Tuesday, September 23, 2008

What Does It Take to Modify a MBS Servicing Agreement?

(Credit Slips) This evening I did a little sample of MBS indentures and pooling and servicing agreements (PSAs) to see what it takes to modify them. This is an important issue because it will determine the amount of MBS that the government would have to buy in a bailout to be able to get to the underlying loans in order to modify them and help financially distressed homeowners. I looked at 24 MBS deals (I used Alan White's deal sample, but couldn't find docs for two deals). By my read of the documents, doing any serious loan modification would require the government to hold a lot of MBS. Of the 24 deals, 21 or 87.5% required a 2/3 majority to modify the servicing agreement, while only 3 or 12.5% required a simple majority.

Many PSAs, however, further provide that any amendment that would "reduce in any manner the amount of, or delay the timing of, payment received on Mortgage Loans which are required to be distributed on any certificate.." may not be done without the consent of the certificate holder. Widescale modifications and loan restructurings would inevitably reduce the amount of payment to be distributed or delay the timing of the payments. If the pool is overcollateralized or there is a first loss position willing to absorb these losses, then 100% shouldn't be necessary, but if widescale modifications are necessary, 100% agreement of MBS holders will be necessary.

This means it will be difficult, if not impossible, for the government to gather up enough MBS to get to the underlying mortgages. Not everyone holding MBS will sell to the government or even be eligible to participate in the bailout. And there are second mortgages that are in separate pools. It will also take time to process and to sort, time during which the foreclosure machine will keep rolling along. This is Humpty-Dumpty, and all of Paulson's horses and all of Bernanke's men will have a lot of trouble putting these pools back together again.

What this means is that it will be entirely arbitrary which homeowners the government will be able to assist in the end. It will have nothing to do with the merits of a homeowner's case or the homeowner's willingness to incur a cost. It will be entirely a function of which financial institutions work with the government and who happens to hold what MBS paper. This is another why bankruptcy modification is necessary--it is the only fair solution that is available to all homeowners, not a lucky, random few.

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