Most readers were not happy when I didn’t buy into the mainstream presentation of a the widespread news reports that a letter sent on behalf of a group of investors constituting approximately $16.5 billion (per the Wall Street Journal) of $47 billion (presumably face amount) of bonds was a Really Big Deal in terms of the damage it might do to Bank of America.
Let’s start with the obvious. I’m no fan of Countrywide, in fact I was a early to criticize Bank of America’s staged purchase. I think mods are a great thing, and anything to promote mods is a plus. There is plenty of evidence that servicers behave badly, so the idea that Countrywide has behaved in ways that would make people eager to sue them is entirely credible. So you would think I’d like this case.
While the letter that the investors sent to Countrywide is laying the groundwork for litigation, any litigation is going to be more of an uphill battle and less lucrative than the breathless reports would lead you to believe. Part of this overreaction is in keeping with the excitement over similar putback litigation by the monolines, who despite their better grounds for lawsuits, is similarly overhyped. But the presence of famous names, particularly that of the New York Fed, has led this case-in-the-making to be treated as more damaging than it is likely to be.
And with misreporting to boot, no wonder Mr. Market got excited. This is from The Street.com:
The news follows reports earlier Tuesday that institutional investors are pressuring Bank of America to repurchase $47 billion worth of mortgage-backed securities.
No, sports fans, the investors group is not seeking a repurchase, but a putback of bad loans, and that is a subset of the total value of the deal. Again, recall that the investor press release reports that they hold 25% of voting interest; the Wall Street Journal puts their holdings at $16.5 billion (which we are assuming is face amount) of the total.
The underlying beef, in simple form, is that Countrywide has not done right by the investors as a servicer and and really ought to have put a lot of loans back to the originator, which in this case happens to be Countywide, but almost certainly a different legal entity (we have Countrywide as Master Servicer, identified in the documents as Countrywide Home Loans Servicing LP ;note that the Bank of New York is also a recipient of the letter but per its own assessment it not presently a target). Here is the juicy part of the letter:
1. Section 2.03(c) of the PSAs states that “Upon discovery by any of the parties hereto of a breach of a representation or warranty with respect to a Mortgage Loan made pursuant to Section 2.03(a) … that materially and adversely affects the interests of the Certificateholders in that Mortgage Loan, the party discovering such breach shall give prompt notice thereof to the other parties.” The Master Servicer has failed to give notice to the other parties in the following respects:
a. Although it regularly modifies loans, and in the process of doing so has discovered that specific loans violated the required representations and warranties at the time the Seller sold them to the Trusts, the Master Servicer has not notified the other parties of this breach;
b. Although it has been specifically notified by MBIA, Ambac, FGIC, Assured Guaranty, and other mortgage and mono-line insurers of specific loans that violated the required representations and warranties, the Master Servicer has not notified any other parties of these breaches of representations and warranties;
c. Although aware of loans that specifically violate the required Seller representations and warranties, the Master Servicer has failed to enforce the Sellers’ repurchase obligations, as is required by Section 2.03; and,
d. Although there are tens of thousands of loans in the RMBS pools that secure the Certificates, the Trustee has advised the Holders that the Master Servicer has never notified it of the discovery of even one mortgage that violated applicable representations and warranties at the time it was purchased by the Trusts.
The real significance of this move is political. It is a new front in the battle between investors and banks. However, this measure isn’t as radical as it sounds; Freddie and Fannie have been putting back certain types of bad mortgages to major banks for some time, which has led to an ongoing drain to major bank earnings. But Freddie and Fannie deals provide for relatively straightforward putback provisions. The process here is procedurally far more difficult, and establishing damages is also more cumbersome and costly. That means the odds of success and the level of any payout are likely to be lower than most assume. Note that a secondary objective is for Countrywide to accelerate its handling of delinquent loans. From the first report on this story, by Jody Shenn of Bloomberg:
If Countrywide doesn’t correct the servicing problems within a few months, her clients could have the right to pursue legal action against Bank of America, Bank of New York or both, she said. “None of the bondholders are opposed to modifications for deserving borrowers, but you’ve got to get it done” in a timely fashion, she added.
Let’s look at the major issues:
This is not going to play out quickly. The group has sent a “Notice of Non-Performance,” which is intended to start a 60 day period for Countrywide to remedy the alleged breaches. Countrywide is likely to adopt a posture of foot-dragging, for instance, by saying they need more time to conduct their review. And after that period is done, Countrywide is likely to reply that it found no (or perhaps very few) material breaches that would justify investor action. So this has to go at least a round, perhaps longer, before any litigation will be filed to declare Countrywide in default of its servicing obligations.
Any lawsuit has to pass procedural hurdles. The Bloomberg article mentioned that the investors may lack standing to sue and that is not a non-issue. The problem is that unlike Fannie and Freddie, the investors have to get to Countrywide-as-originator through Countrywide-as-servicer. Now that language from the letter seemed really strong, right? Surely there is a problem here……but wait! Consider this discussion from Subprime Shakeout:
Nevertheless, these efforts may well fail for an additional reason that was cited as a basis for Bank of New York’s refusal to comply with Patrick’s earlier request – the failure to provide evidence of a specific breach. Though Patrick’s letter is reported to identify several provisions of the relevant PSAs that it alleges were violated, it’s unclear what, if any, specific evidence Patrick has provided that would induce the trustee to act. A Bank of New York spokesman has already indicated that the trustee will not act in response to this letter, stating, “[The letter] appears to be directed to Countrywide and does not ask BNY Mellon to take any action. We will continue to perform our duties as trustee.”
Yves here. That comment was written without having had the benefit of reviewing the actual text of the letter. The problem in suing is a bit circular: you need to be able to argue specifically what sort of breaches occured, but the investors lack access to the loan information to enable them to refer to specific breaches in a lawsuit. Or to put it in a bit more legalistically, unless the pooling and servicing agreement gives the certificateholders some rights to access to the loan files, you are likely to have an impediment: you may not be able to allege specific enough breaches to get to perform discovery.
