Hedge fund manager Och-Ziff Capital Management and BNY Mellon are locking horns over the calculation of payments on 156 residential mortgage securitizations completed by Countrywide Financial Corp. and now serviced by Bank of America.
The case could have broad implications for $18 billion in still-outstanding Countrywide securities issued before the financial crisis and shows how, more than a decade after the mortgage crisis, big investors are still finding ways to make money in legacy RMBS.
The dispute involves what are known as interest-only certificates, which are securities that are senior in payment priority but are only entitled to "excess interest" — essentially, the amount that interest rates on the loans used as collateral exceed a specified benchmark. (The principal of the certificates is not repaid.) The trustee for the securitization trusts, Bank of New York Mellon, has been calculating excess interest using current interest rates on the mortgages. Over time, rates on many of these loans have been reduced as the loans have been modified, resulting in less excess interest.
But in December, an investor that owns IO certificates issued by 156 Countrywide securitization trusts sued BNY Mellon in the U.S. District Court for the Southern District of New York, claiming that excess interest should be calculated using the original interest rates on the collateral. Notably, this would result in more funds for IO certificate holders, but would reduce funds available to pay holders of some other classes of certificates.
This investor, Silian Ventures, is an entity incorporated in Delaware, according to the complaint. Incorporation documents show that it is controlled by affiliates of Och-Ziff.
Och-Ziff declined to comment on the matter.
BNY Mellon defends the way it has been calculating excess interest, but it is seeking a resolution in a different venue, one in which all investors in the 156 securitizations can participate.
On Jan. 24, the trustee filed an interpleader action in the New York County Supreme Court (a trial-level court in Manhattan) asking for judicial instructions. It wants the court to confirm that its current methodology for calculating payments to IO certificate holders is correct. BNY Mellon also asks the court to confirm that the specific way it calculates payments is based on a "reasonable interpretation" of the pooling and servicing agreements of all of the securitization trusts and to bar investors in these deals from asserting claims against it related to its calculations.
In the event that the court instructs BNY Mellon to change the way it calculates payments to IO certificate holders, the trustee would like instruction as to whether the change should only be made on future payments, or if it should be applied to past distributions.
In the filing and in a statement provided to National Mortgage News, the trustee said it distributes monthly payments to certificate holders in accordance with the terms of the relevant contracts.
"The trustee has commenced this proceeding to give all certificate holders who might have a stake in the outcome of the Silian proceeding — including certificate holders in the 165 trust at issue and certificate holders in other trusts whose governing agreements have similar distribution language — an opportunity to appear and be heard," the filing states.
It noted that Silian's proceeding fails to join or provide notice to any of the other certificate holders.
One question for investors in the 156 deals is whether BNY Mellon will withhold interest and principal payments until the cases are resolved, in order to cover any potential shortfall resulting from a change in the calculation method, according to Nomura Securities. For similar reasons, the bank said, it's also unlikely that any of these deals will be called before the dispute is resolved. In a Feb. 1 report, it said this could take 18-24 months.
In its petition, BNY Mellon argues that for over a decade, not one certificate holder has objected to its current method for calculating payments. It said this method is corroborated by the way parties in other similar trusts calculate payments. Even in cases where the payments are calculated by a master servicer, as opposed to a trustee, the same method is used. "This is especially noteworthy because, for those trusts, it is the master servicer (rather than the IO certificate) that receives the excess interest." So the methodology results in less interest being paid the master servicer.
In comparison, BNY Mellon has no economic stake or interest in how money is distributed to the various classes of certificate holders.
Silian claims in its complaint that it alerted the trustee to "discrepancies in its computation of interest payments owed" in February 2018, and has since "repeatedly" sought to engage BNY Mellon. The bank refused to provide an explanation for over six months, and when it was issued, it failed to address fundamental flaws, according to the complaint.
In its proceeding, Silian argues that the meaning of "mortgage rate" as defined in the pooling and servicing agreement should be read alongside "mortgage note" in a way that suggests the rate, and thus the adjusted net rate, must be static. BNY Mellon described this stance as "erroneous" in its filing.
Nomura sees three options for bondholders affected by the dispute. In addition to siding with either BNY Mellon (continue calculating payments the same way) or Silian (calculating payments in a way that benefits IO certificate holders and hurts other investors), they can also seek a third way to calculate excess interest that leaves IO certificate holders worse off than they are now, the report states.
