Ambac Drops Bombshell Proposed Amended Complaint on JP Morgan, EMC

Posted on January 25, 2011 by Isaac Gradman

In a pleading filled with allegations that can only be described as shocking, Ambac has accused Bear Stearns and its former subsidiary EMC Mortgage (both now owned by JP Morgan) of a parade of horribles in its proposed amended complaint in its case over defective residential mortgages in the Southern District of New York.  If only a fraction of these allegations are true–and the documentary evidence cited in support suggests that they are–it constitutes the most damning evidence thus far that securitizing banks engaged in out-and-out fraud in the race to churn out more RMBS and enhance their bottom lines.

Among the allegations are that Bear Stearns (now JP Morgan Securities) profited by obtaining settlements from certain lenders that sold the bank defective loans, while at the same time denying repurchase requests from investors and insurers based on the same loans and the same deficiencies (thereby “double-dipping” on these loans); that Bear Stearns was simultaneously selling short shares of banks holding Ambac-insured securities as it denied the bond insurer the benefit of its contractual right to have Bear repurchase defective loans; that Bear covertly cut the time allowed for early payment defaults without telling investors, allowing it to securitize more loans that had already gone bad; and that Bear ignored its own due diligence findings on loan deficiencies, lied to rating agencies about this data, and then went ahead and securitized these loans, anyway.

I first reported on this lawsuit back in November of 2008, and noted that while Ambac had accused EMC of originating mortgages it knew could not be repaid, it stopped short of alleging fraudulent or negligent misrepresentation on the part of the originator of loans or arranger of the securitizations it had agreed to insure.  Apparently, Ambac was simply waiting for better evidence of such misrepresentation to emerge during the discovery process.  It now looks like the strategy paid off in spades.

I can’t possibly do justice to this slew of new allegations against Bear, culled mostly from emails and testimony obtained by the bond insurer in discovery, so I will just recommend that you read the Proposed Amended Complaint (long but well worth it) or some of the excellent news articles that came out today.  I am quoted in this article by Jody Shenn at Bloomberg News about Ambac amending its complaint to allege that Bear Stearns was talking out of both sides of its mouth on the same deficient loans.  This is another great story from The Atlantic, which has been following the news of whistleblowers within EMC since May of 2010, discussing some of the colorful emails obtained from Bear Stearns execs, including one from Bear deal manager Nicolas Smith on August 11th, 2006 to Keith Lind, a Managing Director on the trading desk, referring to a particular bond, SACO 2006-8, as “SACK OF SHIT [2006-]8” and saying, “I hope your [sic] making a lot of money off this trade.”

Much more to come on this fascinating new development.  I shouldn’t be surprised anymore by the audacity and utter lack of principles shown by Wall Street execs over the last five years, but somehow, I still am.

Posted in accounting fraud, Ambac, bad faith, Bear Stearns, Complaints, discovery, due diligence firms, emc, JPMorgan, monoline actions, rep and warranty, repurchase, RMBS, securities fraud | 12 Comments

Wells Fargo Sues EMC as Trustees Start Playing Ball with RMBS Investors; Servicers Still Holding Out

Posted on January 21, 2011 by Isaac Gradman

Will we look back at this point in the mortgage crisis fallout as the turning point for RMBS investors?  With the news that Wells Fargo, as securitization trustee, has sued EMC Mortgage in Delaware Chancery Court over loan files, trustee cooperation with bondholders is starting to feel distinctly like a trend, and I can’t help but hear the words to Bob Dylan’s famous folk anthem in my head:

You better start swimming or you’ll sink like a stone/
For the times, they are a-changin’

According to Bloomberg, Wells Fargo is seeking over 2,000 loan files underlying mortgages in Bear Stearns Mortgage Funding Trust 2007-AR2, based on “serious” questions raised by investors in the trust regarding whether EMC, a wholly-owned subsidiary of JP Morgan, complied with its reps and warranties when originating the loans.  Wells Fargo further stated in the Delaware complaint that it had received a letter from attorney David Grais (who was the moving force behind Greenwich v. Countrywide, the FHLB SF case and the FHLB Seattle case) on behalf of an unnamed hedge fund purporting to hold 42% of the bonds in this deal.  In that letter, Grais stated that he had investigated 1,317 loans held by the trust on behalf of his client and found that 938 breached EMC’s reps and warranties–a whopping 71% deficiency rate!

