Realized loss treatment for deferred principal modifications does not extend to termination price calculations.
The New York State Supreme court recently ruled on two separate cases for the treatment of deferred principal when calculating the termination price in connection with the 10% clean-up call for RMBS transactions.
In a complaint filed by Deer Park Road Management Co., LP against Nationstar d/b/a Mr. Cooper and an Article 77 Petition filed by US Bank and Trust, the court held that termination price for the at-issue trusts should include deferred principal and that HAMP modifications were not intended to exclude deferred principal from the termination price. This ruling comes on the heels of the CA court’s finding that that the termination price should include deferred principal resulting from loan modification, which Oakleaf noted in its September 8, 2023 commentary.
A noteworthy consideration in the US Bank’s Article 77 petition is that the court found that deferred principal is not a realized loss. Specifically, for the CSMC 2007-NC1 transaction, the petitioner noted that the pooling and servicing agreement’s (PSA) realized loss definition includes principal reductions as part of a modification. The PSA also provides for realized losses to be deducted from the stated principal balance, the basis for calculating the termination price for the clean-up call.
Despite this provision, the court ruled that deferred principal is not a realized loss, since the principal balance is only bifurcated into an interest bearing and non-interesting bearing portion and not forgiven, and therefore, such amounts should be included as the stated principal balance for calculating the termination price (i.e. 100% of the unpaid principal balance of the collateral including non-interest bearing deferred amounts plus accrued interest thereon).
The Deer Park claim centered around the SAIL 2004-3 transaction. The master servicer terminated the transaction in November 2021 and paid 100% of the unpaid principal of the mortgage loans plus accrued interest thereon but excluded $2.5million of deferred principal plus other debt and accrued interest when calculating the termination payment, shorting the certificateholders $3.7 million in total. The motion to dismiss by the master servicer was denied by the Court and is currently under appeal.
Treatment of forborne principal as a realized loss has been justified by Servicers as a method to ensure parity between interest bearing loans and the issued certificates; without this mechanism, the interest bearing portion of certificates would exceed that of the collateral resulting in interest shortfalls and excessive write-downs for non-defaulted loan losses. However, according to the court’s ruling, this accounting mechanism does not extend to the calculation of the termination price.
The ruling can have implications for legacy and non-legacy RMBS, particularly in light of the number of modifications that allowed principal to be deferred arising from the Covid pandemic. Many RMBS PSAs provide for realized loss treatment for forborne principal. Following this ruling, termination price calculations for clean-up calls will have to include deferred principal if it is counted as outstanding and due from the borrower at the end the loan’s term.
Most RMBS deals have cleanup calls that provide servicers with the option to purchase the remaining mortgage loans from the trust once the trust has paid down to 10% of its original balance. When exercising this option, the servicer buys the mortgage loans from trust for a lump sum “termination price”, and the termination price is distributed to certificateholders as a lump sum final payment. The amount of the termination price is set forth in the Pooling and Servicing Agreement and generally consists of the unpaid balance of each mortgage loan plus any accrued and unpaid interest through the date of the termination. (Any REO properties held by the trust in the month of termination are also acquired by the servicer according to a price set forth in the PSA.)
Oakleaf Group, a Bethesda, Maryland based mortgage industry consulting firm serving RMBS investors, has been working with investors to determine which deals had outstanding forborne principal at the time the clean-up call was exercised and the amounts, if any, that were consequently underpaid to certificates held by investors. Oakleaf can provide audit services to additional investors to assess the extent to which their portfolio has been impacted by similar underpayments. To have your portfolio reviewed, please contact John St. Martin at firstname.lastname@example.org.
(The cases are 652307/2022 and 654474/2022 in New York State.)
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