Here’s why.
Washington wants to reduce its footprint in the housing finance market
While the 2008 real estate crash killed the subprime mortgage market, it also put an end to the private label securitization market. Private label securities do not require government credit guarantees, and they were a popular way to finance mortgage loans before the crash. But they were wiped out by a collapse in mortgage-backed securities and numerous defaults.
Policymakers in Washington have long agreed that the current state of housing finance is unsustainable. The U.S. taxpayer essentially bears the credit risk of the vast majority of mortgages in the U.S. The bipartisan consensus has long been to revert to the pre-bubble days, when the private sector took on the credit risk and the government risk was largely limited to loans from the FHFA and the Veterans Administration.
This change in Fannie and Freddie’s commitment to investment properties could be the catalyst for the revival of the private label securitization market. The problem with the private label has been a lack of critical mass and a solid history of prepayment and default data. These two questions are essential to get institutional investors to have an appetite for this document. The new limits of Fannie Mae and Freddie Mac could prove to be a catalyst to bring the market back.
Redwood Trust is the leader in non-government secured securitization
Redwood Trust is a mortgage real estate investment trust (REIT) specializing in providing mortgages that are not guaranteed by the US government. Historically, this has meant mortgages too large to be guaranteed by the government, which are commonly referred to as jumbo loans. Despite the absence of collateral, these loans often have such strong credit characteristics that the borrowing rates are more or less in line with standard government rates.
Redwood is also the source of loans that do not meet government guidelines for reasons other than size. These loans have higher rates and are often made to professional real estate investors, fixed buyers and self-employed people. Redwood sees the single-family rental market as a massive growth opportunity. The company also aims to have the best technology for the non-QM (Qualified Mortgage) assembly space and has launched several initiatives to further capture the market for commercial purposes.
Like most mortgage REITs, Redwood struggled during the early days of the COVID-19 pandemic and was forced to deal with margin calls and a sudden collapse in the non-QM securitization market. This reduced the company’s book value per share by 38% to $ 9.91 and caused the company to reduce its dividend. These problems have affected the entire industry, but seem to be a thing of the past now.
Redwood is the market leader in non-government secured securitization, having issued 110 securitizations valued at $ 55 billion since the late 1990s. The company has a network of over 200 institutional investors who will purchase these issues. . High quality investor and second home loans would be a perfect strategic fit for Redwood’s portfolio.
Redwood recently hiked its quarterly dividend from 14% to $ 0.16 per share. This gave the company a 5.9% dividend yield at Friday’s close, lower than the typical mortgage REIT. However, Redwood generates a lot of fee income, which offsets some of the interest rate and credit risk. Non-securitization leverage is low, at 1.3 times equity.
Non-quality management loans are poised to become the fastest growing sector of the mortgage market, and Redwood Trust is at the center of it. The rapid appreciation in house prices will stimulate the demand for jumbo loans and business loans. The loss of some of these loans will have a slight negative effect on the largest originators such as Rocket; however, Rocket’s loss will be Redwood Trust’s gain.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.