The finesse appears to be that the investors are trying to piggyback on the actions of various monolines who are also suing Countrywide and argue that because they are suing for breaches, Countrywide failed in its duties to inform them (note the monoline contracts with the originators give them much easier access to the loan level information. But the problem is these monoline claims are mere allegations; Countrywide is disputing them. Even if it had an obligation to notify the certificate holders, it seems hard to believe it would extend to having to provide the loan information, which is what the investors really need.
Rep and warranty suits tend not to produce big settlements. Even if the investor group can get access to the loan files, it has to argue its breaches on a loan by loan basis. It needs to prove that the loan defaulted not for normal credit loss reasons, such as death, disability, job loss, but due to failure to adhere to the representations and warranties made. (see ScribD for an illustrative set of reps and warranties, pages 3-6). This is brutal for both sides to pursue, so the two sides tend to settle rather than get very far with pursuing the case. And Bank of America has indicated it is well aware of this issue and will fight hard:
“It’s loan by loan, and we have the resources to deploy in that kind of review,” said Brian T. Moynihan, Bank of America’s chief executive, on a conference call to discuss the bank’s results for the third quarter.
This gives Bank of America more than a bit of a home court advantage. It can deploy comparatively cheap bank employees to do this analysis; the investors will have to use more costly experts and law firm resources.
Although the sample of my sources is limited, their experience with rep and warrranty cases is that the plaintiff only recovers 10-20% of the amount of credit losses. Now these loans were really drecky; we might assume 25%, and Bank of America has been reserving 1/3 against other rep and warranty cases (but their language says this is all over the map, so the reserves may also vary a lot by deal. It’s also possible that BofA reserves generously for this sort of litigation). But let’s do some math, and readers are invited to chip in.
Normally, you can sue only based on actual losses, not expected losses. On subprime deals, these are only running at 10% thus far (the 28%+ loss estimates for all subprime RMBS are total expected losses, only a portion of which have been realized). I’d wonder if the reason Bank of America’s reserves are so high is that there are such firm forecasts of future subprime losses that they are also reserving for a portion of expected losses. So let’s do some rough math; you can use your own assumptions for damage percentages.
The key bit is subrime losses are only 10% of original par amount. Principal paydowns are about 50% on these deals. Of the remaining 40%, the expected losses are about 40-45%.
So if you take the $16.5 billion the investors own x 10% (losses) x 33% (losses due to rep and warranty breach) = $545 million
If you assume they get a lesser percentage on expected losses, say 15% (I’ll be generous and assume 20%), then the math is:
$16.5 billion x 40% (remaining value) x (45%) expected losses x 20% (amount deemed due to rep and warranty breaches) = $594 million.
So the two together take you to just over $1 billion.
The one factor that could make these numbers much larger is if the bond amounts reported in the media are market value, not face value, then I would need to apply much higher percentages to get the right loss and expected loss amounts.
But as you can see, the multi-billion claim looks to be a stretch. Given that the attorney made a big procedural misstep on her first effort, I would not take her estimates of recoveries as seriously as I might otherwise.
Update 2:00 PM: Received this from a source who knows the bond insurer litigation (and is no fan of banks, this is not an industry friendly source):
The bond insurers currently have access to the mortgage loan data and they have not been able to prove widespread fraud (or even widespread breaches), so I am skeptical that there is really a goldmine here for investors. What he is describing is a fishing expedition. There may have been a case or two of a loan reported to be 70% LTV but it really was 100% and that would be material, but I am fairly confident that isn’t widespread.
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It’s good to agree with you on some things. Yes, this is not as big as it appears. But more important why the hell aren’t the banks trying to do more mods? The economics of a mod can’t be worse than a full foreclosure although I suppose the timing of revaluing the asset might be different.
Maybe it’s just too much work to figure out what price the house goes for in a foreclosure auction and then modify the loan. Or maybe the incidence of the borrower re-defaulting is too high.
I’d even make a moral case for more mods…I guess there’s just so many to deal with.
Mods are good for everyone except the people who could make the mods, the servicer. Not only does the servicer get nice fees for foreclosing, and nothing to mod, it needs to foreclose in order to recover its principal and interest advances (which it makes when the borrower becomes delinquent).
Now, THAT is a reason to go after the servicer if you’re a bond holder. The bond holder obviously wants the best recovery not to pay lawyers and servicers
That’s a reason to go after the servicer if you’re a senior bondholder,or a CDS writer on CDOs, if the advances were made to the junior bondholders.
I’m not clear why it’s still servicer industry practice to advance on the defaulted pieces, given the spike in defaults. It seems that the declining foreclosure values would throw the increased fees/recoveries incentive calculation out of whack.
Are the srs trying this move to claw back (through put backs) the money sent to the juniors via the advances?
I think it would help to understand the Fed’s (Maiden Lane) motivation in joining this action to figure out the overall objective. I’m not sure what that is, but the Fed at a min needs to realize Maiden Lanes 08 mkt value to be made whole.
Please excuse my ignorance, as I am way out of my league here… But doesn’t the existence of the CDS sort of remove the rational to do mods or principal reductions or anything that might help the home owner? Why not foreclose, if it causes the MBS to go south more quickly? OR, if you cannot be counter-party to a CDS for a loan that you own, why not make agreement to buy someone else’s “s**ty deal” and and take out a CDS against it? They can take one out against yours. The amount of a CDS is not relative to the instrument again which it is written, no? Seems to me like there’s a lot of opportunity to be had by the servicers not doing much in the way of service.
If it is meant to bring peanuts, WHY are they doing it ???
Don’t ask me why no one looked at the economics of this sort of litigation. In M&A I saw people do stupid deals and pay too much all the time. I learned early on that big name does not necessarily equal good decision process.
