Mortgage Securitizations May Help Borrowers

Endorsements in blank and Pooling and Servicing Agreements may make it impossible for banks to prove they have the right to foreclose. I explained endorsements in blank in Produce the Note, An Alternate View, Part 3 and the right to foreclose, or standing, in Produce the Note, An Alternate View, Part 1. The Pooling and Servicing Agreement (PSA) is the heart of a mortgage securitization. It requires a “depositor” or “transferor” to transfer all of the mortgage loans being securitized to a trustee who “holds” them for the benefit of the investors who buy the mortgage back securities.

The mortgage notes transferred to the trustee pursuant to the PSA must be endorsed in blank. But, under UCC 3-301, transferring possession of a bearer note transfers only the right to enforce the note. It does not transfer ownership of the note and ownership, I have argued, determines who has the right to foreclose. UCC 3-301 affords a non-owner of the note, or even a thief, the right to enforce the note.

Because PSAs routinely required notes in the pool to be endorsed in blank, parties in the secondary mortgage market often endorsed notes in blank well before the PSA depositor or transferor would come into possession. So, if the foreclosing party produces the PSA as proof of its ownership on a motion to dismiss for lack of standing, the borrower will want to know who transferred possession to the foreclosing party and to see proof of that transferee’s ownership. This process should be pursued for every link in the chain all the way back to the party that endorsed the note in blank. The foreclosing party normally has the burden of proof on standing and it likely will be difficult, if not impossible, for the foreclosing party to prove ownership for every transferee in the chain. The longer the chain, the harder it will be. If proof of ownership is lacking at any link, it follows that the foreclosing party has not established the right to foreclose and the foreclosure action should be dismissed.

Treasury’s Servicer Ratings for Modifications are Eye Opening

The Treasury Department recently issued The Making Home Affordable Program Performance Report Through April 2011 which reviews mortgage servicers in their administration of President Obama’s Making Home Affordable program. Bank of America, J.P. Morgan Chase Bank and Wells Fargo Bank did so poorly that the government will withhold the financial incentives it pays for mortgage modifications made through the program until these servicers show improvement.

The Report includes a number of metrics for the servicers reviewed but the one I found most interesting was the “Income Calculation Error %.” The borrower’s income is critical to a determination of whether the borrower qualifies for a Making Home Affordable modification. The Making Home Affordable-Compliance unit (MHA-C) did its own income calculation for certain applicants and compared it to the servicer’s income calculation. Differences of 5% or more between MHA-C’s and the servicer’s calculation were included in the “Income Calculation Error %.” Treasury set a benchmark of less than 5% meaning that Treasury believes that MHA-C’s and the servicer’s calculations should be within 5% of each other 95% of the time. None of the ten servicers reviewed met the benchmark. The results ranged from 6% for GMAC Mortgage and Litton Loan Servicing to 33% for Ocwen Loan Servicing. J.P. Morgan Chase was 31%, Bank of America was 22% and Wells Fargo was 27%.

This data means that many borrowers did not get mortgage modifications because the servicer miscalculated their income. We can applaud the Treasury for taking steps to correct the servicers’ miscalculations for future applications. But what’s being done for those who lost a modification opportunity because of an income miscalculation?

Forensic Mortgage Audits are of Limited Utility

A forensic mortgage audit is an analysis of the loan from the application, to the closing and through the default. The primary goal is determine whether there are violations of the Truth in Lending Act (TILA) or the Real Estate Settlement Procedures Act (RESPA). A secondary goal is to determine whether loan payments were properly applied and all loan charges are consistent with the loan documents. Forensic auditors maintain that this information can give a borrower leverage in mortgage modification negotiations. I’m not so sure.

TILA and RESPA violations, or improper payment applications and loan charges, are claims that the borrower must prove in court. Merely presenting a forensic mortgage audit report that concludes the bank engaged in wrongdoing does not mean that the bank engaged in wrongdoing. The bank is entitled to have the borrower’s claims follow the normal litigation process. This means pleadings, documents discovery, depositions, experts, dispositive motions and possibly a trial. The bank can subject the audit report, and the person that prepared it, to close scrutiny. The bank will have its own competing audit report. This is all time consuming and expensive for the borrower. The banks, of course, know this. They also know that a borrower in mortgage default is not likely to have the financial resources to pay a lawyer to fight the fight. It’s true that this type of litigation is also expensive for the bank, but the bank may just want to see how far into the litigation the borrower’s resources will take him. Think of it like a game of litigation chicken. The bank is in a better position to win that game.

