JP Morgan isn’t the only one paying the price for its alleged mortgage bond misdeeds.
When the firm agreed to spend $4 billion in consumer relief as part of its $13 billion settlement with the U.S. Department of Justice, it also put investors in these mortgage bonds on the hook.
At least $2 billion of the consumer relief will be in the form of principal forgiveness, which the bank could opt to fund in the form of principal forgiveness on loans in private label RMBS, according to a report published today by Standard & Poor's.
The terms of the settlement, which was reached in November, give JP Morgan gets a 50% credit for forgiving balance on loans in private-label RMBS. In other words, JPMorgan will get credit towards the settlement, while actual losses will be borne by the securitization investors.
This provides JPMorgan with an almost costless option to achieve the $4 billion target at the expense of non-agency investors, explained analysts at Barclays in a report published last month.
“JPMorgan could decide to try to reach the entire $4 billion credit through first-lien forbearance on private label deals,” Barclays stated in the report. “This would involve about $8 billion of forgiveness on these loans, since they only receive 50% credit.”
The majority of these transactions already allow most types of loan modifications, so investor consent wouldn’t even be necessary, according to S&P.
In cases where consent would be required, S&P said that the process has proven difficult for trustees and transaction parties, “so this could be a formidable obstacle to modifying loans where investor consent is required.”
A large increase in modifications could result in a drop in the weighted average coupon paid by the collateral; an increase in losses from principal forgiveness or forbearance modifications; or an increase in prepayments if loans are refinanced, according to S&P.
“Principal forgiveness and forbearance would have an immediate impact on losses and credit support, while interest rate reductions could cause interest shortfalls or reduce the projected credit support available for transactions that rely on excess interest,” explained S&P analysts in the report.