The other way litigation can extract more than it ought to is if the discovery process can unearth really embarrassing material. I don’t see that here, but I could be missing something.
Yves, that lawyer’s blog you linked for the procedural screw up also states that failure to allege an actual instance of breach of duty could undermine the litigation.
In the absence of an allegation of an actual instance, discovery becomes a fishing expedition, which the courts don’t allow. So even that could fail to produce.
Correct, I mentioned in the post (perhaps not clearly enough) that they may not be able to prove a breach, that is, get to the loan files. I neglected to use the word discovery, I’ll go back and add that to make the point clear.
Evidence: I did read this morning that once the put-back plaintiffs represent 25% of the total bond amount, they have contractual access to the underlying loans/mortgage information, and then use that access to provide the court-required specific evidence of breaches.
So this won’t be difficult as post-PSLRA securities actions or lawsuits touching on Nat’l Security (i.e. “I’m suing for, among other things, discovery because I need to get more information to prove my claims.” “Well, since you don’t have the evidence you can’t start the suit to get the evidence.”)
Where did you see that? You need access to the loan files. The PSAs might allow for that, but this is across 115 transactions. Admittedly Countrywide probably had similar language across all of them, but it depends on the language of the PSA. If it isn’t clearly provided for, this may be a problem, it is something the plaintiffs have to surmount. Both the attorney linked to, who knows this type of litigation, and the one I consulted with, who is also following this type of litigation, thought it could be a hurdle. If it’s an informed source, that’s one matter, but unless the PSAs stipulate the right, the procedural question mentioned by Subprime Shakeout applies.
@Yves: “But I’ve also heard that the 25% number is crucial on this front, too. If you own 25% of a securitized issue, I’m told, you can force the custodian to hand over the underlying, individual loan documents — exactly the same documents that Clayton and other due diligence companies examined before the bonds were issued. At that point, it becomes a lot easier to find specific breaches and to make BofA’s life a legal nightmare.”
http://blogs.reuters.com/felix-salmon/2010/10/20/bofas-legal-predicament/
take it with a grain of salt. I recently commented on Felix’s blog that he would be well-served by reviewing his legal analysis with securities litigators – his broad brush strokes and forecasting of ‘common sense’ legal conclusions are probably way off the mark, as anyone who’s dealt with complex litigation knows.
Bank of New York (the trustee, what counts is the trustee, the custodian is a subcontractor to the trustee) said very clearly in one of the news accounts that it thinks it does not have to do anything. They are not playing ball.
Big Picure has this transcript from a court hearing on discovery and sampling accounts to gather evidence by statistical criteria:
http://www.ritholtz.com/blog/2010/10/bofa-comparison-conference-call-vs-court-transcripts/
I loves it. Court room packed with sharp lawyers, yet the record is full of non sequiturs and people interrupting and trailing-off like Chief Wiggum.
The task is so daunting that lawyers on both sides want to adjourn so they can end up in a group hug!
Yves,
1. Why do you think the institutions that hold the remaining 75% won’t join in?
2. Why do you think that this is face and not market value?
3. Why did the NY Fed join?
BoA will be nationalized
3. Maiden Lane
I am just curious who is behind the NY Fed action? Goldman and JPM I bet. Anyone know?
http://www.nytimes.com/2009/05/19/business/19blackrock.html?_r=1
“But it is the company’s highly prized role as a government adviser and contractor that is now drawing attention.
By dint of its expertise and track record, it has won contracts to help the government manage the complex rescues of Bear Stearns, the American International Group and Citigroup.
It also won a bid to carry out a Federal Reserve program to stimulate the moribund housing market, and it has been hired to help evaluate Fannie Mae and Freddie Mac, the government-created mortgage finance giants.”
Didn’t Blackrock bid for Ally Financial’s residential mortgage arm Rescap?
I’m less interested in this particular case and more interested if there will be further ramifications to the future MBS market.
I have a hard time believing investors will flock to the MBS market and be as passive with the trusts as they were last time. Then again, it does seem that big money is big stupid, so who knows?
who in their right mind would buy an MBS originated by X and then securitized and then pooled into a trust by Y, and do so for a yield only fractionally higher than a Treasury?
can everybody really go back to “business as usual”?
Of course they aren’t in their right minds, Yearn. Did you doubt that?
If you want to do some “rough math” that will express the real outcome and “home court advantage” of this mess you have to factor in the money being paid to the shills that make the scam ‘rule of law’ …
Excerpts …
“Big bailout recipients contribute to New York pols, Republican Senate aspirants
By Paul Blumenthal on 09/10/10 @ 11:54 am
They received billions in help from the federal government to stay afloat during the worst days of the financial crisis and they’ve–mostly–paid it all back since. Now the top six biggest recipients of money from the Troubled Asset Relief Program–the Treasury Department program adopted in 2008 to shore up troubled banks–are contributing to the campaigns of congressional office seekers across the political spectrum.
Of the top fifteen recipients of campaign contributions from employees and political action committees of Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo, five are running for office in New York state, Wall Street’s home base, and five are Republican candidates seeking election to the Senate. This is based on data collected from the Center for Responsive Politics.”
More here …
http://blog.sunlightfoundation.com/2010/09/10/big-bailout-recipients-contribute-to-new-york-pols-republican-senate-aspirants/
Welcome to the superpac days …
Deception is the strongest political force on the planet.
How interesting is this?
Bank of America Accused of Racketeering in Foreclosure Lawsuit in Indiana bloomberg
By Andrew M. Harris – Oct 20, 2010 12:01 AM ET
Bank of America Corp. and its Countrywide Home Loans unit were accused of racketeering in a lawsuit filed by two Indiana residents claiming that perjured affidavits were used to foreclose on their home.
Dwayne Ransom Davis and Melisa Davis filed the complaint yesterday in federal court in Indianapolis. Their lawyer, Irwin Levin, confirmed the filing in a phone interview. The filing couldn’t be independently verified.
