A review of a large sample of non-agency RMBS transactions, which are backed by varying types of collateral, revealed that optional call eligibility varied depending upon the type and vintage of underlying collateral. Based on the review sample, the trusts, backed by subprime collateral, are the first to become eligible for an optional call, followed closely by option arm and Alt-A trusts. The optional call eligibility also varied by vintage. All of the 2004 trusts reviewed met call eligibility, while only a portion of the 2005 (average of 60%) vintage met the eligibility criteria. Additionally, less than 20% of the 2006 population were eligible, followed by less than 5% of the 2007 vintage.
Generally, subprime bonds, insured bonds and NIMS trusts are not good candidates for redemption. Prior to gaining control and collapsing the trust, the bonds principal and interest (current and accrued) plus expenses, need to be paid in full. If the certificates are insured, the aggregate unpaid bond insurance claims must be reimbursed in full prior to the call being exercised. If there is a NIMS associated with the trust, the NIMS certificate holders must be paid in full. Due to the rapid deterioration experienced in the subprime sector and the lingering poor performance, certain types of transactions are not ideal candidates for redemption. A large majority of the NIMS holders have not yet received the full return on their investment.
The timing, responsibility and economics of exercising a cleanup call are outlined in the governing documents. The designated party may be permitted to exercise their right to terminate the trust agreement once the aggregate principal balance of the mortgage loans is less than the threshold limit. The threshold limit varies from 5% to 20%, but most typically is 10%. The authorized parties usually consist of one or more of the following entities: the servicer, the master servicer, the issuer, the residual holder or the trustee. The terminating party must repurchase the following at par: the remaining collateral + REOs (based on current appraisal price) + one month’s interest + unreimbursed servicer advances + fees payable to the servicer and/or trustee. In most cases the repurchase amount must be sufficient to pay all accrued interest + principal balance of each certificate outstanding. The language regarding any remaining excess funds is not always clearly described in the documents. However, the funds are distributed pursuant to the document’s waterfall, which usually results in the excess funds being released to the residual holder.
One of the largest and most active players in the optional call market is New Residential Investment Corp. (”NRZ”). NRZ is a publicly traded mortgage real estate investment trust with $5.5 billion market capitalization. NRZ has been successfully executing clean up calls for several years. To date, they have executed 339 clean-up calls with an unpaid principal balance of approximately $8.5 billion and, in the 3Q 2017, they executed clean-up calls on 36 seasoned non-agency deals totaling $1.0 billion. According to their 3Q investor presentation, their bond portfolio consists of $1.4 billion in net equity – up from $1.0 billion one year prior. Their strategy is to buy non-agency securities where they already own the call rights. This permits them to pay off the outstanding RMBS at par in exchange for ownership in the underlying collateral. NRZ actively purchases call rights from servicers. According to their most recent annual report, they control the call rights on approximately 30% of the non-agency mortgage market. NRZ purchases underlying bonds at a discount and realize the accretion to par upon execution of the call rights. During last quarter, their average purchase price was 69%.
Potential obstacles to purchasing clean-up call rights:
– Exposure to housing market risk.
– Rising interest rates could adversely impact the value of your collateral.
– Recent actions by the trusts withholding funds once a cleanup call is exercised introduces additional uncertainty to call economics.
Based on this review, trusts eligible for optional call can be cuspy depending on the timing of issuance, and the type of underlying collateral. This, coupled with the uncertainty of home prices and interest rates, further complicates the selection of optional call candidates.
* Net Interest Margin Securities (NIMS) is a security tied to the excess cash flows from securitized mortgage pools after the certificate holders secured of the mortgage pool have received their cashflow consistent with the trust documents. The excess funds are pledged to the NIMS trust account for distribution to the NIMS investors.
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