The main advantages of blockchain securitization in RMBS transactions

Words have not failed to write about the applicability of distributed ledger (DLT) technology to the securitization market, and the recent Sequoia Mortgage Trust deal suggests that could finally happen, if not as the first and least difficult step.

Securitizations involve multiple parties exchanging critical information, which increases the likelihood of delays and errors and the associated costs. DLT, also known as blockchain technology, should securely encrypt this information in the submission schedule, so that all authorized parties can access it quickly, greatly reducing the current loopholes.

In what appears to be the first example of DLT used by an issuer that regularly taps the agency-less residential asset-backed securities (RMBS) market, Redwood Trust, Inc., on September 22 announced the pricing of a pulling securitization. party of the blockchain. He enlisted Liquid Mortgage, a digital asset and data platform in which the specialist finance company has a minority stake, to act as the distributed ledger agent on the transaction.

The $ 431 million Sequoia Mortgage Trust (SEMT) 2021-6 deal has been split into five AAA-rated tranches, according to Finsight, with all but one tranche bearing a 15% credit enhancement (CE) and four priced coins. a coupon of 2.5%. . A $ 49 million coin had a CE level of 4% while retaining the 2.5% coupon, while a $ 95 million coin had a 2% coupon with a CEO of 15%.

Digital Mortgage will provide end users with daily loan-level payment reports of principal and interest on the underlying mortgages, instead of a one-month delay, which is standard industry practice.

“This inclusion of enhanced payment and prepayment reporting within the Sequoia securitization platform (SEMT) is the first step on the path to setting up an entire RMBS transaction on the blockchain,” said Fred Matera, managing director and head of residential at Redwood Trust, in a statement.

In fact, the idea of ​​using DLT to make the securitization market more efficient and secure has been around for years. In 2017, the Structured Finance Industry Group (SFIG) and the Digital Chamber of Commerce commissioned Deloitte to explore how blockchain could reinvent the securitization market, resulting in a 34-page report. S&P Global Ratings released a report in February 2019 on what blockchain could mean for structured finance, and in September 2021 it released a follow-up titled “Distributed Ledger Technology Prepares for Take-off”.

The report notes that once a securitization incorporates DLT, the Special Purpose Entity (SPE) can continue to host the assets, but DLT technology’s “smart contracts” could facilitate the cash flow cascade.

“The provision of data and performance on the assets of service providers and other relevant parties would potentially be available in real time on the distributed ledger, thereby improving punctuality and potentially reducing errors,” the report said.

The S&P Global Ratings report does not mention the Redwood transaction, but it does note that some structured finance transactions used DLT, including three Société Générale covered bonds between 2019 and 2021, and some Chinese bond transactions placed from private way.

“These securitizations use authorized blockchains primarily to record and verify asset data and cash flows,” says S&P Global Ratings.

In the United States, the report notes, Figure Technologies issued RMBS last year on a blockchain operated by partner company Provenance. On March 11, 2020, the company announced that it had issued the “very first loan-backed securitization issued, managed, funded and sold on blockchain,” claiming that the use of blockchain resulted in more than 100 basis points of savings. Jefferies Group and Nomura Securities were the main underwriters, Tilden Park Capital provided loans and bought the subordinate part, and a major asset manager bought the senior rating, according to S&P Global Ratings.

Provenance published a white paper around this time, noting that the deal was divided into a $ 127 million portion with a 4.0% coupon and 15% credit enhancement, and a subordinated portion of $ 22 million. dollars without credit enhancement.

The company’s approach “represents an implementation of blockchain in a complex end-to-end value chain rather than its application to a discrete business process,” according to the white paper. A spokesperson for Figure Technology did not respond to a request as to whether it has since completed additional ABS offerings.

[DELETE–Figure Technology begins applying the blockchain—DELETE] The Liquid Mortgage blockchain solution begins after the loan is originated, whether it is the next day or years after the loan maturity date. It creates a unique digital asset that references each loan with a loan-level account on the blockchain, assigns a digital fingerprint – or hash – to the documents related to the loan, and then places them in the loan account.

“The information and documentation will still be with the loan, and you can still validate loan, document and payment data,” said Ian Ferreira, Founder and CEO of Liquid Mortgage.

The technology also receives payment data from services and reflects it on a public blockchain via digital asset accounts, encrypting payment and balance information when payments arrive, amounts.

“The aim of this first phase is to create ultimate transparency at the loan level,” Ferreira said, adding that investors will have daily access to payment information, instead of waiting for the usual 55 days.

Matera said the inclusion of enhanced payment and prepayment reporting within the SEMT securitization platform is the first step towards getting the entire RMBS platform up and running on the blockchain.

“By taking advantage of the speed and precision of [DLT] we believe we can dramatically increase transparency and reduce friction points in the life of a residential mortgage, including legal documents and contracts, due diligence, reporting and data, ”said Matera.

As an example, he added, loan-level payment reports can provide better insight into borrowers’ payment and prepayment activities on a more frequent basis than is traditionally available.

Ferreira said the second phase, which currently aims to be completed in mid-2022, will be working with service providers to create payment rails through the blockchain allowing borrowers to make payments that will be distributed directly. to the portfolio or trust that holds the loans. In the third phase, he added, the company aims to create a trading platform for digital assets backed by loans or split loans.

“The ultimate goal is to be able to trade these digital assets on a blockchain, where parties can easily trade assets within seconds,” he said.

The arrival of the last two phases, which go beyond access to information and transactional capacity, may depend in part on regulators.

“Everyone wants to stay in the safeguards, and I think there is still an element to be determined what that is,” said Tom Schopflocher, senior director of global structured products research at S&P Global. Ratings.

S&P Global Ratings analyzed the potential risks of placing ABS on a blockchain in the context of its “five pillars” approach to rating structured finance transactions. He determined that the two most important types of risk are “legal and regulatory”, followed by “operational and administrative”.

Severity risk and portability risk follow, and credit risk is the fifth type of risk and the least of concern.

“We don’t expect asset performance to be affected initially if blockchain is adopted, nor do we expect borrower behavior to be influenced by the use of blockchain,” said S&P Global Ratings. “As such, we believe that the credit quality of assets would be the least affected pillar of our analysis.”

Michael J. Birnbaum

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