This is the second major battle currently being fought by a RMBS trustee to pursue bondholder interests.  In the District Court of Washington, D.C., Deutsche Bank is suing JP Morgan and the FDIC over loan repurchase responsibilities for mortgages in at least 159 WaMu-sponsored securitizations.   Though a major issue in that case is who should be left holding the bag for WaMu’s bad loans between the FDIC, the conservator of WaMu, and JPM, the purchaser of the failed bank, the issue of loan files is also at the forefront.  Just last week, Deutsche Bank filed a response to the Motions to Dismiss filed by JPM and the FDIC, and the Partial Motion for Summary Judgment filed by JPM, arguing that JPM is in continuing breach of its obligations to turn over loan files to the Trustee upon “reasonable notice.”  Deutsche Bank maintains that it should not be punished for failing to identify specific loans that are subject to repurchase in its Complaint when JPM is withholding that information in violation of its obligations in the relevant Pooling and Servicing Agreements.

So that’s two major trustees who are taking very aggressive approaches towards JP Morgan and its affiliates regarding their refusal to turn over loan files.  Could it be that the trustees are starting to realize that bondholders will eventually mobilize, and they don’t want to be caught in the crosshairs?

For he that gets hurt will be he who has stalled/
There’s a battle outside and it is ragin’/
It’ll soon shake your windows and rattle your walls/
For the times they are a-changin’

This passage could apply to EMC and other servicers who have thrown up road block after road block to investor attempts to get the loan files underlying their investments.  Colorfully, Wells Fargo states in its complaint against EMC that it had repeatedly asked the servicer for these documents, but, “EMC has played proverbial ‘rope a dope’ and otherwise continued to drag its feet, and has produced nothing.”  These loan files are expected to be treasure troves for putback claims, rife with evidence of poor underwriting and defective origination.

But Dylan’s lyrics about the costs of stalling could also apply to the pension funds, insurance companies and other institutional investors who are sitting on their hands while the statute of limitations clock ticks on billions of dollars worth of distressed RMBS in their portfolios.  In fact, these investors may have already blown the chance to raise securities fraud claims as to 2005-vintage MBS, while the window for rep and warranty claims as to the ’05 collateral will slam shut by the end of this year.

Your old road is rapidly agin’/
Please get out of the new one if you can’t lend your hand/
For the times they are a-changin’

Though servicers and trustees are both contractually obligated to act in the interests of the trust and the ultimate bondholders, as the owners of the trust, neither group had responded to repeated bondholder calls for action, let alone gone out of their way to find out how so many poor candidates for mortgage credit slipped through the cracks from 2005 to 2008.  Until recently.  The word on the street is that the same investors who were getting stonewalled by their trustees one year ago are now finding the trustees more receptive to their requests for investigations, loan files, and the initiation of repurchase requests.

This could have something to do with the anticipation building around the Investor Syndicate, which, according to this Bloomberg article, now boasts that it represents 1,325 trusts with at least a 50% ownership stake (and over 3,200 trusts with a 25% ownership stake).  This 50% magic number means that investors could fire and replace trustees and servicers that the bondholders feel have breached their contractual obligations.  The trustees seem to be recognizing that while they were willing to drag their heels at first in the name of industry solidarity, this isn’t their battle, and they don’t want to find themselves on the hook for the errors and omissions of subprime lenders.

Come senators, congressmen, please heed the call/
Don’t stand in the doorway, don’t block up the hall

Which brings us to the servicers like EMC who are still refusing to cooperate with demands for loan files.  Though their contractual obligations require them to act in the interest of bondholders, even at the expense of their own interests, the major servicers are all affiliates of major subprime lenders, and are thus far too interested to let a little thing like a contract stand in their way.  That is, if EMC begins turning over files, it would open the floodgates to putback claims against its parent, JP Morgan Chase.

