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A few weeks ago, I published an article suggesting that the increased cooperation of MBS trustees may signal the turning point in bondholder litigation. It seems I’m not alone in reaching this conclusion.
The following week, on January 27, Adam Levitin, associate law professor at Georgetown University and vocal commentator on banks’ potential liabilities stemming from subprime lending, published a blog post entitled, “Clash of the Titans: RMBS Edition.” The post does a great job of summarizing the key early litigation in this space, including linking to some articles from The Subprime Shakeout, while also analyzing where this trend may be heading.
Levitin’s verdict? That the storm we’ve long predicted is coming. Levitin writes, “We’re about to witness the main event in financial institution internecine warefare: investment funds (MBS buyers) vs. banks (MBS sellers).” The catalyst he identifies is that a group of large institutional investors has banded together and filed suit, in what Levintin calls the first “A-list litigation.” This would be the case filed by Dexia, New York Life, and TIAA-CREF, among others, against Countrywide and BAC.
Besides including the usual slew of allegations regarding loosening guidelines, breaches of underwriting reps and warranties and misrepresentations regarding lending standards, Dexia and the other plaintiffs raise (for the first time I can recall in either bondholder or insurer litigation) chain of title issues regarding whether ownership of the note and deed was properly transferred through the securitization chain. The Complaint discusses in detail the revelations of Linda DeMartini from Kemp v. Countrywide that Countrywide routinely did not transfer the mortgage note when it sold a loan into securitization. Such errors became meaningful after the Massachusetts Supreme Court handed down the Ibanez decision, holding that the entity foreclosing had to able to show that they were the holder of the note and deed at the time they initiated foreclosure proceedings. As Levitin points out, the Dexia complaint merely scratches the surface on chain of title issues, but it gives credibility to an argument that was long dismissed by the banks as a mere technicality.
Levitin also agrees that trustee intercession on behalf of bondholders could only mean the times are a-changin’. In that regard, Levitin writes, “It looks like the trustees see that it’s checkmate once the investors get to the collective action threshold and are finally squeezing the servicers… This ain’t gonna end pretty.”
One day after Levitin’s article came out, industry publication Debtwire reported a similar trend. In an article entitled, “JPMorgan slowly loosens grip on loan files in bitter EMC, WaMu buyback disputes” (subscription only), reporter Allison Pyburn, whose writing has long reflected a strong handle on these issues, states:
This week, JPMorgan also agreed to relinquish 400 of the 902 loan files requested that serve as collateral for Bear Stearns Mortgage Funding Trust 2007-AR2, according to a letter filed Wednesday in Delaware Chancery Court in Wilmington. The case, Wells Fargo Bank v. EMC Mortgage Corp., has investor standing in 42% of the deal and loan level data alleged to prove a breach of the 902 loan files requested on 20 September.
Movements by the bank to turn over loan documents to trustees investigating buyback disputes could represent a shift of power between banks and investors seeking buybacks, said an RMBS investor and lawyer familiar with the disputes. A JPMorgan Chase spokesman declined to comment.
Make no mistake about it, loan files are the key to unraveling this whole mess. Once bondholders obtain possession of these critical documents–and eventually they will–they will be privy to a mountain of fodder for rep and warranty and misrepresentation claims, and losses will flow back to the originators and underwriters of these toxic loans. The servicers (a.k.a. the originators and keepers of the files related to many of these loans) have been able to sit on their hands and refuse to turn over loan files thus far because passive trustees and arduous procedural hurdles have stood between the bondholders and loan access rights. When this changes–and all evidence suggests that it already is–servicers will be left without a leg to stand on, and the files will be produced, either voluntarily, or by court order. Brace yourself for the ruckus.