Talk about dipping your toes in the water

Redwood Trust is preparing what may be the first securitization of residential mortgage bonds that do not fall under new rules designed to ensure that borrowers can afford the payments.

Two of them.

The $329.95 million Sequoia Mortgage Trust 2014-3 is backed by 462 loans on primary or secondary residences, of which 448 have application dates of Jan. 10 or later, and are therefore subject to the so-called ability-to-repay rule. Of these, just two loans, or 0.06% of the pool, were originated as non-qualifying mortgages and so are not immune from consumer lawsuits, according to rating agency presale reports.

The remaining loans were either classified as qualified mortgages that benefit from a safe harbor (96.9%), for which the ratings agencies did not require any adjustment to their loss severity; or are not subject to the qualified mortgage rule (2.6%), either because they were originated before Jan. 10 or because they were originated as investment properties.

Fitch Ratings said in its presale report that including the two non-QM two loans resulted in a "negligible" increase of less than five basis points to the expected loss severity of the deal's triple-A tranches.

Kroll Bond Ratings 'presale report states that the two non-QM loans were originated to borrowers with substantial equity in their properties and a significant amount of reserves, resulting in "a minimal adjustment," or approximately 1 basis point, to its loss severity and expected loss.

Prior to this deal, all private-label mortgage securitizations have been backed either by loans originated before the qualified mortgage took effect by QM loans, or a mix of both. That may be partly because there was an overhang of older loans available to be securitized, because of a reticence to test investor appetite for such loans, or because lenders have not yet originated a great number of non-QM loans.

The other ratings drivers outlined in the presale reports are more typical of recent private-label mortgage securitizations, including the geographic concentration of the properties, which is relatively low, and the lack of performance history of some of the loan sellers.

The highest concentration of the loan pool, at roughly 10%, is in the San Francisco metropolitan statistical area and almost 9% is in the Seattle MSA. Also of note, a single loan comprising 0.14% of the pool is located in Napa, Calif., which may have been impacted by the Aug. 24 earthquake, according to Fitch.

However, as part of its due diligence, Redwood Trust ordered a drive-by inspection to confirm that the property was still intact and no material external damage was present. For this reason, Fitch did not make any adjustment in its analysis for this loan.

Kroll's report notes that Redwood continues to diversify the loan sellers contributing to its transactions, with the loans in this deal coming from 89 different originators. "While seller diversity helps reduce geographic concentration, it also increases exposure to the underwriting standards and processes of sellers with limited jumbo mortgage loan performance history," the report states.

Kroll also noted that the credit quality of the borrowers is strong, as evidenced by weighted average credit score of 771.

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