“The defendants and their cohorts engaged in a pattern of racketeering activity in which they routinely and repeatedly prepared perjured affidavits in order to rapidly churn foreclosures,” the couple said in the complaint.
“To my knowledge, we have not seen this suit and cannot comment on it,” Simon said of the Davis case in a later phone interview yesterday.
The Davises accuse the lenders of using “robo-signers,” people who sign affidavits attesting to facts underlying foreclosures without actual knowledge of those facts, to push through paperwork to take their home in Knightstown, Indiana.
While the borrowers aren’t asking the court to reverse their foreclosure, they’re seeking compensatory damages tripled under federal racketeering laws, as well as class action, or group, status to sue on behalf of anyone whose home was allegedly taken since October 2006 under similar circumstances.
Levin said the group might include hundreds of thousands of people.
Missing link
Bank of America Accused of Racketeering in Foreclosure Lawsuit in Indiana bloomberg
I see the put back letter as a necessary step to bring litgation. It’s a stronger step than I’ll sue, it’s the first step in bringing suit.
Now what does the threat of put back do with respect to the outstanding tranches that are held by the threatening parties? It tends to support the price of the oustanding and effected tranches. That strikes me as being the objective of the exercise.
Does that mean that those tranches are now a bargain, hardly so. Even with putbacks those tranches will still contain a substantial quantity of unrealized losses. Moreover, as correctly noted by Yves, the actual recovery will be a very modest number, most of which will go to attorney’s fees.
Do not be amazed to learn that the threatening parties are quietly selling the dreck that enervates their current action.
That’s a fair point, there are degrees of seriousness between “suit v. no suit yet” and I probably could have calibrated this better in the post However, the plaintiffs probably have not yet drafted a claim, and as I indicated, Countrywide may find ways to drag the supposed 60 day phase out.
Hi Yves,
You make many valid points indeed, but I think the bottom line is that “SOMEONE” (whether it is the MBS or the big bank originator/securitizer/servicer) is going to sustain massive losses from the inability to foreclose on any properties due to lack of proper document retention, as well as the reversal of prior foreclosures that should not have occurred.
From Bloomberg:
The initiative covered by the letter sent to Bank of America and BNY Mellon yesterday is separate from the effort coordinated through Dallas lawyer Talcott Franklin, Patrick said. That firm is coordinating action for a larger group of mortgage-bond investors holding more than $500 billion of the debt.
Participants in that so-called RMBS Investor Clearing House include BlackRock, Pimco, Fortress Investment Group LLC, Fannie Mae and Federal Home Loan Banks, people familiar with the matter said last month. MetLife isn’t part of that group, Calagna said.
Membership in the clearing house has risen to 110 from 65, during the last two weeks, said Bill Frey, head of Greenwich, Connecticut-based securities firm Greenwich Financial Services LLC.
http://www.bloomberg.com/news/2010-10-20/new-york-fed-adds-weight-to-mortgage-bond-investors-seeking-loan-relief.html
From NY Times:
“Any hedge fund with a distressed desk is contemplating this trade,” said one analyst who insisted on anonymity. “The idea of bottom-fishing vulture funds buying this stuff up for a nickel on the dollar so they can sue the banks to get 100 cents must be pretty odious for the Treasury, which bailed out the banks in the first place.”
Indeed, the group that includes the Fed is one of two coalitions that is gearing up for a fight with the banks.
Bill Frey, chief executive of Greenwich Financial Services, leads a group of investors that holds just under $600 billion worth of mortgage-backed securities.
But it is the recent controversy over foreclosures that has jump-started interest by pension funds, hedge funds and other players. “In the last two weeks, there has been a flood of new investors,” Mr. Frey said. “We haven’t even had a chance to do the arithmetic, that’s how fast they’re coming in.”
http://www.nytimes.com/2010/10/20/business/20bond.html?_r=2&ref=business
“SOMEONE” … is going to sustain massive losses …”
One guess who that “SOMEONE”
Yves,
Some fine work as always. A few comments though.
Isn’t the 50 some billion the UPB already? It seems strange for bondholders to sue and state the original principal balance.
The current losses don’t really factor into the math because the current bondholders are most likely not the ones who took the losses in the first place. Actually, this detail makes me think that some of these big players just figure if they can get their hands on loan docs they can prove widespread fraud. Example: a pool is quoted in offering docs to be 50% stated income the number is actually 90% when you go back to original loan documents. Or instead of income verification you go after asset verification. Or CLTV. Seconds had been horrendously documented and I am sure that during origination a lot of piggybacks were not properly disclosed to investors. Part of this is because it is hard to keep track of investors that apply for a bunch of loans at once and partly because they didn’t really care if they missed something.
I think, as many do, that there was a bunch of fraud perpetrated by originators during the boom. Some of these problems are VERY simliar to what we have seen in other parts of the mortgage process and hinge upon getting their grubby mits on some loan information that hopefully the politicos can hand over to them so they can take out their pound of flesh. Once that happens Home Court Advantage disappears and while under normal circumstances a flaw in origination would require a lot of legwork to get a putback at this point, if you were sold a alt-a fulldoc 70 CLTV that was really a subprime NINJA 110 CLTV AT THE TIME OF ORIGINATION in las vegas that is currently in the holding pattern for foreclosure (and perhaps the huge fcl pipeline helps these economics rather than hurt) you should have a pretty good case for getting some money back.
Oh, and PIMCO and Blackrock have some of the best mortgage teams in the market. They ARE the experts people would hire to get opinions about things like this and thats why investors are lining up behind them. I think Moynihan quote is simply posturing. He really has no idea what a thorough analyst would find going through the drecks of countrywide origination.
I ran your comment by an industry expert who is also an attorney. His reply:
The bond insurers currently have access to the mortgage loan data and they have not been able to prove widespread fraud (or even widespread breaches), so I am skeptical that there is really a goldmine here for investors. What he is describing is a fishing expedition. There may have been a case or two of a loan reported to be 70% ltv but it really was 100% and that would be material, but I am fairly confident that isn’t widespread.
