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FHFA Announces Settlement in Lead MBS Action
On July 25, the FHFA announced that a financial institution agreed to pay roughly $885 million to settle allegations that the offering documents it provided to Fannie Mae and Freddie Mac in connection with the sale of billions of dollars in residential MBS included materially false statements or omitted material information, resulting in massive losses to the enterprises. The institution will pay approximately $415 million to Fannie Mae and $470 million to Freddie Mac to resolve claims related to securities sold to the companies between 2004 and 2007. The settlement ends the lead case of 18 cases the FHFA filed in 2011. In April 2013, the Second Circuit held that the action, filed within three years after the FHFA was appointed conservator of Freddie Mac and Fannie Mae, was timely under the relevant sections of Housing and Economic Recovery Act, and that the FHFA has standing to bring the action.
FINRA To Begin Sharing Additional MBS Information
On July 22, FINRA announced that it will begin to disseminate information for so-called specified pool transactions in agency pass-through mortgage-backed securities and SBA-backed securities, including transaction information such as the time of the trade, price and volume. Transactions must be reported to within two hours of execution (the reporting period is reduced to one hour after a six month implementation period), and are disseminated as soon as received. Combined with FINRA’s action last year to begin disseminating transaction information for agency pass-through mortgage-backed securities traded "to-be-announced" (TBA), FINRA now will be sharing information for securities that represent over 90 percent of the par value traded in all asset- and mortgage-backed securities.
California Federal District Court Allows Government's FIRREA-Based RMBS Suit to Proceed
On July 16, the U.S. District Court for the Central District of California denied a major credit rating agency’s motion to dismiss a DOJ complaint alleging that the firm defrauded investors in residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) by issuing inflated ratings that misrepresented the securities’ true credit risks, and by falsely representing that its ratings were uninfluenced by its relationships with investment banks. U.S. v. McGraw-Hill Cos., Inc., No. 13-779, slip. op (C.D. Cal. Jul. 16, 2013). The court held that the government met its initial pleading burden, in part, because it sufficiently had alleged that the rating agency “engaged in a ‘scheme to defraud investors in RMBS and CDOs tranches’ and ‘to obtain money from these investors by means of material false and fraudulent pretenses, representations, and promises, and the concealment of material facts’ with ‘intent to defraud.’” In doing so, the court allowed the government to pursue its $5 billion claims grounded in the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). The court did not, however, consider the weight of the government’s evidence, specifically whether the rating agency’s alleged statements and conduct were part of an actual “scheme to defraud,” a key element to any FIRREA claim.
Tenth Circuit Affirms Dismissal of Securities Act Claims Against Banks That Underwrote Stock of Failed Mortgage Lender
On July 9, the U.S. Court of Appeals for the Tenth Circuit affirmed a district court’s order dismissing claims brought by investors against banks that had underwritten a mortgage lender’s stock offerings. Slater v. A.G. Edwards & Sons, Inc., No. 11-2170, 2013 WL 3390038 (10th Cir. Jul. 9, 2013). The lender, which focused on the adjustable-rate mortgage market, attempted to raise new capital through a series of stock offerings in 2007 and 2008 before filing for bankruptcy in 2009. Investors in those offerings filed suit after the stock price dropped following the lender’s disclosure that it had been subject to margin calls triggered by a decline in the value of certain Alt-A mortgages that backed securities the lender had purchased. The investors alleged that documents related to the offerings violated Section 11 of the Securities Act because they did not disclose, among other things, the existence of the Alt-A MBS. In affirming dismissal of the claims against the underwriters, the Tenth Circuit concluded that plaintiffs had not alleged “an actionable misrepresentation or omission at the time of [the] stock offerings.” The court explained that the lender was not under any obligation to disclose the MBS to make its statements true and accurate, and that the picture it provided was materially accurate, in part because the prospectus warned that the lender’s liquidity conditions could worsen.
