Two weeks ago, the New York Times's Gretchen Morgensen wrote an article in which she touched upon the curious case of Kemp vs. Countrywide Home Loans in which Countrywide held on to the original mortgage note and related docs "even though the pooling and servicing agreement governing the mortgage pool that supposedly held the note required that it be delivered to the trustee, the court document shows" thereby impairing the integrity and validity of all downstream securities. Prior to this (and since) we have seen many more cases in which there was outright court fraud in some capacity, either w/r/t the PSA or the already well known issue of robosigning. It is no surprise that after making a splash, this topic has disappeared from the mainstream media, as banks are doing all they can to "silence" the debate, whose implications could be terminal for the US leveraged housing paradigm, which has existed since the advent of the GSEs. Yet, surprisingly, in today's Weekly Credit Outlook, Moody's brings new attention to this particular case, and adds some language that if one were the CEO of Bank of America, one would be very, very nervous, more so than even how damaging the revelations from the Wikileaks disclosure on BofA may end up being. To wit: "We believe the case will lead to increased litigation, higher servicing costs, and more foreclosure delays. This will pressure BofA’s earnings. Increased foreclosure timelines and costs associated with potentially defective loans will also increase losses for Countrywide-sponsored RMBS. This is negative for both BofA and Countrywide-sponsored RMBS." Did Moody's (always horrendous at timing its entrance and exit) just pee in the proverbial RMBS pool?
Full note from Moody's David Fanger:
New Jersey Court Decision May Be Unique, but Still Bad for BofA and RMBS
On 16 November, a bankruptcy court in New Jersey dismissed Bank of America’s (BofA, Aa3 negative, C-/Baa2 stable) claim for standing to enforce a mortgage originated and securitized by Countrywide in 2006. The judge concluded Countrywide had failed to properly endorse and transfer possession of the mortgage note to the securitization’s trustee, leaving it unenforceable under New Jersey law. Last week BofA was reported in the press as saying that the facts upon which the judge based her conclusion may not have been correct.
We believe the case will lead to increased litigation, higher servicing costs, and more foreclosure delays. This will pressure BofA’s earnings. Increased foreclosure timelines and costs associated with potentially defective loans will also increase losses for Countrywide-sponsored RMBS. This is negative for both BofA and Countrywide-sponsored RMBS.
Kemp v. Countrywide Home Loans, Inc. involves a May 2008 Chapter 13 bankruptcy filing where BofA/Countrywide, as mortgage servicer, filed a proof of claim on behalf of a securitization trust. Testimony by a BofA mortgage servicing employee and statements by BofA’s local attorney indicated that the mortgage note was never properly delivered, with endorsements, to the securitization trustee as required by the pooling and servicing agreement (a requirement typical of most securitizations). However, the employee also said she had never worked in originations (the area responsible for delivering the note), nor was she comfortable testifying on the extent to which the mortgage documents were moved. No additional information was provided to the court regarding the note’s chain of possession.
The Kemp case raises questions about whether, by failing to comply with the pooling and servicing agreement, BofA/Countrywide would be required to repurchase the mortgage from the trust. After the case was reported in the press, BofA highlighted that the employee’s testimony had been outside her area of expertise, and stated that “Countrywide’s policy and practice has been, and remains to fully comply with the pooling and servicing agreements, including forwarding any necessary documents to the trustee.”
In light of BofA’s statements, it appears the case was concluded without all of the relevant facts. We don’t believe Countrywide as a matter of standard practice failed to deliver mortgage notes to the trustee, and we don’t expect the Kemp case to set a wide precedent for bankruptcy and foreclosure cases involving Countrywide mortgages. However, we still don’t know to what extent their documentation and transfer process was defective. Any such defects will increase foreclosure timelines and costs and in some cases may preclude the servicer from enforcing the mortgage altogether. We also believe the case will encourage other mortgage borrowers as well as investors in Countrywide securitizations to challenge BofA. We expect this will increase servicing and litigation costs for BofA, and could reveal defects in BofA’s mortgage servicing processes, exposing the bank to further unfavorable legal decisions.
The case is also negative for RMBS in general. It shows that where sponsors failed to deliver and endorse the mortgage notes in accordance with the transaction documents, servicers may not be able to foreclose or enforce bankruptcy proofs of claim when challenged by borrowers. The extent to which sponsors failed to adhere to the requirements in the transaction documents is unclear. The current Attorneys General investigations could shed light on this, although it is unclear whether their scope will include document transfer issues.
Operational flaws in supervising and lawyering foreclosures and bankruptcies also pose an issue for BofA and other servicers. The Kemp case reveals that the servicer’s employees and lawyers may be unaware of the complexity and requirements of the securitization process. This kind of disconnect between the servicing and the securitizing subject RMBS to additional delays, costs and losses – and is probably not confined to BofA.