I think you are correct on the face amount description.
Also – all of the bond insurer cases have been on second lien loans, fyi.
His argument is a bunch of maybes and what ifs – that may not be enough to prevail in court against a motion to dismiss, and even if it does, the track record for proving there was widespread fraud is poor.
Finally, I’d be happy to go head to head with any of the rocket scientists at black rock or pimco – i know an number of them and I’m not intimidated.
On the other hand, the fact that the monolines didn’t find evidence of underwriting fraud doesn’t really give me a warm feeling. I’m not sure of the relationship there, but wouldn’t that be like suing yourself, or at least like Jacoby suing Meyers?
Also, I listened to some monoline quarterly report webcasts during the boom and the CEOs had the same kool-aid fevered pitch about the tremendous growth they were achieving that seemed to afflict banks, rating agencies GSEs, etc…
I did see Elliot Spitzer interviewed lately and he said if he were State Attorney General, he would start handing out subpoenas. That’s one way to get evidence. I don’t like the argument that “you can’t sue me without evidence, and I get to keep all the evidence secret, and by the way, if you want to know if these bonds are any good, we have a rating agency blessing on them”. Right now, our belief in “transparency” is rather tenuous, and we need better answers than that.
No, the monolines are broke, and the only reason they have not been put in receivership is that they are claiming they will get big recoveries on these suits. I haven’t independently verified it, but my understanding is they’ve booked pretty big expected recoveries as assets on their balance sheets.
So they most assuredly want to collect on this one. Remember, they never should have had to look at the loan files. The seller represented that they were getting goods of a certain type, say ground beef. They are basically saying what they got wasn’t USDA standard ground beef, a lot of hide and hooves were ground up with the meat. Misrepresentations here makes the monolines look good, it says their implosion wasn’t entirely their fault.
Yves, why did the investment banks fail to record the notes with the MBS trusts if there is nothing to hide?
Yves,
Thank you for your reply.
What is normally provided to the monolines as a representation of loan information are what is known as a tape. Instead of actual copies of individual loan files they have a data file that has a loan number, fico, ltv etc. The tape also will state type of income verification and asset verification. The monolines did not have (at origination at least) any truly detailed information like origination documents for their loans. This is due to privacy laws and because it would have been impossible to do this at for the significant volume that was thrown through the sausage factory. There is an imbalance of information between all parties (maybe not the GSEs) and the originators. As an aside I once spoke to a colleague about a MBS transaction in AUS where credit analysis done for a CRA required a committee to review each individual’s documentation for each securitization a deal took could take half a year to close. It sounded laughable and quaint.
To determine if asset/income verification was done properly you need to examine more than the data the monolines were given (and much much much more than the investors were given). Perhaps there really isn’t anything underneath the carpet but generally well informed investors must think it is worth finding out.
As described in numerous investor conference calls, at the time they were considering insuring the deal, the bond insurers reviewed and analyzed the collateral tapes, just like the rating agencies did. Potential bond holders often did not have such information.
At the time of potential litigation, under the express terms of the insurance agreements, the bond insurers could request access to the loan files and could perform extra diligence and determine if the claims they were paying were legitimate. It appears that all of the bond insurers took advantage of this provision and hired independent diligence firms to review the loan files to see if there were any breaches of reps. Then they went through an extended period of back and forth with the sellers over terms and potential put backs. Eventually, they brought their claims.
Ambac and MBIA have discussed their diligence results on numerous earnings calls and cited them as the grounds for their case. This isn’t any sort of special inside information.
Bank of America will be nationalized its Countrywide foreclosures added to the GSE pile and sold off in large chucks to various investor groups in time. The bondholders are trying to position themselves for maximum recovery since this will be both a political and financial event.
RealtyTrac has an interactive map that displays area’s by zip code, street, neighborhood etc that shows the current and future direction of foreclosure in that area. For those thinking of buying property it is an excellent way to judge what will be occurring as the shadow inventory comes to market in those neighborhoods and provides an excellent view
into the financial health of these areas.
I can only speak for Calif and its clear that vast tracts of suburban housing will be marked down and its basic infrastructure of shopping Malls along with it. The numbers of houses are in the millions and beyond our governments ability to manage in any traditional manner such as mortgage MODS or even one off foreclosure sales.
Great blog all around. I thought I would make a technical point on behalf of law dorks. You wrote:
“Or to put it in a bit more legalistically, you’d need the sort of information you can only obtain in discovery to allege specific enough breaches to get past a motion of summary judgment (which is the normal impediment you need to surmount to do discovery).”
I think you meant a motion to dismiss or demurrer, not a motion for summary judgment. MSJ’s are ordinarily filed after lots of discovery has taken place and the (discovered) facts show there are no disputes about material facts.
Also, regarding the fishing expedition aspect of your post, although almost always a subject of dispute, document and written discovery is commonly permitted to proceed during the motion to dismiss phase. This is especially true where, as appears to be the case here, all of the facts are under the control of the defendant(s). Of course, plaintiffs would have enough facts to elevate their claim above the speculative to convince the judge that some discovery should proceed.
Whoops, never should write about fine points of procedure when I’ve been up all night! I watered down that section of the post, thanks!
Yves , you says the following:
Would you mind explaining the second example and where that 40% comes from as I would have thought that if there was fault the entire pool is part of the equation and not the amount that’s gone.
See the earlier discussion. 50% of these deals have already paid out in principal repayments.
The 40% is remaining value ex losses, so 100% – (10% + 50%). That is times 45%.
Put it another way, realized + expected losses needs to be in the 28% or slightly higher range. This way, you have 10% + (40% x 45%), which gets you to 28%.
