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

Recording Of Compass Point Mortgage Repurchase Call Available

Posted on August 31, 2010 by Isaac Gradman

We had a great turnout for the Compass Point call today on mortgage repurchase liability and I thought the questions and remarks of the various participants were interesting and informative.  For those of you who missed the call, you can access a recording by downloading the .wav file at http://audio3.confpro.com and use reference #2528811.  You can also dial 888.284.7564 and use reference #252811 to hear a replay of the call.

Thanks to Jason Stewart, Mike Turner and Chris Gamaitoni for putting this call together, having me on as the featured guest, and raising awareness about this important issue.  As more investors and media outlets become aware of the significant outstanding mortgage repurchase liability facing many of the largest banks, we can expect to see more of the owners of mortgage backed securities coming forward to enforce their rights and banks beginning to acknowledge this potential liability in their loss reserves.  All this points to an increase in mortgage buy back litigation on the horizon, and an eventual transfer of wealth from the banks that originated and securitized massive numbers of defective loans to the pension funds, mutual funds, and other ordinary investors who bought an interest in those loans in reliance on the banks’ representations regarding underwriting quality.


Keep an eye out for an article later this week on how many of the banks’ former friends in Washington have finally woken up to this issue, and changed their tunes, accordingly…

Posted in Compass Point, irresponsible lending, liabilities, litigation, public perceptions, rep and warranty, repurchase, reserve reporting | 3 Comments