This is the reason that congressmen like Brad Miller have begun urging federal regulators to use their authority under the Frank-Dodd Act to force large financial institutions to divest their loan servicing arms.  Though this recognition by Washington comes late in the game–and after many failed efforts to induce servicers to modify loans without understanding their conflicts of interest (see, e.g., my series of articles about the Servicer Safe Harbor)–letters like Miller’s are an encouraging sign that even the politicians are beginning to see the writing on the wall.  This battle will eventually be brought to the door of the major subprime lenders, or the Big Four banks foolish enough to have taken on their liabilities, and you don’t want to be caught standing in the way of that tidal wave.  To quote another great Dylan track, for subprime and Alt-A lenders, it’s a hard rain’s a-gonna fall.

Now that trustees appear to be giving in to the momentum building around loan putbacks, a major procedural hurdle that has been hampering prior bondholder efforts will be swept aside.  Now, so long as investors can pull together 25% or more of the Voting Rights in a particular deal, and offer the trustee some credible evidence of shenanigans in the servicing or underwriting of the loans in the trust, they should be able to convince the trustee to act on their behalf, making it significantly easier to get loan files and initiate repurchase requests.  So, while only time will tell, this moment could indeed be the point we look back upon in private label putback efforts and say “that’s when everything changed.”

The order is rapidly fadin’/
And the first one now will later be last/
For the times they are a-changin’

[Lyrics to “The Times They Are A-Changing” courtesy of bobdylan.com.  Copyright © 1963, 1964 by Warner Bros. Inc.; renewed 1991, 1992 by Special Rider Music.  Special thanks to Manal Mehta for passing along news of the Wells Fargo suit against EMC.  The case is Bear Stearns Mortgage Funding Trust 2007-AR2 by Wells Fargo Bank N.A. as Trustee v. EMC Mortgage Corp., CA6132, Delaware Chancery Court (Wilmington). – IMG]
Posted in Bear Stearns, Deutsche Bank, emc, FDIC, Investor Syndicate, loan files, private label MBS, procedural hurdles, putbacks, rep and warranty, repurchase, Trustees, WaMu, Wells Fargo | 3 Comments

Massachusetts Supreme Court Hands Down Ruling in Ibanez, Invalidates Postforeclosure Assignments and Assignments in Blank

Posted on January 8, 2011 by Isaac Gradman
The Massachusetts Supreme Court has issued its highly-anticipated opinion in the case of US Bank National Association v. Ibanez (and the related case of Wells Fargo Bank v. LaRace), bringing with it more bad news for the lending industry.  The unanimous opinion, authored by Justice Ralph Gants (available here and embedded below), upholds the prior decision in Massachusetts Land Court that foreclosure sales conducted as to properties inhabited by borrowers Antonio Ibanez and Mark and Tammy LaRacemakes were invalid because the Trustees attempting to foreclose were not the holders of the mortgages at the time they initiated foreclosure proceedings.

The decision confirms what many legal commentators had feared: that the common industry practice of assigning a mortgage “in blank” – meaning without specifying to whom the mortgage would be assigned until after the fact – does not constitute a proper assignment.  The Supreme Court further held that, without proof of a proper assignment to the party attempting to foreclose prior to the initiation of foreclosure proceedings (and proof that the party from whom the mortgage was assigned was a holder of the mortgage at the time of such assignment), the trustees could not rely on assignments after the fact to cure this deficiency.  The majority opinion was careful to distinguish between proper assignment in advance of foreclosure and proper recording of that assignment, holding that the latter could be effectuated after the fact.  The Court also found that being the holder of the promissory note was not enough to foreclose, if that entity did not also hold the mortgage.

