New ruling answers legacy mortgage bond servicing question

The New York Supreme Court has weighed in on a contractual dilemma Wells Fargo has reportedly faced as a residential mortgage-backed securities trustee with a responsibility to oversee investor payment distributions impacted by unforeseen policy changes.

A judge has ruled on how trustees and servicers should handle forborne principal from loans in the now-defunct Home Affordable Modification Program, according to McCool Smith, a law firm involved in the case, and court documents.

The decision, which could redirect around $400 million of losses, addresses a dilemma common for many legacy private-label securitizations and points to potential concern for investors from a slew of more recent servicing policy changes emerging from the pandemic.

"The ruling has sweeping implications for the RMBS industry and resolves longstanding ambiguity surrounding the accounting treatment for HAMP-modified loans," said McKool Smith Principal Courtney Statfeld, in a press release issued Wednesday.

"This decision not only resolves the dispute regarding the 34 trusts at issue but also provides much-needed guidance to Wells Fargo and other trust administrators on how to account for the billions of dollars in principal forbearance," said Robert Scheef, another principal at the law firm.

The ruling also is a "win" for junior bondholders 400 Capital Management, La Verdad Holdings, Solula and Robert Dechert, according to McCool Smith, which represented those clients as they took a position contrary to that of prominent investors like Pacific Investment Management Co.

Justice Andrew Borrok ruled in his decision that "the payment of previously deferred principal pursuant to a HAMP modification treated as a realized loss is a subsequent recovery," according to court documents filed earlier this week.

Junior bondholders supported that position while investors in senior tranches had argued that "subsequent recoveries are limited to loss recoveries on fully liquidated loans," according to the law firm.

PIMCO declined to comment. Other senior bondholders reportedly affected were AIG, Ellington Management, DW Partner, HBK Capital, Axonic Capital, Deer Park Road Management and One William Street Capital.

Ellington Management also declined to comment. None of the other senior bondholders named had responded to this publication's inquiries at the time of this writing. Wells also had not returned a request for comment at deadline.

There were many complications around how to process principal forbearance in the wake of the Great Financial Crisis' housing crash, when loan modification practices proliferated and became more standardized for the first time.

While junior bondholders typically are in a weaker position than their senior counterparts, disputes can arise over how cashflows are distributed, depending on how the loan pooling and servicing agreements are interpreted.

There can be a lot of variation in those agreements within the private-label mortgage securitization market, which was quite large before the crash transformed the market into one in which more standardized government-related bonds came to dominate.

During both of President Trump's terms, officials have looked at freeing two enterprises that play a large role in the government-related mortgage securitization market from the conservatorship they've been in since the crisis, which could increase private-label bond activity.

The enterprises' regulator and conservator is positioning their joint-venture uniform mortgage-backed securities for broader use in the private sector, which could involve the application of more standardized contracts in PL RMBS.