By the time you read this, the second jumbo MBS deal in 10 months will be wrapped up and sold to clamoring investors—but not without a minor controversy concerning the rating of this $290 million “nonconforming” bond.
Here's the particulars: about two weeks ago Redwood Trust, a publicly traded REIT from Mill Valley, Calif., came to market with the deal, soliciting two different rating agencies to grade the security, Fitch and Moody's Investors Service. In the end, Fitch got the nod, and then shortly thereafter Moody's issued a warning on the security, telling investors they may want to consider the "earthquake risk" on the deal.
That's right: earthquake risk.
"Based on preliminary information on the Sequoia Mortgage Trust 2011-1 transaction, we believe that the pool is more exposed to earthquake risk than most RMBS pools given that 56% of the loans by principal balance are in California and much of that exposure is in the San Francisco metropolitan statistical area," wrote Linda Stesney, a Moody's managing director. "If a major earthquake were to strike the San Francisco MSA, the decline in the values of damaged properties, and the likelihood that borrowers could abandon properties whose value has plummeted, will likely result in either losses to senior certificate holders or deterioration of the credit quality of the notes to junk status."
A handful of MBS investors and analysts I spoke to were scratching their heads about the Moody's note. Indeed, a majority of the homes collateralizing the bond are located in San Francisco (also known as “earthquake central”) but no one I talked to could recall ever seeing a rating agency issue a warning about a natural disaster on an MBS deal. (Maybe I haven't been around long enough.)
One source at Fitch, requesting his name not used, had this to say: "Earthquake risk? I've never seen anything like that in my life."
The offering circulating on bond (Sequoia is the name of Redwood's shelf) notes that Redwood and Moody's had a difference of opinion on the bond's risk, namely the earthquake business. Although, none of the parties to the disagreement would talk on the record about the matter, I would venture that Moody's asked Redwood to put up more money to allay investors' fears about San Francisco falling into the ocean when the “big one” hits. Redwood said no, and that's why Moody's didn't get the assignment.
Still, Moody's put out a warning on the deal. A spokesman for Moody's said there is nothing unusual about a rating agency writing about bonds that it did not get an assignment on. "We've done that a number of times," he said.
In other words, any time we see bonds backed by homes in “risky” geographic areas we could see warnings about not just earthquakes, but floods, tornadoes and hurricanes. (Mortgage bankers and Realtors in Florida will love this.)
Those who are suspect of the Moody's note see the warning, perhaps, as sour grapes. (It didn't get the assignment.)
One player in the jumbo market noted that many years ago when Republic Bank of San Francisco issued a $170 million jumbo bond an earthquake ensued and its ultimate loss on the deal was less than $400,000.
Then again, maybe Moody's is just being careful. The rating agency and Fitch (and others) have a lot to make up for. Remember all those subprime securities it gave glowing ratings to during the housing boom? Better safe than sorry, I guess.
