Legacy private-label RMBS market participants should take note: junior bondholders in certain vintages of low-rated nonagency RMBS have, in some cases, ended up with a payoff due to slow liquidation timelines, and a “rare” servicing transfer risk has surfaced, according to two recent rating agency reports.
A servicing transfer recently led to a swap termination, causing a sudden halt in cash flows. The disruptions in cash flows led the trust to not receive any principal.
Debash Chatterjee, a senior vice president at Moody’s Investors Service, said he cannot recall any other instances where this happened.
When asked if it could recur in the future, he said it is possible that it could, but situations where the trust did not receive any principal whatsoever are rare.
“Usually there’s enough to make the swap payment,” he said. “In many cases principal payments to bondholders get disrupted, but this was a circumstance where no cash was admitted to the trust.”
A catalyst for the change were differing strategies on the part of first servicing compared to the second, Kruti Muni, vice president and senior credit officer at Moody’s, told this publication.
Servicers’ loss mitigation practices can vary a lot, Chatterjee noted.
“Bigger servicers...have large depository institutions that can back the advances they are making versus some of the smaller servicers [who] are more constrained for cash. They are much more conservative in advancing.”
Servicing transfers continue to be a factor in legacy nonagency RMBS, as “many mortgage originators have gone bankrupt and their servicing arms have been picked up by other entities,” Chatterjee noted.
In a separate report, Moody’s analysts wrote about how the junior-most tranches in poorly performing subprime transactions from before 2005 paid off their principal balance.
Amy Tobey, vice president and senior credit officer at Moody’s, explained to this publication that this can happen when there may be material pipelines of delinquency but the losses aren’t being liquidated.
Chatterjee noted in an interview that the 2002-2003 deals involved in this circumstance went through a period back in 2005 and 2006 where there were high levels of prepayments.
“Many of the senior bonds got prepaid pretty rapidly or got paid down pretty rapidly, so as the senior bonds got paid down, the credit enhancement on the subordinate bonds increased,” said Chatterjee. Later, the market slowed down, the housing market crashed and delinquencies ramped up. If the delinquent loans had been liquidated on a timely basis, the credit enhancement that had built up for the junior bonds would have started a process where it would have been written down.
But because of modifications and because of foreclosure issues, the losses did not arrive. Thus, “even though the delinquencies keep on rising, the principal got diverted to the junior-most bonds, not to the senior-most bonds,” Chatterjee said
In contrast, “the deals that were issued in 2005, 2006, 2007, they performed so poorly right off the bat that they failed triggers,” he said.
Only junior bonds from years like 2002 and 2003 could see the aforementioned principal payments, as they performed relatively well at the outset and initially their losses were lower.