Can someone please comment on the statements made “But Freddie and Fannie deals provide for relatively straightforward putback provisions. The process here is procedurally far more difficult, and establishing damages is also more cumbersome and costly.” I have not closely reviewed the repurchase provision in the GSE arrangements but have in the insurance wrapper agreements. MBIA and Ambac have made statements in both public calls and court filings that the violations / repurchase obligations are consistent and similar to the obligations triggered and honored from the GSEs. According to the monolines, the banks have honored the GSE repurchase requests because of their governmental status (subpoena power) and ongoing business relationship and not because of meaningful differences in the contractual arrangements
please enough of the troofer nonsense. They are primary dealers that the Fed uses to transact bond aunctions.
What you are saying is not inconsistent with where I am coming out, but you are conflating two issues, disclosure and putback rights.
The monolines’ agreements give them ready access to the loan files. Apparently this is true for the GSEs too, per your comments.
My understanding is the GSEs have very clear putback rights (as in they don’t need to sue, I’m not familiar with the fine points, I’ve followed private label deal issues, not GSE paper). So procedurally, I’d assume the onus would be on the banks to sue to block a GSE putback where the GSE had followed whatever procedures were stipulated.
Contrary-wise, the monolines still have to sue to do putbacks.
It further appears likely that this investor group BOTH lacks ready access to the loan files (as in they will have to fight to get to them) AND will have to go through further hoops to do any putbacks (or get compensated).
Who are the primary dealers for the repo market? Don’t they work with the NY Fed?
http://www.bloomberg.com/news/2010-10-20/new-york-fed-adds-weight-to-mortgage-bond-investors-seeking-loan-relief.html
http://www.reuters.com/article/idUSN1060610220090710
Primary credit?
http://www.ny.frb.org/newsevents/news/research/2009/rp090903.html
http://www.newyorkfed.org/markets/pridealers_current.html
Are these guys trying to corner the market on bank liquidity?
See: I yearn to learn.
Interesting how Geithner advanced from NYFed president to US Treasury Secretary. One would think there’s a revolving door between the two entities: NYFed and IMF, er US Treasury.
Not only is standing a huge issue, but class certification is very problematic. The defense will argue that each underlying putback should be reviewed individually on its own and that it is not a class action. This could well be true since each loan needs to be looked at individually to determine the FICO score and individual misrepresentation.
Also major problem with choice of law in which state. Can’t use same foreclosure law uniformily thoughout the United States since the laws are different in each state.
Certainly venue will be a key factor. It will be Federal Court but where is not yet known.
If case gets beyond standing, class issues and choice of law issue the case will drag on for years through the appelate courts.
Of interesting note is the firm that is representing the plaintiffs is a Houston firm with little mortgage experience. Not your typical NY Blue Blood firm, that may understand the huge procedurals hurdles.
Richfam says:
October 20, 2010 at 6:50 am
“Yes, this is not as big as it appears. But more important why the hell aren’t the banks trying to do more mods?”
Once again, it’s a combo of the huge number of mods and dealing with clunky, legacy IT systems. Sorry but Yves’ explanation on this point (foreclosures are lucrative)is off.
That isn’t the view of a source who has visited over 100 servicers. He thinks the incentives to recoup the P&I advances are a meaningful factor.
I suggest you Google NACA. There is a process to streamline matters for banks. They’d be enthusiasts if they really wanted to do mods. It takes a lot of the analytical/paperwork burden off them.
Well, er, even the longest of journeys starts with but a single step.
And I’m not sure this was a misstep. There’s an awful lot of confident legal analysis in these comments that appears based on an understanding of the situation derived from a couple of media reports and not much more.
My question–which tends to supports the headline of the original post–is: Was this a first step, or is it just part of the general milling around while everybody gets organized and before it’s time for ‘Wagon’s, Ho!’.
I suggest you look at Fred’s comment of 12:32. He thinks the hurdles are serious too.
First, there are very few attorneys who are up to speed on this litigation. The attorney who is behind this action blew her first salvo and is NOT one of the small group of attorneys known to be any good at structured finance litigation. This is a very new field, and on top of that, very few people are willing to sue banks. Subprime Shakeout knows the terrain; the attorney I spoke to is also knowledgeable and is very familiar with the monoline litigation, which is operating on similar theories.
Second, the math is the math. I indicated where the calculations might be off, the big point of risk is my assumption on face value versus market value.
You base claims on actual losses, you might push in settlement negotiations and have some modest success with actual losses, but that applies only in a settlement negotiation. You need to prove on a loan by loan basis who defaulted why, as to whether it was a rep and warranties breach or a normal credit loss. How are you going to prove that on prospective defaults?
Yves,
If you look at the putback letter alone– or even the dispute between the bond holders and BAC as a whole– you’re correct. This no big deal.
But if you look at the putback letter within the broader context of what is happening out there with the foreclosure mess, for the first time we have major players accusing a TBTF bank of being a deadbeat. Until now, only homeowners who failed to pay their mortgages were deadbeats. The putback letter fundamentally changes the political dynamic by legitimizing a lot of the complaints and concerns of people who have been marginalized. The magnitude of the vector may not seem like much, but its direction is the opposite of what it had been.
I agree, the politics of this look more significant than the dollar amounts at issue. BUT this suit is bizarre. There are far better legal theories the investors could have used to pursue the banks.
Plus I didn’t add another issue, because I haven’t reverified it. Remember, when BofA bought Countrywide, it set out to have it be bankruptcy remote. This was pretty contentious, Chris Whalen was very unhappy because IIRC BofA stripped the deposits out.
Now if BofA succeeded, how much will this bunch be able to collect even if they succeed? A lot of claims are being filed against Countrywide, and its servicing arm is now losing money. So even if they prevail, do they have recourse against BofA?
Yves Smith says:
October 20, 2010 at 1:33 pm
“That isn’t the view of a source who has visited over 100 servicers. He thinks the incentives to recoup the P&I advances are a meaningful factor.