New York’s Foreclosure Settlement Conference Program

New York’s Foreclosure Settlement Conference program provides court oversight to the mortgage modification process. The goal is to insure that the borrower timely submits the necessary information for the bank to make a modification determination. More importantly for the borrower, the program gives the bank some accountability for receiving the necessary information and for making a timely decision.

Only borrowers who are defendants in a foreclosure lawsuit are eligible for the program. After the bank serves the borrower with the summons and complaint, the bank is obliged to file with the court a form that notifies the court’s clerk to send the parties notice of the first conference. The conference takes place at the courthouse but not in a courtroom, although the borrower may be waiting in a courtroom for the borrower’s case to be called. When the case is called, the borrower will be escorted into a private room. The borrower, the borrower’s lawyer (if the borrower has one), the bank’s lawyer and a state employee who is not a judge are the only people in the room. There is no court reporter or clerk. The bank’s lawyer will give the state employee some basic information about the loan like the type of loan (fixed or adjustable rate, etc.), when the last payment was made and the outstanding principal balance. The state employee will then discuss with the borrower the reasons for the default and whether the borrower wants to retain the property. Assuming the borrower wants to remain in the property, the bank’s lawyer will provide the borrower with some forms to complete and a list of documents to submit. The forms ask for the borrower’s income, expenses, and assets. The documents normally include bank statements, pay stubs, tax returns and a current utility bill. The borrower will also have to submit a hardship affidavit explaining the financial hardship that caused the borrower to default. The hardship affidavit is often one of the forms for the borrower to complete but sometimes the borrower must provide it separately.

The next conference is normally scheduled at the conclusion of the first conference. The borrower should submit the forms and documents before the next conference. The subsequent conferences will address any requests the bank has for additional information or any questions about the information submitted. The length of the process normally requires the borrower to periodically submit updated paystubs and bank statements.

MERS Mortgages May Be Invalid

A mortgage loan has at least two parts: a note and a mortgage instrument. The note evidences the debt and the mortgage instrument provides an interest in real property as collateral for repayment of the debt. In a non-MERS mortgage loan transaction, the borrower signs a note payable to the lender and a mortgage instrument giving the lender an interest in the property. In a MERS mortgage loan transaction, the borrower signs a note payable to the lender but the mortgage instrument gives the mortgage interest to MERS instead of the lender. This splitting of the note and mortgage may make the mortgage interest invalid, which would make the mortgage loan an unsecured debt.

To see why, it’s helpful to consider a non-MERS loan where the original lender attempts to assign, or sell, only the mortgage interest and not the underlying debt. The original lender in a non-MERS loan owns the debt and has the mortgage interest in the property. It is a fairly universal principle that where a party tries to assign only the mortgage interest, without the underlying debt, the transaction is a nullity. It can’t be done. The putative assignee gets no mortgage interest in the property and acquires no right to foreclose. Logic suggests that if the original lender can’t transfer a mortgage interest to a party that does not have the debt, neither can the borrower. MERS does not make, buy or sell loans. Its sole function is to receive the mortgage interest. Thus, in a MERS mortgage transaction, the mortgage interest is purportedly created in a party that does not also have the underlying debt. This, as we’ve seen, cannot be done.

Of course, MERS and the bank will claim that MERS takes the mortgage interest only as the lender’s “nominee,” whatever that means; MERS mortgages do not define “nominee.” They do, however, usually say things like “MERS is the mortgagee under this security instrument” and “MERS holds only legal title to the interests granted herein.” They also usually purport to give MERS the right to foreclose. This gives the borrower a good argument that the mortgage instrument certainly purports to vest the mortgage interest in MERS. At worst, MERS mortgages are ambiguous on the point, which under the well-known contra proferentem rule, requires the mortgage to be interpreted against the party claiming the mortgage interest.

The Connecticut Supreme Court will be considering this argument regarding the invalidity of MERS mortgages in a case most likely to be heard in the Fall 2011.

Deed in Lieu of Foreclosure

The “deed in lieu of foreclosure” is the foreclosure alternative in which the property owner turns over the property to the lender and avoids the formal foreclosure process. As in a true short sale, the borrower’s goal in a “deed in lieu” resolution is to avoid liability for the deficiency that results if the property is worth less than what the borrower owes on the debt. The general idea is that the borrower saves the lender the expense of foreclosing by giving the lender the deed to property. In exchange the lender waives the deficiency.

