News about the biggest banks and their struggles with residential mortgage-backed securities and their related liabilities is more or less inescapable these days.
Regional banks have proportionate exposure to nonagency RMBS which is similar to that of the bigger banks. For some reason, this point has received little attention from the media.
The regionals themselves have been conspicuously silent about the subprime and alt-A mortgage-backed securities crisis. The banks certainly seem to be making full disclosure in their GAAP filings, but why has an issue of such importance to regional banks been kept quiet for the last four years?
Curious about steps taken by regional banks to mitigate the steady losses coming from their residential mortgage backed securities portfolios, I recently conducted several news searches. The answer was the same in each case: Almost no news about the banks' RMBS exposure, the steady accumulation of unrealized losses each quarter, warnings of continuing losses and nothing about loss mitigation or about the banks' recovery efforts.
A glance at the most recent 10-Q filings of the 10 U.S. regional banks with the largest RMBS portfolios reveals some surprising facts:
• Nine of the top 10 had zero exposure to nonagency RMBS (i.e., private-label mortgage-backed bonds not issued by U.S. governmental agencies).
• The other nine banks had over $37 billion in nonagency RMBS, and approximately $2 billion in unrealized losses, or about 5% of their remaining aggregate exposure.
• Each of the nine reported increasing unrealized losses during the first two quarters of 2011 through June 30, 2011.
The management of each exposed bank identified their nonagency RMBS investment portfolio as the source of potential additional future losses. To date, however, only one of them, Charles Schwab Bank, has described any steps taken to mitigate losses or recover last value. Schwab's attorneys at the estimable firm of Grais & Ellsworth filed suit against 11 major banks, claiming that the defendants “…made numerous statements to Schwab about the [RMBS] certificates and the credit quality of the mortgage loans that backed them” and “…many of those statements were untrue as to material facts.” This is Schwab's second such suit.
Given the banks' concerns with NIM pressure, capital requirements and deteriorating housing market conditions, why aren't the banks aggressively enforcing their rights as bondholders against RMBS counterparties?
Perhaps it is the reluctance of the residents in glass houses to throw stones. Indeed, several of the regionals (PNC, SunTrust, and Capital One, for example) are themselves targets of ongoing mortgage loan put-back disputes. It may be that arguing for the enforcement of their loan put-back rights would contradict the arguments they are making in defending against similar claims against them. In any case, these banks are therefore certainly familiar with the put-back route to potential value recovery. They will also be familiar with the costs and lengthy timelines that come with put-back claims.
But what about the banks' other creditor rights? Loan servicers in securitizations generally make contractual promises to undertake a number of positive servicing obligations (e.g., make payments when due, provide reports on a timely basis). The banks could use such contractual commitments to gain negotiating leverage, if it is found that the obligations have been breached. Leverage can pay off in a material manner via cash settlements, enhanced collection efforts and/or servicer termination.
It's possible that the banks are deterred because they do not own 25% of the certificates issued by a given trust, and 25% ownership is usually a requirement for any bondholder who wishes to enforce his or her creditor rights. If so, it is worth noting that we are no longer in 2008, when it was difficult or impossible to find enough bondholders to meet the 25% test. Since then, growing awareness of the bondholders of their common plight, increasing numbers of investors taking aggressive action and proliferation of formal and informal clearing houses have greatly mitigated this threshold problem.
With respect to their balance-sheet loans, leases and other direct credit exposures, regional bankers are justifiably renowned for enforcing creditor rights for the benefit of their stockholders. RMBS portfolios are balance-sheet assets, too. Similar efforts directed at RMBS counterparties should not receive a lower priority.
Steve Ruterman is an independent consultant to institutions and institutional investors with significant RMBS exposures.
