Countrywide and Convexity

The news that Countrywide is modifying a huge swathe of mortgages brings out the issue of servicer related convexity again.

Countrywide is going to modify two types of borrower according to Naked Capitalism:

Borrowers who are current now but look unable to cope with an upcoming reset. That is budgeted for $4 billion of loans

Delinquent borrowers. These will be targeted with a "predetermined, preapproved" reduction. This program is targeted to $2.2 billion of mortgages.

For Countrywide the aim of this programme appears to be to keep as many borrowers current as possible and so earn their servicing fee. But remember a mod will typically decrease cashflow. If these mortgages have been securitised (as is highly likely) that cashflow reduction flows through the waterfall and hits the tranches. In other words, the servicer's proactive attempt to protect their fees is modifying the cashflows on securities they likely do not own. Which tranches are effected depends on the precise securitisation structure and the history of the security (losses and prepays so far). Nonetheless it is not obvious that Countrywide have the interests of all security holders at heart in implementing this mod programme.