Some weekend foreclosure scandal, securitisation-related reading.
It’s based on a 159-page class action lawsuit, filed in Kentucky on behalf of all Kentuckian homeowners, and against MERS and several financials. And it rather sums up what’s happening in the States at the moment — an outright attack on the legality of mortgage securitisations, specifically the idea of true sale.
We’re going to steal the below chart from the FCIC again. It shows the typical creation process for a Mortgage-Backed Security (MBS). We’ve added in the master document custodian, which keeps and maintains key documents in the deal.
In words, here’s how it works. The originators or mortgage lenders, sell their mortgage notes to the sponsor to be turned into an MBS bond. Between the sponsor and the trustee stands the depositor. At the end of the whole process is the master document custodian — who store original mortgage notes etc. in document vaults. Mortgage notes have to be conveyed throughout the securitisation process, or ‘mortgage assignments’ showing transfer of ownership have to be made.
The reason the whole thing is so convoluted — involving special purpose vehicles, multiple players, etc. — is because it is meant to satisfy the true sale requirement embedded in securitisations. That is to make sure the investors have a genuine right to the underlying loans. This type of structure is called a Remic, and in addition to satisfying the true sale requirement it also comes with certain tax benefits.
There are a few rules securitisations have to abide by, most of which are set out in Pooling and Servicing Agreements (PSAs). Here’s what the lawsuit says:
The PSA merely sets forth what happens after the mortgages are bundled together. However, the PSA also sets forth a Cut Off Date. The Cut Off Date is the date on which all mortgage loans in the MBS/Trust must be identified and set out in the SEC required list of mortgage loans. Often, these loans were identified and listed for the SEC and the investors, regardless of whether the loan existed or had been closed. Some loans were listed in SEC filings in multiple MBS.
You can guess what’s coming next. In addition to the cut-off date, MBS deals also have a closing date. This is the period by which all the underlying loans that have been selected for the deal must have been transferred to the trustee:
The Closing Date is the date that the individual identified mortgages were to be transferred through the [Trust] Custodian for the benefit of the investors. The Trust Custodian must certify that for each mortgage loan, the Trust Custodian has possession of the original Promissory Note, all original endorsements and assignments transferring the Note and proof that the ownership of the Note has been transferred for the benefit of the shareholder/investors.
Further proof of the ownership of a mortgage loan is required by a public recording of the Mortgage or Assignment of the Mortgage itself. This MUST have occurred by the closing date. Most importantly for this action, the “Trustee”/Custodian MUST have the mortgages recorded in the investors name as the beneficiaries of a MBS in the year the MBS “closed.” Every mortgage in the MBS should have been publicly recorded in the Kentucky County where the property was located with a mortgage in the name similar to “2006 ABC REMIC Trust on behalf of the beneficiaries of the 2006 ABC REMIC Trust.”
It’s a wider issue than just saying the underlying mortgage notes may not have been properly conveyed through the securitisation process. If that were the case, as per the Mortgage Litigation Help Center (or, ahem, ‘Sue my Lender’), you would simply go to the custodian to produce the mortgage docs. It might not totally solve the conveyance problem, but it should prove that someone owns the loan.
Only going to the custodian could be complicated. From the lawsuit:
To solve the problem of the missing and non-existent Assignments, the MBS/Trustees, their attorneys and their Servicing Agents, decided to fabricate Assignments from thin air and then quietly record the fabricated Assignments. If a Promissory Note Assignment is presented to the Court, it deliberately do not state the date the promissory Note was assigned. It was procured after the fact and is based in fraud and in violation of MBS Trusts’ tax status requirements. The dateless Promissory Note Assignment or allonge is then affixed to a copy of the Promissory Note as the original Promissory Note simply does not exist. The fabricated Promissory Note Assignments are affixed to Motions for Default or Summary Judgment. (103) The Assignments of the Mortgage were signed and notarized many years after the actual date of the loan and the date listed with the SEC and IRS as the “Closing” of the REMIC.
Even if the conveyance (assignment) docs do exist and putting aside the issue of MERS — there’s a challenge to the timeline of the securitisation process. The lawsuit claims that “most times” mortgage assignments are dated after the filing of the foreclosure, and all the class action members have mortgage loans which were recorded in the name of MERS, or which were attempted through a mortgage assignment to be transferred into a Remic after that Remic’s cut off and closing dates.
From the suit:
Before the ink on the new mortgages was dry, and before the loan would be considered “dry” by industry standards; while the loan was still “wet” and in many cases non-existent legally, the lenders promptly sold the loans, in secretive transactions, to “investors” for some percentage or fraction of what had been the alleged value of the mortgage and the property by which it was secured just days or weeks earlier. In some cases, the loan was listed inside a MBS and sold before the loan was even consummated. Most were sold without the Note ever being in the possession of the MBS. All loans, for purposes of this action, were securitized and sold with the mortgage recorded in the name of MERS.
We’re not lawyers at FT Alphaville — though sometimes we do go out with them — but we find the lawsuit interesting since it seems to cast doubt on key threads of the securitisation process; true sale, timing. Not only will MBS investors have to prove the right conveyance docs are there, they’ll have to prove they’re there in the right order. It’s the same ‘blank name’ idea picked up by analyst Joshua Rosner.
It’s also amazing that this is making headlines now (again) — when it’s already been mentioned back in 2007 after a ruling against Deutsche Bank, and even waaaayyy back in 2003. Check out Kenneth Kettering’s quote in this CFO Magazine article.
It also highlights one of the reasons this foreclosure thing is so difficult to gauge.
The mortgage mess could end up being a very short-lived blip in the securitisation market or something more sinister depending on how pervasive missing, forged or back-dated documentation is — and how the courts decide to address complaints like this Kentucky one. To paraphrase one analyst, you don’t know what’s missing until you try to find it — and as this is one of the first occasions that mortgage deal documentation could well be systemically-tested, we’ll just have to wait and see.