Countrywide Complaint Against A.I.G. Subsidiary United Guaranty Now Available

Posted on March 24, 2009 by Isaac Gradman

Earlier this week, I posted the complaint filed by A.I.G. subsidiary United Guaranty Mortgage Indemnity Co. (UG) in federal court in Los Angeles. The Subprime Shakeout has now obtained the complaint that started this battle of mortgage industry titans, filed by Countrywide on March 18, 2009 in Los Angeles County Superior Court.

The complaint, also embedded below, alleges that UG refused to pay claims by Countrywide on losses covered under the terms of its insurance policies. Countrywide seeks declaratory relief, compensatory damages based on breach of contract and punitive damages breach of the implied covenant of good faith and fair dealing.

A few observations about this dispute:

  • Removal: The first major battle in this case will likely be over the removability ofCountrywide’s state court action. As UG has brought a related action in federal court in Los Angeles (based on diversity jurisdiction), it will likely remove Countrywide’s action to federal court and attempt to consolidate the actions. Countrywide, apparently anticipating this move, has named Countrywide Servicing LP as a plaintiff and alleged that the entity is a North Carolina citizen, making it non-diverse from UG (also a North Carolina entity). While Countrywide Servicing is organized under the laws of Texas and has its principal place of business there, Countrywide argues that Countrywide Servicing is a citizen of North Carolina because the General Partner and Limited Partner of Countrywide Servicing (neither of which, incidentally, are organized under the laws of North Carolina) “are citizens of North Carolina, as their sole owner/member is Bank of America,” which has its main office in North Carolina. This is one of the most convoluted attempts to destroy complete diversity that I’ve seen, and it seems unlikely that Countrywide will succeed in having the case remanded to state court.
  • Loss Causation: Countrywide, like UG, confronts the loss causation issue head-on, arguing that it’s been conducting its lending operations in the same manner that it has for years, and that UG is only complaining now that the housing market has collapsed and the country is in a “deep economic recession” (see pages 24-25). Though Countrywide maintains that “[t]he increase of defaults is not limited to loans originated by Countrywide, but is a phenomenon occurring nationwide and has impacted all mortgage lenders” (page 25(emphasis added)), it is unclear whether the absolute default rates on the pools of Countrywide loans at issue here are greater than comparable pools. Countrywide maintains that they are (at pages 26-27), but such numbers can be manipulated depending on the pools chosen as “comparable.” UG would be wise to further develop its allegations and supporting evidence in this regard if it hopes to refute Countrywide’s contention that the market, not Countrywide, caused UG’s losses.
  • Sophistication: Another interesting dichotomy set up by these two complaints is the sophistication of UG in insuring subprime mortgage loans. While UG argued in its complaint that “[p]rior to 2006, United Guaranty had very limited experience insuring subprime mortgage loans,” (see UG Complaint, page 14) Countrywide argues that UG, “is a sophisticated market actor in this area” (see Countrywide Complaint, page 17). Countrywide goes to great lengths to show that UG understood the risks it was undertaking, quoting such diverse sources as the Mortgage Insurance Companies of America (page 18), an article by Robert Stowe in which a UG executive is quoted (page 19), and an AIG Mortgage Industry Presentation (page 20). Ultimately, however, this dispute will boil down to whether Countrywide followed its stated guidelines or not. If it did not, it will be difficult to argue that UG assumed the risk.
  • AIG’s Financial Condition: As support for its claims of bad faith and unjustified denial of coverage under the policies, Countrywide includes allegations about AIG’s and UG’s “deteriorating financial condition” (page 29) and contends that UG is unlikely to receive any financial support from its parent, AIG. Countrywide thus argues that it, “has justifiable cause to believe that United Guaranty’s recent decision to stop the payment of otherwise covered claims may be related to its financial condition and the financial condition of AIG and its affiliates, rather than to the merits of whether particular claims should be paid” (page 31). Countrywide further alleges that the only justification provided thus far by UG for its refusal to pay coverage is that “it has already paid too much” (page 28). While this line of argument may provide effective coloring or “atmospherics” underlying the suit for a judge or jury, UG has likely provided sufficient justification in its complaint for its refusal, in the form of its allegations regarding Countrywide’s deficient underwriting, to overcome Countrywide’s bad faith argument. However, the specter of bad faith must be cause for some concern at UG, especially if the claim mak
    es it past the summary judgment stage. Given UG’s tenuous financial position and its unorthodox approach of wholesale refusal to pay claims on any loans contained in the subject securitizations, regardless of individual loan characteristics, it is conceivable that a judge or jury could conclude that UG unreasonably denied coverage for the purpose of using the money elsewhere. And a punitive damages award against one of its subsidiaries is just about the last thing AIG needs in this political and financial climate.

