A money manager owned by Canada's Manulife Financial Corp is seeking to fire one of the largest subprime mortgage companies in the United States, claiming that Carrington Mortgage Services is unfairly tarnishing some bonds.

Declaration Management & Research, which manages $12 billion, is trying to rally other investors to help it take on Carrington, which it claims has failed to manage loans to provide the best possible returns for all bondholders.

Carrington appears to favor practices that steer payments to the riskiest parts of bonds, some of which it may own, according to analysts.

Carrington defended its practices as being in line with its contracts governing mortgage-backed securities.

The controversy over Carrington practices comes as it and other servicers are being asked by the U.S. government to boost efforts to stop foreclosures using federal programs to modify troubled loans. Soaring foreclosures are seen as a key factor in worsening the recession by fueling a vicious cycle of falling home prices and defaults.

But federal programs have increased the conflict at servicing companies that collect and distribute payments from mortgages to owners of the loans, investors said.

The current environment pits bondholders interests versus servicers interest, said Bill Frey, president of Greenwich Financial Services in Greenwich, Connecticut. This is like having the fox watch the henhouse.

Declaration, in recent website commentary, warned customers the federal programs providing financial incentives to modify mortgages will have negative implications for all home loans outside the umbrella of federal guarantees.

Santa Ana, California-based Carrington is participating in the U.S. program, and could earn incentives of $195 million. Ocwen Financial Corp., another big subprime servicer, this month gave investors a rosy outlook based on expectations of government-sanctioned modifications.

Declaration, based in McLean, Virginia, wants to gather enough co-investors to force the trustee of the deals to wrestle servicing from Carrington, but it was unclear how successful it has been gathering the requisite 25 percent of bondholders to launch the effort. Its complaints were first reported by DebtWire.

Declaration continues to speak with others concerned that the servicer of Carrington Mortgage Loan Trust deals may be breaching its contractual duties to investors, it said in an e-mailed statement.

Carrington's owner, Greenwich, Connecticut-based Carrington Capital Management, bought the servicing business of bankrupt New Century Financial Corp. in June 2007, and has become one of the only companies to maintain payments on the risky segments of bonds, known as residuals, analysts said. It has done this by sharply boosting modifications, and reducing liquidations of properties by relying on rentals, they said.

Our job is clear ... to maximize proceeds to all certificate holders and limit loss severity to the trust, said Chris Orlando, a Carrington spokesman. We are confident our strategy does both and is completely consistent with the pooling and servicing agreements.

It's also in step with public policy, which is to keep folks in their homes and stabilize the real estate market, he added.

Unusually active modification efforts raised suspicions at Amherst Securities Group, which asserted that loans are redone on a scale large enough to keep losses low, and thus keep money flowing to residual owners. Some three-quarters of the loans on one Carrington deal had balances that exceeded the value of the properties, meaning modifications did not benefit the borrower and were destined to redefault, it said.

Holding down liquidations and losses can reduce cash flows available to senior bondholders.

Resolutions to non-performing mortgages also aid servicers by letting the companies reimburse themselves for payments advanced to investors during delinquency. The advances are done with borrowed money, and have been a big weight on profit.

The government has also irked bondholders by taking steps to protect servicers against potential lawsuits from investors. The so-called safe harbor legislation was promoted by the biggest banks, which are also servicers, that claimed risk of litigation was capping modifications.

Investors mobilized against safe harbor say servicing companies will ramp up modifications for their own benefit and break their fiduciary duties to maximize returns on the bonds, which have already wreaked havoc on financial companies.

Certainly, much of the weakness in securities' valuations over the past six months reflects concern about adverse forms of loan modification, Declaration said in its commentary.

(Editing by Leslie Adler)

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