RMBS market worries quiet mortgage cramdowns may get louder

The Helping Families Save Their Homes in Bankruptcy Act, signed into law mid-2009, threatened to derail parts of the residential mortgage-backed securities market. That was until legislators stripped out the part that allows bankruptcy judges to cram down mortgages. Credit rating agency and analytics firm DBRS is reporting that mortgage writedowns since then are, in fact, currently being done by some bankruptcy judges. Bankruptcy judges arguably only wish to reduce the mortgage so the debt is more in line with the actual value of the property. However, the “news has the RMBS market worrying about an increase in triple-A downgrades and bankruptcy filings,” said a note from DBRS Monday. Most RMBS transactions have subordinate tranches that can absorb these losses due to bankruptcy filings. But those loss provisions have a limit. “Any bankruptcy losses exceeding this limit may be allocated on a pro rata basis, which can lead to losses on the senior most tranches,” said the DBRS letter to clients. “Furthermore, when a bankruptcy judge reduces the principal amount of the loan to the fair-market value of the property, the amount of the writedown becomes an unsecured debt that will be paid pro rata along with any other unsecured claims that the borrower has, such as credit cards.” DBRS fears cramdowns will likely increase as personal bankruptcies grow through the year. Judges are also more likely to become more aggressive in the use of debt forgiveness. Write to Jacob Gaffney. Follow him on Twitter @JacobGaffney.