The Subprime Shakeout

Federal Home Loan Bank of Pittsburgh Scores Important Early Victory in Pennsylvania Lawsuit

Posted on December 7, 2010 by Isaac Gradman

In the first substantive decision handed down in any of the five major lawsuits by the Federal Home Loan Banks (FHLB) over RMBS losses, the Hon. Stanton Wettick, Jr. of the Court of Common Pleas of Allegheny County, Pennsylvania dealt a blow to JPMorgan Chase, Countrywide and other securitizers of subprime and Alt-A mortgage loans, while letting the ratings agencies largely off the hook. In the Order on Defendant’s Motion to Dismiss (full copy available here), Judge Wettick found that the FHLB’s claims for fraud, negligent misrepresentation and Securities Act violations could proceed against J.P. Morgan Securities, Inc., the entity that actually offered the mortgage backed securities for sale to investors and put together the securities’ offering documents.

The crux of the FHLB’s claims are that the securitizers (also known as depositors or sellers and sponsors) of various MBS offerings it purchased allowed those securities to be sold as AAA-rated or investment grade debt (which, according to the FHLB, indicated that they were virtually riskless), despite the fact that these securitizers knew that the ratings agencies had no way of determining the likely default rate of the underlying loans. Though the Court dismissed these claims as to the other JPMorgan entities that had acquired and transferred the loans earlier in the securitization chain, the Order was definitely a win for the FHLB because it confirmed that at least one investment bank entity would be on the hook for the sale of these toxic securities.

Meanwhile, the various ratings agency defendants were pleased with Judge Wettick’s Order, as it dismissed all claims against them except the claims of fraudulent (also known as intentional) misrepresentation. The Judge ruled that the plaintiff had stated a claim for fraud based on the theory that the ratings agencies did not actually believe their own ratings (note that considerable evidence has recently emerged to support this argument, in particular, the findings of the Financial Crisis Inquiry Commission that the ratings agencies ignored evidence that these loans were unsound, as testified by former Clayton president D. Keith Johnson). The Court further held that while the First Amendment protected the ratings agencies from liability for negligent misrepresentation, it did not protect the agencies from claims of fraud. The Court further dismissed the Securities Act claim against the ratings agencies based on Section 11 of the Act, finding that the defendants were not “underwriters” subject to the statute, as defined therein.

Judge Wettick’s Order is an important early bellwether in investor litigation over losses from RMBS, because it shows that plaintiffs should be able to survive a motion to dismiss and get into the discovery phase without having a ton of hard evidence. Indeed, as the first of the FHLBs to file suit (Pittsburgh’s suit was followed by the FHLBs of Seattle, San Francisco, Chicago and, most recently, Indianapolis), plaintiff’s counsel had not yet developed or taken advantage of the analytical tools used later in the Seattle and San Francisco complaints to show that specific representations made in the offering documents were false (see prior post on the Subprime Shakeout). As we are still very early in the timeline of investor RMBS litigation, and do not have much precedent for how judges will treat these types of loss-related claims, this opinion bodes well, not only for the FHLB lawsuits, but for other impending investor actions.

Without access to loan files, plaintiffs are often caught in a tough position of having to make claims that the loans did not meet guidelines or representations without having the evidence to support such claims. While the massive losses related to these products indicate investors were sold a defective bill of goods, servicers have largely refused to turn over documents that might confirm or disprove these claims. Indeed, that is what the discovery process is intended to do, but there has long been speculation as to whether plaintiffs had enough to go on to surmount a motion to dismiss. This Order reinforces my belief that the massive RMBS losses suffered by plaintiffs are enough to overcome this initial hurdle, meaning that plaintiffs will eventually get access to these treasure troves of misrepresentation fodder when banks are forced to turn over loan files in discovery. And this decision bodes especially well for the later-filed FHLB complaints, which cite stronger evidence of widespread breaches of reps and warranties, thanks to the analysis provided by due diligence firm, CoreLogic.

Another interesting aspect to note about this case is the Judge’s handling of defendants’ “sole remedy” argument. Namely, JPMorgan and the other defendants have argued, as have other banks in RMBS litigation, that plaintiffs may not assert claims for fraud, negligent misrepresentation, or other torts, because the language in the Pooling and Servicing Agreements (“PSA”) makes clear that the repurchase or replacement of a defective loan is the sole remedy for a breach of originators’ or underwriters’ reps and warranties. Judge Wittick dismissed this argument, finding that the repurchase remedy was only available to the Trustee, and not to investors, so this could provision could not have been intended to apply to bondholders. Though I have not reviewed these particular PSAs in detail, I would be surprised if they did not provide that investors could petition the trustee for such relief, should they amass a sufficient percentage of Voting Rights (generally 25%).

While I have often discussed the procedural hurdles investors face in taking advantage of this remedy, it is simply not the case that the repurchase re
medy is entirely unavailable to investors. Thus, Wettick reached the proper conclusion, but for the wrong reasons. I think the better-reasoned approach is to find that while repurchases are the sole remedy for contractual breaches of reps and warranties, the claims being made by the FHLB of Pittsburgh do not seek damages for breaches of reps and warranties in the underlying loans–they seek damages for material misrepresentations in the offering memoranda related to the ratings of the securities. While breaches of reps and warranties may be related to the reasons the securities underperformed their ratings, I think that what the securitizers knew about the ratings when they made these representations is an entirely different question, only tangentially related to breaches of reps and warranties. In fact, the securitizers could have been entirely unaware that there were breaches of reps and warranties, but still could have known that ratings agencies were not capable of estimating the risk of loss in these securities, and thus should have included disclaimers in the offering documents. Simply put, relief for misrepresentation in prospectus and other offering documents should not be limited by the “sole remedy” language applicable to breaches of reps and warranties made by the originators of these mortgages in separate contracts.

Update on Other FHLB Actions
Several readers have requested updates on the actions brought by the FHLBs of Seattle and San Francisco. The going has been slow in those cases (they are months behind the Pittsburgh case, which just now passed the motion to dismiss phase), but here is what I’m able to tell you: both cases were removed from state court to federal court by the defendants, in an attempt to obtain federal court jurisdiction over the plaintiffs’ claims. So far, most of the action in these cases has been related to adjudicating the removal issue. The way this works is that the cases are automatically moved to federal court upon the filing of a procedurally proper notice by a defendant. The plaintiff(s) may then file what’s called a Motion to Remand, arguing that the federal courts do not have jurisdiction over the claims and that the case should be remanded to state court.

