In an ironic twist of events, last night Bank of America's Chris Flanagan, head of MBS strategy penned an article titled: "Foreclosure Issues Pose Risks, Should Be Resolved With Time" in which the Bank of American proudly reports the following piece of supreme denial: "While that resolution should involve time, effort, and cost, we do not believe it will result in a major long–term disruption to the housing or mortgage markets...Additionally, the allocation of additional costs due to advancing and legal fees will have to worked out. We do believe that the tenets of securitization, MERS, extensive legal foundation that has been established over the last 30 years, and REMIC eligibility will stand." Well isn't it ironic, as Alanis would say... To think all this occurred when Bank of America was still just above it 15 month lows. After today's festivities, not so much. As for the tenets of, well, all those things that are supposed to stand, we are sure that is the case: after all would Moynihan wouldn't risk perjury if he was concerned that a multi-decade culture of perjury, fraud and lies could ever be overturned. The alternative of course would be jail time. And recall what happened to his securities-fraud committing predecessor. Regardless, here is the full MBS defense as presented by the bank with the most to lose when things finally get out of hand. Oddly enough, even this most KoolAided of defenses admits that "the end result will likely be a further extension of foreclosure timelines." Which makes one wonder: just what gives the bank the confidence that it will be able to lift the moratorium within a week? And just what will happen to the firm if it is unable to sweep all these tens of billions in future losses under the rug.
Complete KoolAid, er, report:
Foreclosure Issues Pose Risks, Should Be Resolved With Time
Recently, some issues surrounding foreclosure sale proceedings have come to the forefront, leading several large banks to halt foreclosure sale proceedings in many states. The purpose of this note is twofold: to clear up some confusion on what exactly the issues at hand are and to bring some perspective to those issues. For instance, we note that the “foreclosure issue” that we are addressing here is separate from considerations surrounding potential bank loan repurchases. After the JPMorgan Chase earnings call, in which the company announced increased repurchase reserves, the two issues seem to have been muddied.
With respect to the issues surrounding foreclosure sales, while there are some outstanding risks, we think the issues that can be definitively addressed suggest a resolution could be possible over a matter of months. While that resolution should involve time, effort, and cost, we do not believe it will result in a major long–term disruption to the housing or mortgage markets.
The issues surrounding foreclosure sale proceedings were initially brought to light on September 17, when GMAC/Ally halted evictions and REO sales in 23 judicial foreclosure states. Since that time, GMAC has extended their review to all 50 states, and four other large banks have halted foreclosure sales or launched internal reviews of their foreclosure processes: Bank of America has halted foreclosure sales in 50 states, JPMorgan Chase in 41 states, PNC in 23 states, and Litton is reviewing proceedings. Wells Fargo has stated that they are reviewing all pending foreclosures, but not halting the process and are confident their processes are robust. Attorneys General from all 50 states announced Wednesday that they have formed the Mortgage Foreclosure Multistate Group to review some of the practices around foreclosures proceedings.
The “foreclosure issues” being discussed at this point seem to encompass a few distinct problems, which we think it is useful to break down: robo-signers, MERS, and trust transfers.
The Robo-Signer Issue
While judicial foreclosure proceedings vary from state to state depending on different laws, many involve the presentation of an “affidavit of debt” before the court, which certifies that an employee of the mortgage servicer is familiar with the mortgage and borrower under question. Across several servicers burdened with an increasing number of foreclosures, there were employees who allegedly signed large numbers of affidavits without “personal knowledge” of the stated information. In addition, some affidavits were not notarized at the time of affidavit signing. These deficiencies created became a problem when brought before judges.
Importantly, however, although these deficiencies introduce risk, the issue does not seem to be insurmountable. We believe that the likelihood for widespread outright forgiveness of debt in cases where affidavits were signed or attested improperly is low. The details behind resolving cases such as these are not clear from a legal standpoint, but they seem likely to be, in part, a matter of rectifying the affidavit, issues of time, effort, and cost. Similar issues exist for fixing faulty foreclosure processes from the start; it may be possible to solve the robo-signer issue by staffing up teams or via other efforts. While more costly, and likely to delay foreclosure processes a few to several months, again, in our view, the issues do not seem to be insurmountable.
The MERS Issue
A second issue that has arisen questions the validity of MERS, an electronic registration system for mortgages meant to simplify the process of transferring mortgage ownership. In the past, there have been court rulings in support of the MERS model, e.g. that holding title for the benefit of another party was valid or that foreclosure initiation in the name of MERS was valid. There have also been cases in which the model was not supported (e.g. Landmark v. Kessler in Kansas), but in most instances it seems those efforts have failed or been overturned. In the event the matters challenging MERS succeed, resolution seems to be a practical issue; while the process is unclear at this point, it may simply be a matter of assigning the mortgage from MERS to the foreclosing party in cases where foreclosure in the name of MERS is ruled against or of simply foreclosing in the name of the bank instead of in the name of MERS. There has been at least one case (U.S. Bank v. Ibanez) in Massachusetts, which calls into question the separation of legal and beneficial title holding, similar to that used in the MERS model. That case is currently under appeal.
In addition, there also seems to be some misinformation about the MERS system itself and whether some banks are utilizing it or not. MERS put out a press release yesterday to address some of these concerns, citing the fact that Chase registers their correspondent loans in MERS, but does not register their retail loans.
The Trust Transfer Issue
A third issue that has arisen concerns the validity of the trust as the owner of the mortgage for loans that have been securitized. When the note is transferred to a trust, it is endorsed “in blank”, meaning that the owner of the note is not assigned. The note is only endorsed to the trustee or servicer on behalf of the trust if they need to institute foreclosure proceedings. Our understanding is that this is a common practice when notes are transferred to a trust. With respect to physical documents, those are delivered and held by the designated custodian for the trust. Both the seller and the custodian should have verified the existence and validity of the notes upon transfer. If there were any deficiencies, the custodian should have notified the seller to remedy any deficiencies or if they could not be remedied, put the loan back to the seller. The transfer of the notes is governed by the loan purchase agreement which also provides for evidence of ownership of the loans by the trust. Also, when the notes are transferred, the servicer records the ownership of the loans with MERS.
The primary risk in our view is not that the affidavits issue remains unresolved, but how much time and effort the resolution will take and how far the scope of investigations expands beyond this issue. As mentioned, the Attorneys General from each state have formed a task force to look into the affidavit matter to determine if they were processed correctly under state laws. However, given that AGs from non-judicial states have joined the task force, the scope of their investigation may expand beyond this issue and lengthen the timeframe for resolution. Complicating matters is that servicers have to abide by individual state regulations with respect to foreclosure processing.
In the end, we believe that the vast majority of foreclosures will stand assuming that the actions were taken against borrowers who were delinquent. However, the end result will likely be a further extension of foreclosure timelines. We believe that the incremental increase in loss severity should be minimal if these issues can be resolved in the next 3-6 months. For servicers this means additional staffing requirements as well as increased costs. With respect to investors, headline risk will remain the predominant near term concern. Additionally, the allocation of additional costs due to advancing and legal fees will have to worked out. We do believe that the tenets of securitization, MERS, extensive legal foundation that has been established over the last 30 years, and REMIC eligibility will stand.
In other words: all shall be well, and all manner of thing shall be well.