I suggest you Google NACA. There is a process to streamline matters for banks. They’d be enthusiasts if they really wanted to do mods. It takes a lot of the analytical/paperwork burden off them.”
NACA? Perhaps the banks should join hands with ACORN too? You’re a bright woman but your friend is misinformed. Please explain how the banks would integrate their systems with Lynx? What would the trust level be? Also, NACA serves “urban and rural areas”…how many suburban mortgages are delinquent/in default?
Did you actually read how NACA handles mods? You appear not to have read at all. They have a streamlined process for doing mods, they’ve had sessions with all major servicers in California and Florida for borrowers all over the US.
And what exactly does ACORN have to do with? NACA is legit, all the major banks have participated. You’ve just announced bias.
http://www.nakedcapitalism.com/2010/08/why-are-nacas-innovative-mortgage-modification-marathons-below-the-radar.html
Nope, no evidence of widespread fraud (or even widespread breaches) here, yet C-Wide/BoA shelled out $108 million to settle the largest FTC mortgage servicing case ever. Nothing to see here, now move along folks.
Countrywide Will Pay $108 Million for Overcharging Struggling Homeowners;
Loan Servicer Inflated Fees, Mishandled Loans of Borrowers in Bankruptcy
FTC – 6/07/2010
http://www.ftc.gov:80/opa/2010/06/countrywide.shtm
Did I ever say there were no problems? I’m saying this case is unlikely to be as lucrative as the MSM is saying. Two different statements.
Don’t put words in my mouth.
Interesting take on the process bit and link:
http://livinglies.wordpress.com/2010/10/19/why-the-paperwork-appears-sloppy/
“The game was to move money under a scheme of deceit and fraud. First sell the bonds and collect the money into a pool. Second take your fees, third take what’s left and get it committed into “loans” (which were in actuality securities) sold to homeowners under the same false pretenses as the bonds were sold to investors. By controlling the flow of funds and documentation, the middlemen were able to sell, pledge and otherwise trade off the flow of receivables several times over — a necessary complexity not only for the profit it generated, but to make it far more difficult for anyone to track the footprints in the sand.
If the loans had actually been securitized, the issue would not arise. They were not securitized. This was a mass illusion or hallucination induced by Wall Street spiking the punch bowl. The gap (second tier yield spread premium) created between the amount of money funded by investors and the amount of money actually deployed into “loans” was so large that it could not be justified as fees. It was profit on sale from the aggregator to the “trust” (special purpose vehicle). It was undisclosed, deceitful and fraudulent.
Thus the “credit enhancement” scenario with tranches, credit default swaps and insurance had to be created so that it appeared that the gap was covered. But that could only work if the parties to those contracts claimed to have the loans. And since multiple parties were making the same claim in these side contracts and guarantees, counter-party agreements etc. the actual documents could not be allowed to appear nor even be created unless and until it was the end of the road in an evidential hearing in court. They used when necessary “copies” that were in fact fabricated (counterfeited) as needed to suit the occasion. You end up with lawyers arriving in court with the “original” note signed in blue (for the desired effect on the Judge) when it was signed in black — but the lawyer didn’t know that. The actual original is either destroyed (see Katherine Porter’s 2007 study) or “lost.” In this case “lost” doesn’t mean really lost. It means that if they really must come up with something they will call an original they will do so.
So the reason why the paperwork is all out of order is that there was no paperwork. There only entries on databases and spreadsheets. The loans were not in actuality assigned to any one particular trust or any one particular bond or any one particular individual or group of investors. They were “allocated” as receivables multiple times to multiple parties usually to an extent in excess of the nominal receivable itself. This is why the servicers keep paying on loans that are being declared in default. The essential component of every loan that was never revealed to either the lenders (investors) nor the borrowers (homeowner/investors) was the addition of co-obligors and terms that neither the investor nor the borrower knew anything about. The “insurance” and other enhancements were actually cover for the intermediaries who had no money at risk in the loans, but for the potential liability for defrauding the lenders and borrowers.
The result, as anyone can plainly see, is that the typical Ponzi outcome — heads I win, tails you lose. With that, Wall Street was allowed to suck trillions out of an economy that could not afford it. That $5 trillion surplus left when Clinton was in office was just too darn tempting for Wall Street. They just had to have it. And they got it. So the paperwork was carefully created and crafted to cover the tracks of theft. Most of the securitization paperwork remains buried such that it takes search services to reach any of them. The documents that were needed to record title and encumbrances was finessed so that they could keep their options open when someone made demand for actual proof. The documents were not messed up and neither was the processing. They were just keeping their options open, so like the salad oil scandal, they could fill the tank that someone wanted to look into.”
I saw that last night and it makes no sense. This was my message to an attorney (different one than the one quoted earlier in this thread, he’s the most on top of the broader actions on mortgages against banks of any person I’ve come across):
My message to him:
“Only skimmed it. Garfield’s explanation was sufficiently unclear as to make me doubt his veracity.”
His reply:
“Neil Garfield is a fucktard and quoting him is like quoting a functioning lunatic on complex physics. It just doesn’t work.”
Yves,
You profess having a policy against ad hominem attacks in the comment section of your blog. Even though you purport to be quoting another here, you have clearly breached this covenant with your readership. This goes beyond “snarky”. Whether you wrote it or somebody else did and you’re just quoting them, ergo you’re ‘not really’ the originator, doesn’t make you less responsible.
Yves Smith says:
October 20, 2010 at 4:55 pm
“Did you actually read how NACA handles mods? You appear not to have read at all. They have a streamlined process for doing mods, they’ve had sessions with all major servicers in California and Florida for borrowers all over the US.”
I’ll look into this and get back to you. It would have been nice if you had provided the link to your August blog about NACA instead of sending me to Google.
Sorry for getting a bit snarky, but I really try to avoid spending much time in comments, it takes time away from writing new posts. I knew I had to here given my contrarian view.
Urban Dictionary: fucktard LOL
Someone who sees 13 pages of definitions for a basic combination of two words and feels the need to add another, identical one.