The FHLBs filed Motions to Remand in both cases. The Motion was granted in the Seattle case in September, Case No. 2:10-CV-00148-RSM, and the case was remanded back to Kings County Superior Court. The San Francisco case is still before Judge Conti in the Northern District of California, Case No. 3:10-CV-03039-SC. The judge has taken the Plaintiff’s Motion for Remand under submission, and all other dates have been postponed pending the outcome of that decision. Note that the Pittsburgh case discussed above is proceeding in Pennsylvania state court, rather than federal court. I’ll keep readers apprised of any developments in these cases, as I become aware of them.

Posted in Countrywide, Federal Home Loan Banks, investors, JPMorgan, lawsuits, loan files, misrespresentation, ratings agencies, remand, removability, rep and warranty, repurchase, sole remedy, toxic assets | 8 Comments

Barron’s Article Pulls No Punches in Assessing Bank Putback Liability

Posted on November 22, 2010 by Isaac Gradman

If you’re looking for a great primer on the latest developments in the legal saga over who will ultimately bear the losses for the detritus that passed as subprime and Alt-A mortgage loans from 2004 to 2007, check out this article published by Jonathan Laing at Barron’s over the weekend. In the article, entitled “Banks Face Another Mortgage Crisis,” Laing does a great job of bringing the casual observer up to speed on the various efforts by investors and insurers to force originating and securitizing banks to buy back souring mortgage loans that are found to breach the guarantees made when the loans were first originated and sold.

Among the highlights: the article frankly admits that with $2 trillion in subprime, Alt-A and adjustable rate mortgages having been originated during the last years of the housing boom, the losses on these loans could reach approximately $700 billion. Laing also accurately assesses that the biggest battles the banks will face will come from investors in private label (i.e. non-agency backed) securities, and that banks may seek another government bailout to help ease the significant pain these private label putbacks may cause. Laing also does not mince words about whether the banks deserve to be on the hook for these mortgages. My favorite passage:

Certainly, some of the major banks amply deserve to suffer additional putback losses. By almost any measure, they were either negligent or willfully culpable in issuing securities with such glaring defects on the global investment markets. They had little incentive to worry much about investment quality, since the securitized loans passed off their balance sheets, ladling all the credit risks onto the credulous buyers.

The banks had created such a fee-rich securities sausage factory during the middle of the current decade that the ingredients going into their products were of little concern. It was merely important to keep production levels elevated even after the pool of creditworthy mortgage borrowers had run dry, only to be replaced by dead-beat subprime borrowers and alt-A mortgage-financed home speculators ready to mail their home keys to their lenders at the first whiff of home-price weakness.

Bankers argue that economic woes rather than shoddy loan underwriting are to blame for most of the lamentable financial performance of the mortgage market. Therefore, the pugnacious CEO of Bank of America, Brian Moynihan, has promised that the bank will engage in “hand-to-hand” combat to fight putback claims. “People who come back and say, ‘I bought a Chevy Vega, but I wanted it to be a Mercedes with a 12-cylinder [engine].’ We’re not putting up with that,” he insisted during a recent conference call.

Yet there’s plenty of evidence that the banks during that key three-year period in the middle of the decade passed off some Yugos as sleek sedans.

Laing also does a great job of pulling some of the juiciest pieces of evidence into his article that suggest that the banks were more than just sloppy–they may have knowingly duped investors regarding the quality of the loans they were selling. Particularly damning is the testimony provided by the former president of Clayton Holdings, D. Keith Johnson, regarding the due diligence firm’s findings and the fact that they were often ignored by the securitizing banks, who “waived” deficient loans into securitizations.

But, I must disagree with a few of the points made in this article. First, Laird refers to the legal principles under which investors will likely proceed to remedy defective mortgages–i.e., the representations and warranties found in the trust agreements–as “arcane.” This wording implies that the legal principles are esoteric or overly complicated, and that investors’ reliance on them to putback loans seeks to take advantage of an obscure technicality. Quite to the contrary, though Pooling and Servicing Agreements (PSAs) were often overly complicated, the reps and warranties provided by lenders were the key contractual guarantees that investors received when agreeing to purchase securities backed by the loans at issue. These guarantees provided investors with the comfort that, though they lacked the capacity to review every loan to make sure it met certain quality thresholds, they could rely on lenders’ statements regarding the loans, and could rest assured that lenders would take back any loans that didn’t comply. Thus, rather than “arcane” legal principles, reps and warranties are fundamental building blocks of any securitization, and the investors have every right to hold banks to their collective word.

Second, Laing describes the content of these reps and warranties as “at best, vague.” I have to respectfully disagree. The reps and warranties provided by subprime and Alt-A lenders were often extensive, and commonly included a representation that the lender would follow its published underwriting guidelines. And even though these were “non-conforming” loans, and thus had more lenient underwriting standards than those for agency-backed or “conforming” loans, they were still underwritten with concrete guidelines about what characteristics they had to possess and the procedure that had to be followed by the lender when determining whether the borrower qualified for a loan.

A commonly misunderstood aspect of these loans is that many were so-called “stated income loans,” that is, the borrower did not need to provide proof of income, but simply stated it on the loan application. Many take this to mean that the lender had no responsibility to confirm the accuracy of this statement, and instead could take at face value whatever the borrower claimed to make as income. Yet, originators of stated income loans generally included in their published guidelines that they would confirm that the borrower’s stated income was reasonable and in line with the borrower’s occupation and years of experience. Originators had extensive databases they were supposed to use to perform this review function. When going back and reviewing a loan file after the fact, it is relatively easy to determine whether the originator followed this procedural step. If it did not, it’s a clear breach of the underwriter’s guidelines, regardless of whether the borrower’s stated income turned out to be true or false. It has long been my view here at The Subprime Shakeout that once loan files are turned over to investors, it will not be difficult to prove that there were widespread breaches of lenders’ underwriting guidelines and procedures.

Finally, Laing takes it as a given that banks will be on their own this time, i.e., that the federal government will have no appetite to provide the banks with any financial assistance to ease the pain of this latest mortgage crisis. I am not so sure that this can be assumed. Instead, I think regulators are eager to avoid another financial panic like the one that was touched off by the failure of Lehman Brothers. Should one of the Big Four banks become dangerously undercapitalized upon the crystallization of putback liability, I’m afraid that the government will be asked (and be under intense political pressure) to step in once again. I don’t necessary agree with this approach, but given what we’ve seen over the last two years, it certainly can’t be ruled out.

All told, though I take issue with some of the finer points contained within this article, I commend Mr. Laird on this fine piece of journalism and encourage readers looking for a concise and intelligible summary of banks’ potential subprime mortgage liabilities to check it out.

Thanks to Manal Mehta at Branch Hill Capital for first alerting me to this story – IMG.

