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RMBS: Securitization stuffs the seniors – again

Senior RMBS bondholders will pay the price from US mortgage chaos.

Of all the unintended consequences of the chaos in the US mortgage markets, the impact on RMBS noteholders of stalled foreclosure proceedings might be the most perverse.

Each mortgage securitization is established using a pooling and servicing agreement (PSA). This sets out the rules under which the mortgages in the pool are serviced and directs cashflows into the structure to a reserve account. These monies are then distributed to bondholders in line with the waterfall laid out in the prospectus until such time as the mortgage trust structure is dissolved – for example, through foreclosure on the assets in the pool.

So far, so straightforward. When the deal is in trouble and the mortgages in the pool are in default the lender forecloses, the transaction is unwound and cash is distributed to bondholders, with the junior noteholders taking the first hit. But what happens when widespread abuse in servicing practices is discovered and foreclosure procedures are stalled and challenged in court? Then things start to get rather complicated.

The impact of the recent challenges to many foreclosure proceedings on the securitization transactions that are backed by the mortgages in default is essentially to leave them in limbo.