October 14, 2010
Several new-media have quoted an early story on our October 12th note which suggested we saw risks that origination flaws would allow investors to challenge securitizations on $1.3 trillion of mortgages. This is incorrect. The story read: “potential paperwork errors on some of the $1.34 trillion of securitized home mortgages may give investors an opening to challenge the legality of deals, threatening to unnerve financial markets”.
Based on the large scale operational failures in foreclosure processing and the number of foreclosures in which borrowers have been able to challenge a mortgage trusts ability to foreclose, it appears that some trustees are at risk of large scale failures to properly assign the notes to the trust.
Before anyone can offer a reasonable estimate of the number of mortgages or trusts at risk, there needs to be a broad assessment of operational controls that oversaw the moving of pools of mortgages from originators to trusts for the benefit of MBS investors. We believe that the assignment of notes in “blank” name, which was a standard practice, materially increased the risks of shoddy assignments.
We are not suggesting a Lehman style crisis will necessarily occur. We are suggesting
that if the investigation of front-end documentation practices uncovers assignment
failures in any scale resembling the back-end foreclosure processing failures, the scale of uncertainty could create a market response reminiscent of that Lehman period.
It is our belief that, given the black box nature of the process and the former white-hot origination market, some trustees may not have properly transferred notes to the trusts. If not properly transferred, the “true sale” of mortgages to the trusts that issued mortgagebacked securities would be in question. If this proves to have occurred we believe the Trustee, may have liability.
To understand the increased risks posed from “blank” assignments, it is worth
understanding the arcane process by which mortgages are transferred from a
securitization sponsor to the trust. As we stated in our comment of October 12th:
“Nearly all Pooling and Servicing Agreements require that “On the Closing Date, the Purchaser will assign to the Trustee pursuant to the Pooling and Servicing Agreement all of its right, title and interest in and to the Mortgage Loans and its rights under this Agreement (to the extent set forth in Section 15), and the Trustee shall succeed to such right, title and interest in and to the Mortgage Loans and the Purchaser’s rights under this Agreement (to the extent set forth in Section 15)”. Also, an Assignment of Mortgage must accompany each note and this almost never happens. We believe nearly every single loan transferred was transferred to the Trust in “blank” name.
“In blank name” is a concern to us because of the increased risks of documentation failure that it brings. When a note is assigned “in blank name” it apparently becomes a “bearer instrument”. As a result the requirements of transfer become significantly more cumbersome and at risk of failure. Because “blank name” makes this a bearer instrument, a receipt of delivery and acceptance from the originator to the sponsor, a receipt of delivery and acceptance from the sponsor to the depositor, and a receipt of delivery and acceptance from the depositor to the trustee are all required. Moreover, the custodian must have all of these documents and the original notes before the loan is considered to be owned by the trust. It is the responsibility of the trustee to make sure that all documentation has been properly delivered to the custodian and, it is our belief and understanding, that is would be the trustees that would be on the hook for failing in that capacity.
There have been a large numbers of foreclosure proceedings where, because of improper assignments, the trust has been unable to demonstrate the right to foreclose. It is thus that we raised concern about the transfer “in blank name”. We do believe it likely the rush to move large volumes of loans may well have resulted in operational failures in the “true sale” process by some selling firms and trustees. Were this “missing assignment” problem, which we are witnessing in individual foreclosure proceedings, to be found to have resulted from widespread failure of issuers and trusts to properly transfer rights there would be appear to be a strong legal basis for the calling into question securitizations. As example, consider an investor who bought an MBS security in 2007 and sold that MBS at a loss in the market meltdown of 2008. As a result of the information coming out during the “foreclosure moratoria”, the investor might now witness the trusts inability to
foreclose on a defaulted borrower because it is found not to have properly perfected their mortgage note claim. Substantively, the original investor who bought and took a loss on a “mortgage backed” security would have taken a loss on a “mortgage backed” that did not properly own the mortgages it claimed to be backed by. It is reasonable to believe that this investor would consider suit against the trustee to recoup losses.
Unfortunately, the rising uncertainty is only increased by the current reality that real
estate, trust and many of the related tax issues are currently addressed as state rather than federal issues. Other than offering to act as referee, short of a politically charged battle that may result from asserting interstate commerce authorities, there appears no current opportunity for the federal government to create a uniform solution.
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