Back in June, Fitch Ratings warned Wells Fargo customers that as much as $2.2 billion in residential mortgage-backed securities (RMBS) could be at risk of downgrade. On Wednesday, Fitch downgraded $2.4 billon in Wells Fargo RMBSs in 348 classes.
The downgrades were based upon 84 transactions issued between 2004 and 2007 and, according to Fitch, “reflect the risk of future payment disruption from the retention of trust funds” by Wells, to reserve against any legal defense expenses the bank from disgruntled investors.
Fitch's move stems from Wells Fargo withholding money from the called transactions in June, an action Fitch said “reflects an assumption of future legal expenses of $3,000 per loan originally in the trust, plus $130,000 for each transaction.” According to Fitch, on the July distribution date, Wells Fargo withheld approximately $65,000 on the only called transaction involved in ongoing litigation.
“Fitch assumes the lower amount withheld for that transaction is due to its inclusion in the recently approved Lehman Brothers RMBS settlement, which is expected to result in its removal from the ongoing trustee litigation,” the company stated.
The downgraded classes have not been directly affected by Wells Fargo's actions to date, but are at increased risk for payment disruption in the future “if Wells Fargo continues the behavior exhibited on the June remittance date when rated classes in called transactions incurred unrecovered principal and unpaid interest,” Fitch stated. “While some of the classes in those called transactions may ultimately recover their full principal amount, the lack of interest payments resulted in a default under Fitch's rating definitions and those classes were downgraded to 'Dsf' on August 1.”
Fitch says the timing of a resolution to the litigation and Wells Fargo's fund retention strategy remains uncertain, and that the bank has yet to provided any clear public guidance on their withholding strategy going forward. Lacking any additional guidance from Wells Fargo, Fitch said it will assume a withholding amount of $3,000 per loan and $130,000 per transaction when analyzing the risk of future payment disruption to outstanding rated classes.
The rating agency said the transactions in litigation that are currently callable or callable within the near future and include bonds with credit enhancement less than an estimated future retained amount are at the highest risk. That, in numbers, is 298 of the 348 classes downgraded, including 44 classes that were previously investment grade, Fitch stated.
At next greatest risk are classes with credit enhancement less than the estimated future withholding amount, but within transactions that will not soon be eligible to be called. Thirty-four of the 348 classes downgraded fall into this category, including five classes that were previously investment grade as well.
Fitch said the ratings will be affected by future court decisions or the resolution of pending litigation that can influence the risk of payment disruption on the affected trusts, and could also be affected by a change in the fund retention strategy by Wells Fargo.
“It is currently uncertain how Wells Fargo's action affects the probability that trusts named in litigation may be called through an optional redemption,” the company stated. “Fitch is currently assuming the probability of a call is not affected.”