Posted in allocation of loss, Barron's, Clayton Holdings, Lehman Brothers, loan files, private label MBS, rep and warranty, repurchase, responsibility, stated income, too big to fail, underwriting practices | 2 Comments

Bank of America Fires Off Response to BlackRock and PIMCO Demand Letter, Accuses Lawyer of “Ulterior Agenda”

Posted on November 9, 2010 by Isaac Gradman

In a response that can only be described as indignant, Bank of America fired back on November 4 at the group of investors that demanded that Countrywide/BofA repurchase loans in connection with $47 billion worth of private-label mortgage backed securities. In the strongly-worded letter, a full copy of which is embedded below, BofA attorneys Theodore Mirvis of Wachtell, Lipton, Rosen & Katz; Brian Pastuszenski of Goodwin Procter and Marc Dworsky of Munger, Tolles & Olson railed against the allegations contained in the October 18 letter authored by attorney Kathy Patrick of Gibbs & Bruns, stating that Patrick’s letter contained “misleading statements,” alleged claims that were “utterly baseless,” and appeared to have been “written for an improper purpose, or in furtherance of a [sic] ulterior agenda.”

Much has made of Patrick’s October 18 letter, which was signed by such major institutional investors as BlackRock, PIMCO, MetLife, the New York Fed and Freddie Mac, making it the the most high-profile investor repurchase demand to date as to non-conforming mortgages. In fact, BAC’s stock slid nearly 5% when news of the letter first emerged.

Yet, as I noted when I first posted about this letter and when I posted a copy of the letter a few days later, this first high-profile investor putback effort featured some serious deficiencies that might prevent it from succeeding – namely, that it failed to identify specific breaches of reps and warranties with respect to specific loan files or provide any evidence supporting those specific breaches. Indeed, this turns out to be the very first point BofA’s attorneys make in responding to the letter. In pointing out some of the “glaringly evident” deficiencies in the letter, BofA’s attorneys state:

Your letter fails to set forth a single fact in support of any of your allegations, but rather relies solely on conclusory and often misleading statements. (emphasis in original)

The BofA letter goes on to demand that the investors provide “sufficient factual basis for their allegations” and “identify the specific provisions of the specific PSA that is alleged to have been breached.” Pursuant to the procedural roadmap from Judge Kapnick’s opinion dismissing the plaintiffs’ case in Greenwich Financial v. Countrywide, I would agree that Kathy Patrick’s investors will have to make this showing to survive a motion to dismiss for lack of standing if they eventually file suit against BofA/Countrywide.

However, the BofA letter also makes a number of points that are far less grounded in fact and appear designed to place political pressure on investors hoping to recover a portion of their MBS losses. For example, BofA characterizes Patrick’s letter as demanding that Countrywide hasten foreclosures and reduce loan modifications. The letter even accuses Freddie Mac’s involvement with Patrick’s group as “patently inconsistent” with the GSEs and federal government’s stated goal of helping troubled borrowers stay in their homes. While this has historically been a hot button political subject, BofA’s statements are not an accurate representation of what the investors are seeking.

In fact, the Patrick letter specifically states that investors “do not seek to halt bona fide modifications of troubled loans for borrowers who need them.” Instead, investors take issue with the Countrywide settlement with state Attorneys General in which, in exchange for the AGs dropping claims of predatory lending against Countrywide, Countrywide agreed to modify 400,000 loans, the large majority of which it no longer held on its books. Patrick’s group seeks simply to hold Countrywide to its contractual agreement to repurchase loans that it modifies as a cure for predatory lending.

Similarly, Patrick’s letter does not demand that Countrywide force borrowers out of their homes. To the contrary, the investors are simply demanding compliance with the Countrywide pooling and servicing agreement provision (Section 3.11(a)) that states that the Master Servicer must,

use reasonable efforts to foreclose upon or otherwise comparably convert the ownership of properties securing such of the Mortgage Loans as come into and continue in default and as to which no satisfactory arrangements can be made for collection of delinquent payments. (emphasis mine)

In other words, Patrick’s letter simply asks that Countrywide modify where it is reasonable to do so (and where it is not a remedy for Countrywide’s own predatory lending) and foreclose promptly where it is apparent that no satisfactory modification is to be had. Patrick’s letter is thus better characterized as a demand that Countrywide perform its fundamental role as servicer, rather than as a heartless demand that Countrywide start kicking people out of their homes.

Finally, BofA’s letter sets forth a plethora of additional information from investors that it demands be provided prior to Countrywide taking any action. Included in this is a demand that Patrick provide, for each bondholder who signed onto the letter, the names of the individuals who authorized that signature, whether the bondholder’s board of directors authorized that letter, and whether any of the bondholder’s controlling shareholders authorized the letter. I’m not sure from where BofA derives the authority to demand this information, but it clearly suggests that BofA is not convinced that the internal management within each of the signing entities was unanimous in support of the Patrick letter. BofA may also be trying to dissuade others from authorizing similar letters in the future for fear of their names being publicly revealed, something that institutional investors and their managers have thus far been reluctant to do.

Ultimately, though the BofA letter contains a lot of bark, the only bite that I can discern is the demand for more specific information. Everything else is, well, politics as usual.

BofA Response Letter to Patrick Group http://d1.scribdassets.com/ScribdViewer.swf?document_id=41592157&access_key=key-13u1yigrl82ah6i4l1rm&page=1&viewMode=list

Posted in Attorneys General, BlackRock, BofA, Countrywide, Event of Default, Federal Reserve, Freddie Mac, Kathy Patrick, MBS, PIMCO, procedural hurdles, rep and warranty, repurchase, servicers, specificity | Leave a comment

Countrywide Loan Modification Settlement Becomes Issue In Connecticut Senatorial Race

Posted on November 2, 2010 by Isaac Gradman

The ramifications of the Mortgage Crisis are being felt on this Election Day 2010, as the issues of foreclosures, loan modifications and MBS-related losses to pensionholders’ portfolios are being brought to the forefront in some key political battles. As a prime example, take the heated race for Chris Dodd’s open Senate seat in Connecticut, where Democratic candidate Richard Blumenthal still held a single-digit lead over Republican candidate Linda McMahon in polls leading up to today’s vote.

Embedded below is a television spot by McMahon, entitled “The Biggest Lie,” which attacks Blumenthal’s participation in the settlement between Attorneys General from 44 states and Countrywide over the lender’s alleged predatory lending practices. The ad suggests that while Blumenthal has stated that taxpayers would not pay a dime for the settlement, taxpayers would end up footing the entire bill for the loan modifications Countrywide agreed to perform. The ad quotes an article by Alex Ulam called “The Bank of America Mortgage Settlement Fiasco” in the left-leaning publication, The Nation.

