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Holdbacks put callable mezzanine classes at risk
admin | December 7, 2018
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Just when it might be safe to buy callable legacy mezzanine RMBS, a new round of trustee holdbacks has put those classes at risk. HSBC, US Bank and Wells Fargo, acting as trustees on four legacy RMBS trusts, held back approximately $10 million of call proceeds, adversely impacting mezzanine bonds in the called trusts. While this round of withholdings is more modest than ones during the summer, they are nonetheless both concerning and surprising, especially in light the recent Wells Fargo and US Bank trustee settlements.
Holdbacks occur when a trustee traps cash to cover potential future expenses–cash that would have been otherwise paid to bondholders when a trust is liquidated. In the case where a clean-up call is executed, the trust is dissolved, causing the trustee to estimate future expenses and withhold them from the proceeds. These holdbacks have been driven by investor lawsuits alleging RMBS trustee negligence in their fiduciary duties to bondholders.
Four trusts called in the November remittance cycle saw holdbacks. Two HSBC trustee deals, ACE 2005-ASP1 and ACE 2006-ASP2, saw fixed trustee holdbacks of $2 million per trust and, in a curious wrinkle, each trust had $505,000 withheld by Wells Fargo as securities administrator. Wells Fargo as trustee had the largest withholding of the month, where they held back $3,838,500 against the call proceeds of SARM 2004-16 despite having settled their trustee suit with Blackrock, PIMCO and associated plaintiffs for $43 million last month releasing them from all future claims. (Exhibit 1) Additionally US Bank as trustee withheld $1.5 million in proceeds from SURF 2006-BC1 despite recently settling their litigation with Blackrock and associated plaintiffs as well.
Exhibit 1: Four trusts across three trustees experienced holdbacks in November
Source: Intex, Bloomberg, Amherst Pierpont
One potential explanation for the holdbacks is that while Wells, US Bank and more recently Deutsche Bank have settled with the largest plaintiffs, there are still other smaller cases outstanding that trustees may have to reserve against. While the Blackrock and PIMCO suits made up roughly 80% of potential claims against the six major RMBS trustees, smaller claims by the NCUA, FDIC and others still remain. (Exhibit 2)
Exhibit 2: Settled & outstanding trustee claims by trustee and plaintiff
Source: Bloomberg, Amherst Pierpont *Denotes settled claim
The holdbacks were somewhat inconsistent across trustees and even across trusts with the same trustee. This is likely driven by the fact that recent precedent has significantly narrowed the scope of the plaintiff’s claims, reducing potential holdbacks to a much narrower set of loans than initial holdbacks where reserves were held against each loan originally in the trust. As the cases have been litigated, the plaintiffs have had to demonstrate actual breaches where the trustee did not act in its contractually obligated capacity under the terms of each trust’s Pooling and Servicing Agreement.
Given this it seems curious that holdbacks would be exactly the same across the two HSBC trusts with significantly different performance. The ACE 2005-ASP1 trust had 2,050 loans at origination and has experienced 14.5 points of cumulative loss to date while the ACE 2006-ASP2 deal has experienced 21.4 points of cumulative loss on 200 less loans than the 2005 deal. This likely illustrates the fact that these holdbacks may not be representative of the trustee’s actual potential future exposure but more so a conservative estimate of it.
This latest round of holdbacks caught legacy investors off guard. Based on existing precedent we would expect withholdings to be smaller and less impactful than the $91 million Wells withheld last summer across twenty BOAA/BOAMS trusts. That notwithstanding, these holdbacks could have an outsized impact on currently callable mezzanine profiles, potentially driving prices significantly lower on those bonds.
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