Wells Fargo and US Bank, who are acting as the Trustees for the securitizations purporting to hold the mortgages at issue, each argued that, aside from having been assigned the mortgages via assignments in blank, they had been assigned the mortgages under their respective pooling and servicing agreements.   The Court rejected both arguments.  First, the Court found that, “We have long held that a conveyance of real property, such as a mortgage, that does not name the assignee conveys nothing and is void; we do not regard an assignment of land in blank as giving legal title in land to the bearer of the assignment” (Order p. 11).  The Court went on to find that poolwide assignments of “all right, title and interest” in the mortgages contained in the trust agreements were also ineffective because the trustees did not provide any proof that the loans at issue were included in any schedules attached as exhibits to those agreements.
Further – and this is important for investors considering possible legal action with respect to private label MBS – the Court held that there was no evidence that the Trusts, the entities that purportedly assigned the mortgages to Wells and US Bank, ever held the mortgages to be assigned. This suggests that many mortgages were never properly transferred into the securitizing trusts in the first place, meaning that investors may be holding unsecured debt instruments.  As two of the four biggest Trustees of mortgage backed securitizations, Wells Fargo and US Bank could experience increased liability as a result of this decision, as they had certain obligations to confirm that the mortgages were properly transferred into the trusts and that all relevant paperwork was in order.  Both banks’ stock prices took a hit immediately following the release of the Mass. Order.
Notably, the Court also explicitly rejected the Trustees’ request that the ruling be held to be only prospective in application, and not retroactive (see Order p. 12).  The Court noted that its opinion had not changed settled case law, but was simply enforcing well established legal principles and requirements.  Thus, there was no need to restrict the opinion only to future foreclosure cases.  This opens the door for borrowers who were previously foreclosed-upon on the basis of an assignment-in-blank to come back and challenge the foreclosure as invalid.  Chaotic times, indeed.

Even if foreclosing banks can cobble together the necessary paperwork to prove valid assignment prior to initiating proceedings going forward, the Ibanez decision means that private investors will take an even greater loss on their MBS investments than they have already, as this ruling will certainly lead to longer foreclosure timelines, higher legal costs coming out of securitization trusts, and higher loss severities for delinquent loans.  And the costs will be even higher if banks have lost paperwork or are unable to cure their assignment problems, as many suspect.  Of course, the allocation of this loss could change if bondholders mobilize and take legal action against the arrangers of the securtizations in which they invested.  Indeed, if the debt instruments they purchased were held out to be backed by collateral (i.e. mortgages) that the trusts never really held, investors will have some potent legal arguments that they can return these instruments to Wall Street for a full refund.
[For additional solid analysis of this opinion, check out this article on Felix Salmon’s Reuters blog and the comments at the end from Adam Levitin – IMG.]

Posted in allocation of loss, assignment in blank, bondholder actions, chain of title, foreclosure crisis, investors, massachusetts, mortgage market, securitization, standing, Trustees, US Bank, Wells Fargo | 8 Comments

Streaming Audio of Bloomberg Radio’s Hays Advantage Segment Featuring Isaac Gradman Now Available

Posted on January 4, 2011 by Isaac Gradman

On October 22, 2010, I appeared Bloomberg Radio’s “The Hays Advantage” with Kathleen Hays to discuss issues facing RMBS investors in litigation against originators and underwriters.  A number of readers have asked me if a recording of the interview was available.  Below, please find links to that interview, split up into two segments.  Select “Open With” to hear them in your preferred media player.  Many thanks to Kathleen Hays and producer Kendall Kulper for inviting me onto the show and for providing me with these recordings.

Click here to play streaming audio of Segment 1 of Hays Advantage Bloomberg Radio spot featuring Isaac Gradman.
Click here to play streaming audio of Segment 2 of Hays Advantage Bloomberg Radio spot featuring Isaac Gradman.

Posted in Bloomberg Radio, foreclosure crisis, investors, lawsuits, media coverage, putbacks, rep and warranty, repurchase, RMBS | 1 Comment

MBIA Sampling Order Signals Shorter Path to RMBS Putbacks

Posted on December 30, 2010 by Isaac Gradman

The news gets worse for Bank of America.  Not only will it have to eat massive numbers of Countrywide-originated loans, but the bank may have to complete repurchases sooner than previously thought.  Judge Eileen Bransten’s long-awaited evidentiary ruling in the New York state court makes it clear – MBIA can use statistical sampling to prove its claims against Countrywide/BofA.  The ruling provides the bond insurer–and other insurers and private label investors–with a short cut to proving claims against lenders and originators of defective mortgage loans.