To be fair, taxpayers will not be footing the entire bill for the Countrywide settlement, as Countrywide/BofA still owns some of the loans at issue (the article in The Nation reports that the number is a paltry 12%), and The Nation article itself states that, “as it turned out later, much of the settlement’s cost would be covered by taxpayers…” (emphasis mine). Thus, McMahon’s ad is not entirely forthright, either. Furthermore, it’s unclear that Blumenthal fully understood the way the settlement would play out (see prior post), and The Nation suggests that Blumenthal “seems to have missed it entirely,” so calling his statement a “lie” smacks of political rhetoric. But, the point is still a good one – the Countrywide settlement shifted the majority of losses to taxpayers and largely let Countrywide and BofA off the hook for its irresponsible lending practices.

I had a chance to meet with Alex Ulam, the author of “The Bank of America Mortgage Settlement Fiasco,” a number of times in San Francisco when he was first beginning his research for this story and was relatively new to the issues surrounding securitizations and loan servicing, such as servicer conflicts of interest and loan repurchase liability. He came to me for some background on the Countrywide settlement (note that BofA spokesman Terry Francisco is quoted in the article as calling it an “agreement,” not a “settlement”) and an explanation of who would bear the costs of the agreed-upon modifications. By the time Ulam’s article was published some months later, he evinced a firm grasp of the issues, and wrote a thorough and scathing piece for The Nation regarding the shortcomings of the resolution between the Attorneys General and the country’s largest subprime lender.

To be certain, this issue has been discussed previously in The Supbrime Shakeout (articles here, here and here) and in this article in the Daily Journal and California Lawyer Magazine. However, Ulam’s article was one of the first in a nationwide publication to understand and explain to its readers that by agreeing to modify loans that it no longer owned, Countrywide was shifting the losses associated with its troubled loans to the pension funds, hedge funds, insurance funds and other investors who had purchased MBS backed by these loans. And the article has made its impact, prompting McMahon to raise the issue as an attack on Blumenthal, and garnering a good deal of local media coverage in Connecticut, such as this article in the Greenwich Times/Stamford Advocate.

It remains to be seen whether the allocation of losses relating to the Mortgage Crisis will be a major factor in this year’s elections, but it is clear that these issues are beginning to seep into the mainstream consciousness. I would imagine that politicians all over the country are watching the Connecticut senatorial election closely to see whether voters care enough about these issues to make them pay at the polls for their role in the crisis or their failure to effectively clean it up.

Posted in allocation of loss, Attorneys General, BofA, Christopher Dodd (D-CT), Countrywide, global settlement, Linda McMahon, loan modifications, political ads, Richard Blumenthal, senate races, The Nation | 2 Comments

Full Text of BlackRock, PIMCO Letter to Bank of New York and Bank of America Available

Posted on October 21, 2010 by Isaac Gradman

Below, please find the full text of the letter sent by Kathy Patrick and the law firm of Gibbs & Bruns to Bank of New York and BofA/Countrywide on behalf of private label mortgage investors, including BlackRock, PIMCO, MetLife, Freddie Mac and the New York Fed. This letter represents one of the first formal attempts by a group of bondholders to issue binding instructions to a Trustee to take action on their behalf.

As you read through, keep in mind that the bondholders must identify a specific breach or event of default in order to meet the procedural preconditions to Trustee action and gain standing to sue if the Trustee does not act within 60 day (see recent article on procedural preconditions to bondholder standing). See if you think Patrick’s allegations regarding Countrywide’s knowledge of breaches of underwriting reps and warranties, based on its modification of loans and its lawsuits with bond insurers, or her allegations regarding Countrywide’s improper maintenance of loan documents, overcharging for maintenance services or failure to notify the Trustee of defects in the loans constitute the specific evidence of breaches necessary to meet her procedural requirements. Given that she does not identify a single loan by loan number or provide any specific evidence supporting any of her allegations (the closest she comes is citing a press release issued by the FTC), I remain skeptical.

[Many thanks to the folks at Branch Hill Capital for providing me with a copy of this letter – IMG.]
Bondholder Letter to BofNY and BofA Over Countrywide Loans http://d1.scribdassets.com/ScribdViewer.swf?document_id=39838424&access_key=key-9ff9j4kbi9sxm0s3l2u&page=1&viewMode=list

Posted in Bank of New York, BlackRock, BofA, bondholder actions, Countrywide, Federal Reserve, Freddie Mac, Kathy Patrick, loan modifications, MetLife, PIMCO, private label MBS, procedural hurdles | 6 Comments

PIMCO, BlackRock, New York Fed To Demand That BofA Repuchase Faulty Non-Agency Mortgages

Posted on October 19, 2010 by Isaac Gradman

Private label residential mortgage backed securities (RMBS) investors, including BlackRock, PIMCO, and the New York Fed, are expected to join MetLife, Inc. in its efforts to force BofA to repurchase defective subprime and Alt-A mortgage loans originated by Countrywide and backing the group’s investments, Bloomberg reports. The group, led by Houston lawyer Kathy Patrick (see bio and promotional video here) and the law firm of Gibbs & Bruns, has stated in a letter to Bank of America and Bank of New York, the trustee in these securitizations, that it wants to be compensated for losses relating to inadequate servicing on certain loans and to have loans that failed to meet contractual reps and warranties repurchased by the originator. The group holds approximately 25% of the voting rights in $47 billion of Countrywide RMBS in approximately 115 separately identified deals, according to a press release issued by the firm. The Wall Street Journal reports that the group’s holdings total $16.5 billion.

By the close of trading today, BAC’s stock had slid to 11.80 (-4.38%) based on this news and the release of the company’s third quarter earnings report, in which it stated that it could not determine the potential size of its losses from private label putbacks and mortgage and bond insurer rescissions. Still, BofA CEO Brian Moynihan vowed to “defend our shareholders” by disputed demands that it repurchase non-agency mortgages.

While Kathy Patrick’s group is much smaller than the Investor Syndicate represented by Talcott Franklin (which is reported to have amassed over $500 billion of RMBS), Patrick’s group has done what the Syndicate has not yet been able to do – convince its members to move forward with concerted action demanding that the trustee and the originator of the loans backing its investments take action. According to Patrick, ““We now are in a position where we have to start a clock ticking.”