Most lenders in the states where I practice law, Connecticut and New York, require the borrower to list the property for sale for a certain time period (usually at least 90 days) before they will consider a taking a deed in lieu of foreclosing. Whether the lender actually accepts the deed, or waives the deficiency, after the time period expires is an open question. I have not been involved with any deed in lieu transaction in Connecticut or New York nor have I heard of any completed deed in lieu transaction in Connecticut or New York. I think this is largely for three reasons. First, the bank would much prefer that the borrower sell the property rather than the bank have to add the property to its inventory of unsold, “bank-owned” properties. The bank has carrying costs on the properties it owns and there is no reason to increase those costs in a terrible real estate market. Plus, real estate agents will tell you that it is generally easier to sell a property that is occupied than it is to sell a property that is vacant. If the bank takes the deed, the property will be vacant.

Second, Connecticut and New York are judicial foreclosure states. By the time the borrower starts considering a deed in lieu in transaction, the bank has already commenced the foreclosure lawsuit. For residential foreclosures, the parties will spend time in Connecticut’s Foreclosure Mediation program or New York’s Foreclosure Settlement Conference program trying to agree to a mortgage modification. If the programs fail to achieve a modification, most banks believe completing the foreclosure is a foregone conclusion. The bank has less incentive to consider a deed in lieu because it has already initiated and, in its view, can expeditiously complete, the foreclosure without having to waive the deficiency. Contrast this with a nonjudicial foreclosure state where a deed in lieu can avoid commencement of the foreclosure process.

Finally, banks don’t like to waive deficiencies. In a judicial foreclosure state, where the foreclosure lawsuit has already commenced, the borrower gets no real benefit from a deed in lieu if the bank will not waive the deficiency. This is essentially the flip-side of the bank’s viewpoint discussed above: the bank has little incentive to consider a deed in lieu when the foreclosure action is pending and neither does the borrower.

That being said, if a borrower is resigned to losing the property, it cannot hurt to explore the deed in lieu possibility with the bank. At the least, it might provide the borrower with some flexibility in vacating the property.

What is MERS?

MERS, or Mortgage Electronic Registration System, Inc., is a company formed by the residential mortgage lending industry to avoid paying government mortgage recording fees and to make it simpler to buy and sell residential mortgage loans. It is easier to understand what MERS is if you first understand why it was created. A mortgage loan has two parts: a promissory note and a mortgage instrument (mortgage deed or deed of trust). The mortgage instrument must be recorded with a governmental office. In most states, the governmental recording office is the County Clerk or County Recorder. In other states, like Connecticut, the governmental office is the Town Clerk. The governmental office charges a fee to record the mortgage instrument. Recording helps potential new creditors evaluate whether to accept the mortgaged property as collateral for a loan because it determines the order in which the creditors are paid if the property is sold. Recording also identifies the parties claiming interests in the property. This information can be necessary to foreclosure proceedings. It is also important to know where to direct questions about the claimed interest.

The mortgage securitization industry is in the business of buying, selling and pooling mortgage loans and then selling rights to receive a fraction of the payments on the mortgages in the pool. Every time a mortgage loan is sold, an “assignment of mortgage” or “mortgage assignment” is supposed to be filed with the government recording office. The assignment must specifically describe the individual mortgage being assigned and must be signed by the assignor. The recording office charges a fee for recording the assignment. Since securitizations involve hundreds or thousands of mortgage loans, it is burdensome to prepare and sign an assignment for each individual loan. It is also difficult and expensive to identify the proper recording office and to pay the recording fee for each assignment.

The mortgage industry formed MERS to avoid the burdens and costs associated with recording mortgage assignments. Think of MERS as a club, with membership open to mortgage loan originators, buyers and sellers. The mortgage loan originator who is a MERS member has the borrower sign a note payable to the originator and a mortgage instrument in favor of MERS. The borrower is charged the recording fee as a closing cost. The closing agent for the loan sees to it that the mortgage instrument is recorded in MERS’ name in the proper recording office. The member-originator can sell the loan to another MERS member without having to record a mortgage assignment. The buyer-member can also turn around and sell the loan without having to record an assignment. The members are supposed to report mortgage loan sales to MERS so that MERS can keep track of who owns which debt. If MERS receives an inquiry about a mortgage interest, or is named in a foreclosure proceeding, MERS notifies the member who owns the associated debt.

The industry’s theory is that MERS is merely a placeholder in the recording office for the owner of the debt. As we will see in future posts, however, there is an argument that giving the note to one party and the mortgage interest to another voids the mortgage interest such that the loan is unsecured.