Countrywide v. UG Complaint

http://d.scribd.com/ScribdViewer.swf?document_id=13618313&access_key=key-1bics03k17wsz6tt5itr&page=1&version=1&viewMode=

Posted in AIG, bad faith, causes of the crisis, Complaints, Countrywide, lawsuits, lenders, lending guidelines, loss causation, mortgage insurers, removability, sophistication, subprime, underwriting practices | Leave a comment

A.I.G. (United Guaranty) v. Countrywide Complaint Now Available

Posted on March 24, 2009 by Isaac Gradman

The complaint filed in federal court in Los Angeles by United Guaranty Mortgage Indemnity Co., the mortgage insurer subsidiary of A.I.G., against Countrywide Financial Corp., Countrywide Home Loans, Inc. and the Bank of New York Trust Company is posted below. As discussed previously, United Guaranty (UG) seeks rescission of mortgage insurance coverage and $30 million in damages from Countrywide as a result of its alleged fraudulent acts, misrepresentation, and negligence in inducing UG to insure over $1 billion in subprime mortgage loans.

Having now had a chance to take a closer look at the Complaint, I note several items of interest regarding the approach taken by United Guaranty (UG) attorneys Quinn Emanuel:

  • At page 3, UG alleges that Countrywide’s own loan files often note that “the sole justification for granting an underwriting exception was to increase its market share by matching a competitor’s offer.” If true, this is compelling evidence that Countrywide (and likely many other lenders) completely and explicitly abandoned underwriting standards in their efforts to pump out greater and greater volumes of subprime residential mortgage loans.
  • As expected, UG attempts to confront the loss causation issue (also discussed previously here) head-on, by arguing that its losses were caused, not by the economic downturn itself, but by Countrywide’s underwriting failures. Interestingly, however, UG attempts to depict Countrywide’s failures as a major cause of the larger economic downturn, arguing that:

“it has become clear that the prolifieration of high risk mortgages combined
with inadequate and fraudulent underwriting processes is largely responsible for
the historically high rate of default in the mortgage industry…Countrywide’s
combination of high risk loan products and fraudulent or willfully blind
underwriting created a perfect storm that has lead to massive defaults in the
Mortgage Loans…” (pages 3-4)

  • UG also identifies a practice allegedly pursued by Countrywide of “keep the best and sell the rest,” (pages 4, 28) meaning that Countrywide would keep the good loans on its books, and securitize or sell the worst loans to investors. I have heard that this policy was actually driven by market demand for riskier (and thus higher return-generating) bonds, but I’d be interested if anyone has any insight into whether and why this may have been done.
  • UG recounts, in detail, the various lawsuits against Countrywide filed by the Attorneys General of eleven states. UG notes that the complaints contain numerous allegations of fraud or reckless lending similar to its own findings, and that Countrywide agreed to settle the suits for an estimated cost of $8.6 billion in loan modifications within four months of the filing of the first suit (pages 5, 23-27). Yet, while UG notes that Bank of America acknowledged when it acquired Countrywide that “[t]he cost of restructuring these loans is within the range of losses we estimated when we acquired Countrywide” (page 27), the complaint make no mention of the fact that Countrywide will not actually bear the costs of these modifications because it no longer owns most of the loans. I can understand why UG is attempting to frame the settlement as an acknowledgment of wrongdoing, but it would seem even more powerful to be able to argue that Countrywide (and BofA) has thus far largely escaped the consequences of its irresponsible lending.

