With settlements on representation and warranty violations in private-label residential mortgage-backed securitizations beginning to pick up momentum, investors are becoming more comfortable with pricing the potential recovery cash flow from a settlement or loan repurchase.
Amherst Securities Group looked at historical market total return performance on a cumulative basis for the last 12 months broken out by different categories of securities tied to rep and warrants litigation.
Upon review, all of the various rep and warrant categories outperformed the securities not tied to any litigation of this type, which appears to show that these securities received different treatment as investors likely included recovery cash flows, and priced the bonds accordingly, explained analysts for mortgage-backed securities group at Amherst Securities.
“We have shown that the market has identified securities involved rep and warrant violation claims and has reacted by pricing these securities higher, reflecting the potential cash flow from subsequent recoveries,” Amherst explained.
The research group found that settlement securities were priced with an average 7% recovery cash flows while non-settlement securities are priced with 2% yield.
“To the extent investors have the conviction that recoveries are higher, they may view these securities as an attractive investment. And always keep in mind all securities are unique, and have varying degrees of sensitivity to recovery cash flows,” the analysts stated.
For instance, the bankruptcy filing of Residential Capital in May 2012, where MBS investors were allowed an $8.7 billion unsecured claim, provides a market event that investors were able to react to.
Amherst took a sample of Alt-A securities originally serviced by ResCap and tracked their weighted average month-end price over times.
These securities were then broken out by those associated with the settlement and those that are not.
“The settlement bonds were priced $1.80 below the non-settlement securities back in May 2012, but are now priced $1.46 above the non-settlement securities,” the analysts explained.
They concluded, “The exhibit shows the market digested the bankruptcy and reacted over time as information became more available. The price move is another indicator that the market might be favoring these securities because of potential recovery cash flows.”