Don’t Beat Up the Trustee

Are MBS trustees really afraid of their own shadows?  An article in this week’s Wall Street Journal might lead you to believe so.

The article described a recent decision by a group of investors holding a position in a bad 2006 Bank of America securitization to bypass their bond trustee, The Bank of New York Mellon, and to pursue litigation against BoA on their own.  The article seems to infer that the group, known as “Walnut Place”, had become frustrated by the trustee dragging its feet in pursuit of the investors’ claims against the issuer.

While we are already on the record for prodding bond trustees to become more proactive in the pursuit of their fiduciary responsibilities, we feel compelled to point out that it is more than likely that there is more to this story than may meet the eye; certainly more than a casual reader might take away from the WSJ article.

First, we would point out that the bond trustee represents ALL the bondholders of a particular issue.  As such, the trustee must carefully weigh the claims of any holder or group of holders against the rights and best interests of all other holders of that security.  We have no information about the actual percentage of the outstanding bonds that the Walnut Place group holds of the BoA 2006 series but if it less than a majority of the bonds outstanding, then it is not hard to understand that Walnut’s “strategy” may not be consistent with the best interests or even with direction provided to the trustee by other bondholders.  One possible clue as to how much of the issue is held by Walnut Place could simply be The Bank of New York Mellon’s refusal to file suit against BoA.  If Walnut held a majority of the bonds (51% or more), under normal circumstances, the trustee would be hard pressed to say no. 

On the other hand, Walnut Place may hold a majority of the issue but that might only illuminate another very good reason why BNYM did not file suit.  It could very well be that Walnut Place was not willing to indemnify the trustee for taking up the chase.  Standard provisions in nearly all trust agreements allow the trustee to ask for appropriate indemnities from the holders that they represent in these types of situations, particularly when asked to take legal action against an issuer or arranger.

If, in fact, Walnut Place does hold a majority of the BoA 2006 bonds, we would guess that they refused to provide the trustee with an appropriate indemnity.  We have been the first to recommend that the trustees become more proactive in the pursuit of the interests of their bondholders, by becoming more engaged in their pursuit of remedies in cases of bond defaults, bankruptcy, etc.  We have witnessed the trustee community be a little too guilty of touting their “fiduciary role” and then running for the hills when the going gets tough.

However, we agree wholeheartedly that pre-default compensation levels for trustees of mortgage-backs, asset-backs and other structured debt programs are, in no way, enough to support the work and the liability that goes along with the pursuit of these litigations.  We would also point out that bondholders, particularly sophisticated holders of complex instruments, know this fact very well.

We suspect that the facts that may not have been included in the WSJ article could be that either Walnut Place is a minority holder or they were not willing to stand behind BNYM with a proper indemnity. 

Holders are always free to pursue their own interests.  In  this case, perhaps that is the best course and that might make this a little less of a story then it might appear to be at first glance.

About markferraris
Managing Principal Orchard Street Partners LLC

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