Many Street analysts are talking about the transactions that Ocwen Loan Servicing serviced that reported interest shortfalls seen in some of the senior classes. These were revealed by the May remittance reports.
"The May remittance reports for certain deals contained unpleasant surprises for many noteholders (including senior classes), " according to a Barclays Capital report released this morning.
The report said that numerous transactions that were serviced by Ocwen, many of which had Wells Fargo the master servicer, reported interest shortfalls rising as high as the senior classes. "How could AAA rated, senior notes experience interest rate shortfalls? " asked Barclays analysts.
According to them, the answers are in the loan modification and servicer-advance recoveries and the treatment of partial principal charge-offs, such as principal reduction. Analysts said that within the deals in question, Ocwen made considerable amounts of loan modifications, which were equivalent to 2.2% of outstanding loans per month, on average, or roughly 25% per year.
Upon the modification, a mortgage is reclassified as current, and servicer advances on such loan are usually seen as nonrecoverable, Barclays said. This, they said, will permit the servicer to pay back itself for all prior advances in terms of the loan from interest collections at the top of the cash flow waterfall.
"The increasing popularity of loan modifications suggests that reimbursement of nonrecoverable advances likely will become more common," Barclays said.
Analysts said that such collections could limit the interest paid to tranches at the bottom of the capital structure, but usually should leave triple-A allocations untouched. However, this might not be the case if there are massive loan modifications and the transaction is performing very poorly.
They added that a more worrisome is the apparent recent practice of taking partial loan write-downs from the interest waterfall and thus bypassing structural protections built into the principal waterfall.
Barclays said that the principal reduction such as debt forgiveness on modified loans was generally much bigger compared with the accumulated servicer advances in the Ocwen transactions that they looked at. Additionally, in many cases, it was sufficient to deplete interest allocations to the triple-A tranches, according to analysts.
In a research note released yesterday, Credit Suisse analysts said that aside frominterest-related mods, the servicing firm has also stepped up its utilization of principal reduction mods. According to Credit Suisse, the required trial mod period is also lessened from six to three months.
Analysts added that Ocwen has tightened recoverability assumptions on advances, adding that the firms advance-related servicing cost has risen substantially. "The recent ramp-up in modifications and other advance-related changes will allow Ocwen to reduce the advance cost," analysts wrote.
Credit Suisse said that it is too soon to know the impact of the recent Ocwen mod increases on buysiders. Analysts said that should the newly modified loans successfully re-perform, ABS buyers should be better off. But, considering that the re-underwriting of modified loans is not disclosed, analysts said that it is impossible to know whether these are good mods that have a decent chance of re-performing or if they are bad mods that have a high likelihood to re-default.