UG v Countrywide Complainthttp://d.scribd.com/ScribdViewer.swf?document_id=13589125&access_key=key-21c1cwvo9gvy7ilzxah8&page=1&version=1&viewMode=

Posted in AIG, allocation of loss, BofA, causes of the crisis, Complaints, Countrywide, lawsuits, litigation, loan modifications, loss causation, misrespresentation, mortgage fraud, United Guaranty | Leave a comment

A.I.G. and Countrywide Go Head-to-Head Over Mortgage Insurance Coverage

Posted on March 23, 2009 by Isaac Gradman

The battle of the titans has begun. As reported by Reuters on Friday, both A.I.G. and Countrywide have now sued one another over who will bear the losses on a $1 billion pool of subprime mortgage loans.

Countrywide fired the opening salvo on Wednesday when it sued A.I.G.’s United Guaranty Mortgage Indemnity Co. in Los Angeles County Court, alleging that the insurer was refusing to honor its mortgage insurance obligations. One day later, United Guaranty responded by suing Countrywide in federal court in Los Angeles, alleging that Countrywide had misrepresented the risks tied to the pool of mortgage loans and had failed to follow its own underwriting guidelines.
Based on the arguments asserted by both sides in their complaints, this clash of mortgage giants features two familiar but wildly disparate perspectives on the causes of this crisis. On one hand, Countrywide argues that United Guaranty profited for years from the premiums it received to insure loans against borrower default, but now that it is “fac[ing] the reality of steep financial losses because of a significant economic downturn,” United Guaranty is trying to escape its obligations.

On the other hand, United Guaranty argues that Countrywide took advantage of its long-standing relationship with the insurer to induce United Guaranty to insure loans that never should have been approved. According to another article in Bloomberg, United Guaranty’s review of loan files from 11 separate policies for asset-backed securities revealed that most either violated Countrywide’s own underwriting standards or had material defects such as misrepresented credit scores or fake social security numbers.

United Guaranty will likely have a mountain of salacious evidence on its side to demonstrate Countrywide’s improper and irresponsible lending, as other lawsuits against the former lending giant have revealed a shocking abandonment of underwriting standards and practices. Yet, United Guaranty will have several hurdles to overcome. First, according to its Complaint, United Guaranty has already paid out over $30 million in insurance claims on these loans. This is sure to raise arguments of waiver or estoppel by Countrywide and questions of whether the insurer should have known about the quality of loans when it placed insurance coverage or, at the very least, when it paid claims. Second, United Guaranty will have to counter Countrywide’s argument that these losses were caused by the broader economic downturn, and show that they were caused, in fact, by Countrywide’s abusive and irresponsible lending practices. United Guaranty might be able to do this by demonstrating that this pool of mortgage loans is significantly worse than comparable pools and/or by showing that Countrywide’s underwriting deficiencies directly caused the loans to fail. The latter approach will likely prove much tougher than the former, as we have already seen litigants struggle to make out the loss causation claim in prior mortgage crisis litigation.
Regardless, this heavyweight legal matchup will be closely watched by the industry and is certain to have a significant impact on future lawsuits stemming from the broader financial crisis.
Posted in AIG, allocation of loss, causes of the crisis, Countrywide, lawsuits, lenders, litigation, loss causation, misrespresentation, mortgage insurers, underwriting practices, United Guaranty | 1 Comment

Senate to Consider Bill That Threatens to Obliterate Mortgage Bondholders’ Contract Rights

Posted on March 16, 2009 by Isaac Gradman

On March 5, 2009, the U.S. House of Representatives passed H.R. 1106, also known as the “Helping Families Save Their Homes Act of 2009,” which threatens to override the contract rights of bondholders who invested in mortgage-backed securities (MBS). A version of the bill has been referred to the Senate Committee on Banking, Housing and Urban Affairs, but the Senate has not yet voted on the legislation. You can follow the progress of this bill here at govtrack.us or here at thomas.loc.gov.