Bipartisan Group of Senators Propose Housing Finance Reform Bill
On June 25, Senators Mark Warner (D-VA) and Bob Corker (R-TN) announced the introduction of a new bill to reform the secondary mortgage market. The bill, known as the Housing Finance Reform and Taxpayer Protection Act, has bipartisan support from several other members of the Senate Banking Committee. The bill is designed to draw private capital back into the secondary mortgage market by providing a limited government guarantee to qualifying mortgage-backed securities (MBS). It would replace over a period of time Fannie Mae and Freddie Mac and in their stead establish the Federal Mortgage Insurance Corporation (FMIC), which would oversee a variety of secondary market utility functions, many of which are similar to those under development by the FHFA. Under the new system, the FMIC would insure MBS securitized by FMIC-approved issuers, provided that the MBS place in the first loss position a private investor with at least 10 cents in equity capital for every dollar of risk. FMIC-insured MBS also would be required to be collateralized by “eligible mortgages” – mortgages that, among other things, meet the CFPB’s ability to pay requirements, have a down payment of at least five percent, and are below the conforming loan limit. The FMIC also would have responsibility for approving bond guarantors to provide credit enhancement, servicers eligible to service loans in MBS pools, and private mortgage insurance companies to insure mortgages with a loan-to-value ratio above 80 percent. The bill also would establish an affordable housing fund subsidized through fees on securitized loans and would grant the FMIC authority to back the entire MBS market for a limited period of time in emergencies.
CFPB Director Affirms Mortgage Rule Effective Dates, Acknowledges Potential Secondary Market Impacts
On Wednesday, CFPB Director Richard Cordray delivered remarks at an Exchequer Club luncheon in Washington, DC. During a brief question and answer segment, Mr. Cordray confirmed that the Bureau does not intend to delay the effective date of the mortgage rules and fully expects institutions to be in compliance when the rules take effect in January 2014. Financial institutions and their trade associations have expressed concern about implementing certain aspects of the myriad rules in the short time allowed by the CFPB and the potential impact on credit markets. Most recently industry representatives highlighted specific challenges at a House Financial Services Committee hearing that focused on the potential effects of the ability-to-repay/qualified mortgage (ATR/QM) rule.
Mr. Cordray generally downplayed the potential market impact and cost of compliance with the CFPB’s mortgage rules, with a particular focus on the ATR/QM rule. Mr. Cordray explained the CFPB expects that the spread between QM and non-QM loans, if passed to the consumer, should be only 10 basis points, and that, as a result, concerns over the significant cost of compliance with the ATR/QM rule’s requirements are overblown. Some market participants believe this estimate may be overly optimistic and not in line with the factors they are considering in making pricing decisions on non-QM loans. These observers believe that the underlying CFPB economic analysis for the estimate includes a series of critical assumptions based on limited data, such as the probability that a borrower will allege a rule violation and estimated repurchase and litigation costs.
Mr. Cordray reiterated the agency’s promise to provide further guidance on the interplay of fair lending compliance and QM lending although, given his expectations that QM and non-QM loans will not vary significantly from a pricing perspective, he expressed the view that the issue is not a major concern. He also downplayed concerns that changes to FHA premium requirements will cause more QM loans to exceed the APR threshold required for QM safe harbor status, an issue recently addressed by FHA Commissioner Galante.
In response to an observation from BuckleySandler Partner Jerry Buckley that the assignee liability provisions of the ATR/QM rule may act as an impediment to private capital re-entering the secondary market -- an issue that could become more critical since the Federal Reserve Board has signaled it may soon begin to taper its quantitative easing activities, which have buoyed secondary market liquidity -- Mr. Cordray acknowledged that the provision could possibly serve as a brake on secondary market liquidity. He also noted the CFPB’s ongoing work with the FHFA to develop a national mortgage database, which is intended to allow the agencies to monitor, among other things, the health of the secondary market.
Freddie Mac Announces Start of Modified Loans Securitization
On May 23, Freddie Mac announced that it has begun securitizing certain loans that were modified for borrowers at risk of foreclosure. The announcement explains that (i) to be eligible for securitization, loans must be current for at least six consecutive months, (ii) the modified loans are pooled into new Freddie Mac Fixed-Rate Modified Participation Certificates (Modified PCs) with new “MA-MD” prefixes, and (iii) the pools are not TBA deliverable and do not include loans modified through HAMP. Freddie Mac intends to provide additional pool-level and loan-level disclosures specific to the Modified PCs, as well as pool-level disclosure of payment history covering up to 36 months before the Modified PC issuance.