What Patrick is referring to is that her October 18 letter, termed a “Notice of Non-Performance,” is expected to trigger a 60-day waiting period within which both the originator and trustee must act to remedy the breaches identified by the group. While Countrywide/BofA will likely be asked to shoulder the financial responsibility for these alleged breaches, the letter urges Bank of New York, as trustee, to enforce Countrywide’s servicing obligations including the obligation to maintain accurate loan records, demand repurchase of loans failing to comply with underwriting guidelines, and compel the sellers of ineligible loans to bear the costs of modifying or repurchasing them. Patrick further states that if these problems are not resolved within 60 days, they will trigger an Event of Default, which would allow the investors to file a lawsuit against both companies. Patrick was careful to note that, investors “aren’t trying to halt loan modifications for troubled borrowers.”

This latest effort from Patrick and her firm appears to be larger and more well-conceived than her prior effort (discussed previously on The Subprime Shakeout), in which she was stonewalled by Bank of New York for failing to comply with the procedural preconditions to trustee action. Instead of proceeding under a provision seeking an investigation by the Trustee that required proof of 25% of the voting rights in each tranch, which Patrick’s investors did not have, Patrick is now proceeding under Section 7.01 of the pooling and servicing agreement (PSA), relating to the remedies for identified breaches, which requires 25% of the voting rights of the entire pool.

Nevertheless, these efforts may well fail for an additional reason that was cited as a basis for Bank of New York’s refusal to comply with Patrick’s earlier request – the failure to provide evidence of a specific breach. Though Patrick’s letter is reported to identify several provisions of the relevant PSAs that it alleges were violated, it’s unclear what, if any, specific evidence Patrick has provided that would induce the trustee to act. A Bank of New York spokesman has already indicated that the trustee will not act in response to this letter, stating, “[The letter] appears to be directed to Countrywide and does not ask BNY Mellon to take any action. We will continue to perform our duties as trustee.”

Aside from size, the advantage of the Investor Syndicate over groups such as Patrick’s is that it is reported to have analytic methods for identifying and providing specific evidence of servicer breaches, allowing it to overcome this procedural hurdle. However, the longer this group sits on the sidelines, the more losses will accumulate for investors, and the less relevant the Syndicate will become. Perhaps this is why some of the investors, such as BlackRock and PIMCO, that were previously identified as members of Franklin’s group, are now reported to be considering joining Patrick’s group. The Syndicate may want to begin taking action before it loses more investors to its competitors.

Posted in Bank of New York, BlackRock, BofA, demand letter, Event of Default, Investor Syndicate, Kathy Patrick, PIMCO, procedural hurdles, rep and warranty, repurchase, RMBS, servicer defaults, Trustees | 7 Comments

Mortgage Mess Causes Bank Stocks To Plummet

Posted on October 15, 2010 by Isaac Gradman

Bank stocks have taken a sharp hit this week as awareness regarding potential liabilities for faulty mortgages and foreclosures reaches critical mass.

You can’t turn on the TV or open a newspaper these days without seeing reports on the recent “Foreclosure Crisis” and the resulting foreclosure moratorium. For those who have been napping, this latest crisis surrounds the issue of whether the major loan servicers were dealing with the glut of foreclosures on their books by hiring inexperienced employees to act as “robo-signers,” signing thousands of affidavits attesting to facts of which they had no knowledge. Deposition testimony from a number of foreclosure cases has recently emerged that reveals a huge number of judicial foreclosures may have rested upon phony affidavits, and that these affidavits were the only proof provided by the banks that they had the right to foreclosure on delinquent borrowers.

While this issue has been brushed off by some as a mere administrative problem that can easily be remedied, the reaction of informed analysts and the major servicers themselves says otherwise. BofA has now frozen foreclosures in all 50 states, even those not requiring judicial intervention to effectuate a foreclosure, joining JPMorgan Chase and Ally Financial (formerly GMAC), which had previously imposed a foreclosure moratorium in the 23 judicial foreclosure states. Moreover, it is unclear how long these moratoria may last, as banks may not even possess the proper documentation to cure this defect and prove the right to foreclose. A riveting and terrifying report by analyst Joshua Rosner has been circulating that argues that the banks may not have properly assigned the mortgages to the securitizations to which they were sold in the first place (see CNBC article here and great post on Naked Capitalism about the Rosner report here). If true, this would mean that bondholders were not provided the consideration they bargained for, as their investments were essentially unsecured, rendering the investment contracts subject to rescission. At the very least, this fact would render all improperly-assigned loans subject to repurchase for breach of the rep and warranty regarding a true sale of the mortgages to the trust, providing private-label investors, such as the Investor Syndicate, even more ammunition to use against banks and originators.

In addition, a great report called “Foreclosures Gone Wild,” explaining the nature and implications of the Foreclosure Crisis, was published by, of all entities, CitiBank (which has not yet frozen foreclosures) this week. The report (text version available here), cites the comments Georgetown professor Adam Levitin made during a conference call hosted by the bank. While Citibank tempers these comments by describing them as “one of the bleaker portraits of these matters and their ultimate resolution,” you’ve got to wonder whether someone at Citi is currently on the Budweiser Hot Seat over the decision to select Levitin as the featured guest.

Adding fuel to this foreclosure fire, banks are holding their Q3 earnings calls this week, and are expected to announce additional litigation reserves and loss reserves for mortgage repurchases. JPMorgan has already announced a $1billion increase in repurchase reserves, and the transcript from the earnings call held by bank CEO Jamie Dimon earlier this week is great reading, both for what Dillon says and for what he doesn’t say. Pay particular attention to the sections of the Q&A where Dimon confirms the banks’ apparent strategy to drag out the losses from mortgage repurchases through litigation, and his warnings that a prolonged foreclosure crisis would have “a lot of consequences, most of which would be adverse on everybody.”

On top of this, a report written by Manal Mehta, who has been a guest blogger on the Subprime Shakeout (read Mehta’s guest post on JPMorgan’s insufficient mortgage repurchase reserves here), has suddenly gone viral, and is having a material impact on the stock price of lenders and bond insurers. Manal’s report was originally circulated in August, but got hundreds of thousands of hits in the last two days when it was posted on the website Business Insider. The report details why Mehta, and his fund Branch Hill Capital in San Francisco, believe that Bank of American has undereserved for potential losses associated with repurchases of defective residential mortgages and why bond insurers such as MBIA will benefit from such repurchases. The report has now been cited by The New York Times, The Street, and was featured on CNBC (see article and video here).