In its current form, H.R. 1106 contains several provisions that would undermine investors’ contract rights and could result in a significant shifting of economic losses to bondholders. First, the bill will allow judicial modification of primary residential mortgages in borrowers’ bankruptcy proceedings (also known as “bankruptcy cramdowns”). This means that judges can now forgive principal on the debtor’s primary residential mortgage, just as they already could for other types of debt. This change in the bankruptcy codes, part of President Obama’s economic plan, has been anticipated for some time, especially since banks began relaxing their opposition to this idea (see prior posting regarding Citigroup here).

However, the troubling aspect of H.R. 1106 for investors is Section 124, which renders unenforceable, as against public policy, any provisions of investment contracts between servicers and securitization vehicles that require excess bankruptcy losses over a certain dollar amount to be borne by all classes of certificates on a pro rata basis. What that means is that instead of having bankruptcy losses hit every bond in the capital structure proportionately, the losses from bankruptcy cramdowns will now “trickle up” from the most junior bonds before hitting senior bonds (the traditional way losses are treated).
Yet, such pro-rata loss provisions in securitization contracts were put in place specifically to attract investors for the junior classes of securities and assuage their concerns that they would be disproportionately exposed to excess bankruptcy losses. Currently, many of the senior classes of bonds in these securitizations are held by major lending institutions who fear that downgrades will put significant pressure on the amount of capital they’re required to hold by law. The practical impact of Section 124 is thus to shift the the loss burden from banks to bondholders. I’ll discuss the constitutionality concerns raised by such a shift in a later posting, but query whether, from a purely equitable standpoint, the risk that borrowers would not be able to make their mortgage payments should be born by banks that often underwrote and issued these loans, or by the outside investors who specifically contracted against bearing that risk.
The second provision raising equitable concerns is the so-called “Servicer Safe Harbor.” This provision will have a direct impact on who will bear the losses for loan modifications, another important issue for the financial well-being of banks, and one that has been discussed at length in prior postings on this blog. Again, many contracts governing securitizations contained provisions mandating that servicers bear the costs of any loans they modify, such as by lowering a borrower’s interest rate, extending the duration of the loan, or reducing the borrower’s principal balance. This is the precise issue being litigated in a suit by Greenwich Financial Services against Countrywide (see prior postings here).
The Servicer Safe Harbor provision of H.R. 1106 threatens to cause a sea change in the loan modification landscape. Pursuant to this provision, servicers will not be obligated to repurchase loans or make payments to the securitization vehicle because of loan modifications or other loss mitigation plans, so long as the loans subject to modification are in default or default is reasonable foreseeable (which is the case for most loans eligible for modification). As if this shift in liability wasn’t dramatic enough, the bill also provides cash incentives ($1000 per loan) for servicers to modify loans, in an attempt to help defray origination costs. Keep in mind that these will apply more often than not to the same servicers who originated the loans and were often grossly negligent in underwriting the loans to determine if the borrower actually had the ability to repay. Not only would this bill let such servicers off the hook for their irresponsible lending practices (see, e.g., prior postings here and here on Countrywide passing off the costs of its settlement with Attorneys General), but servicers will now get handouts from the Government for correcting their mistakes! With the current political climate so supportive of “Helping Families Save Their Homes” and easing the rates of foreclosure, it seems that the goal of allocating losses fairly to the parties who contributed most to this mess has been utterly forgotten.
Check back soon for an analysis of the potential constitutional challenges to H.R. 1106 if, as expected, the bill is passed by the Senate in the coming weeks…
Posted in allocation of loss, bankruptcy, bankruptcy cramdown, Countrywide, Greenwich Financial Services, Helping Families Save Homes, legislation, litigation, loan modifications, Servicer Safe Harbor | 1 Comment

