Wells Fargo’s recent withholding of major funds from mortgage bond investors opened new wounds in a sector still recovering from aftershocks of the housing crisis.
Trading in crisis-era mortgage bonds has not altogether dried up since June, when Wells opted to withhold around US$91m from bond investors.
But investors are once again facing the pitfalls from owning bonds that are still prone to unexpected losses, a decade since the housing bubble burst.
“We’ve now taken some highly questionable shortfalls,” said Christopher Abate, president and CFO of mortgage investor Redwood Trust, on the company’s second-quarter earnings call. “So we’re forced into a position here where we need to closely monitor the situation and ultimately, protect our interest,” he said.
“But our frustration with this trustee matter should be pretty evident at this point.”
Redwood recorded a US$500,000 loss on one legacy mortgage bond hit by the Wells holdback and an overall cash shortfall of US$1.1m in the second quarter.
It was far from the only investor to suffer.
Despite the bonds being called at par, Wells kept hold of funds from 20 RMBS deals in June.
Pacific Investment Management Company, already part of ongoing trustee litigation against Wells, reacted with a new suit in July that asked a New York court to stop Wells from “looting” RMBS trusts.
Wells said it was entitled to reserve funds to help pay its legal costs, rather than sending onto bondholders the full payment on called deals.
It is anyone’s guess whether the legal dispute will end in a swift settlement, some degree of bond repayments, or a battle that drags on for years. But for those looking for a rekindling of confidence in the RMBS market, the latest dispute feels like a setback.
RATINGS TAKE A HIT
Moody’s and Fitch initially flagged the holdbacks as a new source of risk in the RMBS market, and warned that similar trustee actions could follow.
They moved next to a string of downgrades after several months passed of non-payment on the bonds that were hit in June by holdbacks.
Fitch went even a step further than Moody’s and slashed its ratings on a total of US$2.4bn of RMBS deals - some of which had not yet been subject to large trustee holdbacks.
“These classes are identified to be at risk for a future writedowns if Wells continues to retain funds like they did in June,” said Grant Bailey, the US RMBS group head at Fitch, about the agency’s decision.
HARDER SELL
These surprise summer losses and downgrades have shifted the market’s focus to uncertainty from one of recovery.
In the past five years the median sales price of US homes has increased 38%, which has greatly helped increase the appeal of mortgage bonds once considered toxic.
Improved payoff rates of older loans also meant older RMBS deals were being called regularly at par, and producing a nice windfall to investors who had bought the notes at a discount.
But now the threat of trustee holdbacks has put a damper on trading in so-called “legacy” RMBS bonds that could end up impaired or entirely wiped out.
“If you have a bond that looks callable, the offer is unchanged,” said Colin McBurnette, a portfolio manager at Angel Oak Capital Advisors. “But the bid is accounting for dollars going away, which means very little has traded - and we don’t expect that to change.”
SEEKING RATIONALE
The scope of the bonds at risk due to their inclusion in ongoing trustee lawsuits is about US$255bn, or nearly half of all existing pre-crisis mortgage bond deals, according to JP Morgan.
The dispute has also caught the attention of the Structured Finance Industry Group, which while avoiding taking sides on the litigation, said its broad base of members was still seeking clarity about the rationale for the holdbacks.
Chief among the questions being asked is what deal documentation is being relied on as a basis for the holdbacks. Another is what calculation is being used to determine the amounts behind held in reserve.
Ambiguous deal documents and lack of transparency have contributed to a “crisis of confidence from which the securitisation market is still trying to recover,” SFIG said in a statement.
“We believe the market is best served, as a matter of principle, by a transparent approach to decisions and information that will have a material and direct impact on transaction stakeholders,” the statement said.