Is Fraudclosure About To Claim Its First Victim: First Horizon Plunges After Subpoena Disclosed As FHFA Announces No Reserve Established

Tyler Durden's picture

Investors in FHN are not very happy after it was just announced that the the bank has been subpoenaed by the FHFA, conservator for the GSE, in connection to ongoing probe; and further allegations that it may be unable to determine probable loss, and that no reserve was established. Oops. And here we were thinking that the recent subpoenas disclosed as launched by the FHFA (which also target JPM among others, and obviously First Horizon) would result in absolutely nothing. Luckily, the SEC last week reminded all banks that keeping track of mortgage repurchases and foreclosure reviews may be a good idea after all. Looks like just as "Waddell and Reed" was the SEC sacrificial lamb in regards to HFT, so FHN may be tasked with the same function vis-a-vis fraudclosure... Unless we actually see comparable actions taken against the real villains in this case: BofA, Wells, JPM and Citi.

From the just released 10-Q:

FHN has been subpoenaed by the conservator for two GSE investors in six securitizations in connection with an ongoing investigation which may or may not result in claims based on representations and warranties. Since the investigation is neither a repurchase claim nor litigation, the associated loans are not considered part of the repurchase pipeline and FHN is unable to estimate any liability for this matter. At the time this report is filed, FHN was a defendant in lawsuits by three investors in securitizations which claim that the offering documents under which certificates were sold to them were materially deficient. Although these suits are in very early stages, FHN intends to defend itself vigorously. These lawsuit matters have been analyzed and treated as litigation matters under applicable accounting standards. At September 30, 2010 and at the time this report was filed, FHN was unable to determine a probable loss or estimate a range of loss due to the uncertainty related to these matters and no reserve had been established. Similar claims may be pursued by other investors.

Oh they will be. And some more on what may soon be coming to most other banks as well:

Unlike loans sold to GSEs, contractual representations and warranties for proprietary securitizations do not include general representations regarding the absence of fraud or negligence in the underwriting or origination of the mortgage loans. Securitization documents typically provide the investors with a right to request that the trustee investigate and initiate repurchase if FHN breached certain representations and warranties made at the time the securitization closed. Investors generally are required to coordinate with other investors comprising not less than 25 percent of the voting rights in certificates issued by the trust to pursue claims for breach of representations and warranties through the trustee under the applicable trust agreement, and generally are required to indemnify the trustee for it’s costs related to repurchase actions taken. GSEs were among the purchasers of certificates in securitizations. As such they are covered by the same representations and warranties as other investors. However, GSEs acting through their conservator, under federal law are permitted to pursue such claims independently of the other investors.

Also unlike loans sold to GSEs, interests in securitized loans were sold as securities under prospectuses or other disclosure documents subject to the disclosure requirements of applicable federal and state securities laws. As an alternative to pursuing a claim for breach of representations and warranties through the trustee as mentioned above, investors could pursue a claim alleging that the prospectus or other offering documents were deficient by containing materially false or misleading information or by omitting material information. Claims for such disclosure deficiencies typically could be brought under applicable federal or state securities statutes, and the statutory remedies typically could include rescission of the investment or monetary damages measured in relation to the original investment made. If a plaintiff properly made and proved its allegations, the plaintiff might attempt to claim that damages could include loss of market value on the investment even if there were little or no credit loss in the underlying loans. Claims based on alleged disclosure deficiencies also could be brought as traditional fraud or negligence claims with a wider scope of damages possible. Each investor could bring such a claim individually, without acting through the trustee to pursue a claim for breach of representations and warranties, and investors could attempt joint claims or attempt to pursue claims on a class-action basis. Claims of this sort are likely to be resolved in a litigation context in most cases, unlike most of the GSE repurchase requests. The analysis of loss content and establishment of appropriate reserves in those cases would follow principles and practices associated with litigation matters, including an analysis of available procedural and substantive defenses in each particular case and an estimation of the probability of ultimate loss, if any. FHN expects most litigation claims to take much longer to resolve than repurchase requests typically have taken.

At September 30, 2010, the repurchase request pipeline contained no repurchase requests related to securitized loans based on claims related to breaches of representations and warranties. FHN has been subpoenaed by the FHFA, Conservator for Fannie Mae and Freddie Mac, related to investments made by the two GSEs in six proprietary securitizations issued in 2005 and early 2006 in connection with an ongoing investigation which may or may not result in claims based on representations and warranties. The original and current (as of September 30, 2010) combined certificate balances related to Fannie Mae investments were $443.2 million and $194.0 million, respectively. The original and current (as of September 30, 2010) combined certificate balances related to Freddie Mac investments were $842.0 million and $402.1 million, respectively. Since the investigation is neither a repurchase claim nor litigation, the associated loans are not considered part of the repurchase pipeline and FHN is unable to estimate any liability for this matter.

At the time this report is filed, FHN was a defendant in lawsuits by three investors in securitizations which claim that the offering documents under which certificates were sold to them were materially deficient. Although these suits are in very early stages, FHN intends to defend itself vigorously. These lawsuit matters have been analyzed and treated as litigation matters under applicable accounting standards. As of September 30, 2010 and at the time this report was filed, FHN is unable to determine a probable loss or estimate a range of loss due to the uncertainty related to these matters and, accordingly, no reserve had been established. Similar claims may be pursued by other investors.

At September 30, 2010, FHN had not reserved for exposure for repurchase of loans arising from claims that FHN breached its representations and warranties made at closing, nor for exposure for investment rescission or damages arising from claims by investors that the offering documents under which the loans were securitized were materially deficient.

You read that right: complete lack of preparedness for putbacks. Oops.