Current Financial Crisis Likely Will Lead to Events of Default in RMBS Trusts

Unlike our usual posts, which analyze recent Commercial Division decisions, this post is written to alert RMBS certificateholders of imminent events of default in RMBS trusts due to the liquidity crisis most servicers are expected to face beginning this month. RMBS certificateholders should understand their rights and the protections to which they are entitled in this situation and how to invoke them.

In a typical New York common law RMBS trust, if a homeowner misses a payment, the servicer is obligated to advance those unpaid funds to the trust and is allowed to recoup those advances once the missed payment is made. The financial press has widely reported the potentially serious impact on servicers from homeowners failing to make mortgage payments because of the financial turmoil created by the COVID-19 pandemic.

Most of the focus has been on the impact on servicers of having to fund significant servicing advances. And some servicers believe they have a plan to weather this storm, even for non-agency RMBS.

This situation is likely to affect the trustees of RMBS trusts as well as the servicers. Typically, if a servicer fails to make advances, it is an event of default under the trust’s pooling and servicing agreement and the trustee is allowed (we would argue, is required) to make the advances itself. We do not know how, if at all, trustees will react to such events of default.

One lesson from the 2008 financial crisis is that the better course is to get ahead of problems with the trustee’s administration of an RMBS trust. For that reason, we recommend that RMBS certificateholders put trustees on notice of their obligations to take action—including paying the servicing advances themselves—to shield certificateholders from the effects of a servicer’s inability to make servicing advances.

Schlam Stone & Dolan represents investors in RMBS actions against underwriters and trustees and in related proceedings, such as trust instruction proceedings where an RMBS trustee seeks court guidance regarding the management of an RMBS trust. If you or a client are RMBS investors and have questions regarding potential claims against a trustee or how to influence the trustee's prosecution of a put back or repurchase action like the one at issue here, contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com.