The subordinate bonds in some Saxon-sponsored securitization deals still have value.

This is because these bonds are still receiving interest payments as a result of a feature that does not write them down for mortgage losses, according to a Moody's Investors Service report included in its Moody's Resi Landscape publication.

Analysts estimated that the bonds' net present values are as high as 35% of par — those at the bottom of the capital structure generally have the most value.

The value for these bonds, according to Moody's analysts,  is greatest under slow-prepayment assumptions. These would prolong the payment of interest on the bonds’ nominal principal amount.

In most RMBS offerings, the rating agency said, losses on the underlying mortgages lessen the subordinate bonds's balance, which results in a  “write-down.” In this case, the bonds do not receive interest on the written down principal, which makes these worthless after a complete write-down.

The subordinate bonds in Saxon Asset Securities Trust 2005-1, 2005-2, 2005-3, and 2006-1 benefit from a unique structural feature that does not allow any bond principal write-down that is caused by losses on the underlying mortgages, Moody's said.

This feature allows subordinate bond holders to get interest payments for as long as underlying mortgages generate enough interest. This feature applies even if the mortgages have had losses that exceed the subordinate bonds' balance, resulting in under-collateralization.

In most subprime deals, this feature applies to senior classes only.  Because of this feature, these subordinate bonds will get interest cash flow to the extent the underlying mortgages would still be generating interest from collections as well as servicer advances, Moody's said.

As of June 2010, the ratio between the interest on the mortgages and interest on the bonds or the "coverage ratio” for these deals ranged from 3.73-7.31, according to charts presented by Moody's.

If the assumption is based on the mortgage bond and coupons staying the same, the mortgage pools have to experience losses above 80% for most of the subordinate bonds to experience an interest shortfall.

A potential risk to the cash flow is the high percentage of collected interest from servicer advamces. If the servicer changed its advancing practices, the amount of cash flows will become more volatile, according to Moody's. 

The other probable sources of volatility are loan modifications, which would likely reduce interest on the mortgages, and future Libor paths, an increase in which will cause the bond coupon to rise more than the mortgage coupon.

To estimate the value of the bonds, analsyts ran cash flows for each of the four deals via the Moody’s Wall Street Analytics’ Structured Finance Workstation® (SFW). The rating agency's cash flows included 16 scenarios that incorporated its loss expectations aside from different combinations of default timing and prepayment assumptions. They discounted the cash flows at  10% to arrive at a net present value, expressed as a percentage of the April 2010 remaining par value of the bond.

For instance, the agency's estimated net present value of Saxon 2005-1 Class B-3 is 35% of par at a discount rate of 10%. A NPV of 35% suggests that a bond purchased at a 65% discount will yield 10%, which is above 900 basis points over six-month Libor in June 2010.

The NPVs of the subordinate bonds in these transactions range between 7% and 35% of par and are generally highest for the bonds at the bottom of the capital structure, which have the highest coupons.

An added unusual attribute of these bonds is that they tend to benefit from slow prepayments, which make the payment of interest on the bonds’ nominal principal amount longer.

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