Confusion over how to account for principal forbearance resulted in $1 billion in surprise losses on mortgage bonds backed by Nationstar-serviced loans.

Fitch Ratings discussed the steep and unexpected loss in a research note Tuesday.

Principal forbearance modifications generally reduce a borrower’s principal balance for interest and monthly calculations, the ratings giant explained.

The forbearance process then lets a borrower repay the full principal amount during a property sale or refinancing initiative or the forborne principal amount is later paid off in a balloon payment if the loan is still outstanding at the time of maturity.

The confusion for servicers, like Nationstar, stems from a lack of consistency in how servicers reported these forbearance amounts early on in the housing crisis, Fitch suggests. The transactions' pooling and servicing agreements did not elaborate on this, neither did the Home Affordable Mortgage Modification Program initially.

Then, in June 2012, the Treasury advised servicers to report their HAMP forbearance amounts as losses, with future amounts repaid to be considered recovery. It's under this particular scenario in which losses are expected on the RMBS pools.

Nationstar Mortgage Holdings intends to revise the reporting of principal forbearance modifications given that it will have marginal rating implications, specifically among low-rated residential mortgage-backed securities tranches.

"Fitch expects the impact to be concentrated in classes currently rated 'CCsf' or below and currently does not anticipate significant rating changes as a result of the revision," said Grant Bailey, Diane Pendley and Thomas Crowe, analysts for Fitch Ratings.

The revised losses impact loans acquired in 2012 from Aurora Bank and Aurora Loan Services, its wholly owned subsidiary. However, Nationstar currently does not anticipate future revisions on loans recently acquired from Bank of America (BAC) or on any loans unrelated to the Aurora acquisition.

Nationstar’s announcement follows a similar revision by Ocwen Financial Corp. (OCN) in May, which also resulted in $1 billion in realized losses.

Fitch reviewed 883 RMBS classes following Ocwen’s revised loss reporting and subsequently downgraded 20 classes – all rated ‘CCsf’ or below — prior to the review. 

Nationstar’s revised loss amount in this case is roughly 1.5% of the total balance of the mortgage pools impacted. 

Furthermore, the ratings of classes in the trusts most affected by the revisions have generally already experienced some type of downgrade activity. Additionally, principal forbearance modification activity is usually the highest among poor performing mortgage pools with large percentages of underwater borrowers, the credit ratings agency noted.

cmlynski@housingwire.com