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The Asset Management Group (AMG) of the Securities Industry and Financial Markets Association (SIFMA) today issued the following statement on the principal forbearance in loan modifications:
“The Asset Management Group (“AMG”) of SIFMA believes that the appropriate treatment for principal forbearance modifications is that they should be treated as realized losses at the time of modification. Principal forbearance modifications reduce a borrower’s monthly payment by permanently eliminating the interest accrual and amortization on a portion of the original principal balance. The non-accruing, non-amortizing portion of the original debt is due at maturity or liquidation. This innovative loss mitigation technique was created to combat the unprecedented delinquencies associated with the recent housing crisis. An unfortunate aspect of the inventiveness of principal forgiveness modifications is that securitization documents (pooling and servicing agreements and prospectus supplements) typically do not contemplate them. Correspondingly, principal forbearance modifications are not included in the enumeration of Realized Losses in virtually any pooling and servicing agreement. Trustees are thereby operating without sufficient guidance regarding how to treat the event of a principal modification. The result is inconsistency and confusion, which threatens to further dislocate the non-agency residential mortgage-backed securities market (RMBS).
“Treating principal forbearance modifications as realized losses at the time of modification maintains the intended distribution of interest and principal across the capital structure. If the principal forbearance modification occurs and a realized loss does not occur, a number of untenable situations result. The collateral supporting the issued bonds no longer accrue interest while the bonds continue to accrue interest. Unless there is sufficient excess interest, the bonds will experience interest shortfalls. Moreover, disproportionately redirecting cash flow to the junior classes effectively reduces the credit enhancement to the senior classes. As a result, there are clear economic losses associated with the principal forbearance modification. Any treatment of principal forbearance other than as a realized loss at the time of modification is, furthermore, contrary to the spirit of the structure and its initial rating. Failure to treat principal forbearance modifications as realized losses at the time of modification will result in a further dislocation in the non-agency RMBS market, by increasing required returns for all bonds exposed to principal forbearance modifications.”
SIFMA’s AMG represents U.S. asset management firms whose combined assets under management exceed $20 trillion. The clients of AMG member firms include state and local pension funds, universities, and individuals saving for retirement. AMG members conduct their businesses as fiduciaries for their clients even if they are part of a larger financial organization.
