Who Speaks for a CDO ?
It has been asserted that many mortgage servicing contracts are inefficient, because they give the servicer incentives to foreclose even when re-negotiation would be better for the owner of the mortgage. An inefficiency is a profit opportunity. If there are such contracts, then a different contract can generate higher revenue for both the servicer and the final owner.
If this is a problem, then it is especially tricky in the case of mortgages owned by special purpose entities which issued various debt like tranches and an equity tranche (owned by the sponsor). In such cases, for all I know, any renegotiation of the service contract might be forbidden, but I think it is more likely that the sponsor as equity holder could renegotiate the contract with the mortgage servicer. The problem is that, for many CDOs the equity stake is worthless and would remain worthless even if the mortgage servicing contract were improved.
Owners of more senior tranches might benefit from a new contract which is equally valuable to the mortgage servicer, but they don’t control the special purpose entity. The debt like tranches are really more like preferred stock, since failure to make scheduled payments does not constitute default. Owners of those securities can’t ask a bankruptcy court to seize the special purpose entity to protect their interests. So, as things stand, there might be an inefficiency such that no one can profit by eliminating it.
The solution would be for the sponsor to purchase some of the preferred stock like securities, then renegotiate the mortgage servicing contract. Alternatively, an investor could buy the equity tranche (which is worth almost exactly zero) and some of the preferred stock like securities and then renegotiate.
I think there is a possible profit opportunity.
Basically, you are proposing to undo tranching operation. It’s like joining the prime and score of an equity and getting something a lot like a share of stock. It might actually work. In fact, you could build a derivative out of it, something that almost looks like a piece of a mortgage package, but is actually built out of pieces of tranches. You still won’t be able to foreclose, but I can see the profit making part of the operation.
For some reason, this reminds me of the end of The Wheeler Dealers, which, by the way, is a great financial comedy.
If various books are correct the CDO’s where the lower rated tranches of the securitization, the whole point of a cdo was to take a bunch of BBB stuff and wave a wand and get a lot of AAA stuff. So I suspect that most of the original securitization is not involved in the CDO, let alone if its a synthetic CDO in which case it has nothing to do directly with servicer behavior.
I don’t follow the first clause in your first sentence. If I understand correctly, you are saying that the special purpose entities with worthless equity tranches are all made of preferred stock like tranches of other special purpose entities. If so my proposal wouldn’t work. But there are two questions. One is are there a lot of worthless equity tranches of CDOs of tranches of CDOs of RBMS (surely yes). The other is are there any special purpose entities with worthless equity tranches which also own whole mortgages.
I clearly made a mess of things using the acronym CDO. I meant the special purpose entity which issued the first level RMBS. Who speaks for them ?
I meant that CDO’s were a way to take the BBB rated tranches of securitizations package them up, and then get the ratings agencies to bless a large piece of the combined mess as AAA rated trash. So if the distributions of ratings of the original RMBS reported are correct its the AAA, AA and A tranches that would be the majority of the securitization.
So it is my understanding that a CDO is made up of the BBB tranche. So the equity tranche is the lowest rung on the ladder of getting money on the BBB bonds that make it up.
I assume you meant the trustee of the original RMBS, so it would take a majority of the tranches of the securitization to push the trustee to do something.