As the market reaction shows, not only are Wall Street analysts finally delving into reports on mortgage repurchase liability such as Mehta’s, but that the Street is coming to understand that repurchase liability is real, and poses a credible threat to banks’ balance sheets. Though there are certainly procedural hurdles to enforcing bondholder rights that must be overcome, and the dismissal of Greenwich Financial’s lawsuit against Countrywide last week vividly illustrates the importance of complying with these preconditions, I believe that these hurdles can be properly navigated by experienced counsel, and that RMBS bondholders will eventually get their act together take the proper steps to bring massive claims against the banks. And while the putbacks from breaches of underwriting guidelines or procedures alone could be well over 50% of these 2005 to 2007-era subprime and Alt-A pools, that number could skyrocket should analysts’ fears regarding improper assignment of mortgages prove actionable.

[Update: after linking to Citi’s report entitled, “Foreclosures Gone Wild,” complete with the statement that, “[i]t appears that in many instances during the mortgage securitization process over the past few years, the paperwork was not properly transferred,” I learned that Citi had apparently hired the firm of Kilpatrick Stockton LLP to remove the report from all Internet sites that posted it in its original form. This article now links to the text from the repo
rt, which can be found at Foreclosure Blues. Citi’s official response to this decision to take down the report was as follows:

“The allegation that Citi has engaged a law firm to remove a specific research report from the internet because of its content is untrue. As is standard practice with our proprietary client research, we investigate any misuse of Citi’s intellectual property. Citi’s research is independent and in accordance with industry practice, our analysts do not comment on our Firm when discussing market activity.”]

Posted in BofA, branch hill capital, foreclosure crisis, foreclosure moratorium, improper documentation, JPMorgan, liabilities, loss estimates, rep and warranty, repurchase, robo-signers, true sale | 4 Comments

New York Judge Tosses Greenwich Suit Against Countrywide Over Loan Modifications For Failure To Follow PSA Procedure

Posted on October 13, 2010 by Isaac Gradman

In a ruling dated October 7, 2010, New York County Supreme Court Judge Barbara R. Kapnick tossed out Greenwich Financial’s lawsuit against Countrywide. The suit sought a declaratory judgment that Countrywide had to repurchase any loans that it modified pursuant to its settlement with state Attorneys General. The Order, available here, grants Countrywide’s Motion to Dismiss the Complaint–thereby disposing of the case entirely–because Greenwich failed to comply with the procedural preconditions to bringing suit.

In an article from the Wall St. Journal today, Greenwich attorney David Grais, of the law firm Grais & Ellsworth is quoted as saying that, “We are reviewing the opinion and considering whether to file an appeal.” However, given the facts as recounted in Judge Kapnick’s Order, it would seem that Greenwich has a steep hill to climb to succeed on any appeal.

In its Motion to Dismiss, Countrywide, the servicer in the challenged RMBS deals, relied on Section 10.08 of the Pooling and Servicing Agreement (“PSA”), a provision that sets forth the procedural preconditions for bondholders wishing to initiate suit. Included in these preconditions, which are standard in most PSAs, are the requirements that the bondholders to first approach the Trustee with proof of ownership of 25% of the voting rights in the Trust and proof of some Event of Default, make a written demand on the Trustee to institute an action in its own name to remedy such Default within 60 days, and provide the Trustee reasonable indemnity against costs and liabilities arising from any such suit. There is no argument from Greenwich that it failed to comply with these preconditions before bringing its action.

Instead, Greenwich argued in Opposition to the Motion to Dismiss that it was not required to comply with these preconditions for three reasons: 1) these preconditions apply only to actions that may unfairly benefit one class of bondholders over another, and Greenwich’s suit would benefit all bondholders equally; 2) the preconditions only apply where there is an Event of Default, defined as the failure of the servicer to perform certain identified acts, and not including the failure to repurchase a modified mortgage; and 3) that compliance with the preconditions is excused because such a demand would have been futile. In support of the third point, Plaintiff argued that, soon after instituting suit, it served on the Trustee a request that it join in the suit, which the Trustee refused. Countrywide countered that this request did not comply with the procedural preconditions of Section 10.08. Judge Kapnick rejected all of these arguments, essentially finding that the language of Section 10.08 applied broadly to all actions, and that Greenwich had failed to comply with any of these preconditions.

This result is surprising to me, given the experience of David Grais and Bill Frey, the principal of Greenwich Financial Services, in litigation surrounding RMBS deals (including Grais’ lawsuits on behalf of the Federal Home Loan Banks and Frey’s participation in the Syndicate of RMBS investors). These are sophisticated players familiar with the preconditions to suit found in nearly every PSA from this time period. It is also my understanding that Greenwich could have shown 25% ownership in at least some of the challenged deals, making it even more curious why they did not at least attempt to comply with Section 10.08 prior to filing suit. Of course, they were probably correct that such an attempt would have been futile, given that most investors have encountered general resistance from Trustees when they attempt to induce action on their behalf, but at least Greenwich would have then been able to make the argument that it attempted to comply but was rebuffed by the Trustee.

Perhaps there were other considerations at play that led Greenwich and Grais to file this suit prior to haggling with the Trustee and waiting the requisite 60 days to take action. Some readers will recall that this lawsuit was filed as a response to a broad settlement–to the tune of $8.4 billion dollars–by Countrywide with the Attorneys General of 15 states (dozens more signed on after the fact) regarding Countrywide’s predatory lending practices in those states. The settlement stipulated that Countrywide would remedy these practices by agreeing to modify over 400,000 loans to allow borrowers to stay in their homes.

There were only two glitches in this settlement, which was hailed by Jerry Brown as a great success story. First, Countrywide no longer owned upwards of 80% of these loans it was agreeing to modify. Because any modification imposes some kind of cost on the ultimate holder of the loan–by either reducing principal, reducing interest rates, or prolonging the repayment period–the bulk of the $8.4 billion in loan modifications would have been borne by the bondholders. Second, the bondholders have favorable provisions in the PSAs and in the Stipulated Settlement between Countrywide and the AGs requiring the servicer to buy back any loan it agrees to modify. Maybe the rush to the courts for a declaratory action was an effort to halt these modifications prior to their institution.

And perhaps this tactic was successful. Countrywide and other servicers have been largely reluctant to carry out extensive loan modifications (see interesting stories here, here and here), in part because as reported in the Wall St. Journal, they fear being forced to repurchase those loans. And the filing set the wheels of politics in motion, resulting in a full blown lobbying effort by BofA/Countrywide to encourage the passage of a Servicer Safe Harbor to shield servicers from liability for modifying mortgages. This lobbying effort had the reciprocal effect of inducing bondholders to band together to form their own lobbying group, which group became the precursor to the Investor Syndicate gearing up to take on servicers over a broader range of originating and servicing defaults.