1) A fucking retard
2) A retarded fuck
3) A fuck, who is also retarded
A contraction of “fucking retard”.
fucking + retard = fucktard
http://www.urbandictionary.com/define.php?term=fucktard+
Hello Yves, this evening I had a nice dinner with a good friend who is very close to the servicers. Bottom line: NACA wants mods at very low interest rates (i.e. 2%). Obviously, this doesn’t work for the servicers or bond investors. All of the servicers work with NACA but only a small % of their mods come from them.
I also Googled NACA founder Bruce Marks. I’m independent minded, but Marks seems to be a leftist thug. It is what it is. I stand by my original comment. I believe the servicers are doing the best that they can given the tsunami of problem mortgages coupled with legacy IT systems requiring manual intervention. Most servicers are on a hiring spree here and overseas.
The snarky comments didn’t hurt my feelings. I enjoy your blog, thanks.
Ahem, you need to discount the source. And you have only one opinion, on top of that.
First, servicers in normal times find their profits dependent on foreclosure fees (the rest of their business is breakeven, thin profit at best) and in bad times (when the process in attenuated due to backlog and overhang of inventory) they need the foreclosures even more because their advances of principal and interest payments on defaulted mortgages make them cash flow negative (as in they are hemorrhaging cash). So they are driven to foreclose.
Mods by contrast, are a big nuisance and don’t earn them fees. Look, I was at the Treasury, even Geithner, a big defender of banks, made it VERY clear that Treasury felt the servicers gamed them big time on HAMP and didn’t do remotely enough mods.
Second, NACA has a technology. Did you miss that part? It appears so. NACA does the document assembly, uploads it to site so the servicer can see it too, and puts household budget info in a spreadsheet. That’s the part the banks find onerous.
What level of mod is appropriate is a different topic. If you read the NACA process, the homeowner, once they have their income data and budget together, then goes and sits down with the servicer. NACA may want a deeper mod, doesn’t mean thats’s what the servicer will give.
Third, you have been BADLY mislead as to the sort of mods banks will give when they encounter lawyers who argue the legal theory we have reviewed here (failure to convey the note). They suddenly become willing to do 30 year deals, deep interest reductions AND deep principal balance reductions. Exactly the sort of mod your servicer friend pooh poohed is happening NOW, although they sure don’t want that publicized.
And fourth, you act as if (based on biased servicer opinion) that there is something wrong with a deep mod. The ONLY parties that do not want deep mods are servicers, Lender Processing Services and its competitors, and foreclosure mills. Investors would MUCH rather have a deep mod than a foreclosure if the borrower is at all viable (which the NACA process is designed to assess). A 40-50% loss is better than a 70%+ loss.
Black Rock, complaining about Countrywide, yah right.
One head of Black Rock retired, Peter Peterson and is trying to kill Social Security, calling it an entitlement.
The other is Laurence Fink bragging about how he started the mortgage securitization business. May that epithet be etched in his tombstone.
http://online.wsj.com/video/viewpoints-fink-on-mortgage-securitization/2114E4CA-7C62-4E46-9461-2DDF74F8BE65.html?KEYWORDS=mortgage+securitization+trust
And the Federal Reserve has hired them to run their 1.2 Trillion MBS package.
Blackrock will bury any problems, not bring them to light.
The importance of this case is that the settlement reached will be the standard by which all future settlements will be considered involving all of the banks. From that standpoint all of the loan originators have an interest in the outcome.This is because new legal ground is being plowed here. The presence of the Fed will lend credibility to any settlement reached while at the same time allowing it to keep the claims of the investors from getting too far out of hand. The underlying goal of the fed has to be stability in the finacial system which would be wrecked if a huge result happened against BAC. The other players, BLK (huge relationship to BAC, Pimco (likely paid little for their position)will be inclined to settle quickly. The underlying purpose of the fed should trump any avowed goal of protecting the taxpayer. The taxpayer is much better off with a stable banking system,which won’t happen if big banks stumble over this issue. Most compelling is the decision to bo after BAC through countrywide. This provides little risk to BAC if things get out of hand since as you point out there likely is little risk to BAC if they choose to walk away from CFC. Bankruptsy of CFC will not be a systemic risk. This is the perfect scenario for the gov’t to solve the putback problem favorably for banks,but with some credibility to the process and to do so quickly. Meanwhile shorts have a party with the headlines.
Kabuki lawsuit? I wonder what the FRB interests are now and for the last 20 years visa vi the mortgage securitizations. Certainly the naivete that management works in the corporate best long term interest and that speculators wont over leverage should be passe. One wag put the change of times to when the accounting partnerships handed management from the golden CPA test passers to the rain makers who played golf.
The FRB has been interested in mortage securitizations for a long time.
http://online.wsj.com/article/SB122547596549288517.html?KEYWORDS=mortgage+securitization+trust
Another interesting player is TCW. As I recall they represent the SEIU union (nemesis of Ken Lewis)which has a huge position in BAC.This is another claimant that would have no interest in causing damage to BAC.
I am an attorney, though I won’t claim to understand all of the details here. The problem I have with the hype around this lawsuit centers on damages.
Let’s take a step back. The lawsuit claims that the servicer is in breach. Fine, but what damages are the investors suffering? Unless you believe that the loans in the investment poll can’t be foreclosed because documentation problems, the damages here aren’t huge. In the vast majority of these cases, though, the underlying properties WILL be foreclosed on eventually. So you can certainly make a case that the delay has harmed the plaintiffs, but that number isn’t going to be close stated value of the mortgages.
Yves,
You are the man, I love your post.
I will keep my 30k BAC share tight.
Sounds to me like banks would like to sweep this stuff under the rug and pretend everything is fine…let’s just continue with the foreclosures and nobody will complain too loudly. BS. Start with something like http://www.knowyourmortgagebanker.com/fightBack.html for beginners.