Research from 12th Street Capital pointed out that the new program for homeowner affordability ensures that first and second lien holders are treated fairly and consistent with priority of liens.

However, the servicer’s classification of these modifications and the exact language in the related securitization's governing documents will have a great effect on who will suffer the shortfalls caused by the modifications. 
Rate reductions will have the double effect of reducing the net wac cap, causing net wac cap shortfalls that are not covered by most monoline policies that wrap many of these second lien transactions. They will also reduce any excess interest and lower the chances of any deal restoring OC or paying back monolines for prior period draws and for covering losses,etc.

Analysts said that in the case of forbearance, the effects of the new plan are less clear. "Most servicing agreements and pooling and servicing agreements do not provide specifics on how principal forbearances should be treated," 12th Street analysts said. "Depending on how the servicer/investor accounting treats forbearance: (a) does not write loan balance down and therefore does not apply loss to deal; or (b) writes down loan, applies loss to deal and treats any repayment of forbearance as a subsequent recovery; can have a huge implication on bond payments."

If a servicer follows option a, the interest shortfalls will be covered by the monoline assuming the higher balance is not factored to reduce the net wac cap, but this will create massive wac cap shortfalls. These are not typically covered by monolines because there will be more bonds than loans, explained analysts.

If the servicer is required to advance (fixed-rate seconds, not HELOCs) assuming an interest rate calculated on the full loan balance, there will not be any interest/wac cap shortfalls. However, there will be eventual principal shortfalls when the servicer recovers any advances not recovered on the related mortgage loan from all deal cashflows. These principal shortfalls would be covered by the vast majority of monoline policies. The servicer’s ability to recover advances first, from all available funds, is standard across all RMBS.

However, if option b were followed, principal forgiveness will pass to the monolines, but will   depend on the terms of the individual policy (as incurred or at the final scheduled distribution date of the bond). The option chosen by the servicer will be driven by the requirements of the related servicing/pooling servicing agreement. Once this determination is made, the servicer’s advancing decision will be driven by the defined terms surrounding their advance requirement and how the principal balance requirement it is based on is defined, according to 12th Street.

"The principal balance definition in some deals only recognizes reductions for payments and a final liquidation while others will recognize partial liquidations," analysts said. "This of course assumes that congress will not determine who they think should bear the losses and override the private contracts."

Analysts added that the language used in drafting the monoline wrap from any deal throws another wrench in principal forbearance.

"RMBS transactions require the monoline to cover (1) timely interest, (2) the ultimate recovery of the bond principal balance on a specified due date and, in some transactions, (3) a maintaining of parity between the bonds and the loans," they said. "For transactions with this third requirement, some contracts are drafted so that the monoline is responsible to make a payment whenever the bond balance is greater than the loan balance. It is easy to see how the servicer’s timing on the write down of loans and application of losses on bonds will effect timing in this instance."



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