Tom Adams pointed to an article in American Banker by Kate Berry which discusses how mortgage securitization trustees are increasingly coming under scrutiny in the foreclosure crisis. By way of background, the trustee is the party responsible for securing the assets (the borrower promissory IOUs, liens, and various other documents related to the securitization). The trustee in theory is also responsible for overseeing the servicer. In practice, the trustee does very little, and the pooling and servicing agreement has all sorts of carveouts and indemnifications with the intent of severely limiting (cynics might say eliminating) any risk trustees might have by virtue of their supposed supervisory role.
The biggest mortgage securitization trustees are Bank of New York, Deutsche Bank, Wells Fargo, and US Bank.
The interesting thing about the American Banker article is that the trustees appear to be in a great deal of denial as to how much hot water they are in. No where does the story mention their biggest exposure: that they gave multiple certifications to the investors in the mortgage securtizations that they did indeed have the trust assets. If, as it now appears to be the case, that many mortgage loans were not properly conveyed to the trust (as in endorsed by the originator and all the intermediary parties specified in the contract governing the deal, the pooling and servicing agreement, and finally over to the trust), then all those certifictions were patently untrue. Since investors relied upon these certifications (no one in their right mind would have ponied up for these deals if they had had any doubt that the trust owned the mortgage loans) and the failure to convey the notes is a big cause of problems with foreclosures, it would seem that the trustees are very logical targets for investor litigation.
Let’s begin with a meaty section of the American Banker story (sadly, no online version):
Deutsche Bank AG, the second-largest trustee of asset-backed securities in the U.S. according to Thomson Reuters, recently demanded that the servicers of its deals indemnify the German bank, and the investors it represents, against any “liability, loss, cost and expense of any kind” from “alleged foreclosure deficiencies or from any other alleged acts or omissions of the servicer.”
The Financial Crisis Inquiry Commission is also investigating trustees’ role in the foreclosure mess, according to several people with knowledge of the body’s work. The commission, which was created last year and has held a number of hearings, has no real teeth, but it plans to issue a report Dec. 15 on its findings about the causes of the financial crisis. The report is expected to include some discussion of trustees in securitizations, the people said.
In an Oct. 8 letter, Deutsche cautioned the major mortgage servicers that had halted foreclosures to examine their processes — including Ally Financial Inc. and JPMorgan Chase & Co. — of the need to ensure ownership of loans was properly transferred to trusts when securitizations were formed.
Deutsche Bank told the servicers to “comply with all applicable laws relating to foreclosures,” and requested additional information about alleged loan defects and any actions taken by servicers to fix them.
Thomas Hiner, a partner at Hunton & Williams LLP, said Deutsche Bank, which forwarded the servicer warning to investors on Oct. 25, was trying to appear proactive. “They are attempting to show a good face to the bondholders, that they are in front of the issue and they’re telling the servicers to comply with the law and the documents,” Hiner said.
He also said Deutsche bank was trying “to disclaim responsibility for” servicers’ paperwork blunders.
“Proactive”? This is comical. It appears that Deutsche is trying awfully hard to shift blame to servicers for its own failures. And a misleading letter to investors looks to be a device to get them off Deutshe’s trail.
This is the section, if Thompson Reuters has recounted it correctly, that is dishonest:
Deutsche cautioned the major mortgage servicers that had halted foreclosures to examine their processes — including Ally Financial Inc. and JPMorgan Chase & Co. — of the need to ensure ownership of loans was properly transferred to trusts when securitizations were formed.
Ahem! It was the TRUSTEE’S job to make sure the loans got to the trust! This wasn’t the servicer’s duty. And it is the trustee that is on the hook legally, since it provided certifications that everything was hunky dory. Moreover, it is the trustee that selects the custodian (when a separate custodian is used; trustees often provide custody services). Furthermore, trustees for New York trusts (and New York was overwhelmingly the state law elected for the trusts) are required to segregate trust assets (as in have the assets for each trust in separate place). New York trust law also requires specific endorsement (as in a trust is not only not permitted to hold bearer paper, such as notes endorsed in blank, but the trust assets must be endorsed in the name of the trust, not merely the trustee, which was the lower standard specified in the pooling and servicing agreements).
So if what we are increasingly led to believe it true turns out to be correct, that borrower notes never were conveyed to the trust, and were also not endorsed over to the trust (through the proper chain of conveyance specified in a PSA) in the stipulated time frame (a LONG time ago), the trustees were derelict in the performance of their duties.
So with that in mind, let us reconsider the truly comical part at the beginning of the extract:
Deutsche Bank AG….recently demanded that the servicers of its deals indemnify the German bank, and the investors it represents, against any “liability, loss, cost and expense of any kind” from “alleged foreclosure deficiencies or from any other alleged acts or omissions of the servicer.”
Demand indemnification? What are they smoking? They have absolutely nada in the way of leverage. They can’t realistically fire the servicer (servicing is a loss making business right now, no one would be willing to act as a replacement unless they got more than the current servicer, and that would come out of the investors’ hide). In addition, if they tried to do so, the old servicer and the investors (who now would have to pay more) could say this move was clearly self serving, not in the investors’ interest.
A mortgage securitization expert concurred with our reading:
You are dead on. In fact, no one in the transaction has any negotiating leverage at this point. All negotiating leverage will likely come from one party pointing fingers at the other, trying to interpret the contracts. The trustee will seek to blame the servicer, the servicer will say they were directed by the trustee. Should be great sport…..