Still, regardless of the political motives that may have encouraged a premature filing of suit by Greenwich, Judge Kapnick’s Order illustrates the difficulties facing all bondholders wishing to pursue claims against the servicers, originators or sponsors of their RMBS holdings for losses associated with their investments. Most PSAs require, first, proof of sufficient ownership–usually 25 to 50 percent–just to get the Trustees’ attention. Aggregating enough RMBS holdings to meet this requirement was the primary reason the Investor Syndicate has formed. Second, bondholders must make a demand that the Trustee institute suit in its own name. Often, the Trustee will seek unreasonable indemnity from bondholders and require the execution of onerous confidentiality agreements prior to doing so. Then, the bondholders have to sit on their hands and wait for the Trustee to decide not to institute an action before they can do so on their own.

Many investors appear unwilling to navigate the complexities or incur the expense of jumping through these procedural hurdles prior to taking action. Just last month, Bank of New York, one of the primary Trustees on 2005- to 2007-vintage RMBS deals, refused a demand to investigate by a group of investors, represented by Kathy Patrick of Houston law firm Gibbs & Bruns, because of a failure to comply with procedural preconditions. Sources indicate that this investor group failed to meet the peculiar obligation of the investigation provision under which it attempted to proceed, requiring 25% ownership in every class of securities, and that the group failed to identify particular Events of Default to trigger Bank of New York’s obligations. In short, as the dismissal of Greenwich’s suit against Countrywide and the rejection of Gibbs & Bruns’ efforts illustrate vividly, procedure cannot be ignored, and it would behoove investors to get their ducks in a row before taking expensive legal action.

Posted in Bank of New York, BofA, bondholder actions, Countrywide, Greenwich Financial Services, loan modifications, motions to dismiss, procedural hurdles, settlements, William Frey | 6 Comments

Strange Bedfellows: Barney Frank’s Falling Out With Wall Street Leaves Him Aligned With Former Nemesis

Posted on October 8, 2010 by Isaac Gradman

I have seen some strange things during my time covering the mortgage crisis, but this one may beat them all.

On August 20, 2010, representative Barney Frank (D-MA) sent a letter to Barack Obama, urging the President to appoint a permanent head of the Federal Housing Finance Agency (FHFA) who would aggressively pursue legal claims against the private companies that caused Fannie Mae and Freddie Mac (and thus, taxpayers) to suffer losses, namely, the lenders who originated subprime and Alt-A mortgages during the boom years (roughly 2005 to early 2008). Frank’s letter directly endorses a similar letter sent by representative Paul Kanjorski (D-PA) and the House Financial Services Committee on August 13, 2010, which also urged Obama to appoint an FHFA director to “vigorously pursue all legal claims for losses” sustained by Fannie and Freddie and identified specific legal action the FHFA has taken and should continue to take to recover these losses. Kanjorski’s letter went into greater detail, indentifying the pursuit of mortgage repurchases for rep and warranty violations, the issues private investors had experienced in accessing loan files, the FHFA subpoenas designed to acquire those loan files, and the servicer conflicts of interest that had contributed to their obduracy.

If my readers will recall, some of these same officials had previously taken positions that were vehemently and diametrically opposed to encouraging the pursuit of legal rights against servicers (often affiliates of the same entities that originated these defective loans), and in fact had supported measures that helped protect servicers from legal liability. For example, in October of 2008, Frank was among the congressional signatories on a letter sent to Bill Frey of Greenwich Financial Services, which has filed a lawsuit against Countrywide to prevent the servicer from modifying mortgages without bondholder approval, as required by contract. Frey had long been a vocal bondholder advocate who had publicized the various servicer conflicts of interest and breaches of their obligations to service mortgages in the best interests of bondholders. Frank’s October 2008 letter accused Frey of interfering with Washington’s attempts to avoid foreclosures by encouraging loan modifications, and “invited” Frey to testify before Congress to explain himself. Frey wrote a letter in response, and ended up showing up in Washington to testify, but was never called to the stand.

In another example, both Kanjorski and Frank were sponsors of the Helping Families Save Their Homes Act, a bill passed in 2009 with the ostensible goal of reducing foreclosures, but which attempted to do so by incentivizing servicers to modify mortgages with cash and legal immunity, courtesy of a Servicer Safe Harbor (introduced by Kanjorski and Michael Castle (R-DE)). This Safe Harbor purported to nullify any contractual provisions that required servicers to buy-back the loans that they modified. Soon after, Frey wrote a scathing Op-Ed piece in the Washington Times explaining why servicer conflicts of interest would doom any effort to make them the arbiters of loan modifications. I have also written several articles identifying the folly of this legislation (see examples from the Subprime Shakeout here, here and here, and a longer article on the background and constitutionality of this legislation here) and pointing out how Kanjorski was the second-largest recipient of Countrywide campaign contributions since 1989. It is also interesting to note that Frank’s second-largest donor during the 2008 election cycle was Bank of America, and that Frank’s top 20 donors included Royal Bank of Scotland (No. 4), JPMorgan Chase (tied at No. 11), Credit Suisse, Goldman Sachs and Morgan Stanley (all tied at No. 17).

Frank later began to reverse course in July 2009, issuing a public letter urging regulators to investigate servicer conflicts of interest, including those resulting from their holdings of second lien loans. This indicated that Frank was beginning to realize that it wasn’t bondholders who were truly preventing distressed loans from being modified, but the very same banks that had originated the defective loans in the first place.

Over the next year, it became apparent that Frank wasn’t just talking out of both sides of his mouth, but that he really had changed positions on this issue. This could have been a result of a change in conscience, but more than likely, it was a result of a change in the political landscape and the fact that Frank has a legitimate fight on his hands to achieve reelection in 2010. Tellingly, none of Frank’s former top-20 Wall Street donors from 2008 or any major banks are anywhere to be found in Frank’s list of top donors for the 2010 election cycle.

In July 2010, the Frank-Dodd Financial Reform Bill was signed into law, consisting of 2,000 pages of legislation aimed at halting abusive practices in the mortgage industry and preventing another financial crisis, but which left many of the specifics of such reform for regulators to fill in over the next 6 to 18 months. Frank was a major force behind the bill, as its name suggests, and, in a revealing interview with Charlie Rose, Frank hailed the bill as a victory over Wall Street and discussed the challenges of taking on the banks.

For example, at the 12:20 point in the interview, Frank states that banks were most afraid of (and put most of their guns into opposing) the new consumer protection bureau because they make most of their money on credit card overdraft charges and late fees, rather than loans. Frank then says, “And [the banks] lost.” That’s when it gets really interesting, as Frank says, “they told me not even to try because the banks always win… They didn’t win today.”

