MBS Investors Cry Foul Over National Mortgage Settlement

ab032012mbs.jpg

Mortgage bondholders are threatening legal action over the $25 billion national mortgage settlement, which will give the five largest servicers credits for principal writedowns that the bondholders may take.

The settlement's final terms, released last week, offer banks incentives to write down the principal of loans they own themselves and of loans held in securitized trusts. Investors in those trusts were not a party to the settlement agreement. Now they are objecting to being forced into taking losses — to the banks' benefit — as a result of it

The settlement allows servicers to receive 45 cents of credit for every dollar of principal reductions paid for by investors. Banks will receive $1 of credit for every dollar of principal write downs on mortgages they own.

Vincent Fiorillo, a portfolio manager at DoubleLine Capital and the president of the board of the Association of Mortgage Investors, a trade group of bondholders, says the government is forcing investors to take losses even though they were not responsible for the foreclosure process abuses that led to the banks' settlement with state and federal officials.

"The banks are trying to pay these fines with our money," says Fiorillo, who wants mortgage investors to begin a dialogue with the settlement's external monitor, Joseph A. Smith Jr.

Chris Katopis, the executive director of the bondholder trade group, says it is considering its legal options, including filing a friend of the court amicus brief or suing servicers individually.

"Banks are shifting their liability to first-lien investors that were innocent of robo-signing," he says.

As part of the settlement, Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co., Wells Fargo & Co and Ally Financial Inc. are required to offer borrowers a total of $17 billion in consumer relief. The banks earn different "credits" for each type of aid offered for principal reductions, refinancings, and writedowns of second liens.

The settlement does nothing to change the contractual pooling and servicing agreements between investors and mortgage servicers. Some bondholders may have given banks authority to take writedowns on other settlements, but they were not a party to the $25 billion agreement between the banks and state attorneys general.

If a contract does not permit principal writedowns, the servicer cannot take them, according to an official at the Department of Housing and Urban Development, who spoke to American Banker on Friday but declined to comment publicly.

All modifications made under the settlement must adhere to a "net present value" test, which assesses a borrower's eligibility for a government modification program and determines whether such a program would be more profitable for an investor than a foreclosure, the HUD official said. While investors would incur losses by writing down principal, the losses would be less than what they would suffer if a loan went into foreclosure.

But if they have to take writedowns without getting paid by the banks, mortgage investors don't want banks to get credit for them. Bondholders are especially concerned about writedowns from Bank of America, which has privately securitized more than $285 billion worth of mortgages originated by Countrywide Financial Corp. (B of A acquired Countrywide in 2008).

B of A spokesman Dan Frahm says mortgage investors had previously agreed to give the bank authority to modify loans. B of A will be soliciting 200,000 borrowers to offer them modifications as part of the settlement's terms, though Frahm says he expected about 50,000 borrowers to respond.

"I don't think the focus for us is on credits," Frahm says. "We'll be reaching more customers and potentially offering them deeper principal reduction."

He adds that B of A is reviewing the details of the program, which would address the large volume of delinquent loans in its legacy Countrywide portfolio, with "the limited number of investors who have inquired about it."

Sandeep Bordia, head of residential credit strategy at Barclays Capital, wrote in a report Friday that B of A may be able to forgive as much as $14.3 billion, for which it would receive settlement credits of $6.4 billion. Those figures assume that more than 200,000 borrowers will qualify for debt forgiveness of $100,000 on average, he wrote.

The settlement must be approved by a federal district court, and "there is the possibility that some private investors could resist the settlement," Bordia wrote in his report.

"Even after court approval, an indiscriminate application of modifications to non-agency loans is likely to be met with legal challenges," he added. "The possibility of legal challenges from investors cannot be ruled out if indiscriminate mass modifications were to take place."

The five banks have all said that they reduce principal only on loans for which they have received delegated authority from investors and that the mortgage settlement does not change that.

Ally spokeswoman Gina Proia told American Banker that the lender plans to modify the mortgages it owns first.

"At this point we are focusing on our own portfolio," Proia says, adding that the bank had already modified 28% of all loans in its servicing portfolio prior to the settlement.

Citigroup spokesman Mark Rodgers says the bank takes principal reductions on investor loans "when in the best interests of our investors and allowable under servicing agreements."

Wells Fargo is applying modifications to investor-owned loans, according to spokeswoman Vickee Adams.

JPMorgan Chase spokesman Tom Kelly declined to comment.

Analysts acknowledge that servicers have a bigger incentive to modify their own loans, but some question why regulators would give banks credit for writedowns paid for by investors.

"How can the government impose a benefit on servicers at the expense of the investor?" asks Walter Schmidt, a senior vice president at First Horizon National Corp.'s FTN Financial Capital Markets Corp. "The servicers are going to go to their own book first, but just the fact that they can modify private-label portfolios is a concern."

Most private-label securities contracts already have a 5% to 10% cap on the number of loans in a given trust that can be modified. But those caps depend on each trust's performance and can vary depending on whether investors have already given a servicer the go-ahead to modify loans or offer principal writedowns. Investors say they would have to sue a servicer to force them to abide by the contracts.

Bondholders also claim that during a Feb. 14 conference call with 90 investors, HUD Secretary Shaun Donovan assured them that the number of private-label securities that could be modified under the settlement would be capped at 15%. The settlement did not include a cap, angering investors who claim the government favors banks over bondholders.

The HUD official on Friday said Donovan did not make any promises about a cap on the number of investor-owned loans that could be modifying. The 15% mentioned during the conference call was an estimate of the total number of investor-owned loans the HUD secretary thought banks would modify under the agreement, the official said.

For reprint and licensing requests for this article, click here.
Consumer banking Law and regulation
MORE FROM AMERICAN BANKER