Connecticut’s Foreclosure Mediation Program

Connecticut’s Foreclosure Mediation Program provides court oversight to the mortgage modification process and can help borrowers obtain a mortgage modification that otherwise may have been beyond their reach.

The borrower must satisfy five criteria to be eligible for the program. First, the property must be the borrower’s primary residence. Second, the borrower must occupy the property. Third, the property must be a one to four family residence in Connecticut. Fourth, the person applying to the program must be the borrower. Fifth, the borrower must be the defendant in a mortgage foreclosure action.

If all five criteria are satisfied, the borrower completes and files with the court a Foreclosure Mediation Certificate together with an Appearance. Note that the “appearance” is a form; it does not require a physical appearance in court. A blank Foreclosure Mediation Certificate and Appearance form should be included with the summons and complaint. The borrower must file these forms with the court within 15 days of the return date listed on the summons but the borrower can move for permission to request mediation more than 15 days after the return date.

Shortly after the borrower files the Certificate and Appearance, the court will send the borrower a notice of the first mediation session. The mediations take place at the courthouse but not in a courtroom. They are informal. The only people present are the borrower (and if applicable the borrower’s lawyer), the bank’s lawyer and the mediator, who is a state employee but not a judge.

The program normally takes place over several mediation sessions. At the first session, the bank’s lawyer provides some information about the loan to the mediator, including the outstanding principal balance, whether there are escrows for taxes and insurance and the current payment. The mediator will discuss with the borrower the reasons why the borrower fell behind, the borrower’s employment or income situation and whether the borrower would like to stay in the home. If that is the case, the bank’s lawyer provides the borrower with some forms to complete and a list of documents to provide. The forms ask for information about the borrower’s income, expenses and assets. The documents requested usually include paystubs, bank statements and tax returns.

The court will send the borrower a notice of the next mediation session, which is usually 30-60 days after the first session. Subsequent sessions revolve around making sure the lender has all the documents and information it requested. Certain documents, like paystubs and bank statements, have to be updated as the mediation progresses.

A successful mediation results in a mortgage modification. The mediation process can be as exasperating as applying for a modification outside of the Foreclosure Mediation Program but in my experience the mediator’s oversight helps keep the lender on track.

Short Sale May Not Be All It’s Cracked Up to Be

Lenders may be touting short sales as a foreclosure alternative but the sale may not be truly “short” or even possible. In this post, I discuss how short sales are supposed to work, how they have been (not) working and why they might not work.

How A Short Sale is Supposed to Work

Think of real estate title as a ship. Think of the mortgage as a barnacle that is put on the title when the borrower takes a mortgage loan. The real estate buyer wants to buy a title that is free and clear of all barnacles. This means that the borrower-seller must scrape the mortgage barnacle off the title before she can complete a sale. The normal way to scrape the mortgage barnacle is to use the sale price to pay off the loan associated with the barnacle. If the sale price is insufficient to pay off the underlying debt, the borrower-seller has to ask the lender or mortgage servicer, who often are responsible for foreclosure and short sales, to release its mortgage barnacle even though the sale price is too “short” to fully repay the debt. The difference between what the borrower-seller owes and the net sale proceeds is the deficiency. With a true short sale, the lender takes all of the net proceeds of the sale, releases its mortgage and waives any claim to collect the deficiency from the borrower-seller.

Of course, before the lender or servicer will agree to a short sale, it has to be satisfied that the borrower-seller cannot pay the mortgage and the proposed sale price is reasonable. The borrower-seller demonstrates that he cannot pay the mortgage the same way he does when seeking a mortgage modification: he submits income and expense information and documentation to the lender or servicer, together with an affidavit explaining the hardship. The lender or servicer confirms the reasonableness of the proposed offer with its own appraisal or broker’s price opinion.

How Short Sales have been (Not) Working

Many mortgage servicers have been unwilling to waive the deficiency. The reason for this isn’t entirely clear but probably has something to do with restrictions imposed by mortgage securitization. In a mortgage securitization, the issuer pools mortgages and sells mortgage backed securities, or “MBS”, to investors. The MBS entitles the investor to receive a share of the pooled mortgage payments. The mortgage barnacle, and the personal liability of the borrower, gives the investor security that it will actually receive its proper share of the pooled payments. If the servicer waives the deficiency, the investors may claim that they had a right to that deficiency and the servicer harmed them by the waiver. It is safer for the servicer to refuse to waive the deficiency.