At the 19:35 point, Frank makes another revealing comment. He begins by saying, “public opinion is powerful.” He notes that last year’s bill (probably referring to the Helping Families Save Their Homes Act) was not as powerful as this bill because the media was more focused on health care, “so the big interests won more of the fights than I wanted them to or than I wish they did….” Though it’s easy to be skeptical of comments such as this, Frank’s almost wistful tone in making this statement (watch the video and see if you disagree) leaves the indelible image of a man who has been misled by those he trusted.

Thus, I had some inclination of a falling out between Wall Street and Frank, but I must say I was surprised by Frank’s recent letter regarding the FHFA. It isn’t just that he is now taking a more strident stand against the banks that supported him during the last election cycle, but that, by advocating mortgage repurchases, Frank has now aligned himself (perhaps unwittingly) with the former target of his wrath, Bill Frey.

On September 23, 2010, it was revealed that Frey was involved in efforts by the Investor Syndicate to do just what Frank’s letter to the President urges – pursue legal claims against residential mortgage originators for defective underwriting and breaches of reps and warranties. With their interests now so closely aligned, maybe Frank should recommend that the President appoint Frey as the head of the FHFA. After all, Frey was way out in front of this issue and has the experience to do the job. It’s safe to say that such a development wouldn’t be any stranger than the recent vicissitudes in Frank’s relationship with Wall Street.

Posted in Barack Obama, Barney Frank (D-MA), BofA, campaign finance, FHFA, Greenwich Financial Services, Investor Syndicate, Paul Kanjorski, rep and warranty, repurchase, servicers, William Frey | 2 Comments

Inside Mortgage Finance Sees Private Label Rep and Warranty Claims Increasing

Posted on September 7, 2010 by Isaac Gradman

The following story appeared in the September 3, 2010 issue of Inside Nonconforming Markets, a biweekly newsletter focusing on news and data on non-agency mortgages. This story reflects the growing awareness in the marketplace of the undisclosed mortgage repurchase liabilities facing this nation’s largest financial institutions. Though Barclays makes a statement in this story that buybacks peaked in 2007, note that the mortgages that made up those repurchases were home equity lines of credit, second liens and first lien deals wrapped by mortgage insurers. This shows that the banks have not even begun to face the bulk of first lien loan-level repurchase requests from private investors. As the Investor Syndicate continues to organize and move forward, that is certain to change…

Non-Agency Rep/Warrant Claims Likely to Increase

Loan originators and underwriters of non-agency mortgage-backed securities face increasing repurchase requests due to widespread breaches of representations and warranties, according to industry analysts. While the claims will likely rise, the eventual impact on the non-agency mortgage market remains unclear.

Isaac Gradman, an attorney with Howard Rice Nemerovski Canady Falk & Rabkin in San Francisco, estimates that 50 percent to 80 percent of the mortgages in non-agency MBS are missing documents or are in a direct breach of rep and warrant guidelines. Gradman and his firm represent PMI Mortgage Insurance Co., which recently alleged misrepresentations by WMC Mortgage on a $1 billion subprime MBS pool.

Non-agency MBS repurchase requests based on rep and warrant violations are currently low because MBS investors have had difficulties obtaining loan files from trustees. However, lawsuits by mortgage insurers and some Federal Home Loan Banks, as well as separate pending actions by the Federal Housing Finance Agency, the Federal Reserve and an investor consortium could trigger a rush of non-agency repurchase requests.

While obtaining and analyzing loan files can be costly for non-agency MBS investors, Gradman predicted that investors are going to find that it is worth the up-front cost. “The cost is very small compared to the amount you can recover,” he said.

Analysts at Compass Point Research and Trading estimate that the total liability for rescission requests on subprime MBS is $80.3 billion, with a worst-case estimate of $89.3 billion in liability for the sector and a best-case estimate of $46.6 billion. The research firm’s estimate of the total liability for rescission requests on Alt A MBS is $67.9 billion, with a $99.1 billion worst-case estimate and a $13.4 billion best-case estimate.

Analysts at Barclays Capital agree that non-agency buybacks will likely increase going forward but they suggest buybacks will still be limited due to the numerous obstacles non-agency MBS investors face when seeking buybacks. “Bank losses due to rep and warranty related repurchases should also be more manageable than what many investors might be assuming,” Barclays said.

The quarterly volume of non-agency MBS repurchases has been between $60 million and $100 million since the beginning of 2009, according to Barclays. The repurchases have been dominated by home-equity lines of credit, second liens and by first lien deals wrapped by mortgage insurers.

Non-agency MBS buybacks on a quarterly basis peaked at about $2.75 billion in the first quarter of 2007, according to Barclays. Buybacks at the time were tied to early-payment defaults.

HELOCs and second lien deals account for about 42 percent of the $550 million in non-agency MBS repurchases from the beginning of 2009 through the second quarter of 2010, despite forming only about 15 percent of the delinquent loans, according to Barclays.

Alt A deals accounted for another 35 percent of the repurchases during the period. Barclays said HELOCs and Alt A mortgages likely dominated non-agency repurchases because they were the deals most likely to have mortgage insurance.

Outlook Cloudy

With the majority of subprime and Alt A originators out of business, most rep and warrant activity has focused on non-agency MBS underwriters. Those pursuing repurchase requests generally claim that securitization underwriters misrepresented the profile of loan standards within a security’s initial prospectus.

Gradman said rep and warrant violations were flagrant during the subprime boom. “Once the loan files are received, there’s not going to be a lot of debate,” he said.

He predicted that banks will seriously consider settling with non-agency MBS investors instead of risking even larger losses by fighting the claims in court. Gradman said the few settlements that have already been reached are confidential.

Gradman noted that compensating factors could help originators and MBS underwriters defend against rep and warrant claims, but he said such factors were rarely documented by lenders. Recouping buyback losses from borrowers could also be difficult.

Gradman said borrowers often were not complicit in mortgage fraud and borrowers are unlikely to pay anything material. “It’s hard to prove that the originator did not participate in the fraud,” he said.

Banks have also argued that rep and warrant breaches are minimal and that non-agency MBS investors’ losses have been due to the mortgage crisis in general.

However, judicial momentum could be shifting in favor of non-agency MBS investors. “There is a dawning of understanding in a lot of courts across the country that these losses were not due only to a drop in home prices,” Gradman said.

Meanwhile, Barclays warns that rep and warrant buybacks will make lenders even more cautious in originating new non-agency mortgages. ►

Reprinted with permission of Inside Mortgage Finance Publications, Inc. from Inside Nonconforming Markets, September 3, 2010 www.imfpubs.com

Posted in Federal Home Loan Banks, FHFA, judicial momentum, liabilities, loan files, private label MBS, rep and warranty, repurchase | 1 Comment