January 31, 2014 / 7:31 PM / in 4 years

UPDATE 1-Fund targets legally entangled RMBS

By Adam Tempkin

NEW YORK, Jan 31 (IFR) - A hedge fund holding legacy mortgage securities entangled in JP Morgan’s proposed private settlement with institutional investors is offering other bondholders a whopping 833% premium compared with the bank’s recovery offer in order to get hold of one specific battered bond, according to offer documents seen by IFR.

On January 22, New York-based Fir Tree Partners made a cash tender offer to buy some of the six mortgage bonds caught up in the proposed US$4.5bn settlement from 21 institutional investors. The settlement was arranged by law firm Gibbs & Bruns and the investors include BlackRock and Pimco.

The fund’s long-term strategy is to wring a better payout from JP Morgan than what the bank is currently offering investors in the proposed settlement, which still awaits approval by trustees.

This is based on two assumptions: that prices on the securities will rise, given improving housing fundamentals and MBS valuations; and that JP Morgan can be made to pay more than agreed in the settlement, as it was even more egregious than assumed in hiding the quality of shoddy mortgages in the run-up to the financial crisis.

Fir Tree is telling investors that if they sell, they can get a better deal upfront rather than waiting for the settlement to be approved by trustees.

“Fir Tree is offering a better recovery with a more certain payment outcome on a much faster timeline for the RMBS subject to our tender than the proposed JPM settlement,” said Clinton Biondo, a managing director at Fir Tree. “Holders will get their money now, rather than waiting for the settlement payout, which could potentially take months or years - if it happens at all.”

DIGGING DEEP

Fir Tree might know what it is talking about. The firm has a history of investor activism aimed at maximizing the value of legacy RMBS, and has dug deep into legacy RMBS over the past few years to unearth faulty practices in the assembly of the securities.

Its new offer - involving one first-lien and five second-lien RMBS - is for a handful of securities out of 330 JP Morgan-related crisis-era RMBS that soured during the financial crisis and are tied up in the settlement. The offer expires on February 19.

As of January 7, more than US$700m in aggregate principal balance was outstanding across the available tranches of the six securities. Fir Tree is offering investors an 833% premium to the JP Morgan recovery for tranches from a bond called JPMAC 2006-WMC4, and a 33% premium for the other five bonds.

According to Fir Tree, the complaints filed against JP Morgan with respect to the trusts that are subject to litigation allege pervasive breaches ranging from 79% to as much as 98% of mortgage loans, based upon a review of publicly available information and/or loan file reviews.

For the JPMAC deal, the fund estimates, the JP Morgan settlement would pay a recovery equal to 0.75% of trust losses. By comparison, Fir Tree would pay 7%.

For the other five deals, Fir Tree is offering 10% compared with the average settlement recovery of 7.5%. Even better, Fir Tree would hand over the money now.

The fund has made large post-crisis profits by picking apart and scrutinizing legacy RMBS pools in search of violations of representations and warranties, as well as other violations of deal terms.

Over the past four years, Fir Tree has caused - and in many cases paid for - the re-underwriting of more than 40,000 loans.

Additionally, in recent years the hedge fund has aggressively pursued putbacks from issuers who may have violated representations and warranties by issuing RMBS containing weak credits. A putback means issuers are forced to buy back faulty RMBS.

RELATIVE VALUE

Secondary market trading in 2013 of some of the bonds in question indicates that prices on some of the subprime mortgage securities are still depressed. Investors said the calculation of projected potential recoveries on the bonds was not an easy task, and current prices would need to be taken into consideration.

In September, a senior bond of the subprime RMBS titled SACO 2006-5 - from issuer Bear Stearns, which JP Morgan bought during the crisis - was trading in the low 40 cents on the dollar, according to Empirasign, which operates a database of trading prices for securitised products.

On the other hand, a senior bond of SACO 2006-6 was seen trading in the mid-to-high 80 cents on the dollar in September, up from US$48.50 in April 2012.

In order to ensure that big issuers such as JP Morgan were held accountable and that trustees enforced the rights under the trusts to recover for breaches, Fir Tree, together with a small number of other institutional investors, in recent years began to take actions to cause trustees to enforce the trusts’ rights to recover on these breaches.

This process has developed so that it now often involves litigation against the responsible parties to enforce the trusts’ rights.

In the case of the JPMAC deal, for example, the securities administrator, at the direction of other institutional holders, has initiated litigation against JP Morgan.

Fir Tree has also advised affiliated funds that hold securities issued by some of the 530 securitization trusts within the scope of another proposed settlement related to soured securities issued by Countrywide Financial and Bank of America.

In a May 2013 letter to the judge governing the approval of that settlement, Fir Tree strongly urged the court to affirm the proposed US$8.5bn offer from Bank of America that was hashed out in 2011.

On Friday, Justice Barbara Kapnick of New York state authorized the US$8.5bn settlement. However, the judgment excluded releases on certain loan modification-related claims for which the court found that the trustee acted “unreasonably or beyond the bounds of reasonable judgment.”

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