Stall Foreclosures As Long As Possible, Say Junior Mortgage Bond Investors As Loan Servicers Keep Coughing Up The Cash, Absorbing Up The Pain

A recent story in The Wall Street Journal noted the effect the foreclosure suspensions in connection with the recent robosigner brouhaha may have on cash flow for the holders of junior mortgage bonds:

• While it is unclear whether the delays will have a deep impact on the market for bonds, the changes are already creating some unexpected outcomes, say investors.

• When houses that have been packaged into a mortgage bond are liquidated at a foreclosure sale—the very end of the foreclosure process—the holders of the junior, or riskiest debt, would be the first investors to take losses.

• But if a foreclosure is delayed, the servicer must typically keep advancing payments that will go to all bondholders, including the junior debt holders, even though the home loan itself is producing no revenue stream.

• The latest events thus set up an odd circumstance where junior bondholders—typically at the bottom of the credit structure—could actually end up better off than they expected. Senior bondholders, typically at the top, could end up worse off.

• Not surprisingly, senior debt holders want banks to foreclose faster to reduce expenses. Junior bondholders are generally happy to stretch things out. What is more, it isn't entirely clear how the costs of re-processing tens of thousands of mortgages will be allocated. Those costs could be "significant" said Andrew Sandler, a Washington, D.C., attorney who represents mortgage companies.

• "This is sort of an extraordinary situation," said Debashish Chatterjee, a vice president for Moody's Investors Service who covers structured finance. By delaying foreclosures, "it means the subordinate bondholders don't get written down for a much longer period of time, and they keep getting payments."

For the story, see Mortgage Investors Are Set for More Pain.