Uncategorized

In unreported forbearance, there is unexpected redemption

| July 26, 2019

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.

A growing number of private MBS loans with no record of principal forbearance have shown unexpected recoveries in excess of the reported loan balance when the loan leaves the deal. These surprises generally come from inaccurate data on loan modifications. As the market becomes more attuned to this, trustees and market data providers are reconciling these inaccuracies and updating forbearance amounts, delivering immediate upside to bondholders. Depending on capital structure, these recoveries can drive bond prices up substantially. And since $75 billion of legacy MBS may have some unreported forbearance attached, the opportunity is significant.

A scalable opportunity

One example of this type of potential price appreciation is LBMLT 2006-WL1 M2. This deal saw total reported forbearance on the trust increase by more than $22 million after the trustee reclassified earlier losses as recoverable principal. Discounting the bond’s cash flows at a constant 4% yield and assuming a 50% recovery on existing and newly recognized forbearance, the bond price rises from $55 to more than $80.

Putting an exact number on the opportunity set across legacy MBS is challenging. Unreported forbearance recoveries show up through two channels after a loan is modified. In some cases, the forbearance has been reported as a prior loss, which is reversed in part or whole when the loan leaves the trust through prepayment or liquidation. In other cases, loans show recoveries on balance reductions never recorded as a loss. Given these scenarios we estimate $75 billion of outstanding principal, or roughly 25% of the outstanding legacy universe, may have some unreported forbearance attached to it.  A projected 85% survivorship rate on those loans leaves nearly $25 billion in outstanding losses that have potential associated recoveries (Exhibit 1).

Exhibit 1: Sizing up the potential opportunity in unreported forbearance

Source: Amherst Insight Labs, Amherst Pierpont Securities

Disproportionately large amounts of recoveries have come from certain platforms. The recovery of unreported forbearance is generally associated with trusts where Deutsche Bank or Bank of NY Mellon acts as trustee. Additionally, certain shelves like the Washington Mutual’s WAMU and WMALT shelves as well as Indymac’s INDX and IMJA shelves show disproportionately large absolute and percentage recoveries on outstanding losses (Exhibit 2).

Exhibit 2: Absolute and percentage recoveries by legacy MBS shelf

Source: Amherst Insight Labs, Amherst Pierpont Securities

An example: ARSI 2006-M3

One of many specific examples of this phenomenon is ARSI 2006-M3. Over the life of the deal, $78.5 million of loans have left the pool with no reported forbearance. Those loans carried roughly $8 million in outstanding losses and balance reductions prior to termination. They experienced a 12.0% recovery on past losses and a 20.6% recovery on previous balance reductions. The deal has an additional $16.1 million in outstanding losses and $28.3 million in balance reductions. Upon an analysis of balance modifications using a combination of remittance reports and data available through Loan Performance, the entirety of the losses and reductions look like forbearance. Applying a 60% recovery rate to the $44.4 million in potential unreported forbearance gets an additional $26.6 million in principal.

Exhibit 3: Outstanding losses converted to reported forbearance – ARSI 2006-M3

Note: Updated forbearance is greater than outstanding losses due to a small amount of realized forbearance in the trust prior to reversal of losses. Source: Intex, LP, Amherst Pierpont Securities.

The legacy market remains rife with idiosyncrasies. Not all trustees record balance modifications or subsequent recoveries the same. For example, Deutsche Bank as trustee does not record any balance modifications on loans prior to 2014. Washington Mutual remittance reports do not report forbearance recoveries, and additional forensic work is required to distill reversals of prior losses and balance reductions.

Forbearance gets turned on

The heavy lifting associating with mining the market for hidden principal has proven to be worth it. Over the past 12 months, according to Amherst Pierpont analysis, data providers have added back nearly $3 billion of previously unrecognized recoverable principal. This number represents almost the entirety of outstanding losses on loans that previously had no forbearance attached to them and a potential reversal on 50% of all outstanding losses in the related trusts. Six shelves, including JPMAC and ARSI have made up half of the recently recognized principal balances (Exhibit 4).

Exhibit 4: Total updated forbearance by top 10 shelves

Source: Amherst Insight Labs, Amherst Pierpont Securities

Unreported forbearance by all appearances is a growing albeit localized phenomenon in the legacy market. Investors’ ability to value potential recoveries and bonds most levered to them is an attractive source of potential return in mortgage credit.

admin
jkillian@apsec.com
1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of Amherst Pierpont’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, Amherst Pierpont may act as a market maker or principal dealer, and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://apsec.com/disclaimers.

Important Disclaimers

Copyright © 2023 Amherst Pierpont Securities LLC and its affiliates (“Amherst Pierpont”). All rights reserved. Amherst Pierpont Securities LLC is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, Amherst Pierpont (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which Amherst Pierpont has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of Amherst Pierpont’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, Amherst Pierpont or any of its affiliates may act as a market maker or principal dealer, and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by Amherst Pierpont, (iv) should not be reproduced or disclosed to any other person, without Amherst Pierpont’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, Amherst Pierpont (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

The Library

Search Articles