Midwinter Conference Sparks Lively Discourse, Focuses on Servicing Deficiencies

Posted on February 16, 2011 by Isaac Gradman

I just returned from my first Midwinter Housing Finance Conference in Park City, Utah.  Though the conference, organized by Brian Hershkowitz, has been an annual favorite of snow-loving housing professionals for decades, it tends to receive far less publicity than the American Securitization Forum (ASF), which takes place around the same time every year.  That will hopefully begin to change, as I found this year’s conference to be engaging and, ultimately, newsworthy, thanks to a keynote speech by Fed Reserve Board Gov. Sarah Raskin that placed the servicing industry directly in the cross hairs.

In fact, while a wide range of topics was discussed during the conference’s three days of presentations and panels, servicing deficiencies dominated the conversation.  Most conference participants agreed that the default servicing model was broken, and continued to be major drag on the recovery of the housing market.  There was also a consensus that servicer conflicts of interest and misaligned incentives played a large role in these deficiencies–stymieing loan modification programs and contributing to the latent foreclosure (aka “fraudclosure”) crisis.  However, it seemed that each participant had a different idea about what it would take to fix this important industry. 

This diversity of opinion can be attributed in part to the complexity of the issues, but also to the diversity of the conference participants themselves–something that I found to be one of the strengths of this conference.  The professionals in attendance were not limited to one segment of the housing industry, but included investors, regulators, bankers, academics, financiers, consultants and members of the press.  Indeed, the number of different opinions about the problems with the servicing industry seemed to outnumber even the participants.

I presented on a panel that served as a microcosm of this blend of viewpoints.  The session was called “Investor Putbacks, MERS & the Capital Markets,” and included a presentation on MERS by Christopher Peterson, a law professor at the University of Utah; a presentation on Trends in Investor RMBS Litigation by me, a blogger and litigation consultant; and a presentation on what investors are looking for these days by Neil Powers, a fixed income investor at Vectors Research Mgmt.  Though the topics and viewpoints differed, they combined nicely in my opinion to paint a multilayer picture of the current MBS landscape.  The lively Q&A that followed only enriched that perspective.  

Of course, another topic that arose frequently during conference sessions was the future of the GSEs, especially with the White House’s release on Friday of a white paper suggesting the gradual winding down of Freddie and Fannie.  Cal Professor Dwight M. Jaffee gave an reassuring presentation on why he believes a privatized US mortgage market will work–a refreshing viewpoint for those of us who believe in the future of private mortgage finance.  This was followed, appropriately enough, by a presentation by Fannie Mae’s Doug Duncan called “Economics and Mortgage Market Analysis,” in which he noted that while housing fundamentals were improving, homeownership rates will likely trend downward due to weakness in demand.

But the most surprising moment in the conference came with Fed Gov. Raskin’s speech, the full text of which is available here.  Striking a decidedly more direct tone than her Fed counterparts, Raskin noted that “widespread weaknesses exist in the servicing industry… [T]hese deficiencies pose significant risk to mortgage servicing and foreclosure processes, impair the functioning of mortgage markets, and diminish overall accountability to homeowners.”  She also called out the servicers that are affiliates of the larger banks, saying:

For those in the housing and mortgage fields, making needed changes will not be easy. In particular, for those in the mortgage servicing industry, it means difficult changes and significant investments to rectify broken systems. For those servicers who are subsidiaries or affiliates of a broader parent financial institution, the responsibility for change and further investment absolutely extends up to that parent company, many of which have enjoyed substantial profits while their servicing arms have been run on the cheap.

While Raskin’s speech was short on aggressive proposals to fix these problems, such as legislating a divestment of servicing arms by the major banks to avoid conflicts of interest, she can be commended for attacking head-on the current problems with default servicing and suggesting a variety of alternative business models that might ease some of the problems with this industry.  And though the Midwinter Conference participants could have had a lively debate about the merits of these various models, I think almost all of us could agree with Raskin’s statement that, “Until these operational problems are addressed once and for all, the foreclosure crisis will continue and the housing sector will languish.”

As I checked out of the St. Regis in Park City and headed home, I was left to marinate on these words and the fact that while responsible servicing might not have prevented the Mortgage Crisis, it certainly would have made the cleanup a whole lot easier.  Here’s hoping that the many intelligent folks I met at Midwinter and throughout this industry can reach a consensus on building a better servicing model going forward.

Posted in ASF, conflicts of interest, Fannie Mae, Freddie Mac, incentives, investors, litigation, Midwinter Conference, Presentations, Winding Down GSES | 1 Comment

Commentators Concur: Trustee Involvement Signals Shift in RMBS Litigation

Posted on February 2, 2011 by Isaac Gradman


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.

Posted in allocation of loss, bondholder actions, chain of title, emc, investors, loan files, servicers, TIAA-CREF, Trustees, Wells Fargo | 3 Comments

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