Bransten’s Order has already had an impact in newly-filed litigation over the losses associated with private label residential mortgage backed securities (RMBS).  A $700 million lawsuit filed by Allstate Inusurance Co. against Bank of America this past week refers directly to language from Bransten’s Order (available here and embedded below).

In her 15-page Order, Bransten found that MBIA will “be allowed to use and present evidence for its case through statistical sampling” (p. 15).  This means that MBIA will not have to present evidence of fraud or breach of contract for each of the 300,000-plus loans at issue in its case to a judge or jury; instead, MBIA will be able to evaluate a much smaller but statistically significant sample of loans and extrapolate the findings to the rest of the loans in the challenged securitizations.

In the course of making her ruling and rejecting the vigorous arguments made by Countrywide in opposition to MBIA’s motion, Judge Bransten found that the use of statistical sampling of large populations was not novel, was generally accepted in the scientific community, and was appropriate in the case at bar.  Bransten also explicitly held that her decision, “has the possibility of saving the parties and the court from significant litigation time and may significantly streamline the action without compromising either party from proving its case” (p. 13).

The outcome of MBIA’s evidentiary motion (also known as a motion in limine) was not entirely unexpected based on Judge Bransten’s prior comments.  In a June 16, 2010 hearing (transcript available here), Bransten said,

I think that it makes all the sense in the world that you can use a sample to prove the case because otherwise I can’t imagine a jury listening to 386 thousand cases.  Even if you have that available, nevertheless you are not going to present that to a jury or even a judge.  I’m patient but not that patient.  So, therefore it is going to be a sample in the end…

Yet the fact that an order in this regard has officially been put to paper–and in a closely-watched case such as this one–is already having a major impact in the MBS litigation world.  On Monday, Countrywide and Bank of America were sued by Allstate Insurance Co. and its affiliates over $700 million of RMBS purchased by the insurer (complaint available here).  In that suit, Allstate proposed to use samples of 1600 loans (800 defaulted loans and 800 randomly-sampled loans) from each of 14 securitizations (there are 61 securitizations at issue) to prove its claims.  In support of this methodology, Allstate asserted that,

Allstate‘s sample sizes of Mortgage Loans are more than sufficient to provide statistically-significant data to demonstrate the degree of misrepresentation of the Mortgage Loan characteristics. Analyzing data for each Mortgage Loan in each Offering would have been cost-prohibitive and unnecessary. Statistical sampling is an accepted method of establishing reliable conclusions about broader data sets, and is routinely used by courts, government agencies, and private business. As the sample size increases, the reliability of its estimations of the total population increase as well. Experts in RMBS cases have found that a sample size of just 400 loans can provide statistically significant data, regardless the size of the actual loan pool, because it is unlikely that so large a sample would yield results vastly different from results for the entire population. (Allstate Complaint, p. 38)

Filed by Quinn Emanuel, the same law firm representing MBIA and other monolines, the Allstate Complaint is novel for its assertion of a “matching strategy” by Countrywide–that is, that Countrywide was willing to approve any mortgage feature offered by its competitors, resulting in Countrywide “mixing and matching the worst features of mortgage products from different competitors,” and creating a product that was “very aggressive within the industry” (Allstate Complaint, p. 2).  Such a strategy required Countrywide to systematically abandon its guidelines and resort to the widespread use of unsupported exceptions, according to the Complaint.

As the Allstate Complaint shows, Bransten’s decision in the MBIA case has already dealt a blow to banks trying to defend themselves against mortgage putback liability, as it significantly reduces the prospective litigation costs, as well as the projected timeline, for investors seeking to compel originators to buy back defective loans with the help of the courts.  However, the decision is particularly harmful for BofA’s financial outlook and the credibility of its executives.  In addition to shorting the path to court-mandated repurchases by the bank, which has the most potential putback liability of any of its peers based on its acquisitions of Countrywide and Merrill Lynch, the decision undermines several statements made by BofA’s CEO, Brian Moynihan, regarding his strategy for the battle over rep and warranty liability.  For example, during BofA’s 2010 Q3 earnings call, Moynihan stated that, “This really gets down to a loan-by-loan determination and we have, we believe, the resources to deploy against that kind of a review… we will go in and fight this.  It’s worked to our benefit to–we have thousands of people willing to stand and look at every one of these loans.”