New York State Trial Courts Issue Opposing Opinions on MBS Claims Statute of Limitations
This week, two New York trial court justices issued diverging opinions on when the statute of limitations begins to run on claims related to the repurchase obligations of securitizers under certain MBS pooling and servicing agreements. Both courts explained that under New York law a cause of action for a breach of contract accrues at the time of the breach, and that the statute of limitations for breach of contract is six years. But the courts diverged on the question of whether the clock for claims related to repurchase obligations begins to run from the date the representations for the allegedly faulty mortgages are made, or when the securitizer fails to meet its obligations to repurchase such loans. In one case, the court held that the clock on claims by trustees that the securitizer breached its contract by failing to repurchase began to run on the date the representations were made, i.e. the date the pooling and servicing agreement closed, and dismissed the trustee’s suit because it was filed more than six years after the closing date. Nomura Asset Acceptance Corp. Alt. Loan Trust, Series 2005-S4 v. Nomura Credit & Capital Inc., No. 653541/2011, slip op. (N.Y. Sup. Ct. May 10, 2013). In a second case, the court held the opposite: the statute of limitations did not begin to run until the securitizers improperly rejected the trustee’s repurchase demand, i.e. the breach is the failure to comply, not the date of the representation. Ace Securities Corp, Home Equity Loan Trust Series 2006-SL2 v. DB Structured Prods., Inc., No. 650980/2012, 2013 WL 1981345 (N.Y. Sup. Court, May 13, 2013). Based on that holding, the court found the complaint timely filed and denied the securitizer’s motion to dismiss.
Second Circuit Agrees to Hear Interlocutory Appeal of Key MBS Litigation Questions
On May 7, the U.S. Court of Appeals for the Second Circuit granted two petitions seeking interlocutory appeal of key questions related to pending mortgage backed securities (MBS) cases. Retirement Board of the Policemen's Annuity and Benefit Fund of the City of Chicago v. The Bank of New York Mellon, Nos. 13-00661, 00664 (2nd Cir. May 7, 2013). Taking the two appeals in tandem, the court will address (i) a group of pension funds’ question of whether a named plaintiff purchasing a certificate issued by one MBS trust has standing to represent a class which includes purchasers of certificates issued by trusts from which that plaintiff did not purchase, where the action is against a common trustee and involves repurchase rights for purportedly defective loans issued by a common originator, and (ii) an MBS trustee’s question as to whether certificates evidencing beneficial ownership interests in trusts holding multiple mortgage loans are subject to the Trust Indenture Act.
FHFA Updates Securitization Platform, Contractual and Disclosure Framework Progress
On April 30, the FHFA published a progress report on the current design principles and functions on the common securitization platform for residential mortgage-backed securities that it is building. The report explains that Fannie Mae, Freddie Mac, and the FHFA are working to (i) establish an initial ownership and governance structure, (ii) design dedicated resources and establish an independent location site for the platform team, (iii) develop the design, scope and functional requirements for the platform’s modules and develop the initial business operational process model, (iv) develop a multi-year plan for building, testing and deployment of the system, and (v) develop and begin testing the platform. The report also reviews the status of the alignment of Fannie Mae’s and Freddie Mac’s securitization contracts and standards, including ongoing efforts to align (i) solicitation of borrower refinances of loans in a pool, (ii) repurchases and substitutions of loans from a pool, (iii) representations and warranties, and (iv) pooling practices. According to the report, the FHFA also will continue to (i) identify and develop standards in data, disclosure and seller/servicer contracts, (ii) develop and execute work plans for alignment activities with regard to common standards and creation of legal/contractual documents to facilitate varied credit risk transfer transactions, and (iii) engage with the public in a variety of forums to seek feedback and incorporate revisions and support FHFA progress reports to the public. The report also discusses efforts to respond to concerns about non-guaranteed residential mortgage-backed securities.