Posts tagged ‘mortgage securitization’

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.

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.

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.