Wells Fargo unsettles mortgage bond market by holding back funds
Wells Fargo & Co. surprised investors this week by withholding more than $90 million due to buyers of pre-crisis residential mortgage-backed securities.
The bank said it invoked its right as trustee to hold back funds to cover legal costs. The 20 transactions had a principal balance of $540 million and are among more than 2,000 deals involved in a lawsuit brought by bondholders including BlackRock Inc. and Pacific Investment Management Co. in 2014 to recover losses from the financial crisis.
It's only the second time that proceeds from bonds involved in that litigation have been withheld from investors. Wells Fargo's move caused losses for some bondholders and sent others scrambling to assess risks for similar deals in a market still recovering from the bursting of the housing bubble in 2008.
"I expect the market to somewhat freeze until there is more clarity on the bonds with that clause or similar," said Guillermo Roditi, a portfolio manager at New River Investments in Los Angeles. "I expect there to be a bit of chaos."
Wells Fargo withheld some funds after New Residential Investment Corp. exercised a so-called clean-up call on the debt. The deals were originally sold in 2004 and 2005 and include loans made or acquired by Bank of America Corp. to prime and non-prime U.S. borrowers.
About $3,000 per loan was held back, according to analysts at JPMorgan Chase & Co. and Webbs Hill Advisors LLC. The amount withheld was determined by the "scope of the plaintiffs' claims," said Jen Hibbard, a Wells Fargo spokeswoman.
"Wells Fargo, in its capacity as trustee, has been named as a defendant in lawsuits claiming the trustees breached certain duties to investors," she said. "Wells Fargo has incurred and will incur legal expenses, even though it continues to believe it is not responsible for any losses in the relevant trusts and that these lawsuits are without merit."
Investors are suing six banks over their roles as mortgage-bond trustees, claiming they knew the loans underlying trillions of dollars of RMBS were misrepresented and failed to force the sellers to buy them back. Wells Fargo is trustee for 261 deals, according to JPMorgan.
"This trustee lawsuit and others that are pending have created a new risk for legacy buyers," said JPMorgan analysts led by John Sim. "We expect the trustees to continue to hold onto these reserves and to take on more reserves for called deals until there is more legal clarity."
Wells Fargo's decision is already being felt in the wider market for crisis-era mortgage securities that don't come with a government guarantee. About 400 deals are "somewhat similar" to the redeemed deals, with Wells Fargo acting as trustee for 34, Morgan Stanley analysts led by James Egan wrote in a note to clients on Wednesday.
The outstanding stock of so-called non-agency RMBS has shrunk by about 70% in the past decade to $823 billion, according to the Securities Industry and Financial Markets Association.
"Investors should be concerned with this new policy," wrote Scott Gimpel and Daniel O’Connor at Webbs Hill Advisors. The logic used to calculate the reserve is unknown and there's no third-party oversight to ensure the expenses are legitimate and reasonable, they said.
HSBC Holdings Plc put $2 million in a reserve account when a deal was called in September 2015 and 10 other called deals were paid in full, according to Webbs Hill.
"This has happened before, but not with so many deals at once," said Jasraj Vaidya, a director at Amherst Capital Management and a former mortgage bond analyst at Barclays. "It's definitely a problem for those investors."