Protesters Converge on Front Lawn of Greenwich CEO’s Home

Posted on February 14, 2009 by Isaac Gradman

In another unexpected twist in the fight over the cost of loan modifications, the Stamford Times and the Greenwich Time have reported that protesters converged outside the home of Greenwich Financial Services CEO William Frey on February 8 to protest Frey’s lawsuit against Countrywide and Bank of America. The protest, part of three-day homeowners’ workshop sponsored by the Neighborhood Assistance Corporation of America (NACA), involved anywhere from 350 to 400 people wearing bright yellow hats and T-shirts with pictures of sharks and the words “Stop Loan Sharks” emblazoned on the front (see picture at right).

In one of the most bizarre facets of this story, the protesters, according to the Stamford Times article, placed furniture on Frey’s front lawn to “symbolize the dislocation felt by people who have had their homes foreclosed upon and been evicted, their belongings tossed outside by state marshals.” The article went on to describe how, according to NACA CEO Bruce Marks, this protest was part of an aggressive and confrontational “Predators Tour” aimed at several top executives of companies that refuse to allow NACA to renegotiate the terms of the loans on behalf of its members. According to the Greenwich Time article, the nonprofit’s accountability campaign targets company executives who they believe contributed to the subprime mortgage crisis to encourage them to support the refinancing of these loans.

While I can understand the anger felt by many homeowners at the greed displayed by banking executives such as Merrill Lynch CEO John Thain and others who profited handsomely during the housing bubble, it seems to me that NACA’s protests aimed at Frey are entirely misguided. For those familiar with Greenwich Financial’s lawsuit against Countrywide (discussed in prior postings here), it should be clear that while Frey is intervening in Countrywide’s settlement with dozens of Attorneys General, it’s not because he opposes loan modifications in principle. Instead, Frey seeks to have the costs of these modifications borne by the party primarily responsible for issuing deceptive or unreasonable loans.

The Attorneys General brought charges of predatory and unreasonable lending practices against Countrywide that the company clearly felt were substantial enough to settle for upwards of $8 billion. However, recent evidence has emerged that these costs are not actually coming out of Countrywide’s pockets, but instead being passed down to the ultimate bondholders, who did not directly engage in predatory lending.

Of course, it’s true that investors exhibited a voracious appetite for subprime mortgage-backed securities during the boom, but most of the pooling and servicing agreements for such bonds contained exhaustive representations and warranties by the lenders that the loans were not originated in a predatory or unprincipled manner. For Frey to attempt to hold Countrywide to its representations and force the company to bear the costs of its practices seems perfectly reasonable, even if fundamentally self-interested.

Most would agree that loan modification and foreclosure avoidance will be integral to any comprehensive financial stimulus. But, in the rush to secure loan modifications, it appears that the consequences and costs were not carefully thought through, resulting in the liability being fixed on parties other than those primarily responsible for these problems. Instead, shouldn’t NACA and other homeowner advocacy groups be focusing their anger and political pressure on lenders who ignored any semblance of quality control measures or reasonable lending practices to push greater and greater volumes of loans through the door? What about protesting outside the homes of the Attorneys General who boasted of achieving comprehensive homeowner relief while letting those responsible almost entirely off the hook? It seems these parties are much more deserving of finding couches and armchairs strewn across their front lawns than is William Frey.

Even more radical, it seems, is the idea that instead of pointing fingers at large companies for their problems, troubled homeowners should start by taking a good hard look in the mirror and deciding whether they were being realistic when they took out such hefty loans. If they were being honest, many would have to admit that they expected to be able to refinance into perpetuity to afford mortgage payments beyond their means. While there was certainly a significant volume of predatory lending occurring during the last ten years, I believe, as I’ve discussed in the past, that we all have to hold ourselves accountable to some degree for the borrow-and-spend culture that led to this inevitable credit crunch.

Posted in Attorneys General, causes of the crisis, costs of the crisis, Countrywide, Greenwich Financial Services, John Thain, loan modifications, NACA, pooling agreements, responsibility, William Frey | 3 Comments