Moynihan has also stated that BofA would approach this type of litigation like “hand-to-hand combat,” disputing individual putbacks and dragging out litigation as long as possible to allow the bank’s earnings to offset these contingent liabilities.  Bransten’s Order presents a significant roadblock to the execution of that strategy.  Now, instead of going loan-by-loan, MBIA will be able to use a surprisingly small sample–less than 1.6% of the total loan population in dispute–to prove incidences of breach or fraud in the entire pool.

In its motion in limine, MBIA proposed using a statistical sampling methodology that included sampling 400 loans from each of the 15 securitizations at issue; stratifying the samples into mutually exclusive subgroups based on the characteristics of the borrower’s credit score, combined loan to value ratio (CLTV) and Countrywide’s documentation program; and then dividing each of these subgroups into further subgroups to ensu
re that important loan characteristics were adequately represented in the samples.  The monoline also proposed using delinquency status to stratify the samples used to prove its servicing contract and implied covenant claims.  MBIA asserted that this methodology would provide a confidence level of approximately 95% with a 5% margin of error.  Though Bransten ruled that MBIA could use this methodology to present evidence at trial, she stopped short of rejecting Countrywide’s arguments that this methodology was flawed and subject to challenge, arguments that she conceded “are not without merit” (p. 11). Instead, she ruled that those challenges were “premature,” and that “Defendant’s cited issues will be decided by the trier of fact as pertaining to the weight, rather than the acceptability, of the evidence” (p. 12).

Bransten’s commentary signals that MBIA may not be out of the woods yet in proving its case against Countrywide.  As an initial matter, the sample size seems exceedingly small compared to the overall loan population.  Due diligence firms like Clayton, who were often hired by investment banks to perform due diligence checks on loan pools before the bank would buy them, often took a 10-20% sample to ensure adequacy.  As recounted above, Allstate has chosen a sample size of 1600 loans–four times the sample size chosen by MBIA. With the cost of hiring a third party firm to review a loan file averaging around $300-350, meaning that it would cost MBIA over $5 million more to review a sample of 1,600 loans across its 15 securitizations, it’s easy to see why MBIA is trying to keep its sample size small.  Still, while I’m no statistician, it seems like cutting corners in this way could open MBIA’s data up to a number of technical challenges.

Furthermore, it’s not at all clear how the representative sample would be applied to the overall loan population, even if it was established to be representative by the trier of fact.  The contractual remedy for proving that Countrywide breached a rep and warranty with respect to a loan is the repurchase of that particular loan.  How would that remedy be applied to the overall loan population if MBIA’s sample showed, for example, that 60% of loans breached at least one rep and warranty?  In other words, which loans would Countrywide be forced to repurchase, and how would the court ensure that size and the loss severity of those loans lined up with those found to be defective in the sample?

Still, this decision is a definitive win for MBIA and all RMBS investors hoping to recoup some portion of their losses.  Now that MBIA has received the loan files underlying the securities at issue, it’s only a matter of time before it will be able to find significant percentages of loans with (often multiple) material deficiencies.  By enabling the insurer to project findings on such a small sample to the rest of the pool, this decision provides MBIA with a monumental shortcut to establishing Countrywide’s repurchase liability.  Only time will tell if this changes BofA’s strategy of hand-to-hand combat and brings the bank to the negotiating table, or simply provides the bank with one more issue on which to put up a fight.

[Thank you, as always, to Manal Mehta for sharing his perspective and real time updates on this case – IMG]
Bransten Sampling Order (MBIA v. Countrywide) http://d1.scribdassets.com/ScribdViewer.swf?document_id=46008294&access_key=key-2bvsg4dsfur86xdm5ujv&page=1&viewMode=list

Posted in Allstate, BofA, bondholder actions, Countrywide, due diligence firms, investors, litigation costs, MBIA, monoline actions, quinn emanuel, rep and warranty, repurchase, RMBS, statistical sampling | 5 Comments