The most important part of the investment process is reading. Reading 10-Ks and 10-Qs, bankruptcy docket filings, and bond indentures is an easy way to create an edge. Almost no credit traders on the street read bond indentures for the securities they trade, which can lead to interesting opportunities for those who do.

The WSJ recently highlighted an interesting case in involving Countrywide RMBS Settlement proceeds. The dispute involves language in a Countrywide senior support bond “Alternative Loan Trust 2005-76 2A2” (view the prospectus) in which two hedge funds own which has unique language in its Pooling and Servicing Agreement. According to the WSJ:

Most of the bonds the hedge funds now hold were known in the industry as “senior support” tranches. Originally rated AAA by major ratings firms, they sat alongside other senior bonds and were paid down at the same rate. But their design was such that if loan losses reached the senior-bond level, the support tranches would take principal write-downs before other senior tranches. That allowed them to provide another layer of support to the most senior bonds—and to earn higher returns for the higher risk.[1]

The HF lawyers have stated that according to the bond prospectus, the settlement money should reimburse principal balances of senior bonds and reimburse losses by senior support bonds, it should not solely flow to the senior bonds.

We believe the following is the relevant section in the Pooling and Servicing Agreement (PSA) which is disputed:

Principal Distribution Amount: With respect to each Distribution Date and Loan Group, the excess, if any of (1) the aggregate Class Certificate Balance of the Certificates related to such Loan Group immediately prior to such Distribution Date, over (2) the excess, if any, of (a) the aggregate Stated Principal Balance of the Mortgage Loans in that Loan Group as of the Due Date in the month of that Distribution Date (after giving effect to Principal Prepayments received in the related Prepayment Period), over (b) the Group 1 Overcollateralization Target Amount or the Group 2 Overcollateralization Target Amount, as the case may be, for such Distribution Date.

While we do not have a background in securitized products, we believe the funds are correct in their literal interpretation of the language - and the market agrees with them as the bonds are currently trading around 69, up from 35 ~2 years ago.

There are many funds which attempt to create alpha by reading every prospectus and discovering legal pockets of value. However, the alpha really comes down to information and there are few which approach the problem from the technical side (ie better search algorithms), which is what Volmanac attempts to do.

[1] http://blogs.wsj.com/moneybeat/2016/08/24/an-ironic-twist-in-the-fight-over-mortgage-bond-settlement-cash/