Two weeks ago we first touched upon a key tangential topic of the whole mortgage mess, namely the implication of what potential MERS fraud means for Commercial Mortgage Backed Securities. Well, the topic which has so far avoided broad media attention to the benefit of all CMBS holders may be about to go mainstream. As part of our initial inquiry, we asked: "If residential mortgage foreclosures are being halted and if the very fabric of the MBS securitization architecture is put into question, when will someone ask whether MERS® Commercial allowed such pervasive title fraud as is now apparently ubiquitous in the residential space, to take the CMBS space by storm, and how many billions in dollars will Banc of America Securities, Bear Stearns (d/b/a JP Morgan), GE Capital Real Estate, GMAC Commercial, John Hancock and Wells Fargo be forced to buy back loans that were fraudulently certified." Our question is now being reiterated by Barclays Capital. Next up Bloomberg, Ratigan, and everyone else.
In a note released to clients yesterday, Barclays' Julia Tcherkassova notes that finally MERS foreclosure issues may be spreading to commercial real estate, after "recent lawsuits have raised questions about the legal standing of MERS as a foreclosing entity and an electronic record keeper." And even though Julia attempts to mitigate the full risk of CMBS putbacks and other forms of deal unwinds by stating that foreclosures in the space are still relatively modest (to which one can answer quite simply by asking what the 30, 60 and 90-day delinquency rate is... spoiler alert: record), even she is forced to acknowledge that by looking at the numbers, the upside risk potential is for as much as $280 billion of conduit deals: "we conducted a quick search through the PSAs and pro-sups of deals securitized between 2004 and 2008 and estimated that about $280bn worth of conduit deals have some MERS language in them." A second approach which involves tracking not shelf names but the originator's original exposure to MERS yields a lower downside estimate of about $82 billion. The bottom line is that nobody really knows, and because the MERS Commercial database is not open for public use, and only "broad-based estimates within the CMBS universe could be drawn" it is safe to say that nobody really knows how many deals in the critical 2004-2008 vintages were exposed to the MERS "virus." The final answer: a lot.
And while we will present the BarCap note below as a primer for all other journalists who are way overdue in finally following on this issue which will impact nearly $3 trillion in securitized loans, a far more interesting disclosure is the fact that as Barclays discloses, MERS involvement was in fact presented as a boilerplate risk factor to CMBS transactions. As a result, any additional adverse findings on MERS immediately open up the banks to massive rep and warranty lawsuits, and make the MERS issue orders of magnitude more problematic for the banks to deal with than simple putback issues at the servicer level.
Some deal documents do contain a standard risk disclaimer listed under: "The Recording of the Mortgages in the Name of MERS May Affect the Yield on Your Certificates," specifically:
"The recording of mortgages in the name of MERS is a new practice in the commercial mortgage lending industry. Public recording officers and others may have limited, if any, experience with lenders seeking to foreclose mortgages, assignments of which are registered with MERS. Accordingly, delays and additional costs in commencing, prosecuting and completing foreclosure proceedings and conducting foreclosure sales of the mortgaged properties could result. Those delays and the additional costs could in turn delay the distribution of liquidation proceeds to certificate-holders and increase the amount of losses on the loans."
The banks were perfectly aware that MERS could be a major stumbling block in deal underwriting and put it up front and center as a key risk factor. And since the investor did sign off on this risk, the question really becomes who is more liable: the underwriter or the investor? Is this the smoking gun loophole that banks will huddle around and pull the Goldman excuse that it was really the "sophisticated investor's" duty to perform their own due diligence, with the risk factor out there front and center?
However, just as there is no transparency with regard to MERS commercial, so there appears to be no real disclosure when it comes to servicer opinion on loan doc transfers.
With even Barclays admitting there is risk to near-term prices, (and there certainly is major risk to long-term prices, however it is no bank's interest to admit this: just note the variance in the RMBS putback estimate range, which is from $30 billion to over $100 billion), one wonders: just what are all the investors in assorted tranches of CMBX deals thinking (NA 4 below shown indicatively). If indeed RMBS is about to be unwound due to prevalent MERS fraud, what does this means for CMBS, and for the billions of REITs who have levered up to infinity in full expectation that the Fed will bail them out due to the imminent lack of cash flow coming from tenants? After today's various letters do these same REITs still believe that the Fed will keep pumping money in perpetuity to bail out a few worthless asset managers? And what happens when the MERS fraud in CMBS is attacked in full by the plaintiff bar? We can't wait to see the results.