The refusal to waive the deficiency may be a distinction without much of a difference. Though the deficiency still exists, it is an open question whether any lender or servicer would actively attempt to enforce it. Doing so would most likely require a separate lawsuit because a foreclosure deficiency presumes a foreclosure of title. In a short sale, title is not foreclosed; it is sold with the servicer’s consent. A separate lawsuit to obtain a judgment on the unpaid portion of the debt is another expense for the servicer and one that is unlikely to yield a benefit because the borrower-seller is not likely to have the financial resources to pay it. In such circumstances the borrower-seller is said to be “judgment proof.” The added expense, without any added benefit, may be enough to deter the lender or servicer from pursuing a separate lawsuit based on the deficiency.

A short sale without a waiver of deficiency may be preferable to a foreclosure and deficiency judgment in any event. In a foreclosure lawsuit where the property value is less than the debt, the foreclosing party can obtain a judgment for the deficiency, or deficiency judgment, as part of the foreclosure lawsuit. There is virtually no added expense for the foreclosing party since the foreclosure and deficiency judgment are accomplished as part of the same lawsuit. Though the risk to the borrower of anyone actually trying to collect on the deficiency judgment remains remote, the judgment itself remains viable for a long time — 15 or 20 years in many jurisdictions. That means someone could show up to collect in year 14, after the borrower has righted her financial ship. Contrast that to the short sale with no waiver of deficiency; statutes of limitation can protect the borrower-seller from attempts to collect a long unpaid debt.

Why Short Sales Might Not Work

Going back to mortgage barnacles, a real estate title can have multiple barnacles. For example, many borrowers have a first mortgage and a home equity line of credit, or HELOC. The HELOC is another barnacle. All barnacles have to be removed to sell the property. The first mortgage is usually the largest and the first mortgage lender usually wants all of the net sale proceeds (assuming the net proceeds aren’t enough to fully repay the first mortgage). The HELOC, and any other mortgages or liens, can prevent the sale by refusing to release their barnacles unless they get paid something too. If they can’t agree with the first mortgage on who gets how much, the property can’t be sold. If it takes too long for them to agree, the borrower-seller may lose the buyer, who can’t wait around forever.

The possibility of bickering barnacles and lost buyers makes it imperative for anyone considering selling a property via short sale to use a real estate broker experienced in short sales. From what I’ve seen, an experienced short sale broker can be the difference between a completed short sale and a completed foreclosure.

Motion to Dismiss for Lack of Standing

Produce the Note, An Alternate View, Parts 1, 2 and 3 explained why borrowers might be better off asking the foreclosing party to prove ownership of the debt rather than asking it to produce the note. But how and when does the borrower go about asking the lender to do either of these things? In my view, the best way to do it is by a formal motion to dismiss for lack of standing. Part 1 of the Produce the Note series explained that standing is an aspect of subject matter jurisdiction and that if the foreclosing party lacks standing, the court lacks subject matter jurisdiction. If the court lacks subject matter jurisdiction, the case must be dismissed. When a borrower asks the foreclosing party to prove ownership of the debt (or to produce the note if the borrower goes that route), the borrower is really asking the court to dismiss the case because the foreclosing party can’t prove ownership of the debt (or produce the note). Whether the borrower does this informally, by making the request at a court appearance for example, or formally, by filing a written request with the court, the borrower’s request is a motion to dismiss for lack of subject matter jurisdiction. If the borrower chooses to ask the foreclosing party to prove it owns the debt, the borrower should make a formal written motion. The mortgage industry wants to prove standing merely by producing the note and that is all the courts have been requiring. The borrower needs to why producing the note is not sufficient and that requires a written explanation.

One of the best features of the lack of subject matter jurisdiction is that in some jurisdictions, like Connecticut, it cannot be waived or conferred by consent. This means that the borrower can raise it at any time. Other jurisdictions may require the borrower to do something, like raise it as a defense in the pleadings, to preserve the right to move to dismiss later. Assuming the borrower has properly preserved it, or doesn’t have to, the question of when to move to dismiss for lack of subject matter jurisdiction is really a question of strategy in a particular case. It may not be beneficial to do it early in the case when, for example, the borrower is participating in the Foreclosure Mediation Program (CT) or the Foreclosure Settlement Conference Program (NY). The goal of these programs is to modify the mortgage to keep the borrower in the property. They are essentially “court-annexed” programs, which means that if there is no case pending against the borrower, the borrower cannot participate in the program. A successful motion to dismiss will take the borrower out of the program because it results in there being no case. On the other hand, it may be beneficial to do it early in the case when no court-annexed program is available to the borrower as in the case of an investment property. In those circumstances, the borrower might get some leverage in negotiating a workout or modification if the foreclosing party is facing dismissal.