Investor Syndicate Fires Warning Shot Across Trustee Bows

As first reported by Reuters on Wednesday, and as further detailed by Bloomberg today, the Investor Syndicate has finally begun to emerge from the shadows and give securitization trustees a hint at what’s coming.  According to Talcott Franklin, the Dallas attorney who is spearheading the Syndicate, the group sent letters to some of the major trustees of mortgage-backed securitizations, detailing the holdings of the group and urging trustees to help them enforce servicing breaches and pursue buybacks of improperly-originated loans.  The letters have not yet been made available, as the group appears to be continuing to closely guard the identity of the investors involved.

Franklin would only say that the members of the Syndicate are investors representing over $500 billion in mortgage-backed securities (MBS) holdings, which would account for over one-third of the $1.5 trillion private-label MBS market.  Franklin was formerly with the lobbying group of the Washington, D.C.-based law firm, Patton Boggs, that was involved in bondholders’ lobbying efforts over the Servicer Safe Harbor, but reportedly left the firm this year to head up the Investor Syndicate.

As discussed in prior posts (here and here), the Syndicate’s initial goal was to amass enough representation in a material number of securitizations to meet the 25% or 50% ownership thresholds imposed by the trust agreements, thereby acquiring the right to petition the trustees of those deals to take action.  From Franklin’s statements, it appears that this first step has been accomplished, as he has represented that the Syndicate owns bonds giving them 25% of “voting rights” in over 2,300 deals, 50% in more than 900 deals, and 66% of the bonds in more than 450 deals.

Assuming this is true, the letters sent on behalf of the Syndicate this week should be viewed as merely an opening salvo.  It is only a matter of time before the Syndicate begins issuing communications to trustees identifying specific instances of servicer misconduct or defects in the underwriting with respect to particular loans.  These instances of misconduct, also known as “defaults,” will change the responsibilities and incentives of the parties dramatically.  Once trustees are made aware of specific defaults by bondholders owning the requisite percentage of voting rights, the trustees become essentially fiduciaries of the bondholders, and acquire obligations to take steps to remedy those defaults.  Should they fail to do so, they may be fired or sued.

To those invested in the Big Four banks, which originated and now service huge percentages of the loans underlying these private-label securities, this next step will be the equivalent of yelling “fire” in a crowded movie theater.  Up to now, banks have been able to drag their collective feet in recognizing losses associated with the profligate lending practices of 2005-2007.  When banks originated mortgages and sold them into securitizations, they made representations and warranties regarding the quality of the underwriting and the guidelines they followed.  Should the Investor Syndicate be able to acquire the servicing and loan files associated with these mortgages and find breaches in those reps and warranties (as Freddie and Fannie are trying to do now through their subpoena powers), banks will be inundated with repurchase requests.  And as the media and government officials have only recently begun to recognize, banks have consistently under-reserved for the losses they will likely face from investor buyback obligations.

Further, in their role as servicers, these same banks have been slow to foreclose on hopelessly delinquent borrowers, as they were rife with conflicts of interest based on their second lien holdings.  Servicers have instead been content to rack up late fees while investors remained unorganized and the normally passive securitization trustees had no incentive to act.  Without active trustee enforcement of servicing obligations, the banks have also been able to modify loans as they pleased, irrespective of whether such workouts were in the best interests of bondholders, because trustees would not enforce servicer obligations to obtain the approval of the investors (see articles on the Greenwich Financial lawsuit against Countrywide for more background on this issue).  However, once trustees are compelled to go after these servicing breaches (or are fired and replaced by friendly trustees if they don’t), the banks will be liable for additional losses caused by their failure to service loans in accordance with bondholder wishes.

All this is to say that the financial landscape will change drastically in the coming month as the Investor Syndicate moves forward with its plans.  To drop a shameless Counting Crows reference, the MBS world may look very different in “August and Everything After.”

This entry was posted in fiduciary duties, firing servicers, Investor Syndicate, irresponsible lending, private label MBS, repurchase, reserve reporting, securitization, servicer defaults, Servicer Safe Harbor, Trustees. Bookmark the permalink.
  • http://www.foreclosurehamlet.org/ Lisa

    >I find your blog deeply interesting and enlightening.You may wish to take a peek at the flip side of the coin, the equally defrauded homeowners at ForeclosureHamlet.org.The loan files that the Investor Syndicate seek won't reveal all they hope. Most of our loans are unrecognizable to us when we look at how they were presented in the prospectuses. My own full doc loan is listed in the trust's prospectus as a SISA. Not sure why. Many notes are showing up endorsed directly to the Trustees (http://www.scribd.com/doc/34762843/Deutsche-Bank-as-Trustee-Endorsement-unnamed-trust) Surely something odd is afoot! Investors, insurers, borrowers……….all defrauded on over inflated/rated/appraised values of what were were hoodwinked into purchasing.LisaForeclosureHamlet.org

  • http://foreclosureblues.wordpress.com/ Foreclosureblues

    >It's a beautiful thing.

  • http://Anonymousnoreply@blogger.com Anonymous

    >Gretchen Morgensen, NYT's superlative financial reporter, says that according to unnamed investigators, MBS issuers hired analytic firms to conduct due diligence on underwriting of suspect loans. (http://www.nytimes.com/2010/07/25/business/25gret.html?ref=business) They then used this information to leverage lower prices on the mortgages they bought from originators like New Century. In other words, the MBS issuers knew that they were in violation of warranties and representations to MBS bondholders, but not only failed to remedy the violations, but used the information for self-gain. That practice looks like fraud by the MBS issuers – with potential for punitive damages against them. If the practice was widespread and rises to the level of fraud, the largest issuers may have to set aside much higher reserves.

  • http://Anonymousnoreply@blogger.com Anonymous

    >Why are there no set-offs for forelcosures in the investor lawsuits? Are the monies made through foreclosure sales not paid to the investors? If so, that means that the servicer is the one with largest gain in this scheme. The servicer holds the most power – it is the servicer that can approve a modification (look at the PSA), yest they pass the buck and blame the investor for not being able to modify. At the same time, the servicer is paying the principal and interest on the defaulted loans to keep up the appearance that the loan is current. Upon foreclosure, it is the servicer that gets paid first.

  • http://www.blogger.com/profile/11501168638041947453 Isaac Gradman

    >The monies made through foreclosure sales are paid to investors… eventually. The problem is, that there are many costs and fees associated with foreclosure that are first taken out of any foreclosure recovery. There are also late fees and other delinquency fees that servicers assess to borrowers that are also, as you point out, paid back to the servicer first off the top of any foreclosure recovery. This means that the recovery through foreclosure is often HALF of the original appraised value of the home, meaning major losses for investors. That is why investors would prefer, if there is no viable loan modification alternative, that the servicer foreclose quickly on borrowers who cannot meet their payments, thus preserving as much of the corpus of the collateral as possible.

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